Question Tag: Currency risk

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  • 10 Marks

SCS – Dec 2022 – L3 – Q5 – Financial management

Calculate the required loan, interest earned, and the Cedi gain or loss from a money market hedge.

The Board has directed the CEO to take the necessary steps to arrange with its bankers, a money market hedge for the expected receipts from DMP, to protect the company against the downside risk of expected Cedi appreciation.

Required:
As the Financial Controller of the company, the CEO has asked you to calculate the following relating to money market hedge:

a) The initial dollar amount of loan that TCWL could take from the bank in Cameroon on 1 December 2022 and the cedi equivalent of the initial loan if converted on the same date. (3 marks)
b) The total Cedi amount and interest the company will earn by 31 May 2023, if the converted amount is invested in Ghana for the duration of the money market hedge. (3 marks)
c) The Cedi gain or loss that TCWL would make by hedging. (2 marks)
d) The effective forward rate of the Cedi to U.S. dollar on 31 May 2023. (2 marks)

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  • 5 Marks

AFM – May 2017 – L3 – Q1a – Hedging against financial risk: Non-derivative techniques

Recommendations to mitigate losses on foreign currency transactions due to the depreciation of the Cedi.

In the last couple of years, the Cedi has depreciated substantially against the US Dollar. This has had an adverse effect on the financial performance of most of the multinational companies in Ghana.

Required:
As a Financial Adviser of your organization, a multinational company involved in the export trade, recommend actions to be taken to minimize the loss on foreign currency transactions. (5 marks)

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  • 3 Marks

AFM – Nov 2017 – L3 – Q1d – Hedging against financial risk: Non-derivative techniques

Recommendations on how to minimize the loss on foreign currency transactions for a multinational company involved in export trade.

In the last couple of years, the Cedi has depreciated substantially against the US Dollar. It is also noticed that the Cedi has had volatile movements against the Pounds Sterling since the beginning of year 2017.

Required: As a Finance Director of your organization, a multinational company which is involved in the export trade, recommend THREE actions to be taken to minimize the loss on foreign currency transactions.

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  • 5 Marks

FM – May 2021 – L2 – Q5c – Foreign exchange risk and currency risk management

Explain three advantages of using a forward market hedge compared to a futures market hedge for managing currency risk exposure.

c) Explain TWO (2) advantages to a company dealing with a currency risk exposure using a forward market hedge as against a futures market hedge. (5 marks)

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  • 20 Marks

FM – DEC 2023 – L2 – Q5 – Cost of capital | Foreign exchange risk and currency risk management

Calculation of the effective cost of various financing options and explanation of internal strategies to manage foreign currency risk.

a) Markwei Pharmaceuticals Ltd plans to import active ingredients to produce vitamin syrup. The company’s managers are considering three financing options for the cedi equivalent of an invoice value of GH¢2.5 million. The options are detailed below:

Option 1: Use supplier’s credit. The credit term is 1.5/10 net 45.

Option 2: Issue a commercial paper to raise the money from the Ghanaian money market. The commercial paper will pay interest at the rate of 18% per annum. Issue costs totaling GH¢15,000 will be incurred.

Option 3: Obtain a 3-month bank loan. The interest rate on the loan is 22% per annum. Loan arrangement and processing fees are expected to be GH¢5,000.

Required:
i) Compute the effective annual cost of each financing option and recommend the most cost-effective option. (10 marks)
ii) Explain TWO (2) advantages of financing the invoice through the issue of a commercial paper instead of a bank loan. (5 marks)

b) Abongo Shoes Ltd (Abongo) imports leather from Italy. Abongo’s demand for euros to settle its import bills exposes its cash flow to foreign exchange risk. Abongo’s Management is looking for internal strategies they can deploy to hedge the company’s currency risk exposure as external hedging strategies might be too expensive for the company.

Required:
Explain TWO (2) internal strategies for managing foreign currency risk exposures that Abongo’s Management can use. (5 marks)

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  • 7 Marks

FM – Nov 2020 – L2 – Q3b – Futures and hedging with futures | Hedging with options

Explain intrinsic value of an option and calculate the intrinsic value for USD/GH¢ call options over several months.

i) Explain the term intrinsic value of an option. (1 mark)

ii) DUU Ghana Ltd bought USD/GH¢ call options from KASA Ltd. The table below shows the various spot rates and strike prices for the various tenors.

