Question Tag: Futures Contracts

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FM – May 2019 – L3 – Q6 – Interest Rate Risk Management

Evaluate the effect of using interest rate futures to hedge a loan and compare the total cost after hedging with an interest rate guarantee.

Question

You are the head of the treasury group of Top Flight Aviation (TFA), a Nigerian company. The company operates chartered international flights for the elites in the country.

It is now December 31, and TFA needs to borrow £60 million from a UK bank to finance a new air jet. The borrowing and the purchase will be in three months’ time, and the borrowing will be for a period of six months.

You have decided to hedge the relevant interest rate risk using interest rate futures. Your expectation is that interest rates will increase from 13% by 2% over the next three months.

In the month of March, the current price of Sterling 3-month futures is 87.25. The standard contract size is £500,000.

Required:

a. Set out calculations of the effect of using the futures market to hedge against movements in the interest rate if:
(i) Interest rates increase from 13% by 2% and the futures market price moves by 2%;
(ii) Interest rates increase from 13% by 2% and the futures market price moves by 1.75%;
(iii) Interest rates fall from 13% by 1.5% and the futures market price moves by 1.25%;

In each case, show the hedge efficiency. The time value of money, taxation, and margin requirements should be ignored.

b. Show, for the situations in (a) above, whether the total cost of the loan after hedging would have been lower with the futures hedge chosen by the treasurer or with an interest rate guarantee which the treasurer could have purchased at 13% for a premium of 0.25% of the size of the loan to be guaranteed.

The time value of money, taxation, and margin requirements should be ignored.

(Total: 15 Marks)

Answer

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Tags: Futures Contracts, Hedging, Interest Rate Futures, Loan financing
Level: Level 3

Topic: Interest Rate Risk Management

FM – May 2021 – L3 – Q4 – Foreign Exchange Risk Management

Evaluate economic exposure, forecast exchange rates with inflation, calculate expected receipts using forward and money-market hedges, and discuss problems with futures contracts.

Question

Kingston Plc. (KP) is a Nigerian company based in Aba. KP exports finished products to and imports raw materials from a company Central Africa, with currency of Central Dollar (C$).

KP has the following expected transactions:

You have collected the following information:

Money market rate for KP:

a. Discuss the significance to a multinational company of economic exposure. (5 Marks)

b. Explain how inflation rates can be used to forecast exchange rates. (3 Marks)

c. Calculate the expected naira receipts in one month and in three months using the forward market. (3 Marks)

d. Calculate the expected naira receipts in three months using a money-market hedge and recommend whether a forward market hedge or a money-market hedge should be used. (5 Marks)

e. Discuss FOUR possible problems of using futures contracts to hedge exchange rate risks. (4 Marks)

Answer

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Tags: Economic Exposure, Exchange Rates, Forward Contracts, Futures Contracts, Money market hedge
Level: Level 3

Topic: Foreign Exchange Risk Management

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.

Question

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)

Answer

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Tags: Currency risk, Forward Contracts, Futures Contracts, Hedging, Interest Rate
Level: Level 2

Topic: Foreign exchange risk and currency risk management, Hedging with options
Series: MAY 2016

FM – Nov 2019 – L2 – Q3c – Futures and hedging with futures

Explain the differences between forward contracts and futures contracts.

Question

c) Explain TWO (2) differences between forward contracts and futures contracts. (5 marks)

Answer

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Tags: Derivatives, Forward Contracts, Futures Contracts
Level: Level 2

Topic: Futures and hedging with futures
Series: NOV 2019

FM – MAR 2024 – L2 – Q5 – Working Capital Management

Evaluates different financing options for working capital requirements and compares forward and futures currency contracts.

Question

a) Edziban Foods Ltd has just signed a contract to sell food items worth GH¢120,000 per month to the School Feeding Secretariat on credit. With the average collection period expected to be 45 days, the company will increase its working capital requirement by GH¢177,534. The company’s managers are considering three options for financing the additional working capital requirement:

Option 1 – Trade credit: The company buys about GH¢72,000 of food items per month on terms of “2.5/20, net 60.” Going forward, the company may choose to forgo the discount.
Option 2 – Factoring: The company enters a non-recourse factoring contract, under which the factor takes up the receivables to be created from the credit sales under the contract (i.e., GH¢120,000 per month) for a fee of 2% of the credit sales. The average collection period for the credit sales will remain at 45 days. The factor will advance up to 80% of the face value of the average receivables at an annual interest rate of 16%. It has been estimated that the factor’s services will save the company GH¢1,500 per month in debt collection costs.
Option 3 – Bank loan: The company takes a loan of GH¢197,260 at 15% from its bankers. A 10% compensating balance will be required.

Required:

i) Recommend the best financing option to the managers of the company based on annualized percentage cost.
(11 marks)

ii) Distinguish between “without recourse” factoring agreement and “with recourse” factoring agreement.
(4 marks)

b) Explain THREE (3) differences between a forward currency contract and a futures currency contract.
(5 marks)

Answer

Find Related Questions by Tags, levels, etc.

Tags: Bank Loan, Factoring, Forward Contracts, Futures Contracts, Trade Credit, Working Capital
Level: Level 2

Topic: Working Capital Management
Series: MAR 2024

FM – May 2019 – L3 – Q6 – Interest Rate Risk Management

Evaluate the effect of using interest rate futures to hedge a loan and compare the total cost after hedging with an interest rate guarantee.

Question

You are the head of the treasury group of Top Flight Aviation (TFA), a Nigerian company. The company operates chartered international flights for the elites in the country.

