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Microsoft Word - N1548 A2 TAP XXXXXXXXXXdocx 1 N1548 International Financial Management Assessment Period: May/June 2020 (A2) Duration: 24 hour Take-Away Paper Candidates should attempt ALL questions...

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Microsoft Word - N1548 A2 TAP XXXXXXXXXXdocx
1

N1548 International Financial Management


Assessment Period: May/June 2020 (A2)


Duration: 24 hour Take-Away Paper
Candidates should attempt ALL questions in Section A and Section B

Instructions:
1) The paper will available from: Wednesday 27 May at 10am (UK time)
2) The deadline for submitting the exam is: Thursday 28 May at 10am (UK time)
3) The exam is an individual work, ca
ied out upholding the values of academic integrity.
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own knowledge when answering the questions. All assumptions and information
needed for the questions are provided in this paper, DO NOT access the internet for
help with your answer or to get additional information.
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Microsoft Word, clearly stating which question you are attempting.
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does not include equations and graphs.
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8) Information on format of submission: Submit a MICROSOFT WORD version of the
exam paper using the appropriate link on Canvas.
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XXXXXXXXXX between 10am and 12pm UK time on
the day the TAP is released. Only queries received during this time will be looked
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Section A [60 marks]

Case study: British Powerful Material

It is Friday evening, April 1st 2017. Ramon Sanchez, assistant treasurer at the
British Powerful Material (BPM), sits in his office in Liverpool Street, London. It’s the
weekend, Ramon and his partner have a dinner reservation with another couple at the
Shard at 8pm. “I must get this hedging note done as soon as possible”, thinks Ramon.
Foreign exchange options? I had better get the story right before the CFO starts asking
questions. Let’s see, I am facing crucial decisions related to two situations: one is to
hedge a dividend receivable due on October 1st, from the subsidiary BPM Germany.
The other is to hedge our upcoming payment to the Korean Company Matsukwon for
their spring wireless rooters’ statement (July 1st). With the Korean Won at
1420KRW/GBP and appreciating, I’m glad we haven’t covered the payment so far, but
now I’m getting nervous and I would like to protect ourselves. A decision to buy Won
on July 1st might be just the thing, but it’s a very critical decision”.
Before we discuss the financial situation, let us learn a bit about BPM. British
Powerful Material is a £10 billion sales company engaged in, among other things, the
development, production, selling and marketing of technology equipment. Although 30
percent of the firm’s sales are cu
ently a
oad, the firm has full-fledged manufacturing
facilities in four foreign countries: Germany, Australia, Argentina and South Africa. An
assembly plant in India exists primarily to solder Korean Rooter boards onto circuit
oards and to screw these into Argentinian-made boxes for shipment to South Africa,
Australia, and Germany.
The German subsidiary has developed half of its sales to France, the
Netherlands, and Italy, billing in euros. BPM Germany has accumulated a cash
eserve of EUR1,080,000, worth GBP900,000 at today’s exchange rate. BPM has an
automatic permission from BPM Germany to repatriate EUR2,000,000 by October 1st.
BPM has an agreement to buy 30,000 Wireless Rooter boards at KRW90,000
each semi-annually, and it is this payment that will fall due on July 1st.
The classic means of hedging foreign exchange are forward and future contracts.
These however, are fixed obligations and inviolable. In many cases, there is a good
chance that cash inflows or outflows won’t materialise for different reasons.In such
cases, what is needed is somehow the right, not the obligation, to buy or sell a specific
3

cu
ency at a specific price, and this is what an option precisely provides. There are
surely other means to hedge including using the money market or swap markets, but
each has its own features and could be suitable depending on the scenario a hedger
is facing.
Returning to Ramon, we find that he has printed a lot of financial information from
the markets through the Bloomberg Terminals, and could be summarised as follow:
Table 1: Cu
ency Spot rates:
GBP/EUR 1.20
GBP/USD 1.34
EUR/USD 1.11
GBP/AUD 1.96
GBP/ARS 6.61
GBP/ZAR 23.40
GBP/KRW 1420
GBP/INR 95.33


