Currency options – NBC Institute

FM – May 2022 – L3 – Q6a – Foreign Exchange Risk Management

Evaluate hedging methods for a UK supplier payment of £5 million in three months.

Question

a. You have worked with a major oil servicing company in Nigeria, with headquarters in the USA, for the past six years. Recently you completed your ICAN examinations, and you have been asked to join the international treasury department in New York City for a two-year attachment. The company is due to pay a UK supplier the sum of ₤5million in three months’ time. Your team is considering alternative methods of hedging the expected payment against adverse movements in exchange rate.

You are required to advise the company which of the following hedging strategies should be adopted for the payment due to be made in three months. Show all workings:
i. Forward contract (2 Marks)
ii. Currency futures (5 Marks)
iii. Currency options (5 Marks)

Answer

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Tags: Currency Futures, Currency options, Forward Contracts, Hedging
Level: Level 3

Topic: Foreign Exchange Risk Management

FM – Nov 2018 – L3 – Q6 – Foreign Exchange Risk Management

Evaluate foreign exchange hedging options for Alpha Plc’s expected receipt of Kudi and discuss non-financial risk reduction methods.

Question

Alpha Plc. is a Nigerian manufacturer of plastic containers, selling across West African and other African countries. In three months, Alpha Plc. is due to receive 70 million Kudi from a Central African country. At today’s board meeting, the directors will discuss the need to hedge the foreign exchange exposure associated with this transaction and potential methods.

Three alternatives will be considered:

(i) Not to hedge this transaction;
(ii) Use a forward contract, with current exchange rates quoted by Alpha Plc.’s bank as follows:

Spot: 1.1548 – 1.1608 Kudi/N
3 months forward: 1.1438 – 1.1508 Kudi/N
(iii) Use an over-the-counter currency option on Kudi, available through Alpha Plc.’s bank. Current premiums at an exercise price of 1.1650 Kudi/N are N1.10 per 100 Kudi for a call option and N1.25 per 100 Kudi for a put option.

Required:

a. State four reasons why a firm might reasonably choose not to hedge its exposure to exchange rate risk. (4 Marks)

b. Show the effect of each of the three alternatives being considered, assuming that the spot exchange rate in three months’ time is:
i. 1.1850 – 1.1880 Kudi/N
ii. 1.1295 – 1.1320 Kudi/N (7 Marks)

c. State four methods available to firms to reduce their exposure to foreign exchange risks that do not involve the use of financial contracts. (4 Marks)

Answer

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Tags: Currency options, Exchange rate risk, Foreign exchange exposure, Forward Contracts, Hedging Strategies, Non-Financial Hedging Methods
Level: Level 3

Topic: Foreign Exchange Risk Management

FM – July 2023 – L2 – Q5 – Hedging with options | Working Capital Management

Calculate the overdraft requirement and net working capital, identify the working capital financing policy, and justify using currency futures over options.

Question

a) The Treasury Department of LCM Ltd is preparing financial plans for the ensuing financial year. Annual credit sales revenue is projected to be GH¢500 million while the cost of sales is expected to be GH¢260 million. Its current assets are composed of inventory and trade receivables, while its current liabilities comprise trade payables and bank overdraft. The following targets have been set:

Receivables turnover days: 90 days
Payables turnover days: 30 days
Operating cycle: 150 days
Current ratio: 1.1 times

The company’s long-term capital consists only of owners’ equity. The composition and size of long-term capital are expected to remain the same for the ensuing year. The opportunity cost of equity capital is 20%, and the interest rate on the bank overdraft is 18%.

Required:
i) Compute the amount of bank overdraft the company will need in the ensuing year. (6 marks)
ii) Compute the net working capital of the company for the ensuing financial year. (2 marks)
iii) Compute the cost of financing working capital (in GH¢). (3 marks)
iv) Identify the working capital financing policy LCM Ltd is employing. (4 marks)

b) Risk can be hedged through a variety of derivative instruments such as futures, options, and swaps. Each derivative instrument presents its advantages and disadvantages.

Required:
In reference to the above statement, justify why a company would choose a currency futures contract over a currency option contract in hedging currency exposure. (5 marks)

Answer

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Tags: Currency Futures, Currency options, Financing policy, Payables turnover, Receivables turnover, Working Capital
Level: Level 2

Topic: Hedging with options, Working Capital Management
Series: JULY 2023

FM – May 2022 – L3 – Q6a – Foreign Exchange Risk Management

Evaluate hedging methods for a UK supplier payment of £5 million in three months.

Question

Answer

Find Related Questions by Tags, levels, etc.

Tags: Currency Futures, Currency options, Forward Contracts, Hedging
Level: Level 3

Topic: Foreign Exchange Risk Management

FM – Nov 2018 – L3 – Q6 – Foreign Exchange Risk Management

Evaluate foreign exchange hedging options for Alpha Plc’s expected receipt of Kudi and discuss non-financial risk reduction methods.