Month Spot Rate USD/GH¢ Exercise Rate/Price USD/GH¢
1 5.1 4.8
2 5.3 5.0
3 5.5 5.4
4 5.8 5.8
5 5.7 6.0
6 6.0 6.4

Required:

Determine the intrinsic value of the option for each trading month and clearly indicate the months in which the option is in-the-money, at-the-money, or out-of-the-money. (6 marks)

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  • 25 Marks

FM – MAY 2017 – L2 – Q2 – Foreign exchange risk and currency risk management | Introduction to Investment Appraisal

Discuss the advantages and disadvantages of the payback method, calculate the NPV for DÉCOR Ltd's investment, and analyze currency risk in an international transaction.

a) Payback method refers to the period of time it takes for the cash flows to cover the initial cost of investment or recoup the initial cost of investment. The period is usually calculated in years.

Required:
Identify TWO advantages and TWO disadvantages of using the payback method in investment appraisal.
(4 marks)

b) DÉCOR Ltd is analyzing the purchase of a new machine to produce product Z. The machine is expected to cost GH¢2,000,000. Production and sales of product Z are forecast as follows:

Year 1 2 3 4
Production & Sales (units/year) 70,000 106,000 150,000 72,000

The current selling price is GH¢30 per unit and is expected to increase by 5% a year. The current variable cost is GH¢18 per unit and is expected to increase by 6% per year. Fixed costs will remain the same, but an increase in working capital is required. Analysis of historical data of the levels of working capital of product Z indicates that, at the start of each year, investment in working capital will need to be 10% of sales revenue of that year.

The company pays tax at 25% per year in the year in which taxable profit occurs. The tax liability is reduced by the capital allowance on the machinery, and DÉCOR Ltd can claim on a straight-line basis over the four-year life of the proposed investment (capital allowance rate of 25% per annum). The new machine will have zero scrap value at the end of the four years. The cost of capital is 15% per year.

Required:
Calculate the Net Present Value (NPV) of the proposed investment and advise whether the proposed investment should be undertaken.
(11 marks)

c) An American company sells goods to a Ghanaian buyer for US$280,000 when the exchange rate is $1 = GH¢4.20. The Ghanaian buyer is allowed three months’ credit, and when the American company eventually receives the US dollars three months later and exchanges them for dollars, the exchange rate has moved to $1 = GH¢4.60.

Required:
i) What was the foreign exchange loss to the Ghanaian buyer?
(3 marks)

ii) Explain currency risk in relation to the above.
(2 marks)

iii) Explain transaction risk in relation to the above.
(2 marks)

iv) What will be the effect of the above on the company’s trading profits?
(3 marks)

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  • 20 Marks

FM – MAY 2016 – L2 – Q5 – Foreign exchange risk and currency risk management | Hedging with options

Discuss differences between forward and futures contracts, types of currency risk exposure, disadvantages of hedging with futures, and reasons for differences in interest rates across different maturities.

a) AD Ventures imports tomato paste from Italy for sale in Ghana. AD Ventures typically buys the tomato paste on an open account and pays the euro invoice value two months after receipt of goods. AD Ventures has suffered heavy exchange rate losses of late due to the continuous depreciation of the Ghanaian cedi against the euro. AD Ventures will receive a consignment of tomato paste on 15th May 2016. The value of this consignment is EUR540,000, which must be settled in two months’ time (settlement deadline being 15th July 2016).

The current spot exchange rate for the euro is GH¢4.7110/EUR. Financial pundits forecast that the Ghanaian cedi will depreciate against the euro in the coming months. The owner-manager of AD Venture, Akua Donkor, is worried about the probable foreign exchange loss her business may suffer when the invoice value is settled in two months’ time.

Akua Donkor has heard of the possibility of hedging AD Ventures’ currency exposure with a forward contract or futures contract but does not know what these contracts are. She has asked you to advise her on what to do to hedge against the underlying exposure relating to the EUR540,000 tomato paste consignment.

