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a) Markwei Pharmaceuticals Ltd plans to import active ingredients to produce vitamin syrup. The company’s managers are considering three financing options for the cedi equivalent of an invoice value of GH¢2.5 million. The options are detailed below:
Option 1: Use supplier’s credit. The credit term is 1.5/10 net 45.
Option 2: Issue a commercial paper to raise the money from the Ghanaian money market. The commercial paper will pay interest at the rate of 18% per annum. Issue costs totaling GH¢15,000 will be incurred.
Option 3: Obtain a 3-month bank loan. The interest rate on the loan is 22% per annum. Loan arrangement and processing fees are expected to be GH¢5,000.
Required:
i) Compute the effective annual cost of each financing option and recommend the most cost-effective option. (10 marks)
ii) Explain TWO (2) advantages of financing the invoice through the issue of a commercial paper instead of a bank loan. (5 marks)
b) Abongo Shoes Ltd (Abongo) imports leather from Italy. Abongo’s demand for euros to settle its import bills exposes its cash flow to foreign exchange risk. Abongo’s Management is looking for internal strategies they can deploy to hedge the company’s currency risk exposure as external hedging strategies might be too expensive for the company.
Required:
Explain TWO (2) internal strategies for managing foreign currency risk exposures that Abongo’s Management can use. (5 marks)
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The recent financial sector clean-up in Ghana has created tough economic times for borrowers and investors and has tightened Financial Institutions’ appetite for granting credit and depositors’ appetite for depositing or placing funds with Financial Institutions, thereby creating a tight liquidity situation in the market.
Required:
As an expert in Financial Management, explain the difference between credit risk and liquidity risk. (3 marks)
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a) Payback method refers to the period of time it takes for the cash flows to cover the initial cost of investment or recoup the initial cost of investment. The period is usually calculated in years.
Required:
Identify TWO advantages and TWO disadvantages of using the payback method in investment appraisal.
(4 marks)
b) DÉCOR Ltd is analyzing the purchase of a new machine to produce product Z. The machine is expected to cost GH¢2,000,000. Production and sales of product Z are forecast as follows:
| Year | 1 | 2 | 3 | 4 |
|---|---|---|---|---|
| Production & Sales (units/year) | 70,000 | 106,000 | 150,000 | 72,000 |
The current selling price is GH¢30 per unit and is expected to increase by 5% a year. The current variable cost is GH¢18 per unit and is expected to increase by 6% per year. Fixed costs will remain the same, but an increase in working capital is required. Analysis of historical data of the levels of working capital of product Z indicates that, at the start of each year, investment in working capital will need to be 10% of sales revenue of that year.
The company pays tax at 25% per year in the year in which taxable profit occurs. The tax liability is reduced by the capital allowance on the machinery, and DÉCOR Ltd can claim on a straight-line basis over the four-year life of the proposed investment (capital allowance rate of 25% per annum). The new machine will have zero scrap value at the end of the four years. The cost of capital is 15% per year.
Required:
Calculate the Net Present Value (NPV) of the proposed investment and advise whether the proposed investment should be undertaken.
(11 marks)
c) An American company sells goods to a Ghanaian buyer for US$280,000 when the exchange rate is $1 = GH¢4.20. The Ghanaian buyer is allowed three months’ credit, and when the American company eventually receives the US dollars three months later and exchanges them for dollars, the exchange rate has moved to $1 = GH¢4.60.
Required:
i) What was the foreign exchange loss to the Ghanaian buyer?
(3 marks)
ii) Explain currency risk in relation to the above.
(2 marks)
iii) Explain transaction risk in relation to the above.
(2 marks)
iv) What will be the effect of the above on the company’s trading profits?
(3 marks)
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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:
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)
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a) You have been appointed as the Finance Manager of Jaja Ltd and the expectation of the board is for you to provide education and working solution to their foreign exchange losses problem which your predecessor had no clue.
How will you explain the following? i) Foreign Exchange Risk (2 marks)
ii) Transaction Risk (2 marks)
iii) Translation Risk (2 marks)
iv) Economic Risk (2 marks)
b) Kaluu Ltd is a listed company on the Ghana Stock Exchange Market and showed the following performance. The following information was made available to you:
Required: i) What is the estimated cost of equity using the dividend growth model? (3 marks)
ii) What is the estimated cost of equity using the Capital Assets Pricing model? (3 marks)
c) i) Distinguish between repurchase agreement (repos) and reverse repos. (3 marks)
ii) A company enters into an agreement with a bank and it sells GH¢10 million government bonds with an obligation to buy back the security in 60 days. If the rate is 8.2%, what is the repurchase price of the bond? Assume 365 days in a year. (3 marks)
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Ahuodzen Pharmaceutical Ltd (Ahuodzen) imports chemicals to produce medicines in Ghana. It has received a consignment of chemicals from a supplier in India. The invoice value of US$2 million is payable two months from now. The Treasury Manager of Ahuodzen is worried about volatility in the cedi to US dollar exchange rate.
