- 6 Marks
FM – Nov 2020 – L2 – Q5b – Foreign exchange risk and currency risk management
Identify and explain four internal techniques to hedge exchange rate risk.
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- 5 Marks
FM – March 2023 – L2 – Q5a – Foreign exchange risk and currency risk management
Explain how local currency invoicing can be used to manage currency risk exposure, and discuss the benefits and risks associated with this strategy.
Question
Ahuodzen Pharmaceutical Ltd (Ahuodzen) imports chemicals to produce medicines in Ghana. It has received a consignment of chemicals from a supplier in India. The invoice value of US$2 million is payable two months from now. The Treasury Manager of Ahuodzen is worried about volatility in the cedi to US dollar exchange rate.
Required:
Explain how local currency invoicing would be used as a strategy for managing currency risk exposures and advise the Treasury Manager on the benefit and risk of handling Ahuodzen’s currency risk exposure using local currency invoicing. (5 marks)
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- 5 Marks
FM – April 2022 – L2 – Q5b – Foreign exchange risk and currency risk management
Evaluate how JBL Plc can use a currency swap to manage its underlying currency risk exposure.
Question
Exactly two years ago, JBL Plc took a 5-year US$ 20 million loan at a fixed interest of 12% from an investment bank to finance a plant expansion project. At the time the loan was taken, JBL was exporting a significant proportion of its output to a foreign market. Thus, it was sure that it would be able to earn U.S. dollars to make dollar payments on the loan. For about a year now, JBL has not been able to export its output to its foreign market due to trade restrictions. It sells only to buyers in Ghana for the Ghana cedi. The company now prefers to have its interest obligation in Ghana cedi rather than U.S. dollar.
On the advice of the Treasury Manager, JBL has entered a currency swap arrangement with a bank to manage the underlying risk exposure. Per the terms of the swap, JBL will continue to honour its obligations under the actual loan. Under the swap, JBL and the bank will exchange interests and principals in the appropriate currencies. With a pre-arranged exchange rate of GH¢6.5000/USD1, the notional principals under the swap arrangement are agreed at US$20 million and GH¢130 million. The 12% interest rate on the existing dollar loan will continue to apply to both the original dollar loan and the dollar interest payments under the swap arrangement. The interest rate that will apply to the cedi notional principal is set to 15%.
Required:
Evaluate how JBL Plc can use the currency swap to manage the underlying risk exposure. (5 marks)
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- 10 Marks
FM – April 2022 – L2 – Q3b – Foreign exchange risk and currency risk management
Evaluate the outcome of hedging strategies for Healthy Beverages Ltd using forward contracts and money market transactions.
Question
b) Healthy Beverages Ltd is a food processing company based in Accra, Ghana. It has imported raw soybeans from farmers in the United States for processing into soy milk. The shipment is invoiced at USD800,000, and the company is expected to make payment in three months’ time. The exchange rate between the Ghanaian cedi and the U.S. dollar is currently quoted at GH¢5.8555 / USD1 bid and GH¢5.8585 / USD1 ask/offer. Considering that the Ghanaian cedi has been depreciating against the U.S. dollar in recent times, the managers of the company are worried that the exchange rate might rise further over the next three months.
The Finance Manager is considering two strategies for hedging the company’s foreign exchange risk exposures: a forward market hedge and a money market hedge. Below are pieces of information from the forward foreign exchange market and the money markets:
- Forward market FX rates:
- 3-month forward rate: bid rate = GH¢5.8755 / USD1; ask/offer rate = GH¢5.8785 / USD1
- 6-month forward rate: bid rate = GH¢5.8955 / USD1; ask/offer rate = GH¢5.8985 / USD1
- Money market average interest rates:
- Ghana money market: lending/investing rate = 16.5%; borrowing rate = 18.5%
- U.S. money market: lending/investing rate = 6.5%; borrowing rate = 8.5%
Required:
i) Suppose the risk exposure is to be hedged using a forward foreign exchange contract, calculate and comment on the outcome of the forward market hedge. (4 marks)
ii) Suppose the risk exposure is to be hedged using money market transactions, calculate and comment on the outcome of the money market hedge. (6 marks)
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- 6 Marks
FM – Nov 2020 – L2 – Q5b – Foreign exchange risk and currency risk management
Identify and explain four internal techniques to hedge exchange rate risk.