You would like to recommend a futures market hedge to Akua Donkor. You searched the derivatives market; and you found a futures contract on the euro that matures in August 2016. Other relevant details of the contract follow:

  • Contract size: EUR100,000
  • Futures contract price: GH¢4.8112/EUR

Required:
i) Explain to Akua Donkor FOUR differences between a forward contract and a futures contract. (4 marks)
ii) Currency risk exposure may be transaction risk, economic risk, or translation risk. Which of the three kinds of currency risk exposure is AD Ventures facing in relation to the EUR540,000 tomato paste consignment? Explain why. (4 marks)
iii) Explain to Akua Donkor THREE disadvantages of hedging the euro exposure with a futures hedge. (6 marks)

b) It has been observed that interest rates on debt securities or loans differ for different maturities. For the week ending 28th August 2015, the annual interest rate on the 1-year Government of Ghana note was 22.5% whereas the annual interest rate on the 2-year note was 23%.

Required:
With THREE reasons, explain why interest rates on debt securities and loans are different for different maturity periods. (6 marks)

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  • 20 Marks

FM – AUG 2022 – L2 – Q3 – Foreign exchange risk and currency risk management

Calculate interest rates, required sinking fund contributions, and identifies currency risk exposure with recommended hedging strategies.

a) Jeanne Cosmetics Ltd is located in Taifa and is now considered as the leader of organic and natural cosmetic products in the municipality. Per the cash management policy of Jeanne Cosmetics Ltd, any excess cash that is idle for more than three months should be invested. Three months ago, the company invested GH¢100,000 of idle cash in a 3-month fixed deposit account. The investment matures today, and the company will receive a maturity value of GH¢105,000.

Required:
i) Compute the interest rate earned on the account over the investment holding period. (2 marks)
ii) Suppose the interest rate on the account remains the same, and the company rolls over the principal, compute the annual simple interest rate on the investment. (2 marks)
iii) Suppose the interest rate on the account remains the same and the company rolls over both the principal and interests, compute the annual compound interest rate on the investment. (2 marks)

b) Apphia Fabrics Ltd plans to replace its existing manufacturing plant with a newer version in three years’ time. The replacement cost of the existing plant is GH¢10 million currently. However, experts forecast that the cost of the newer version of the plant will be GH¢12 million in three years’ time.

On the advice of the Finance Manager, the company will start saving from now to raise the required amount to buy the plant in three years’ time. Consequently, the company has signed an investment agreement with DT Financial Services Ltd. Per the agreement, the company will deposit equal amounts into an interest-bearing account at the beginning of each of the next three years. The annual nominal interest rate on the account is 16%, but interest will be compounded monthly.

Required:
Compute the equal annual deposit required to raise the required amount in three years’ time. (4 marks)

c) Aduro Pharmaceuticals Plc is a Ghana-based multinational company with a production facility in India and marketing subsidiaries in some West African countries. The Treasury Department of the company is considering strategies for managing its foreign exchange risk exposures. In particular, the Treasury Department is concerned about the following two cases of foreign exchange risk exposures:

Case 1:
The exchange rate between the Ghanaian cedi (GH¢) and the British pound sterling (GBP) is currently GH¢8.1125/GBP1. The company recently borrowed GBP500,000 from an offshore bank to buy active chemicals for the production of paracetamol syrup. The loan is to be paid in six months’ time. Market pundits project that the Ghanaian cedi would depreciate against the pound sterling over the next six months.

Case 2:
The exchange rate between the Ghanaian cedi (GH¢) and the Indian rupee (INR) is currently GH¢0.0799/INR1. The company’s production subsidiary in India presents its financial statements in the Indian rupee. The net worth of this production subsidiary in India is INR20 million. The company would be preparing its consolidated financial statements in a few months’ time. Market pundits project that the Ghanaian cedi will appreciate against the Indian rupee.

