Foreign Exchange Markets (FIN341) Assignment Total marks: 100 Personal ID: [Enter your Personal ID] I have read the Assignment Guide in the ‘Generalassessment information’ and have applied the...

Foreign Exchange Markets
(FIN341)
Assignment
Total marks: 100

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Instructions to students • This assignment covers Topics 1 to 6 and accounts for 40% of your final grade. • There are six (6) questions in this assignment. You should answer all questions. • The overall word limit for the assignment is 2800 words. Marks will only be awarded for answers up tothe word limit (plus 10%) for each question. Any material written after this will not be counted towards your mark for that question. Headings, quotes and references within the body of the answer are included in the word count. Numerical tables, calculations, and reference lists are not included. Formore information on word counts and their rationale, go to Assessment à Assignment à Generalassessment information. • Refer to the Criteria-based Marking Guide for guidelines on what is expected for each question. • The ‘General assessment information’ section in KapLearn contains information about format and presentation, wordlimits, citations and referencing, collusion, plagiarismand other policies, usefulresources, submitting your assignment and accessing your results. • Full workings must be shown for all calculations. Show all calculations in the text of your assignment and NOT attached as an appendix. Appendices to assignments will not be read. • Answers are to be in your own words. Reference and cite all your sources (within the text of your answer) when quoting or using material from external sources. Include a reference list at the end of your assignment. Refer to the ‘Referencing and Citations Guide’ available from the ‘Library and Resource Centre’ in KapLearn for further information on referencing. • Indicative weightings are noted beside each question. Use these weightings to assist you with your allocation of time and resources. The weightings indicate the relative importance of each question. • State all assumptions used in providing your answer. • Requests for special consideration or information pertaining to special consideration written in the body of the assignment will not be considered by the marker. Refer to the ‘special consideration’ section of the Assessment Policy on Kaplan’s website for more information.

Criteria-based Marking Guide
The Criteria-based Marking Guide provided at the end of each question is designed to assist students to understand what is expected of them in each question and to let them know how their performance will be judged. It provides advice about the criteria used in the marking of the question and what discriminates between an excellent, satisfactory and unsatisfactory answer.
Case study: Hilltop Estate Wines Pty Ltd
Hilltop Estate Wines Pty Ltd is a family run winery located in the Yarra Valley, Victoria. Since inception, ithas only sold to the domestic market. However, with the recent handing over of the reigns to the next generation, Hilltop has decided to begin to exporting wine to the US market — withAustralian wines currently enjoying strong demand.
As Hilltop’s treasurer, Tiana is responsible for managing the company’s financial exposures, cashflows and implementation of treasury policy.
The following is an extract from the Hilltop’s treasury policy manual:
‘… Unless otherwise formally advised by the chairman of the board, all foreign exchange exposures must be fully hedged to the foreign currency amount upon confirmation, asdetermined by the purchase order. Exposures can be managed either through the use offorward exchange contracts or by the purchase of a suitable FX options contract…
Section 5: Any foreign exchange or money market transaction must be undertaken for the solepurpose of hedging corporate exposures. Cross platform and synthetic transactions are permitted provided their sole purpose is to improve pricing efficiency…’
Today is 1st September 2016.
Sales
All sales are denominated in USD with invoices due three calendar months after the shipment date.
Tiana has compiled the following confirmed purchase orders:

Expected shipping date	Invoice amount
5 October 2016	USD1,900,000
6 November 2016	USD1,400,000
24 November 2016	USD1,655,090
5 June 2017	USD2,350,000

You obtain the following pricing information from your bankers:

AAA Bank	BBB Bank
Spot: AUD/USD	0.7116/20	0.7118/22

AUD/USD forward prices (straight months):

Overnight	0.5/0.4	0.5/0.3
tom/next	1.55/1.54	1.55/1.54
3-month	31/30	30/29
4-month	43/40	44/42
5-month	56/54	56/55
6-month	67/66	64/63
12-month	124/118	123/118

