Futures – NBC Institute

FM – Nov 2023 – L3 – SB – Q2 – Foreign Exchange Risk Management

Analyze hedging methods for foreign exchange risk involving a future CHF transaction.

Question

About one year ago, you were employed by Tesco, an American company based in New York. You work online from home in Nigeria and are a member of the international treasury of Tesco.

Tesco supplies medical equipment to the USA and Europe and also buys some basic raw materials from Europe. It is currently 30 November 2024. On 31 May 2025, Tesco is due to receive CHF16.3 million from a Swiss customer and also to pay CHF4.0 million to a Swiss supplier.

Exchange rates (quoted as US$/CHF1):

Spot: 1.0292 – 1.0309
Three months forward: 1.0322 – 1.0341
Six months forward: 1.0356 – 1.0378

Annual interest rates available to Tesco:

Switzerland: 3.2% (investing), 4.4% (borrowing)
USA: 4.6% (investing), 5.8% (borrowing)

Currency futures (contract size CHF125,000, futures price quoted as US$ per CHF1):

Future price: December – 1.0306, March – 1.0336, June – 1.0369

Currency options (contract size CHF125,000; exercise price quotation US$ per CHF1, premium in US cents per CHF1):

Calls				Puts
	Dec	Mar	June	Dec	Mar	June
1.0375	0.47	0.50	0.53	0.74	0.79	0.86

Required:

a. Calculate the net receipt if hedged using a forward contract. (4 Marks)
b. Calculate the net receipt if hedged using money market hedging. (8 Marks)
c. Calculate the net receipt if hedged using futures. (10 Marks)
d. Calculate the net receipt if hedged using options. (8 Marks)
(Total: 30 Marks)

Answer

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Tags: Foreign Exchange, Forward Contract, Futures, Hedging, Money market, Options
Level: Level 3

Topic: Foreign Exchange Risk Management
Series: NOV 2023

FM – NOV 2021 – L2 – Q5 – Cash management

Application of the Miller-Orr model to determine cash levels, comparison with the Baumol model, and the differences between futures and forward contracts.

Question

You are the assistant to the Finance Manager of Horthman Holdings Ltd. The Directors of the company are reviewing the cash management practices of the company. The main concern is that excessive cash balances are held in non-interest-bearing demand deposit accounts for relatively long periods. Your boss has been asked to advise the Directors on the appropriate cash balance levels the company should keep and matters relating to the investment of excess cash.

To assist your boss, you analysed the company’s demand for cash over the last three years and looked for some financial market figures. On the usage of cash, you found that the company’s daily cash needs vary with a standard deviation of GH¢25,000. However, the annual demand for cash averages around GH¢65 million. Considering the results of your examination, your boss proposes that the minimum cash balance is set at GH¢100,000 going forward.

From your search on the financial markets, you found that the company can earn interest from investments in money market securities at an annual rate of 21.6% on an actual/360-day count convention. Also, you found out that the average transaction cost for trading investments in such money market securities is GH¢2,500.

Your boss recommends using the Miller-Orr model for determining the critical cash control levels and investment of temporary excess cash in money market securities.

Required:
a) Using the Miller-Orr model, determine the following:
i) The cash spread between the lower and upper cash limit. (3 marks)
ii) The cash return point. (2 marks)
iii) The cash level at which the company should invest excess cash. (2 marks)

b) The Chief Executive Officer (CEO) believes that the Baumol model is a simpler model than the Miller-Orr model, and your boss should consider recommending that to the Directors. Considering the information provided in the preamble, would you say that the Baumol Model would be more appropriate? Explain. (4 marks)

c) Your boss recommends that temporary excess cash be invested in money market securities. Explain TWO (2) conditions required when deciding on investing temporary excess cash. (4 marks)

d) Future contracts and forward contracts (more commonly referred to as futures and forwards) are used by businesses and investors to hedge against risks or speculate. Futures and forwards are examples of derivative assets that derive their values from underlying assets. Both contracts rely on locking in a specific price for a certain asset, but they have differences.

