Ng Zhai See plc, a company registered in UK, operates in four countries with a total foreign subsidiary turnover of the equivalent of US$100 million. It has a number of intra-group transactions with its four foreign subsidiaries in six months time, and several large international trade deals with third parties. These are summarised below. Intra-group transactions are denominated in US dollars. All third party international trade is denominated in the currency shown. It is now 1 March Intra-group transactions Paying company Receiving UK Sub 1 Sub 2 Sub 3 Sub 4 Company US$000 UK – 300 450 210 270 Sub 1 700 – 420 – 180 Sub 2 140 340 – 410 700 Sub 3 300 140 230 – 350 Sub 4 560 300 110 510 – Exports to third parties Receipts due in six months: £2,000,000 from Amazingland A$3,000,000 from Amazingland US$12 million from the USA £1,800,000 from Dreamland Imports from third parties Payments due in six months: £3,000,000 to the USA A$3,000,000 to Amazingland D$13 million Dreamland £2,000,000 to Freeland Foreign exchange rates Spot 3 month forward 6 month forward US$/£ 1.4960 – 1.4990 1.4720 – 1.4770 1.4550 – 1.4600 Amazingland A$/£ 2.1460 – 2.1500 2.1780 – 2.1840 2.2020 – 2.2090 Dreamland D$£ 2.4560 – 2.4590 2.4140 – 2.4180 2.3830 – 2.3870 Freeland F$/£ 7.7050 – 7.7090 7.9250 – 7.9490 8.0750 – 8.0990 Futures market rates Sterling £62,500 contracts $/£ D$/£ June 1.4820 2.4510 September 1.4800 2.4480 Minimum price movements are: $/£ 0.01 cents, D$/£ 0.01 cents Foreign currency option rates Sterling £31,250 contracts (cents per £) Calls Puts Exercise price June September June September $1.450/£ 3.50 5.75 4.80 7.90 $1.475/£ 1.86 3.42 6.95 9.08 $1.500/£ 0.82 1.95 9.80 11.53 Required: (a) Explain the benefits of multilateral netting and how it might be of benefit to Ng Zhai See Ltd. (8 marks) (b) Recommend, with supporting computations, three hedging strategies that the company might adopt to protect itself against short-term foreign exchange exposure. Do justify your choice of the contracts and exercise prices used. (20 marks) (c) Discuss the advantages and disadvantages of using futures and option in hedging against foreign exchange exposure. Section B: Answer ANY THREE questions (60%) Question 2 At a luncheon meeting the CEO of Chin Ho Mia plc has told two of his independent directors, who hold senior executive positions in different companies that he has recently obtained from his bank forecasts of exchange rates in one year’s time. His two colleagues also work for companies that are heavily engaged in international trade, and both agree to obtain their own forecasts. The following week the three again meet for lunch and compare the forecasts made by their banks. These forecasts are shown below: $/Euro £/Euro Yen/$ $/£ SBD Bank 0•76 0•88 100 1•60 BOU Bank 0•79 0•85 98 1•58 CBCO Bank 0.81 0•86 98 1•54 Current spot rates 0•75 0•86 94 1•55 USA UK Euro bloc Japan Annual inflation rates 2% 4% 3% (1%) Annual short-term interest rates 0•05% 0•5% 0•75% 0•01% The three senior executives are puzzled by this information. Required: Analyse the above information and prepare a report discussing: (a) Why the banks’ forecasts might differ. Your analysis should include calculations based upon inflation rates and interest rates. (12 marks) (b) Whether or not it is possible to accurately forecast such future exchange rates, and if so under what circumstances. Question 3 (a) Explain the benefits and limitations of using interest rate swaps (8 marks) (b) Consider the following information: Char Siew Pau Ltd wishes to borrow $50 million on a floating interest rate basis for a period of four years. The CFO has confirmed with the bank that the company can borrow at SIBOR plus 60 basis points or at a fixed rate of 7.70%. Tou Sar Pau Ltd also wishes to borrow $50 million for four years, but is seeking a fixed rate financing. Its treasury department has also confirmed with the bank that it could borrow at SIBOR plus 10 basis points or at a fixed rate of 9.0%. Pau Kar Liow Bank is willing to act as an intermediary to facilitate a four-year swap, for an upfront fee of $20,000. Any benefits from the agreement will be shared equally between the two parties. Required: Evaluate whether an interest rate swap would benefit both parties. Assume any arbitrage benefits will be equally distributed to the two companies. Question 4 (a) Explain the advantages and disadvantages of cross listing. (12 marks) (b) Discuss the factors to be considered in raising international equity and debt finance. Question 5 Ho Seng Yi Pte Ltd is a family run business in Singapore whose ordinary shares are all owned by three siblings of the family. It has recently begun exporting to Italy and expects to receive €500,000 in six months’ time. The prospect of increased exports to the European country means that Ho Seng Yi needs to expand its existing business operations in order to be able to meet future orders. All of the three siblings are in favour of the planned expansion, but none are in a position to provide additional finance. The company is therefore seeking to raise external finance of approximately $10 million. At the same time, the company plans to take action to hedge the exchange rate risk arising from its Italian exports. Ho Seng Yi cold put cash on deposit in Italy at an annual interest rate of 3% per year, and borrow at 5% per year. The company could put cash on deposit in Singapore at an annual interest rate of 4% per year, and borrow at 6% per year. Inflation in the Italy country is 3% per year, while inflation in Singapore is 4•5% per year. The following exchange rates are currently available to Ho Seng Yi: Current spot exchange rate 2•000 euro per $ Six-month forward exchange rate 1•990 euro per $ One-year forward exchange rate 1•981 euro per $ Required (a) Calculate whether a forward exchange contract or a money market hedge would be financially preferred by Ho Seng Yi to hedge its future euro receipt. (6 marks) (b) Calculate the one-year expected (future) spot rate predicted by purchasing power parity theory and explain the relationship between the expected (future) spot rate and the current forward exchange rate. (6 marks) (c) Discuss the advantages and disadvantages of using forward exchange contracts.
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