Required:
i) For each case, identify the type of currency risk exposure the company is facing. (2 marks)
ii) In respect of Case 1, recommend TWO (2) internal strategies and TWO (2) external hedging strategies the Treasury Department can use to manage the foreign exchange risk exposure. (8 marks)

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  • 20 Marks

FM – MAR 2024 – L2 – Q3 – Foreign exchange risk and currency risk management

Involves calculating the quarterly payment and total interest on a mortgage loan, evaluating an alternative payment plan, and explaining and applying currency risk management techniques using forward contracts.

a) Onana Events Company (Onana) is purchasing a building from a real estate company. The current cash price of the building is GH¢2,500,000. Onana can obtain a GH¢2,500,000 mortgage loan to finance the payment of the cash price of the building. The loan bears a compound annual interest rate of 18% and calls for equal payments at the end of each quarter for 20 years.

Required:

i) Compute the quarterly payment.
(4 marks)

ii) Compute the total interest that will be paid by Onana to the mortgage company over the life of the loan.
(2 marks)

iii) Suppose the real estate company is offering a credit payment plan to Onana. Per the credit terms, Onana will have to pay GH¢500,000 now and then pay GH¢110,000 at the end of each month for one year. The implicit interest rate is 20% per annum. Compute the aggregate present value of the payments under this option.
(4 marks)

b) Sempe Ghana Plc needs to have EUR650,000 in two months’ time to settle a trade payable. The management team fears that the cedi would depreciate against the euro in the coming months. The team is however divided over whether the currency risk exposure should be hedged using a forward foreign exchange contract or a futures foreign exchange contract. The following quotations have been obtained from Ghana’s foreign exchange market:

FX Quotation Bid Rate Ask (Offer) Rate
Spot Rate GH¢12.1854/EUR1 GH¢12.4854/EUR1
2-month Forward Rate GH¢12.5854/EUR1 GH¢12.8854/EUR1

Required:

i) Explain to the management of Sempe Ghana Ltd whether the foreign exchange quotations provided above are direct quotations or indirect quotations.
(5 marks)

ii) Suppose the company uses the forward contract to hedge its currency exposure. Compute the outcome of the forward contract hedge.
(5 marks)

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Has Case Study
  • 10 Marks

SCS – Dec 2022 – L3 – Q5 – Financial management

Calculate the required loan, interest earned, and the Cedi gain or loss from a money market hedge.

The Board has directed the CEO to take the necessary steps to arrange with its bankers, a money market hedge for the expected receipts from DMP, to protect the company against the downside risk of expected Cedi appreciation.

Required:
As the Financial Controller of the company, the CEO has asked you to calculate the following relating to money market hedge:

a) The initial dollar amount of loan that TCWL could take from the bank in Cameroon on 1 December 2022 and the cedi equivalent of the initial loan if converted on the same date. (3 marks)
b) The total Cedi amount and interest the company will earn by 31 May 2023, if the converted amount is invested in Ghana for the duration of the money market hedge. (3 marks)
c) The Cedi gain or loss that TCWL would make by hedging. (2 marks)
d) The effective forward rate of the Cedi to U.S. dollar on 31 May 2023. (2 marks)

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  • 5 Marks

AFM – May 2017 – L3 – Q1a – Hedging against financial risk: Non-derivative techniques

Recommendations to mitigate losses on foreign currency transactions due to the depreciation of the Cedi.

In the last couple of years, the Cedi has depreciated substantially against the US Dollar. This has had an adverse effect on the financial performance of most of the multinational companies in Ghana.

Required:
As a Financial Adviser of your organization, a multinational company involved in the export trade, recommend actions to be taken to minimize the loss on foreign currency transactions. (5 marks)

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  • 3 Marks

AFM – Nov 2017 – L3 – Q1d – Hedging against financial risk: Non-derivative techniques

Recommendations on how to minimize the loss on foreign currency transactions for a multinational company involved in export trade.

In the last couple of years, the Cedi has depreciated substantially against the US Dollar. It is also noticed that the Cedi has had volatile movements against the Pounds Sterling since the beginning of year 2017.

Required: As a Finance Director of your organization, a multinational company which is involved in the export trade, recommend THREE actions to be taken to minimize the loss on foreign currency transactions.

