- 20 Marks
FM – NOV 2021 – L2 – Q3 – Foreign exchange risk and currency risk management
Computation of future value of deposits under different scenarios, currency risk hedging strategy, and explanation of swap contracts.
Question
a) You are the assistant to the Finance Manager of Kunta Medical Centre. Your boss is negotiating a deal with an investment company investing GH¢500,000 over 3 years. The main terms of the proposed investment deal are that if the amount is deposited now and invested continuously for 3 years, it would attract an 18% annual interest rate with quarterly compounding. However, if the initial deposit of GH¢500,000 is maintained and additional deposits of GH¢50,000 each are made at the beginning of year 2 and year 3, the deposits would attract 18.0% annual interest in year 1, 18.5% in year 2, and 19% in year 3, all with quarterly compounding.
Your boss has asked you to do some computations to inform her about the growth of the deposits based on the terms of the proposed deal.
Required:
i) Suppose GH¢500,000 is deposited now, and there are no top-up deposits in the future; Compute the future value of the deposit at the end of the third year. (3 marks)
ii) Suppose the initial deposit of GH¢500,000 is made now, and the top-up deposits of GH¢50,000 each are made in the future per the terms of the proposed investment deal;
- Compute the future value of the initial deposit at the end of the third year. (3 marks)
- Compute the aggregate future value of the top-up deposits at the end of the third year. (3 marks)
- Compute the aggregate future value of all the deposits at the end of the third year. (1 mark)
b) Sesamu Dried Fruits Ltd is a fruits processing company in Ghana. The company has exported raw mangoes to a distributor in Japan. The invoice value of JP¥20 million is to be collected in three months. The exchange rate between the Ghanaian cedi (GH¢) and the Japanese yen (JP¥) is currently GH¢0.0584/JP¥1. It is expected that the Ghana cedi may appreciate against the JP¥ in the coming months.
Required:
Using the leading and lagging strategy for hedging currency risk exposure, is it advisable for the company to lag the collection of the JP¥ invoice value? (5 marks)
c) COVID-19 has led to volatility in the international money market. Although international business has seen some improvement, progress has been very slow. As a result, the risk of losing part of an investment due to exchange rate and currency value fluctuations are very high.
Required:
Explain how Interest Rate Swap and Currency Swap can be used to mitigate the effects of market volatility. (5 marks)
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