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- 5 Marks
FM – March 2023 – L2 – Q5a – Foreign exchange risk and currency risk management
Explain how local currency invoicing can be used to manage currency risk exposure, and discuss the benefits and risks associated with this strategy.
Question
Ahuodzen Pharmaceutical Ltd (Ahuodzen) imports chemicals to produce medicines in Ghana. It has received a consignment of chemicals from a supplier in India. The invoice value of US$2 million is payable two months from now. The Treasury Manager of Ahuodzen is worried about volatility in the cedi to US dollar exchange rate.
Required:
Explain how local currency invoicing would be used as a strategy for managing currency risk exposures and advise the Treasury Manager on the benefit and risk of handling Ahuodzen’s currency risk exposure using local currency invoicing. (5 marks)
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- 5 Marks
FM – April 2022 – L2 – Q5b – Foreign exchange risk and currency risk management
Evaluate how JBL Plc can use a currency swap to manage its underlying currency risk exposure.
Question
Exactly two years ago, JBL Plc took a 5-year US$ 20 million loan at a fixed interest of 12% from an investment bank to finance a plant expansion project. At the time the loan was taken, JBL was exporting a significant proportion of its output to a foreign market. Thus, it was sure that it would be able to earn U.S. dollars to make dollar payments on the loan. For about a year now, JBL has not been able to export its output to its foreign market due to trade restrictions. It sells only to buyers in Ghana for the Ghana cedi. The company now prefers to have its interest obligation in Ghana cedi rather than U.S. dollar.
On the advice of the Treasury Manager, JBL has entered a currency swap arrangement with a bank to manage the underlying risk exposure. Per the terms of the swap, JBL will continue to honour its obligations under the actual loan. Under the swap, JBL and the bank will exchange interests and principals in the appropriate currencies. With a pre-arranged exchange rate of GH¢6.5000/USD1, the notional principals under the swap arrangement are agreed at US$20 million and GH¢130 million. The 12% interest rate on the existing dollar loan will continue to apply to both the original dollar loan and the dollar interest payments under the swap arrangement. The interest rate that will apply to the cedi notional principal is set to 15%.
Required:
Evaluate how JBL Plc can use the currency swap to manage the underlying risk exposure. (5 marks)
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- 10 Marks
FM – April 2022 – L2 – Q3b – Foreign exchange risk and currency risk management
Evaluate the outcome of hedging strategies for Healthy Beverages Ltd using forward contracts and money market transactions.
Question
b) Healthy Beverages Ltd is a food processing company based in Accra, Ghana. It has imported raw soybeans from farmers in the United States for processing into soy milk. The shipment is invoiced at USD800,000, and the company is expected to make payment in three months’ time. The exchange rate between the Ghanaian cedi and the U.S. dollar is currently quoted at GH¢5.8555 / USD1 bid and GH¢5.8585 / USD1 ask/offer. Considering that the Ghanaian cedi has been depreciating against the U.S. dollar in recent times, the managers of the company are worried that the exchange rate might rise further over the next three months.
The Finance Manager is considering two strategies for hedging the company’s foreign exchange risk exposures: a forward market hedge and a money market hedge. Below are pieces of information from the forward foreign exchange market and the money markets:
- Forward market FX rates:
- 3-month forward rate: bid rate = GH¢5.8755 / USD1; ask/offer rate = GH¢5.8785 / USD1
- 6-month forward rate: bid rate = GH¢5.8955 / USD1; ask/offer rate = GH¢5.8985 / USD1
- Money market average interest rates:
- Ghana money market: lending/investing rate = 16.5%; borrowing rate = 18.5%
- U.S. money market: lending/investing rate = 6.5%; borrowing rate = 8.5%
Required:
i) Suppose the risk exposure is to be hedged using a forward foreign exchange contract, calculate and comment on the outcome of the forward market hedge. (4 marks)
ii) Suppose the risk exposure is to be hedged using money market transactions, calculate and comment on the outcome of the money market hedge. (6 marks)
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