New equipment
Recent declines in the AUD/USD exchange rate have brought opportunity to Hilltop in the form of strong interest in their premium brand. Vines planted several years ago are beginning to yield excellent crops. This, coupled with a strong 2015/16 growing season have resulted in Tiana estimating that the throughput during the 2016 vintage will be approximately 40% higher than the previous year. However, the processing equipment currently on hand will not be able to adequately handle the greater volume. Therefore,thefamily has decided to expand production facilities to cater for an expected increase in grape supply. Assuch, they have committed to the purchase of two new fermentation tanks. This item will be sourced from the United States and will cost USD2,700,000. Thispurchase will be fully funded by new debt. A final decision on the exact source of funds is yet to be made, so the Tiana has recommended that this exposure remain unhedged for the time being — something the rest of the family has agreed to.
The company has also hired the services of a specialist consultant and installation company for the new tank. Strangely enough, this team is based in Japan and has quoted a total fee of JPY 4,100,000 payable in twoequal instalments on 5th September 2016 and 5th December 2016. Thesefees have been approved for payment.
Credit and borrowings
The company has a sound balance sheet and holds an AA credit rating. Their existing debt is comprised of a (fully drawn) line of credit from Bendigo Bank.
Recently, several major American banks have been offering attractively priced credit facilities to Hilltop due to Australia’s good economic standing and strong growth forecasts for the industry. Theyhave offered funds at LIBOR (flat). By comparison, Bendigo Bank will only offer a new credit facility for this project at a rate of BBSW + 1.00%.
The economy and currency outlook
The Reserve Bank of Australia (RBA) has hinted that interest rates will remain stable or even rise in the face of an emerging price bubble in the property market. On the other hand, the market seems a little confused regarding the future actions of the US Federal Reserve, but the market consensus is that US rates will ‘stayon hold’ for the foreseeable future. Hilltop’s bankers have provided a forecast that the AUD/USD rate will steadily strengthen to around AUD/USD 0.7700 by mid-2017 — a view that Tiana also adopts in her strategic planning.
Question 1 (15 marks | Word limit: 1000 words)
(a) List and explain four (4) factors that impact on the future level of the Australian dollar. Pleaseprovide suitable support for arguments.
(4 marks)

(b) Explain the concept of PPP (purchasing power parity) as a method of predicting the future value of a currency. Describe one significant weakness in its use.
(2 marks)

(c) Describe the likely impact on the Australian dollar (AUD) of the following announcements:
(i) The ABS releases inflation and growth data that is considerably above market expectations.
(1mark)

(ii) The Australian government approves an application by the Chinese government to purchase all Australian national rail infrastructure.
(1 mark)

(iii) Statistics indicate global economic growth showing clear signs of improvement, supported by IMF forecasts of a doubling of growth over the coming years.
(1 mark)

(iv) The perfect storm occurs for the Australian grain industry — a bumper local wheat crop coupled with drought conditions across the major wheat-belts in the United States.
(1 mark)

(v) Australian commercial banks announce that they will selectively target commercial borrowers with higher interest costs selectively on property due to the existence of a commercial property bubble in Australia. The bubble has been driven mainly by domestic demand funded by domestic borrowings.
(1 mark)

(d) The Australian federal government is about to embark on an extensive public borrowing program to fund the NBN rollout. Explain the likely impact of this program on the AUD if it is funded entirely:
(i) onshore
(2 marks)

(ii) offshore.
(2 marks)

Criteria-based marking guide for Question 1

Excellent (Mark range: 11.5–15 marks)	Satisfactory (Mark range: 7.5–11 marks)	Unsatisfactory (Mark range: 0–7 marks)
(a)	? Correct and detailed explanation of the four (4) factors ? Thorough and detailed link between the explanation and outcomes	? Correct but basic explanation of the four (4) factors ? Adequate link between the explanation and outcomes	? Incorrect or no explanation of the four(4) factors ? Unclear or no link between the explanation and outcomes
(b)	? PPP correctly detailed and explained ? Major PPP weakness well cited andexplained	? PPP adequately detailed and explained ? Major PPP weakness adequately cited and explained	? PPP no explained or incorrectly detailed and explained ? Major PPP weakness not adequately cited or explained
(c)	? Correct and detailed description of the impact of points (i)–(v) on the Australian dollar	? Correct basic description of the impact of points (i)–(v) onthe Australian dollar	? Incorrect, unclear or no description of the impact of any of points (i)–(v) on the Australian dollar
(d)	? Correct and detailed explanation of the impact of points (i)–(ii) on the Australian dollar	? Correct basic explanation of the impact of points (i)–(ii) on the Australian dollar	? Incorrect, unclear or no explanation of the impact of either of points (i)–(ii) on the Australian dollar