Required:
Explain FOUR (4) differences between futures and forwards. (5 marks)

Answer

Find Related Questions by Tags, levels, etc.

Tags: Baumol Model, Cash Flow Management, Cash Management, Forwards, Futures, Miller-Orr Model
Level: Level 2

Topic: Cash management
Series: NOV 2021

FM – Nov 2023 – L3 – SB – Q2 – Foreign Exchange Risk Management

Analyze hedging methods for foreign exchange risk involving a future CHF transaction.

Question

About one year ago, you were employed by Tesco, an American company based in New York. You work online from home in Nigeria and are a member of the international treasury of Tesco.

Exchange rates (quoted as US$/CHF1):

Spot: 1.0292 – 1.0309
Three months forward: 1.0322 – 1.0341
Six months forward: 1.0356 – 1.0378

Annual interest rates available to Tesco:

Switzerland: 3.2% (investing), 4.4% (borrowing)
USA: 4.6% (investing), 5.8% (borrowing)

Currency futures (contract size CHF125,000, futures price quoted as US$ per CHF1):

Future price: December – 1.0306, March – 1.0336, June – 1.0369

Currency options (contract size CHF125,000; exercise price quotation US$ per CHF1, premium in US cents per CHF1):

Calls				Puts
	Dec	Mar	June	Dec	Mar	June
1.0375	0.47	0.50	0.53	0.74	0.79	0.86

Required:

a. Calculate the net receipt if hedged using a forward contract. (4 Marks)
b. Calculate the net receipt if hedged using money market hedging. (8 Marks)
c. Calculate the net receipt if hedged using futures. (10 Marks)
d. Calculate the net receipt if hedged using options. (8 Marks)
(Total: 30 Marks)

Answer

Find Related Questions by Tags, levels, etc.

Tags: Foreign Exchange, Forward Contract, Futures, Hedging, Money market, Options
Level: Level 3

Topic: Foreign Exchange Risk Management
Series: NOV 2023

FM – NOV 2021 – L2 – Q5 – Cash management

Application of the Miller-Orr model to determine cash levels, comparison with the Baumol model, and the differences between futures and forward contracts.

Question

Your boss recommends using the Miller-Orr model for determining the critical cash control levels and investment of temporary excess cash in money market securities.

c) Your boss recommends that temporary excess cash be invested in money market securities. Explain TWO (2) conditions required when deciding on investing temporary excess cash. (4 marks)

Required:
Explain FOUR (4) differences between futures and forwards. (5 marks)

Answer

Find Related Questions by Tags, levels, etc.

Tags: Baumol Model, Cash Flow Management, Cash Management, Forwards, Futures, Miller-Orr Model
Level: Level 2

Topic: Cash management
Series: NOV 2021

Question Tag: Futures

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FM – Nov 2023 – L3 – SB – Q2 – Foreign Exchange Risk Management

Analyze hedging methods for foreign exchange risk involving a future CHF transaction.

FM – NOV 2021 – L2 – Q5 – Cash management

Application of the Miller-Orr model to determine cash levels, comparison with the Baumol model, and the differences between futures and forward contracts.

FM – Nov 2023 – L3 – SB – Q2 – Foreign Exchange Risk Management

Analyze hedging methods for foreign exchange risk involving a future CHF transaction.

FM – NOV 2021 – L2 – Q5 – Cash management

Application of the Miller-Orr model to determine cash levels, comparison with the Baumol model, and the differences between futures and forward contracts.

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Analyze hedging methods for foreign exchange risk involving a future CHF transaction.

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FM – NOV 2021 – L2 – Q5 – Cash management

Application of the Miller-Orr model to determine cash levels, comparison with the Baumol model, and the differences between futures and forward contracts.

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FM – Nov 2023 – L3 – SB – Q2 – Foreign Exchange Risk Management

Analyze hedging methods for foreign exchange risk involving a future CHF transaction.

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FM – NOV 2021 – L2 – Q5 – Cash management

Application of the Miller-Orr model to determine cash levels, comparison with the Baumol model, and the differences between futures and forward contracts.

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