Economic Exposure – NBC Institute

FM – May 2024 – L3 – SC – Q6 – Financial Distress and Bankruptcy

Discuss economic exposure in currency risk management and calculate impact of USD strengthening on Linko Plc’s market value.

Question

(a) With respect to foreign currency risk management, explain economic exposure and discuss generally how a company can manage economic exposure. (8 Marks)

(b) Linko Plc is a UK-based company supplying medical equipment to the USA and Europe, while importing raw materials from the USA. It has net imports of 8 million dollars from the USA, which is expected to continue for the next six years. The company’s cost of capital is 10% per year. Assume cash flows occur at year-end and ignore taxation.

Required:
Assuming no change in the physical volume or dollar price of imports, estimate the impact on the expected market value of Linko Plc, if the market expects the dollar to strengthen by 4% per year against the pound. The current spot exchange rate (US$ per £1) is 1.9156 – 1.9210. (7 Marks)

Answer

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Tags: Cost of Capital, Currency Management, Economic Exposure, Foreign Exchange, Market Value Impact, Spot Rate
Level: Level 3

Topic: Financial Distress and Bankruptcy
Series: MAY 2024

FM – Nov 2017 – L3 – Q4 – Foreign Exchange Risk Management

Evaluate foreign exchange exposure, determine forward rates, assess hedging strategies, and discuss economic exposure significance for Kudi Limited.

Question

You are the Financial Director of Kudi Limited, a Nigerian company that imports raw materials mainly from Tiko (currency: T$) and exports finished products to Katuga (currency: K$). Kudi is partly financed by a loan raised in the domestic market and usually hedges its foreign currency exposure using forward or money markets. Most customers are allowed a 3-month credit. The company recently sold products to a customer in Katuga for K$20 million.

Available Information:

Exchange Rate	K$ per N	T$ per N
Spot Rate	1.9600	1.4600
1 Month Forward	1.9580	1.4579

Central Bank Base Rate Per Annum	Nigeria	Katuga	Tiko
Rate (%)	5.5%	4.25%	3.75%

Required:

(a) Comment on the Interest Rate Parity (IRP) and Purchasing Power Parity (PPP) methods for estimating exchange rates. (6 Marks)

In answering the following questions, include relevant calculations:

Given that interest rates are higher in Nigeria than in Tiko, should T$ be depreciating against the naira and thus trading at a discount? (3 Marks)
Determine the 3-month K$ forward rate of exchange implied by the given information and calculate the naira receipts expected in 3 months from the customer in Katuga. (3 Marks)
Assess whether buying T$ on the spot market now and placing it on deposit would be a sensible policy for Kudi. (3 Marks)

(b) Discuss the concept and significance of foreign exchange economic exposure for a multinational company. (5 Marks)

(Total 20 Marks)

Answer

Find Related Questions by Tags, levels, etc.

Tags: Currency Hedging, Economic Exposure, Financial risk management, Foreign Exchange, Forward Rate, Interest Rate Parity, Multinational Company, Purchasing Power Parity
Level: Level 3

Topic: Foreign Exchange Risk Management
Series: NOV 2017

FM – MAY 2018 – L2 – Q3 – Cost of capital | Introduction to Investment Appraisal

Involves the calculation of the cost of various sources of capital, the weighted average cost of capital (WACC), and the net present value (NPV) of a proposed project, as well as an explanation of transaction and economic exposures and methods of mitigating transaction exposure.

Question

a) Okechukwu Ltd is financed by three types of capital:

i) 1 million 50p ordinary shares each having a current market value of GH¢5.20 cum div. The current dividend, which is due to be paid shortly, is 20p per share. The dividend has grown steadily in the past at a compound annual rate of 15% and is generally expected to continue doing so indefinitely.
ii) 200,000 GH¢1 irredeemable 8% preference shares, each having a current market value of 50p ex div.
iii) GH¢2 million 10% debentures, redeemable in 20 years at a price of 110. The current market value is 80 ex int.