Insert your answers to Question 1(a)–(d) below this line

End of answers to Question 1(a)–(d)

Question 2 (15 marks | Word limit: 400 words)
You begin the process of making the first part-payment of Japanese yen (JPY) to the contractor.
You obtain the following spot prices:

AUD/USD	USD/JPY
Bank DDD	0.7113/17	112.53/58
Bank EEE	0.7111/15	112.57/62

(a) Using the rates from Bank DDD and Bank EEE above, if you transact entirely with only one of these banks, determine which bank provides the best rate to hedge this exposure. Whatisthe rate? Supportyour answer by showing

all

workings.
(4 marks)

(b) If you are able to construct your deal using the prices from both banks above (Bank DDD or BankEEE) what is the best rate achievable (rounded to 2 decimal places) to undertake this transaction and why?



Note:

Show the sequence of trades and cash flows necessary to undertake this deal, leavingnoresidual flows.
(4 marks)

(c) In the following circumstances, identify whether Bendigo Bank is in the role of price maker or pricetaker:
(i) Bendigo Bank phones Canberra Bank asking for a price in spot AUD/USD.
(0.5 mark)

(ii) Hilltop phones Bendigo Bank, dealing on a price in a 3-month AUD/USD FX swap.
(0.5 mark)

(iii) A broker shows Bendigo Bank a price in spot AUD/USD. Bendigo Bank trades on the bid.
(0.5 mark)

(iv) The Bendigo Bank asks the RBA for a price in spot AUD/USD.
(0.5 mark)

(v) Bendigo Bank shows a price in spot AUD/USD to a broker. The broker then advises that BankGGG has traded with them on their bid.
(0.5 mark)

(vi) Bendigo Bank deals on a price provided by Bank DDD a price in a 2-month AUD/USD FX swap.
(0.5mark)

(d) For part (d) only, assume the following holidays occur:
USA: 16 September 2016
Australia: 19 September 2016
Using a 2016 calendar, state the value date for each of the following transactions:

Deal date	Transaction
18 August, 2016	1-month AUD/USD FX swap	(1 mark)
17 August, 2016	1-month AUD/USD FX swap	(1 mark)
14 September, 2016	Spot USD/JPY (priced at Westpac, Sydney)	(1 mark)
15 September, 2016	Spot AUD/USD	(1 mark)

Criteria-based marking guide for Question 2

Excellent (Mark range: 11.5–15 marks)	Satisfactory (Mark range: 7.5–11 marks)	Unsatisfactory (Mark range: 0–7 marks)
(a)	? Correct rate identified ? Detailed, thorough and correct justification and calculations	? Correct rate identified ? Basic and correct justification andcalculations	? Incorrect rate identified ? Incorrect, unclear or no justification and calculations
(b)	? Correct and detailed calculationsgiven ? Correct identification of the best rate achievable ? Detailed, thorough and correct justification of the best rate	? Correct calculations given ? Correct identification of the best rate achievable ? Basic and correct justification of the best rate	? Incorrect or incomplete calculationsgiven ? Incorrect identification of the best rate achievable ? Incorrect, incomplete or no justification of the best rate
(c)	? 5–6 correct identifications of price maker or price taker	? 3–4 correct identifications of price maker or price taker	? Less than 3 correct identifications of price maker or pricetaker
(d)	? All 4 correct value dates	? 3 correct value dates	? Less than 2 correct value dates

Insert your answers to Question 2(a)–(d) below this line

End of answers to Question 2(a)–(d)

Question 3 (35 marks | Word limit: 600 words)
To answer this question, use the pricing data provided in the case study information.
(a) Determine which bank (Bank AAA or Bank BBB) has the best
outright forward
rates at which Hilltopcan hedge the following future shipments.


