Topic: Foreign Exchange Risk Management

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  • 15 Marks

FM – Nov 2014 – L3 – SC – Q7 – Foreign Exchange Risk Management

Address the calculation of potential exchange rate losses, money market hedging, and the advantages and disadvantages of forward contracts.

  1. Build Nigeria Plc. (BNP) is a giant construction company with head office in Kano, Nigeria. It is involved in construction of roads, dams, airfields, etc., in many parts of the country. Recently, the company won construction contracts across a number of African countries. One of the contracts is for the construction of a dam for a country in Central Africa whose currency is Central African Dollar (C$). The dam has now been completed, and the retention money of C$210,000,000 is due for settlement in one year’s time.
    The current spot exchange rate is C$40 = N1. Risk-free rate is 5% in Nigeria and 25% in the foreign country.
    The Chief Finance Officer (CFO) of BNP is worried about the above financial statistics and concluded that BNP will lose as much as N840,000 due to exchange rate movements between now and the end of the year when the retention money is received.

    Required:
    Explain, showing all relevant calculations, how the CFO arrived at the potential loss of N840,000. (4 Marks)

    b. In another contract in a country in the ECOWAS sub-region (with currency of W$), BNP expects the following payment and receipt in six months’ time:
    You are provided with the following financial data:

    • Spot exchange rate:
      N per W$1 = 1.4735 – 1.4755
    • Money Market Rates:
      Deposit % Borrowing %
      Nigeria 13.25
      West African Country 6.5

    Required:
    Show how BNP can make use of money market hedge to mitigate the foreign exchange risk inherent in the above payment and receipt. Show all workings and the necessary steps.

    (7 Marks)

    c. Discuss TWO advantages and TWO disadvantages of forward exchange contracts.

    (4 Marks)

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  • 20 Marks

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.

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)

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  • 12 Marks

FM – May 2022 – L3 – Q6a – Foreign Exchange Risk Management

Evaluate hedging methods for a UK supplier payment of £5 million in three months.

a. You have worked with a major oil servicing company in Nigeria, with headquarters in the USA, for the past six years. Recently you completed your ICAN examinations, and you have been asked to join the international treasury department in New York City for a two-year attachment. The company is due to pay a UK supplier the sum of ₤5million in three months’ time. Your team is considering alternative methods of hedging the expected payment against adverse movements in exchange rate.

You are required to advise the company which of the following hedging strategies should be adopted for the payment due to be made in three months. Show all workings:
i. Forward contract (2 Marks)
ii. Currency futures (5 Marks)
iii. Currency options (5 Marks)

 

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  • 15 Marks

FM – Nov 2018 – L3 – Q6 – Foreign Exchange Risk Management

Evaluate foreign exchange hedging options for Alpha Plc’s expected receipt of Kudi and discuss non-financial risk reduction methods.

Alpha Plc. is a Nigerian manufacturer of plastic containers, selling across West African and other African countries. In three months, Alpha Plc. is due to receive 70 million Kudi from a Central African country. At today’s board meeting, the directors will discuss the need to hedge the foreign exchange exposure associated with this transaction and potential methods.

Three alternatives will be considered:

(i) Not to hedge this transaction;
(ii) Use a forward contract, with current exchange rates quoted by Alpha Plc.’s bank as follows:

  • Spot: 1.1548 – 1.1608 Kudi/N
  • 3 months forward: 1.1438 – 1.1508 Kudi/N
    (iii) Use an over-the-counter currency option on Kudi, available through Alpha Plc.’s bank. Current premiums at an exercise price of 1.1650 Kudi/N are N1.10 per 100 Kudi for a call option and N1.25 per 100 Kudi for a put option.