Okechukwu is considering a new project having the same risk characteristics as existing projects, which would require an immediate outlay of GH¢150,000 and would produce annual net cash inflow of GH¢30,000 indefinitely.

Required:

Evaluate the viability of the new project using appropriate computations.
(15 marks)

b) Foreign currency risk can be managed to reduce or eliminate the risk. Measures to reduce currency risk are known as hedging.

Required:

i) Explain Transaction and Economic Exposure.
(5 marks)

ii) Explain FIVE ways of mitigating transaction exposure.
(5 marks)

Answer

Find Related Questions by Tags, levels, etc.

Tags: Cost of Equity, Debentures, Economic Exposure, NPV, Preference shares, Transaction Exposure, WACC
Level: Level 2

Topic: Cost of capital, Introduction to Investment Appraisal
Series: MAY 2018

FM – May 2024 – L3 – SC – Q6 – Financial Distress and Bankruptcy

Discuss economic exposure in currency risk management and calculate impact of USD strengthening on Linko Plc’s market value.

Question

(a) With respect to foreign currency risk management, explain economic exposure and discuss generally how a company can manage economic exposure. (8 Marks)

Answer

Find Related Questions by Tags, levels, etc.

Tags: Cost of Capital, Currency Management, Economic Exposure, Foreign Exchange, Market Value Impact, Spot Rate
Level: Level 3

Topic: Financial Distress and Bankruptcy
Series: MAY 2024

FM – Nov 2017 – L3 – Q4 – Foreign Exchange Risk Management

Evaluate foreign exchange exposure, determine forward rates, assess hedging strategies, and discuss economic exposure significance for Kudi Limited.

Question

Available Information:

Exchange Rate	K$ per N	T$ per N
Spot Rate	1.9600	1.4600
1 Month Forward	1.9580	1.4579

Central Bank Base Rate Per Annum	Nigeria	Katuga	Tiko
Rate (%)	5.5%	4.25%	3.75%

Required:

(a) Comment on the Interest Rate Parity (IRP) and Purchasing Power Parity (PPP) methods for estimating exchange rates. (6 Marks)

In answering the following questions, include relevant calculations:

Given that interest rates are higher in Nigeria than in Tiko, should T$ be depreciating against the naira and thus trading at a discount? (3 Marks)
Determine the 3-month K$ forward rate of exchange implied by the given information and calculate the naira receipts expected in 3 months from the customer in Katuga. (3 Marks)
Assess whether buying T$ on the spot market now and placing it on deposit would be a sensible policy for Kudi. (3 Marks)

(b) Discuss the concept and significance of foreign exchange economic exposure for a multinational company. (5 Marks)

(Total 20 Marks)

Answer

Find Related Questions by Tags, levels, etc.

Tags: Currency Hedging, Economic Exposure, Financial risk management, Foreign Exchange, Forward Rate, Interest Rate Parity, Multinational Company, Purchasing Power Parity
Level: Level 3

Topic: Foreign Exchange Risk Management
Series: NOV 2017

FM – MAY 2018 – L2 – Q3 – Cost of capital | Introduction to Investment Appraisal

Involves the calculation of the cost of various sources of capital, the weighted average cost of capital (WACC), and the net present value (NPV) of a proposed project, as well as an explanation of transaction and economic exposures and methods of mitigating transaction exposure.

Question

a) Okechukwu Ltd is financed by three types of capital:

i) 1 million 50p ordinary shares each having a current market value of GH¢5.20 cum div. The current dividend, which is due to be paid shortly, is 20p per share. The dividend has grown steadily in the past at a compound annual rate of 15% and is generally expected to continue doing so indefinitely.
ii) 200,000 GH¢1 irredeemable 8% preference shares, each having a current market value of 50p ex div.
iii) GH¢2 million 10% debentures, redeemable in 20 years at a price of 110. The current market value is 80 ex int.

Required:

Evaluate the viability of the new project using appropriate computations.
(15 marks)

b) Foreign currency risk can be managed to reduce or eliminate the risk. Measures to reduce currency risk are known as hedging.