Note:

Show

all

workings, including FEC rates and AUD equivalent cash flows.
(i) Expected shipping date: 5 October 2016.
(3 marks)

(ii) Expected shipping date: 6 November 2016.
(3 marks)

(iii) Expected shipping date: 24 November 2016.
(5 marks)

(b) (i) Rework the pricing for the 5 October 2016 shipment to obtain the
best possible
hedging outcome using both the spot and FX swap prices provided by both banks. Show all relevant exchange rates and cash flows
(5 marks)

(ii) Explain the benefit of using this approach (from part (b)(i)) rather than just dealing an outright forward contract.
(2 marks)

(c) (i) One or more arbitrage opportunities exist within the FX swap prices provided.
Identify this opportunity.
(4 marks)

(ii) Discuss what prevents Tiana from undertaking this trade?
(2 marks)

(d) An FEC that was transacted earlier this year is due to mature soon with Bank BBB. It was used to exactly hedge export receipts from one of Hilltop’s US customers. The details of this transaction with BankBBB are as follows:
Hilltop sells USD 2,500,000.00 at 0.7310 against AUD, value 5 September 2016.
However, the customer has contacted Tiana to advise that they made a mistake with their payment date and have made the payment for value one (business) day earlier than originally expected, namely 2September 2016. The USD account is expected to balance on that date, but the AUD account will be heavily overdrawn on 02 September, so it would suit to change the value date of this cash flow.
Show

all

the transactions needed with Bank BBB to compensate for this cash flow mismatch.
(5marks)

(e) Tiana decides to hedge the second instalment of the JPY payment (due 5th December 2016) usingan AUD/JPY outright forward contract. She asks Bank BBB for an indicative price for 3-month USD/JPY FX swap. They provide the following information:
• 3-month USD/JPY swap = 13/14
• spot basis 112.10/15
Using this information and the AUD/USD FX swap information supplied earlier by Banks AAA and BBB in the case study, calculate:
(i) the
best
rate at which Tiana can hedge the second payment to the Japanesecontractor
(5marks)

(ii) the AUD equivalent of the payment.
(1 mark)

Criteria-based marking guide for Question 3

Excellent (Mark range: 27.5–35 marks)	Satisfactory (Mark range: 18.5–27 marks)	Unsatisfactory (Mark range: 0–18 marks)
(a)	? Correct and detailed calculations for FEC rates and AUD equivalent cash flows for (i), (ii) and/or (iii)	? Correct but basic calculations for FECrates and AUD equivalent cash flows for (i), (ii) and/or (iii)	? Incorrect, incomplete or no calculations for FEC rates and AUD equivalent cash flows for (i), (ii) and/or (iii)
(b)	? Correct calculations for (i) ? Correct and thorough explanations offered for part (ii)	? Mostly correct calculations for (i) ? Correct basic explanations offered for part (ii)	? Incorrect, incomplete or no calculations for (i) ? Incorrect or no explanations offered for part (ii)
(c)	? Correct and detailed description of one (1) arbitrage opportunity ? Correct and detailed calculations offered to support the arbitrage opportunity ? Clear connection drawn between parts (i) and (ii) ? Correct and detailed explanation of the restrictions of the role of treasurer	? Correct basic description of one (1) arbitrage opportunity ? Correct basic calculations offered to support the arbitrage opportunity ? Generally clear connection drawn between parts (i) and (ii) ? Correct basic explanation of the restrictions of the role oftreasurer	? Incorrect, incomplete or no description of one (1) arbitrage opportunity ? Incorrect or incomplete calculations offered to support the arbitrage opportunity ? Lack of connection drawn between parts (i) and (ii) ? Incorrect, unclear or no explanation of the restrictions of the role of treasurer
(d)	? Correct and detailed calculations	? Correct basic calculations	? Incorrect or incomplete calculations
(e)	? Correct and detailed calculations for (i) and (ii)	? Correct basic calculations for (i) and (ii)	? Incorrect or incomplete calculations for (i) and/or (ii)

Insert your answers to Question 3(a)–(e) below this line

End of answers to Question 3(a)–(e)