Table 2: Forward rates
1month
GBP/EUR 1.24
GBP/USD 1.33
EUR/USD 1.14
GBP/KRW1400
2months
GBP/EUR 1.26
GBP/USD 1.32
EUR/USD 1.13
GBP/KRW1380
3months
GBP/EUR 1.28
GBP/USD 1.30
EUR/USD 1.13
GBP/KRW1360
6months
GBP/EUR 1.30
GBP/USD 1.28
EUR/USD 1.12
GBP/KRW1340
7months
GBP/EUR 1.32
GBP/USD 1.28
EUR/USD 1.13
GBP/KRW1320


Table 3. PUT option: premium is 1.5%
Note: The option is always applicable on the unit cu
ency and premium is paid
with the unit cu
ency. For example, for a put or call option with GBP/USD1.28
the option premium is paid in GBP for selling or buying the GBP.
1month
GBP/EUR 1.22
GBP/USD 1.34
EUR/USD 1.15
GBP/KRW1410
2months
GBP/EUR 1.24
GBP/USD 1.33
EUR/USD 1.14
GBP/KRW1400
3months
GBP/EUR 1.26
GBP/USD 1.32
EUR/USD 1.13
GBP/KRW 1380
6months
GBP/EUR 1.38
GBP/USD 1.30
EUR/USD 1.13
GBP/KRW1360
7months
GBP/EUR 1.30
GBP/USD 1.28
EUR/USD 1.12
GBP/KRW1340


4


Table 4. Call options: premium is 2%
Note: The option is always applicable on the unit cu
ency and premium is paid
with the unit cu
ency. For example, for a put or call option with GBP/USD1.28
the option premium is paid in GBP for selling or buying the GBP.
CALL options
1month
GBP/EUR 1.28
GBP/USD 1.33
EUR/USD 1.15
GBP/KRW1410

2months
GBP/EUR 1.30
GBP/USD 1.32
EUR/USD 1.14
GBP/KRW1410

3months
GBP/EUR 1.32
GBP/USD 1.31
EUR/USD 1.13
GBP/KRW 1390

6months
GBP/EUR 1.34
GBP/USD 1.31
EUR/USD 1.13
GBP/KRW1370

7months
GBP/EUR 1.36
GBP/USD 1.28
EUR/USD 1.12
GBP/KRW1360


Table 5: Money Market rates of each country:
UK
1month
3.4%

2months
3.7%

3months
4%

6months
4.3%

7months
5%
US
1month
3.1%

2months
3.3%

3months
3.5%

6months
3.7%

7months
3.9%
EU
1month
4.1%

2months
4.3%

3months
4.5%

6months
4.8%

7months
5.1%
India
1month
5.1%

2months
5.4%

3months
5.7%

6months
6.1%

7months
6.3%
South Korea
1month
4.2%

2months
4.25%

3months
4.40%

6months
4.63%

7months
4.99%


Table 6: Yearly Inflation rates of each country (applicable for the next 5 years)
• UK: 2.4%
• US: 1.8%
• Germany: 2%
• South Korea: 1.4%
• India: 3.8%
• South Africa: 3.4%
• Argentina: 2.6%
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Table 7: BPM’s financial information:
- Revenue of the year 2017: £10 billion
- Total value: £20 billion
- Equity value: £7 billion
- Required return on equity: 13%
- Cost of debt: 8%
- Corporate tax: 17%
- Average Income tax in the UK: 21%

Questions
Please answer the following questions to assist Mr. Ramon in his analysis of cu
ency
hedging for his report to the Finance department of the company:
1. Analyse and compare the different hedging strategies to hedge the exposures
from the expected transactions of Germany and South Korea. You must provide
detailed calculations for ALL HEDGING TECHNIQUES that you may think are
elevant. (Cu
ency Swap calculation is not required in this question).
[20 marks]
2. Identify which hedging technique is most suitable for Ramon’s cases. You must
provide precise interpretation to defend the chosen tools. While doing so,
explain why the other technique(s) are not suitable. [10 marks]
3. Ramon is now considering a cu
ency swap a
angement to manage the
exposure from the
Answered Same Day May 27, 2021