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  • 5 Marks

FM – May 2021 – L2 – Q5c – Foreign exchange risk and currency risk management

Explain three advantages of using a forward market hedge compared to a futures market hedge for managing currency risk exposure.

c) Explain TWO (2) advantages to a company dealing with a currency risk exposure using a forward market hedge as against a futures market hedge. (5 marks)

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  • 20 Marks

FM – DEC 2023 – L2 – Q5 – Cost of capital | Foreign exchange risk and currency risk management

Calculation of the effective cost of various financing options and explanation of internal strategies to manage foreign currency risk.

a) Markwei Pharmaceuticals Ltd plans to import active ingredients to produce vitamin syrup. The company’s managers are considering three financing options for the cedi equivalent of an invoice value of GH¢2.5 million. The options are detailed below:

Option 1: Use supplier’s credit. The credit term is 1.5/10 net 45.

Option 2: Issue a commercial paper to raise the money from the Ghanaian money market. The commercial paper will pay interest at the rate of 18% per annum. Issue costs totaling GH¢15,000 will be incurred.

Option 3: Obtain a 3-month bank loan. The interest rate on the loan is 22% per annum. Loan arrangement and processing fees are expected to be GH¢5,000.

Required:
i) Compute the effective annual cost of each financing option and recommend the most cost-effective option. (10 marks)
ii) Explain TWO (2) advantages of financing the invoice through the issue of a commercial paper instead of a bank loan. (5 marks)

b) Abongo Shoes Ltd (Abongo) imports leather from Italy. Abongo’s demand for euros to settle its import bills exposes its cash flow to foreign exchange risk. Abongo’s Management is looking for internal strategies they can deploy to hedge the company’s currency risk exposure as external hedging strategies might be too expensive for the company.

Required:
Explain TWO (2) internal strategies for managing foreign currency risk exposures that Abongo’s Management can use. (5 marks)

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  • 7 Marks

FM – Nov 2020 – L2 – Q3b – Futures and hedging with futures | Hedging with options

Explain intrinsic value of an option and calculate the intrinsic value for USD/GH¢ call options over several months.

i) Explain the term intrinsic value of an option. (1 mark)

ii) DUU Ghana Ltd bought USD/GH¢ call options from KASA Ltd. The table below shows the various spot rates and strike prices for the various tenors.

Month Spot Rate USD/GH¢ Exercise Rate/Price USD/GH¢
1 5.1 4.8
2 5.3 5.0
3 5.5 5.4
4 5.8 5.8
5 5.7 6.0
6 6.0 6.4

Required:

Determine the intrinsic value of the option for each trading month and clearly indicate the months in which the option is in-the-money, at-the-money, or out-of-the-money. (6 marks)

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  • 25 Marks

FM – MAY 2017 – L2 – Q2 – Foreign exchange risk and currency risk management | Introduction to Investment Appraisal

Discuss the advantages and disadvantages of the payback method, calculate the NPV for DÉCOR Ltd's investment, and analyze currency risk in an international transaction.

a) Payback method refers to the period of time it takes for the cash flows to cover the initial cost of investment or recoup the initial cost of investment. The period is usually calculated in years.

Required:
Identify TWO advantages and TWO disadvantages of using the payback method in investment appraisal.
(4 marks)

b) DÉCOR Ltd is analyzing the purchase of a new machine to produce product Z. The machine is expected to cost GH¢2,000,000. Production and sales of product Z are forecast as follows:

Year 1 2 3 4
Production & Sales (units/year) 70,000 106,000 150,000 72,000

The current selling price is GH¢30 per unit and is expected to increase by 5% a year. The current variable cost is GH¢18 per unit and is expected to increase by 6% per year. Fixed costs will remain the same, but an increase in working capital is required. Analysis of historical data of the levels of working capital of product Z indicates that, at the start of each year, investment in working capital will need to be 10% of sales revenue of that year.

The company pays tax at 25% per year in the year in which taxable profit occurs. The tax liability is reduced by the capital allowance on the machinery, and DÉCOR Ltd can claim on a straight-line basis over the four-year life of the proposed investment (capital allowance rate of 25% per annum). The new machine will have zero scrap value at the end of the four years. The cost of capital is 15% per year.