You have decided to hedge the relevant interest rate risk using interest rate futures. Your expectation is that interest rates will increase from 13% by 2% over the next three months.

In the month of March, the current price of Sterling 3-month futures is 87.25. The standard contract size is £500,000.

Required:

In each case, show the hedge efficiency. The time value of money, taxation, and margin requirements should be ignored.

The time value of money, taxation, and margin requirements should be ignored.

(Total: 15 Marks)

Answer

Find Related Questions by Tags, levels, etc.

Tags: Futures Contracts, Hedging, Interest Rate Futures, Loan financing
Level: Level 3

Topic: Interest Rate Risk Management

FM – May 2021 – L3 – Q4 – Foreign Exchange Risk Management

Evaluate economic exposure, forecast exchange rates with inflation, calculate expected receipts using forward and money-market hedges, and discuss problems with futures contracts.

Question

Kingston Plc. (KP) is a Nigerian company based in Aba. KP exports finished products to and imports raw materials from a company Central Africa, with currency of Central Dollar (C$).

KP has the following expected transactions:

You have collected the following information:

Money market rate for KP:

a. Discuss the significance to a multinational company of economic exposure. (5 Marks)

b. Explain how inflation rates can be used to forecast exchange rates. (3 Marks)

c. Calculate the expected naira receipts in one month and in three months using the forward market. (3 Marks)

d. Calculate the expected naira receipts in three months using a money-market hedge and recommend whether a forward market hedge or a money-market hedge should be used. (5 Marks)

e. Discuss FOUR possible problems of using futures contracts to hedge exchange rate risks. (4 Marks)

Answer

Find Related Questions by Tags, levels, etc.

Tags: Economic Exposure, Exchange Rates, Forward Contracts, Futures Contracts, Money market hedge
Level: Level 3

Topic: Foreign Exchange Risk Management

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.

Question

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

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

Answer

Find Related Questions by Tags, levels, etc.

Tags: Currency risk, Forward Contracts, Futures Contracts, Hedging, Interest Rate
Level: Level 2

Topic: Foreign exchange risk and currency risk management, Hedging with options
Series: MAY 2016

FM – Nov 2019 – L2 – Q3c – Futures and hedging with futures

Explain the differences between forward contracts and futures contracts.

Question

c) Explain TWO (2) differences between forward contracts and futures contracts. (5 marks)

Answer

Find Related Questions by Tags, levels, etc.

Tags: Derivatives, Forward Contracts, Futures Contracts
Level: Level 2

Topic: Futures and hedging with futures
Series: NOV 2019

FM – MAR 2024 – L2 – Q5 – Working Capital Management

Evaluates different financing options for working capital requirements and compares forward and futures currency contracts.

Question

Option 1 – Trade credit: The company buys about GH¢72,000 of food items per month on terms of “2.5/20, net 60.” Going forward, the company may choose to forgo the discount.
Option 2 – Factoring: The company enters a non-recourse factoring contract, under which the factor takes up the receivables to be created from the credit sales under the contract (i.e., GH¢120,000 per month) for a fee of 2% of the credit sales. The average collection period for the credit sales will remain at 45 days. The factor will advance up to 80% of the face value of the average receivables at an annual interest rate of 16%. It has been estimated that the factor’s services will save the company GH¢1,500 per month in debt collection costs.
Option 3 – Bank loan: The company takes a loan of GH¢197,260 at 15% from its bankers. A 10% compensating balance will be required.

Required:

i) Recommend the best financing option to the managers of the company based on annualized percentage cost.
(11 marks)

ii) Distinguish between “without recourse” factoring agreement and “with recourse” factoring agreement.
(4 marks)

b) Explain THREE (3) differences between a forward currency contract and a futures currency contract.
(5 marks)

Answer

Find Related Questions by Tags, levels, etc.

Tags: Bank Loan, Factoring, Forward Contracts, Futures Contracts, Trade Credit, Working Capital
Level: Level 2

Topic: Working Capital Management
Series: MAR 2024

Question Tag: Futures Contracts

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FM – May 2019 – L3 – Q6 – Interest Rate Risk Management

Evaluate the effect of using interest rate futures to hedge a loan and compare the total cost after hedging with an interest rate guarantee.

Required:

FM – May 2021 – L3 – Q4 – Foreign Exchange Risk Management

Evaluate economic exposure, forecast exchange rates with inflation, calculate expected receipts using forward and money-market hedges, and discuss problems with futures contracts.

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.

FM – Nov 2019 – L2 – Q3c – Futures and hedging with futures

Explain the differences between forward contracts and futures contracts.

FM – MAR 2024 – L2 – Q5 – Working Capital Management

Evaluates different financing options for working capital requirements and compares forward and futures currency contracts.

FM – May 2019 – L3 – Q6 – Interest Rate Risk Management

Evaluate the effect of using interest rate futures to hedge a loan and compare the total cost after hedging with an interest rate guarantee.

Required:

FM – May 2021 – L3 – Q4 – Foreign Exchange Risk Management

Evaluate economic exposure, forecast exchange rates with inflation, calculate expected receipts using forward and money-market hedges, and discuss problems with futures contracts.

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.

FM – Nov 2019 – L2 – Q3c – Futures and hedging with futures

Explain the differences between forward contracts and futures contracts.

FM – MAR 2024 – L2 – Q5 – Working Capital Management

Evaluates different financing options for working capital requirements and compares forward and futures currency contracts.

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