Solution

Kushal answered on May 28 2021
132 Votes
Section A British Powerful Material
Question 1
There are four hedging options available for BPM.
1. Money Market hedging
2. Forward agreements
3. Cu
ency Options
4. Cu
ency swaps
However, we will not look into the detailed calculations of the cu
ency swaps here and we will focus only on the first three options for the calculations.
BPM Germany to transfer 2,000,000 Euros to BPM UK after 6 months –
1. Money Market hedge –
Money market hedge tries to lock in the cu
ent exchange rate adjusted for the money market rates. This is the basis of the interest rate covered parity and the effective transaction happens for the a
itrage free rate prevailing after the 6 months.
6 months money market rates –
UK – 4.3%
Germany – 4.8%
Cash flows -
We will bo
ow Present value of 2,000,000 to be received after 6 months and this will be straight away converted into the GBP and put into deposit for the cu
ent interest rates prevailing in the markets.
2,000,000 / 1+ 2.4% =
The GBP at the cu
ent rate would be amounting to,
1,953,125 / 1.2 = 1,627,604
This will be deposited at the cu
ent 6 month rate of 4.3%
This will yield –
1,627,604 * (1 + 4.3% / 2) = 1,662,597
.
2. Forward Market hedging -
Here the German subsidiary will transfer 2,000,000 on July 1st and BPM UK will convert it into GBP. However, if Euro depreciates in that duration then BPM UK will receive lesser GBP for the same amount of euros since the euro worth will be less.
We need to check what is the cu
ent price of the forward rate for the GBP / EUR. This will be a lock in rate and the rate at which the conversion form EUR to GBP will happen. If the rate is lesser than 1.3 then BPM UK stands to lose on this agreement since it could have used the open markets to covert for more GBPs. However if the rate is above 1.3 then the BPM UK stands to gain on this transaction.
GBPs converted = 2,000,000 / 1.3 = 1,538,462 GBP
3. Hedging Option – 2 Call option on GBP / EUR
If the forward rate for GBP /EUR increases then the firm stands to lose. In order to make sure this does not happen, BPM UK can buy a right to buy the EUR at a predetermined price which is called a strike price. For 6 month duration this price is 1.34.
The premium is paid in GBP which is 2%. EUR / GBP rate is 1 / 1.34 = 0.746
2% of this will be = 0.746 * 2% = 0.015 GBP
The premium charged here for 2,000,000 = 0.015 * 2,000,000 = 29,840 GBP
Now when the options are exercised,
The GBP received by the firm will be,
= 2,000,000 / 1.34 – 29,840 = 1,462,697
South Korea hedging –
BPM UK will have to pay the Korean subsidiary the amount of 2,700,000,000 KRW for the circuit boards on 1st July that is 3 months after the cu
ent date. This will require the conversion of GBP into KRW and if the KRW appreciates in this time then more GBP will be needed to get the same amount of 2,700,000,000.
1. Money Market hedging
3 months money market rates –
UK – 4%
Korea – 4.4%
Cash flows -
We will bo
ow Present value of 2,700,000,000 to be paid after 3 months and this will be straight away converted into the GBP and put into deposit for the cu
ent interest rates prevailing in the markets.
PV = 2,700,000,000 / (1 + 4.4% /4) = 2,670,623,145.4
The GBP at the cu
ent rate would be amounting to,
2,670,623,145.4/ 1420 = 1,880,720.52
This will be deposited at the cu
ent 6 month rate of 4%
This will yield –
1,880,720.52* (1 + 4% / 4) = 1,899,527    
2. Hedging Using forward Contracts –
This will be the locked in rate at which the transaction from the GBP to KRW happen. If the rate falls below the 1360 three months forward rate then the firm tends to gain since lower pounds will be used. However, the higher rate will lead to more pounds outflow.
The three months forward rate – 1360
The GBP needed = 2,700,000,000 / 1360 = 1,985,294
3. Hedging Option – 2 Put option on GBP / KRW
Since we stand to lose if GBP/KRW goes below we will choose to get into an put option contract so that we can set the price at which we will sell the GBPs.
KRW / GBP for the premium calculation = 1.5% * 1 / 1380 = 1.086 * 10^ -5
Total premium for 2,700,000,000 = 1.086 * 10^ -5 * 2,700,000,000 = 29,322
Conervsion at the price of...
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