Required:
Explain how local currency invoicing would be used as a strategy for managing currency risk exposures and advise the Treasury Manager on the benefit and risk of handling Ahuodzen’s currency risk exposure using local currency invoicing. (5 marks)
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a) Adjei Departmental Stores’ demand for cash has been quite volatile recently, with the standard deviation in daily cash demand rising to GH¢60,000. The managers of the company are therefore considering using the Miller-Orr model to manage its cash flows. The minimum cash balance would be set to GH¢300,000. The annual interest rate is expected to be 18.25% while the cost of trading investments in securities is GH¢10,000 per transaction.
Required:
i) Compute the cash return point. (4 marks)
ii) Compute the upper cash limit. (2 marks)
iii) Explain how the minimum cash limit, upper cash limit, and cash return point would be used to manage the cash balances of Adjei Departmental Stores. (3 marks)
b) The Founder of a growing technology company has questioned her Chief Finance Officer about the company’s holdings of cash in demand deposit accounts and on hand when the money could be invested in financial securities for returns.
Required:
Explain to the Founder THREE (3) motives for holding cash. (6 marks)
c) Serwaa Home Décor Ltd, a trading company based in Ghana, usually buys foreign currency to settle invoices for imports. The Treasury Manager is considering ways of hedging the company’s foreign currency risk exposures. After considering various options available to her, she has settled on both forwards and futures contracts.
Required:
Explain TWO (2) advantages of currency forwards over currency futures contract. (5 marks)
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Exactly two years ago, JBL Plc took a 5-year US$ 20 million loan at a fixed interest of 12% from an investment bank to finance a plant expansion project. At the time the loan was taken, JBL was exporting a significant proportion of its output to a foreign market. Thus, it was sure that it would be able to earn U.S. dollars to make dollar payments on the loan. For about a year now, JBL has not been able to export its output to its foreign market due to trade restrictions. It sells only to buyers in Ghana for the Ghana cedi. The company now prefers to have its interest obligation in Ghana cedi rather than U.S. dollar.
On the advice of the Treasury Manager, JBL has entered a currency swap arrangement with a bank to manage the underlying risk exposure. Per the terms of the swap, JBL will continue to honour its obligations under the actual loan. Under the swap, JBL and the bank will exchange interests and principals in the appropriate currencies. With a pre-arranged exchange rate of GH¢6.5000/USD1, the notional principals under the swap arrangement are agreed at US$20 million and GH¢130 million. The 12% interest rate on the existing dollar loan will continue to apply to both the original dollar loan and the dollar interest payments under the swap arrangement. The interest rate that will apply to the cedi notional principal is set to 15%.
Required:
Evaluate how JBL Plc can use the currency swap to manage the underlying risk exposure. (5 marks)
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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:
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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a) Jeanne Cosmetics Ltd is located in Taifa and is now considered as the leader of organic and natural cosmetic products in the municipality. Per the cash management policy of Jeanne Cosmetics Ltd, any excess cash that is idle for more than three months should be invested. Three months ago, the company invested GH¢100,000 of idle cash in a 3-month fixed deposit account. The investment matures today, and the company will receive a maturity value of GH¢105,000.
Required:
i) Compute the interest rate earned on the account over the investment holding period. (2 marks)
ii) Suppose the interest rate on the account remains the same, and the company rolls over the principal, compute the annual simple interest rate on the investment. (2 marks)
iii) Suppose the interest rate on the account remains the same and the company rolls over both the principal and interests, compute the annual compound interest rate on the investment. (2 marks)
b) Apphia Fabrics Ltd plans to replace its existing manufacturing plant with a newer version in three years’ time. The replacement cost of the existing plant is GH¢10 million currently. However, experts forecast that the cost of the newer version of the plant will be GH¢12 million in three years’ time.
On the advice of the Finance Manager, the company will start saving from now to raise the required amount to buy the plant in three years’ time. Consequently, the company has signed an investment agreement with DT Financial Services Ltd. Per the agreement, the company will deposit equal amounts into an interest-bearing account at the beginning of each of the next three years. The annual nominal interest rate on the account is 16%, but interest will be compounded monthly.
Required:
Compute the equal annual deposit required to raise the required amount in three years’ time. (4 marks)
c) Aduro Pharmaceuticals Plc is a Ghana-based multinational company with a production facility in India and marketing subsidiaries in some West African countries. The Treasury Department of the company is considering strategies for managing its foreign exchange risk exposures. In particular, the Treasury Department is concerned about the following two cases of foreign exchange risk exposures:
Case 1:
The exchange rate between the Ghanaian cedi (GH¢) and the British pound sterling (GBP) is currently GH¢8.1125/GBP1. The company recently borrowed GBP500,000 from an offshore bank to buy active chemicals for the production of paracetamol syrup. The loan is to be paid in six months’ time. Market pundits project that the Ghanaian cedi would depreciate against the pound sterling over the next six months.