Question

Three alternatives will be considered:

(i) Not to hedge this transaction;
(ii) Use a forward contract, with current exchange rates quoted by Alpha Plc.’s bank as follows:

Spot: 1.1548 – 1.1608 Kudi/N
3 months forward: 1.1438 – 1.1508 Kudi/N
(iii) Use an over-the-counter currency option on Kudi, available through Alpha Plc.’s bank. Current premiums at an exercise price of 1.1650 Kudi/N are N1.10 per 100 Kudi for a call option and N1.25 per 100 Kudi for a put option.

Required:

a. State four reasons why a firm might reasonably choose not to hedge its exposure to exchange rate risk. (4 Marks)

c. State four methods available to firms to reduce their exposure to foreign exchange risks that do not involve the use of financial contracts. (4 Marks)

Answer

Find Related Questions by Tags, levels, etc.

Tags: Currency options, Exchange rate risk, Foreign exchange exposure, Forward Contracts, Hedging Strategies, Non-Financial Hedging Methods
Level: Level 3

Topic: Foreign Exchange Risk Management

FM – July 2023 – L2 – Q5 – Hedging with options | Working Capital Management

Calculate the overdraft requirement and net working capital, identify the working capital financing policy, and justify using currency futures over options.

Question

Receivables turnover days: 90 days
Payables turnover days: 30 days
Operating cycle: 150 days
Current ratio: 1.1 times

b) Risk can be hedged through a variety of derivative instruments such as futures, options, and swaps. Each derivative instrument presents its advantages and disadvantages.

Required:
In reference to the above statement, justify why a company would choose a currency futures contract over a currency option contract in hedging currency exposure. (5 marks)

Answer

Find Related Questions by Tags, levels, etc.

Tags: Currency Futures, Currency options, Financing policy, Payables turnover, Receivables turnover, Working Capital
Level: Level 2

Topic: Hedging with options, Working Capital Management
Series: JULY 2023

Question Tag: Currency options

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FM – May 2022 – L3 – Q6a – Foreign Exchange Risk Management

Evaluate hedging methods for a UK supplier payment of £5 million in three months.

FM – Nov 2018 – L3 – Q6 – Foreign Exchange Risk Management

Evaluate foreign exchange hedging options for Alpha Plc’s expected receipt of Kudi and discuss non-financial risk reduction methods.

FM – July 2023 – L2 – Q5 – Hedging with options | Working Capital Management

Calculate the overdraft requirement and net working capital, identify the working capital financing policy, and justify using currency futures over options.

FM – May 2022 – L3 – Q6a – Foreign Exchange Risk Management

Evaluate hedging methods for a UK supplier payment of £5 million in three months.

FM – Nov 2018 – L3 – Q6 – Foreign Exchange Risk Management

Evaluate foreign exchange hedging options for Alpha Plc’s expected receipt of Kudi and discuss non-financial risk reduction methods.

FM – July 2023 – L2 – Q5 – Hedging with options | Working Capital Management

Calculate the overdraft requirement and net working capital, identify the working capital financing policy, and justify using currency futures over options.

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FM – May 2022 – L3 – Q6a – Foreign Exchange Risk Management

Evaluate hedging methods for a UK supplier payment of £5 million in three months.

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FM – Nov 2018 – L3 – Q6 – Foreign Exchange Risk Management

Evaluate foreign exchange hedging options for Alpha Plc’s expected receipt of Kudi and discuss non-financial risk reduction methods.

You're reporting an error for "FM – Nov 2018 – L3 – Q6 – Foreign Exchange Risk Management"

FM – July 2023 – L2 – Q5 – Hedging with options | Working Capital Management

Calculate the overdraft requirement and net working capital, identify the working capital financing policy, and justify using currency futures over options.

You're reporting an error for "FM – July 2023 – L2 – Q5 – Hedging with options | Working Capital Management"

FM – May 2022 – L3 – Q6a – Foreign Exchange Risk Management

Evaluate hedging methods for a UK supplier payment of £5 million in three months.

You're reporting an error for "FM – May 2022 – L3 – Q6a – Foreign Exchange Risk Management"

FM – Nov 2018 – L3 – Q6 – Foreign Exchange Risk Management

Evaluate foreign exchange hedging options for Alpha Plc’s expected receipt of Kudi and discuss non-financial risk reduction methods.

You're reporting an error for "FM – Nov 2018 – L3 – Q6 – Foreign Exchange Risk Management"

FM – July 2023 – L2 – Q5 – Hedging with options | Working Capital Management

Calculate the overdraft requirement and net working capital, identify the working capital financing policy, and justify using currency futures over options.

You're reporting an error for "FM – July 2023 – L2 – Q5 – Hedging with options | Working Capital Management"

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