Required:
Calculate the Net Present Value (NPV) of the proposed investment and advise whether the proposed investment should be undertaken.
(11 marks)

c) An American company sells goods to a Ghanaian buyer for US$280,000 when the exchange rate is $1 = GH¢4.20. The Ghanaian buyer is allowed three months’ credit, and when the American company eventually receives the US dollars three months later and exchanges them for dollars, the exchange rate has moved to $1 = GH¢4.60.

Required:
i) What was the foreign exchange loss to the Ghanaian buyer?
(3 marks)

ii) Explain currency risk in relation to the above.
(2 marks)

iii) Explain transaction risk in relation to the above.
(2 marks)

iv) What will be the effect of the above on the company’s trading profits?
(3 marks)

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  • 20 Marks

FM – MAY 2016 – L2 – Q5 – Foreign exchange risk and currency risk management | Hedging with options

Discuss differences between forward and futures contracts, types of currency risk exposure, disadvantages of hedging with futures, and reasons for differences in interest rates across different maturities.

a) AD Ventures imports tomato paste from Italy for sale in Ghana. AD Ventures typically buys the tomato paste on an open account and pays the euro invoice value two months after receipt of goods. AD Ventures has suffered heavy exchange rate losses of late due to the continuous depreciation of the Ghanaian cedi against the euro. AD Ventures will receive a consignment of tomato paste on 15th May 2016. The value of this consignment is EUR540,000, which must be settled in two months’ time (settlement deadline being 15th July 2016).

The current spot exchange rate for the euro is GH¢4.7110/EUR. Financial pundits forecast that the Ghanaian cedi will depreciate against the euro in the coming months. The owner-manager of AD Venture, Akua Donkor, is worried about the probable foreign exchange loss her business may suffer when the invoice value is settled in two months’ time.

Akua Donkor has heard of the possibility of hedging AD Ventures’ currency exposure with a forward contract or futures contract but does not know what these contracts are. She has asked you to advise her on what to do to hedge against the underlying exposure relating to the EUR540,000 tomato paste consignment.

You would like to recommend a futures market hedge to Akua Donkor. You searched the derivatives market; and you found a futures contract on the euro that matures in August 2016. Other relevant details of the contract follow:

  • Contract size: EUR100,000
  • Futures contract price: GH¢4.8112/EUR

Required:
i) Explain to Akua Donkor FOUR differences between a forward contract and a futures contract. (4 marks)
ii) Currency risk exposure may be transaction risk, economic risk, or translation risk. Which of the three kinds of currency risk exposure is AD Ventures facing in relation to the EUR540,000 tomato paste consignment? Explain why. (4 marks)
iii) Explain to Akua Donkor THREE disadvantages of hedging the euro exposure with a futures hedge. (6 marks)

b) It has been observed that interest rates on debt securities or loans differ for different maturities. For the week ending 28th August 2015, the annual interest rate on the 1-year Government of Ghana note was 22.5% whereas the annual interest rate on the 2-year note was 23%.

Required:
With THREE reasons, explain why interest rates on debt securities and loans are different for different maturity periods. (6 marks)

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  • 20 Marks

FM – AUG 2022 – L2 – Q3 – Foreign exchange risk and currency risk management

Calculate interest rates, required sinking fund contributions, and identifies currency risk exposure with recommended hedging strategies.

a) Jeanne Cosmetics Ltd is located in Taifa and is now considered as the leader of organic and natural cosmetic products in the municipality. Per the cash management policy of Jeanne Cosmetics Ltd, any excess cash that is idle for more than three months should be invested. Three months ago, the company invested GH¢100,000 of idle cash in a 3-month fixed deposit account. The investment matures today, and the company will receive a maturity value of GH¢105,000.