Required:

i) Explain Transaction and Economic Exposure.
(5 marks)

ii) Explain FIVE ways of mitigating transaction exposure.
(5 marks)

Answer

Find Related Questions by Tags, levels, etc.

Tags: Cost of Equity, Debentures, Economic Exposure, NPV, Preference shares, Transaction Exposure, WACC
Level: Level 2

Topic: Cost of capital, Introduction to Investment Appraisal
Series: MAY 2018

Question Tag: Economic Exposure

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FM – May 2024 – L3 – SC – Q6 – Financial Distress and Bankruptcy

Discuss economic exposure in currency risk management and calculate impact of USD strengthening on Linko Plc’s market value.

FM – Nov 2017 – L3 – Q4 – Foreign Exchange Risk Management

Evaluate foreign exchange exposure, determine forward rates, assess hedging strategies, and discuss economic exposure significance for Kudi Limited.

FM – MAY 2018 – L2 – Q3 – Cost of capital | Introduction to Investment Appraisal

Involves the calculation of the cost of various sources of capital, the weighted average cost of capital (WACC), and the net present value (NPV) of a proposed project, as well as an explanation of transaction and economic exposures and methods of mitigating transaction exposure.

FM – May 2024 – L3 – SC – Q6 – Financial Distress and Bankruptcy

Discuss economic exposure in currency risk management and calculate impact of USD strengthening on Linko Plc’s market value.

FM – Nov 2017 – L3 – Q4 – Foreign Exchange Risk Management

Evaluate foreign exchange exposure, determine forward rates, assess hedging strategies, and discuss economic exposure significance for Kudi Limited.

FM – MAY 2018 – L2 – Q3 – Cost of capital | Introduction to Investment Appraisal

Involves the calculation of the cost of various sources of capital, the weighted average cost of capital (WACC), and the net present value (NPV) of a proposed project, as well as an explanation of transaction and economic exposures and methods of mitigating transaction exposure.

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Question Tag: Economic Exposure

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FM – May 2024 – L3 – SC – Q6 – Financial Distress and Bankruptcy

Discuss economic exposure in currency risk management and calculate impact of USD strengthening on Linko Plc’s market value.

You're reporting an error for "FM – May 2024 – L3 – SC – Q6 – Financial Distress and Bankruptcy"

FM – Nov 2017 – L3 – Q4 – Foreign Exchange Risk Management

Evaluate foreign exchange exposure, determine forward rates, assess hedging strategies, and discuss economic exposure significance for Kudi Limited.

You're reporting an error for "FM – Nov 2017 – L3 – Q4 – Foreign Exchange Risk Management"

FM – MAY 2018 – L2 – Q3 – Cost of capital | Introduction to Investment Appraisal

Involves the calculation of the cost of various sources of capital, the weighted average cost of capital (WACC), and the net present value (NPV) of a proposed project, as well as an explanation of transaction and economic exposures and methods of mitigating transaction exposure.

You're reporting an error for "FM – MAY 2018 – L2 – Q3 – Cost of capital | Introduction to Investment Appraisal"

FM – May 2024 – L3 – SC – Q6 – Financial Distress and Bankruptcy

Discuss economic exposure in currency risk management and calculate impact of USD strengthening on Linko Plc’s market value.

You're reporting an error for "FM – May 2024 – L3 – SC – Q6 – Financial Distress and Bankruptcy"

FM – Nov 2017 – L3 – Q4 – Foreign Exchange Risk Management

Evaluate foreign exchange exposure, determine forward rates, assess hedging strategies, and discuss economic exposure significance for Kudi Limited.

You're reporting an error for "FM – Nov 2017 – L3 – Q4 – Foreign Exchange Risk Management"

FM – MAY 2018 – L2 – Q3 – Cost of capital | Introduction to Investment Appraisal

Involves the calculation of the cost of various sources of capital, the weighted average cost of capital (WACC), and the net present value (NPV) of a proposed project, as well as an explanation of transaction and economic exposures and methods of mitigating transaction exposure.

You're reporting an error for "FM – MAY 2018 – L2 – Q3 – Cost of capital | Introduction to Investment Appraisal"

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