Required:

a. State four reasons why a firm might reasonably choose not to hedge its exposure to exchange rate risk. (4 Marks)

b. Show the effect of each of the three alternatives being considered, assuming that the spot exchange rate in three months’ time is:
i. 1.1850 – 1.1880 Kudi/N
ii. 1.1295 – 1.1320 Kudi/N (7 Marks)

c. State four methods available to firms to reduce their exposure to foreign exchange risks that do not involve the use of financial contracts. (4 Marks)

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  • 20 Marks

FM – Nov 2023 – L3 – SB – Q2 – Foreign Exchange Risk Management

Analyze hedging methods for foreign exchange risk involving a future CHF transaction.

About one year ago, you were employed by Tesco, an American company based in New York. You work online from home in Nigeria and are a member of the international treasury of Tesco.

Tesco supplies medical equipment to the USA and Europe and also buys some basic raw materials from Europe. It is currently 30 November 2024. On 31 May 2025, Tesco is due to receive CHF16.3 million from a Swiss customer and also to pay CHF4.0 million to a Swiss supplier.

Exchange rates (quoted as US$/CHF1):

  • Spot: 1.0292 – 1.0309
  • Three months forward: 1.0322 – 1.0341
  • Six months forward: 1.0356 – 1.0378

Annual interest rates available to Tesco:

  • Switzerland: 3.2% (investing), 4.4% (borrowing)
  • USA: 4.6% (investing), 5.8% (borrowing)

Currency futures (contract size CHF125,000, futures price quoted as US$ per CHF1):

  • Future price: December – 1.0306, March – 1.0336, June – 1.0369

Currency options (contract size CHF125,000; exercise price quotation US$ per CHF1, premium in US cents per CHF1):

Calls Puts
Dec Mar June Dec Mar June
1.0375 0.47 0.50 0.53 0.74 0.79 0.86

Required:

  • a. Calculate the net receipt if hedged using a forward contract. (4 Marks)
  • b. Calculate the net receipt if hedged using money market hedging. (8 Marks)
  • c. Calculate the net receipt if hedged using futures. (10 Marks)
  • d. Calculate the net receipt if hedged using options. (8 Marks)
    (Total: 30 Marks)

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  • 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.

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:

  1. 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)
  2. 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)
  3. 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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  • 15 Marks

FM – Nov 2014 – L3 – SC – Q7 – Foreign Exchange Risk Management

Address the calculation of potential exchange rate losses, money market hedging, and the advantages and disadvantages of forward contracts.

  1. Build Nigeria Plc. (BNP) is a giant construction company with head office in Kano, Nigeria. It is involved in construction of roads, dams, airfields, etc., in many parts of the country. Recently, the company won construction contracts across a number of African countries. One of the contracts is for the construction of a dam for a country in Central Africa whose currency is Central African Dollar (C$). The dam has now been completed, and the retention money of C$210,000,000 is due for settlement in one year’s time.
    The current spot exchange rate is C$40 = N1. Risk-free rate is 5% in Nigeria and 25% in the foreign country.
    The Chief Finance Officer (CFO) of BNP is worried about the above financial statistics and concluded that BNP will lose as much as N840,000 due to exchange rate movements between now and the end of the year when the retention money is received.

    Required:
    Explain, showing all relevant calculations, how the CFO arrived at the potential loss of N840,000. (4 Marks)

    b. In another contract in a country in the ECOWAS sub-region (with currency of W$), BNP expects the following payment and receipt in six months’ time:
    You are provided with the following financial data:

    • Spot exchange rate:
      N per W$1 = 1.4735 – 1.4755
    • Money Market Rates:
      Deposit % Borrowing %
      Nigeria 13.25
      West African Country 6.5

    Required:
    Show how BNP can make use of money market hedge to mitigate the foreign exchange risk inherent in the above payment and receipt. Show all workings and the necessary steps.

    (7 Marks)

    c. Discuss TWO advantages and TWO disadvantages of forward exchange contracts.

    (4 Marks)

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  • 20 Marks

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.

