Question Tag: Money market hedge

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  • 10 Marks

SCS – Dec 2022 – L3 – Q5 – Financial management

Calculate the required loan, interest earned, and the Cedi gain or loss from a money market hedge.

The Board has directed the CEO to take the necessary steps to arrange with its bankers, a money market hedge for the expected receipts from DMP, to protect the company against the downside risk of expected Cedi appreciation.

Required:
As the Financial Controller of the company, the CEO has asked you to calculate the following relating to money market hedge:

a) The initial dollar amount of loan that TCWL could take from the bank in Cameroon on 1 December 2022 and the cedi equivalent of the initial loan if converted on the same date. (3 marks)
b) The total Cedi amount and interest the company will earn by 31 May 2023, if the converted amount is invested in Ghana for the duration of the money market hedge. (3 marks)
c) The Cedi gain or loss that TCWL would make by hedging. (2 marks)
d) The effective forward rate of the Cedi to U.S. dollar on 31 May 2023. (2 marks)

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  • 20 Marks

FM – Nov 2023 – L2 – Q3 – Introduction to Investment Appraisal

Evaluate the best pay-out option for a life insurance policy, compute the annual deposit for a sinking fund, and calculate the outcome of a money market hedge.

a) Eleven years ago, Mr. and Mrs. Akolgo signed onto a joint life insurance policy, which pays out benefits to the surviving spouse when one of them dies. Mrs. Akolgo died a couple of months ago, and Mr. Akolgo has applied for the payment of benefits due him.
He has been presented with three pay-out options to choose from:
Option A: A lump sum payment of GH¢400,000 now.
Option B: A payment of GH¢100,000 now plus quarterly payments of GH¢22,000 at the end of each quarter over the next ten years.
Option C: A monthly payment of GH¢10,000 for life.
The average interest rate in the economy is 25 % per annum.

Required:
Using relevant computations, recommend to Mr. Akolgo the best pay-out option. (6 marks)

b) Gaazie Mining Company (Gaazie) borrows GH¢5 million at a compound interest rate of 28% per annum for five years. Per the terms of the loan agreement, Gaazie will pay interest on the loan monthly over the life of the loan and then make a bullet payment for the principal of the loan at the end of five years.
The managers of the company have decided to deposit equal annual amounts in an interest-bearing savings account to raise money to pay off the loan principal in five years’ time. Interest on the deposits will be paid at a compound rate of 15% per annum.

Required:
Compute the annual deposit Gaazie needs to pay into the savings account. (4 marks)

c) Tofiakwa Ltd is expecting the following in six months’ time:
Receipt: US$700,000
Payment: US$1,200,000
The spot exchange rate between the Ghanaian cedi and the U.S. dollar is currently GH¢11.1255(buy) – GH¢11.5581(sell) to US$1. The cedi-dollar exchange rate has been volatile in recent times, hence the managers of the company have decided to manage the company’s U.S. dollar exposure using a money market hedge.

The following data has been gathered from the Ghanaian and the U.S. money markets:

6-month interest rates Borrowing Investing
U.S. dollar 10.00% 8.00%
Ghanaian cedi 25.00% 18.00%

Required:
i) Set up or construct the money market hedge for the currency exposure. (3 marks)
ii) Calculate the net outcome of the hedge. (7 marks)

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  • 10 Marks

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.

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)

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Has Case Study
  • 10 Marks

SCS – Dec 2022 – L3 – Q5 – Financial management

Calculate the required loan, interest earned, and the Cedi gain or loss from a money market hedge.

The Board has directed the CEO to take the necessary steps to arrange with its bankers, a money market hedge for the expected receipts from DMP, to protect the company against the downside risk of expected Cedi appreciation.

Required:
As the Financial Controller of the company, the CEO has asked you to calculate the following relating to money market hedge:

a) The initial dollar amount of loan that TCWL could take from the bank in Cameroon on 1 December 2022 and the cedi equivalent of the initial loan if converted on the same date. (3 marks)
b) The total Cedi amount and interest the company will earn by 31 May 2023, if the converted amount is invested in Ghana for the duration of the money market hedge. (3 marks)
c) The Cedi gain or loss that TCWL would make by hedging. (2 marks)
d) The effective forward rate of the Cedi to U.S. dollar on 31 May 2023. (2 marks)

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  • 20 Marks

FM – Nov 2023 – L2 – Q3 – Introduction to Investment Appraisal

Evaluate the best pay-out option for a life insurance policy, compute the annual deposit for a sinking fund, and calculate the outcome of a money market hedge.

a) Eleven years ago, Mr. and Mrs. Akolgo signed onto a joint life insurance policy, which pays out benefits to the surviving spouse when one of them dies. Mrs. Akolgo died a couple of months ago, and Mr. Akolgo has applied for the payment of benefits due him.
He has been presented with three pay-out options to choose from:
Option A: A lump sum payment of GH¢400,000 now.
Option B: A payment of GH¢100,000 now plus quarterly payments of GH¢22,000 at the end of each quarter over the next ten years.
Option C: A monthly payment of GH¢10,000 for life.
The average interest rate in the economy is 25 % per annum.

Required:
Using relevant computations, recommend to Mr. Akolgo the best pay-out option. (6 marks)

b) Gaazie Mining Company (Gaazie) borrows GH¢5 million at a compound interest rate of 28% per annum for five years. Per the terms of the loan agreement, Gaazie will pay interest on the loan monthly over the life of the loan and then make a bullet payment for the principal of the loan at the end of five years.
The managers of the company have decided to deposit equal annual amounts in an interest-bearing savings account to raise money to pay off the loan principal in five years’ time. Interest on the deposits will be paid at a compound rate of 15% per annum.

Required:
Compute the annual deposit Gaazie needs to pay into the savings account. (4 marks)

c) Tofiakwa Ltd is expecting the following in six months’ time:
Receipt: US$700,000
Payment: US$1,200,000
The spot exchange rate between the Ghanaian cedi and the U.S. dollar is currently GH¢11.1255(buy) – GH¢11.5581(sell) to US$1. The cedi-dollar exchange rate has been volatile in recent times, hence the managers of the company have decided to manage the company’s U.S. dollar exposure using a money market hedge.

The following data has been gathered from the Ghanaian and the U.S. money markets:

6-month interest rates Borrowing Investing
U.S. dollar 10.00% 8.00%
Ghanaian cedi 25.00% 18.00%

Required:
i) Set up or construct the money market hedge for the currency exposure. (3 marks)
ii) Calculate the net outcome of the hedge. (7 marks)

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  • 10 Marks

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.

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)

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