- 20 Marks
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)
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