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)

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  • 12 Marks

FM – May 2022 – L3 – Q6a – Foreign Exchange Risk Management

Evaluate hedging methods for a UK supplier payment of £5 million in three months.

a. You have worked with a major oil servicing company in Nigeria, with headquarters in the USA, for the past six years. Recently you completed your ICAN examinations, and you have been asked to join the international treasury department in New York City for a two-year attachment. The company is due to pay a UK supplier the sum of ₤5million in three months’ time. Your team is considering alternative methods of hedging the expected payment against adverse movements in exchange rate.

You are required to advise the company which of the following hedging strategies should be adopted for the payment due to be made in three months. Show all workings:
i. Forward contract (2 Marks)
ii. Currency futures (5 Marks)
iii. Currency options (5 Marks)

 

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  • 15 Marks

FM – Nov 2018 – L3 – Q6 – Foreign Exchange Risk Management

Evaluate foreign exchange hedging options for Alpha Plc’s expected receipt of Kudi and discuss non-financial risk reduction methods.

Alpha Plc. is a Nigerian manufacturer of plastic containers, selling across West African and other African countries. In three months, Alpha Plc. is due to receive 70 million Kudi from a Central African country. At today’s board meeting, the directors will discuss the need to hedge the foreign exchange exposure associated with this transaction and potential methods.

Three alternatives will be considered:

(i) Not to hedge this transaction;
(ii) Use a forward contract, with current exchange rates quoted by Alpha Plc.’s bank as follows:

  • Spot: 1.1548 – 1.1608 Kudi/N
  • 3 months forward: 1.1438 – 1.1508 Kudi/N
    (iii) Use an over-the-counter currency option on Kudi, available through Alpha Plc.’s bank. Current premiums at an exercise price of 1.1650 Kudi/N are N1.10 per 100 Kudi for a call option and N1.25 per 100 Kudi for a put option.

Required:

a. State four reasons why a firm might reasonably choose not to hedge its exposure to exchange rate risk. (4 Marks)

b. Show the effect of each of the three alternatives being considered, assuming that the spot exchange rate in three months’ time is:
i. 1.1850 – 1.1880 Kudi/N
ii. 1.1295 – 1.1320 Kudi/N (7 Marks)

c. State four methods available to firms to reduce their exposure to foreign exchange risks that do not involve the use of financial contracts. (4 Marks)

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  • 20 Marks

FM – Nov 2023 – L3 – SB – Q2 – Foreign Exchange Risk Management

Analyze hedging methods for foreign exchange risk involving a future CHF transaction.

About one year ago, you were employed by Tesco, an American company based in New York. You work online from home in Nigeria and are a member of the international treasury of Tesco.

Tesco supplies medical equipment to the USA and Europe and also buys some basic raw materials from Europe. It is currently 30 November 2024. On 31 May 2025, Tesco is due to receive CHF16.3 million from a Swiss customer and also to pay CHF4.0 million to a Swiss supplier.

Exchange rates (quoted as US$/CHF1):

  • Spot: 1.0292 – 1.0309
  • Three months forward: 1.0322 – 1.0341
  • Six months forward: 1.0356 – 1.0378

Annual interest rates available to Tesco:

  • Switzerland: 3.2% (investing), 4.4% (borrowing)
  • USA: 4.6% (investing), 5.8% (borrowing)

Currency futures (contract size CHF125,000, futures price quoted as US$ per CHF1):

  • Future price: December – 1.0306, March – 1.0336, June – 1.0369

Currency options (contract size CHF125,000; exercise price quotation US$ per CHF1, premium in US cents per CHF1):

Calls Puts
Dec Mar June Dec Mar June
1.0375 0.47 0.50 0.53 0.74 0.79 0.86

Required:

  • a. Calculate the net receipt if hedged using a forward contract. (4 Marks)
  • b. Calculate the net receipt if hedged using money market hedging. (8 Marks)
  • c. Calculate the net receipt if hedged using futures. (10 Marks)
  • d. Calculate the net receipt if hedged using options. (8 Marks)
    (Total: 30 Marks)

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  • 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.

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:

  1. 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)
  2. 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)
  3. 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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