Case 2:
The exchange rate between the Ghanaian cedi (GH¢) and the Indian rupee (INR) is currently GH¢0.0799/INR1. The company’s production subsidiary in India presents its financial statements in the Indian rupee. The net worth of this production subsidiary in India is INR20 million. The company would be preparing its consolidated financial statements in a few months’ time. Market pundits project that the Ghanaian cedi will appreciate against the Indian rupee.
Required:
i) For each case, identify the type of currency risk exposure the company is facing. (2 marks)
ii) In respect of Case 1, recommend TWO (2) internal strategies and TWO (2) external hedging strategies the Treasury Department can use to manage the foreign exchange risk exposure. (8 marks)
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d) ValuePack Ghana Ltd is into the manufacturing and sale of drugs in Ghana. The company imports its raw materials from abroad on credit. The suppliers grant them between 3 months and 6 months credit due to their good track record in payment. The company currently has the following invoices due in:
They are looking to buy USD/GH¢ forward to hedge their exchange rate risk, and their bank offers them the following forward rates:
The interest rates applicable to their company for both cedi and US dollar for the same tenors are as follows:
| Tenor | GH¢ Interest Rate | USD Interest Rate |
|---|---|---|
| 3 months | 15% | 2% |
| 6 months | 20% | 3% |
The Spot rate for USD/GH¢ is 5.4 in the market.
Required:
As the newly appointed Finance and Treasury Director of the company, calculate the forward rates for the various tenors based on the information provided above. (5 marks)
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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;
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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a) Onana Events Company (Onana) is purchasing a building from a real estate company. The current cash price of the building is GH¢2,500,000. Onana can obtain a GH¢2,500,000 mortgage loan to finance the payment of the cash price of the building. The loan bears a compound annual interest rate of 18% and calls for equal payments at the end of each quarter for 20 years.
Required:
i) Compute the quarterly payment.
(4 marks)
ii) Compute the total interest that will be paid by Onana to the mortgage company over the life of the loan.
(2 marks)
iii) Suppose the real estate company is offering a credit payment plan to Onana. Per the credit terms, Onana will have to pay GH¢500,000 now and then pay GH¢110,000 at the end of each month for one year. The implicit interest rate is 20% per annum. Compute the aggregate present value of the payments under this option.
(4 marks)
b) Sempe Ghana Plc needs to have EUR650,000 in two months’ time to settle a trade payable. The management team fears that the cedi would depreciate against the euro in the coming months. The team is however divided over whether the currency risk exposure should be hedged using a forward foreign exchange contract or a futures foreign exchange contract. The following quotations have been obtained from Ghana’s foreign exchange market:
| FX Quotation | Bid Rate | Ask (Offer) Rate |
|---|---|---|
| Spot Rate | GH¢12.1854/EUR1 | GH¢12.4854/EUR1 |
| 2-month Forward Rate | GH¢12.5854/EUR1 | GH¢12.8854/EUR1 |
Required:
i) Explain to the management of Sempe Ghana Ltd whether the foreign exchange quotations provided above are direct quotations or indirect quotations.
(5 marks)
ii) Suppose the company uses the forward contract to hedge its currency exposure. Compute the outcome of the forward contract hedge.
(5 marks)
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Universal Plastics Ghana Ltd imported raw materials from U.S.A. and Europe for the manufacture of plastic products. The company entered into option contracts with ZAA Bank Ghana Ltd to hedge its six months’ currency risk or exposure. The details of the option contracts are as follows:
| Details | Transaction Amount | Strike Price/ Exchange Rate | Spot Rate on Maturity Date | Option Premium Paid to the Bank |
|---|---|---|---|---|
| OPTION A | Bought Call option to buy USD against GH¢ | US$10m | USD/GH¢ 4.7 | USD/GH¢ 4.5 |
| OPTION B | Bought Call option to buy EURO against GH¢ | EUR 8m | EUR/GH¢ 5.9 | EUR/GH¢ 6.3 |
Required:
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b. Skytrain, a music production company, imported musical instruments from Sweden for Krona 2,100,000 at a rate of Krona 7.00 to GH₵1.00. Skytrain sold the goods for GH₵600,000 after paying shipping cost of GH₵50,000 and bank transfer charges of GH₵5,000 and Krona 10,000. At the time of paying the bank charges, the Krona was traded at 5 to GH₵1.00.
Required:
Calculate the profit or loss on this transaction. (5 marks)
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Find Related Questions by Tags, levels, etc.
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