Required:
i) Compute the interest rate earned on the account over the investment holding period. (2 marks)
ii) Suppose the interest rate on the account remains the same, and the company rolls over the principal, compute the annual simple interest rate on the investment. (2 marks)
iii) Suppose the interest rate on the account remains the same and the company rolls over both the principal and interests, compute the annual compound interest rate on the investment. (2 marks)

b) Apphia Fabrics Ltd plans to replace its existing manufacturing plant with a newer version in three years’ time. The replacement cost of the existing plant is GH¢10 million currently. However, experts forecast that the cost of the newer version of the plant will be GH¢12 million in three years’ time.

On the advice of the Finance Manager, the company will start saving from now to raise the required amount to buy the plant in three years’ time. Consequently, the company has signed an investment agreement with DT Financial Services Ltd. Per the agreement, the company will deposit equal amounts into an interest-bearing account at the beginning of each of the next three years. The annual nominal interest rate on the account is 16%, but interest will be compounded monthly.

Required:
Compute the equal annual deposit required to raise the required amount in three years’ time. (4 marks)

c) Aduro Pharmaceuticals Plc is a Ghana-based multinational company with a production facility in India and marketing subsidiaries in some West African countries. The Treasury Department of the company is considering strategies for managing its foreign exchange risk exposures. In particular, the Treasury Department is concerned about the following two cases of foreign exchange risk exposures:

Case 1:
The exchange rate between the Ghanaian cedi (GH¢) and the British pound sterling (GBP) is currently GH¢8.1125/GBP1. The company recently borrowed GBP500,000 from an offshore bank to buy active chemicals for the production of paracetamol syrup. The loan is to be paid in six months’ time. Market pundits project that the Ghanaian cedi would depreciate against the pound sterling over the next six months.

Case 2:
The exchange rate between the Ghanaian cedi (GH¢) and the Indian rupee (INR) is currently GH¢0.0799/INR1. The company’s production subsidiary in India presents its financial statements in the Indian rupee. The net worth of this production subsidiary in India is INR20 million. The company would be preparing its consolidated financial statements in a few months’ time. Market pundits project that the Ghanaian cedi will appreciate against the Indian rupee.

Required:
i) For each case, identify the type of currency risk exposure the company is facing. (2 marks)
ii) In respect of Case 1, recommend TWO (2) internal strategies and TWO (2) external hedging strategies the Treasury Department can use to manage the foreign exchange risk exposure. (8 marks)

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  • 20 Marks

FM – MAR 2024 – L2 – Q3 – Foreign exchange risk and currency risk management

Involves calculating the quarterly payment and total interest on a mortgage loan, evaluating an alternative payment plan, and explaining and applying currency risk management techniques using forward contracts.

a) Onana Events Company (Onana) is purchasing a building from a real estate company. The current cash price of the building is GH¢2,500,000. Onana can obtain a GH¢2,500,000 mortgage loan to finance the payment of the cash price of the building. The loan bears a compound annual interest rate of 18% and calls for equal payments at the end of each quarter for 20 years.

Required:

i) Compute the quarterly payment.
(4 marks)

ii) Compute the total interest that will be paid by Onana to the mortgage company over the life of the loan.
(2 marks)

iii) Suppose the real estate company is offering a credit payment plan to Onana. Per the credit terms, Onana will have to pay GH¢500,000 now and then pay GH¢110,000 at the end of each month for one year. The implicit interest rate is 20% per annum. Compute the aggregate present value of the payments under this option.
(4 marks)

b) Sempe Ghana Plc needs to have EUR650,000 in two months’ time to settle a trade payable. The management team fears that the cedi would depreciate against the euro in the coming months. The team is however divided over whether the currency risk exposure should be hedged using a forward foreign exchange contract or a futures foreign exchange contract. The following quotations have been obtained from Ghana’s foreign exchange market:

FX Quotation Bid Rate Ask (Offer) Rate
Spot Rate GH¢12.1854/EUR1 GH¢12.4854/EUR1
2-month Forward Rate GH¢12.5854/EUR1 GH¢12.8854/EUR1

Required:

i) Explain to the management of Sempe Ghana Ltd whether the foreign exchange quotations provided above are direct quotations or indirect quotations.
(5 marks)

ii) Suppose the company uses the forward contract to hedge its currency exposure. Compute the outcome of the forward contract hedge.
(5 marks)

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