Foreign exchange exposure

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 – 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)

Answer

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Tags: Currency risk management, Currency Swap, Foreign exchange exposure, Interest Rate Risk
Level: Level 2

Topic: Foreign exchange risk and currency risk management
Series: APR 2022

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)

Answer

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Tags: Currency risk management, Foreign exchange exposure, Forward market hedge, Money market hedge
Level: Level 2

Topic: Foreign exchange risk and currency risk management
Series: APR 2022

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 – 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

Required:
Evaluate how JBL Plc can use the currency swap to manage the underlying risk exposure. (5 marks)

Answer

Find Related Questions by Tags, levels, etc.

Tags: Currency risk management, Currency Swap, Foreign exchange exposure, Interest Rate Risk
Level: Level 2

Topic: Foreign exchange risk and currency risk management
Series: APR 2022

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

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%

Answer

Find Related Questions by Tags, levels, etc.

Tags: Currency risk management, Foreign exchange exposure, Forward market hedge, Money market hedge
Level: Level 2

Topic: Foreign exchange risk and currency risk management
Series: APR 2022

Question Tag: Foreign exchange exposure

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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.

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.

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.

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 – 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.

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.

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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.

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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.

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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.

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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.

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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.

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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.

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