Question 4 (9 marks | Word limit: 200 words)
In the process of hedging sales receipts you request another bank, Bank CCC, to provide pricing forone of the exposures. They provide the following prices relating to the 6 November 2016 shipment:
5-month cash rates:
• USD: 0.90%/1.00%
• AUD: 2.80%/2.90%
• Spot FX: AUD/USD0.7112/22
(a) Detail the transactions and cash flows needed to hedge the sales receipts from this shipment usingthe money market rate provided by Bank CCC, including the effective hedging rate achieved.
Show

all

calculations and clearly show

all

cash flows required using Bank CCC.
(7 marks)

(b) Determine which hedging method is best for Hilltop.
(2marks)

Criteria-based marking guide for Question 4

Excellent (Mark range: 7.0–9.0 marks)	Satisfactory (Mark range: 4–6.5 marks)	Unsatisfactory (Mark range: 0–3.5 marks)
(a)	? Correct and detailed advantageidentified ? Correct and detailed calculations	? Correct basic advantage identified ? Correct basic calculations	? Unclear, incorrect or no advantageidentified ? Incorrect or incomplete calculations
(b)	? Correct identification of best hedging method	? Best hedging method not satisfactorily defined	? Incorrect or incomplete description of best method

Insert your answers to Question 4(a)–(b) below this line

End of answers to Question 4(a)–(b)

Question 5 (12 marks | Word limit: 400 words)
Turning your attention to the purchase of new equipment from the US, and its associated funding requirement, assume the following applies:
• The term of the borrowing is 360 days. Interest is payable on all currencies every 180 days.
• AUD/USD cross-currency swap: 360-day AUD BBSW versus USD LIBOR: minus 0.50% to borrow USD, paid
at the maturity of the swap.
• 360-day term cash rates: BBSW = 3.70% and LIBOR = 1.90%.
• Spot basis (for all conversions in this exercise): 0.7120.
Tiana wishes to use USD sales receipts to directly service any debt facility. With this objective in mind, Tianaseeks input from the corporate dealer at Bendigo Bank on the feasibility of funding through the Australianmarket versus funding through the US market, particularly given the attractive cross-currency swap rate available to Hilltop.
(a) Explain to Tiana the process by which these alternatives can be achieved. Show

all

cash flows, calculations for the borrowing.
(8 marks)

(b) Determine the effective interest rate of both alternatives for a 360 day borrowing. (Use 0.7120 as an arbitrary conversion rate for easier comparison in a single currency). Explain the most effective funding method?
(2 marks)

(c) Explain two (2) advantages and two (2) disadvantages of funding entirely via the US market.
(2marks)

Criteria-based marking guide for Question 5

Excellent (Mark range: 9.5–12 marks)	Satisfactory (Mark range: 5.5–9 marks)	Unsatisfactory (Mark range: 0–5 marks)
(a)	? Correct and detailed explanation ofmethods ? Correct and detailed cash flows andcalculations	? Correct basic explanation ofmethods ? Correct basic cash flows andcalculations	? Unclear or incorrect explanation ofmethods ? Incorrect or incomplete cash flows and calculations
(b)	? Detailed comparison of the effective interest cost of both the alternatives inAUD terms, highlighting similarities and differences ? Correct, clear, substantiated and relevant conclusion drawn about the alternative that is the most effective ? Detailed justification of conclusion skilfully integrated	? Adequate comparison of the effective interest cost of both the alternatives in AUD terms ? Correct and clear conclusion drawn about the alternative that is the most effective ? Adequate justification of conclusion	? Little or no comparison of the effective interest cost of both the alternatives in AUD terms ? Incorrect, incomplete or no conclusion drawn about the alternative that is the most effective ? Little or no justification ofconclusion
(c)	? Thorough and correct and substantiated explanation of two (2) advantages and two (2) disadvantages of funding entirely via the US market	? Adequate and mostly correct explanation of two (2) advantages and two (2) disadvantages of funding entirely via the US market	? Little or no correct explanation of two (2) advantages and two (2) disadvantages of funding entirely viathe US market

Insert your answers to Question 5(a)–(c) below this line

End of answers to Question 5(a)–(c) Question 6 (14 marks | Word limit: 200 words)
(a) Regarding the 5 June 2017 shipment, in order to determine the best hedging method
(FEC or FX option)you obtain the following FX option pricing from Bank CCC:
ATM forward AUD call (12 months) 3.11/3.15 % USD
ATM forward AUD put (12 months) 3.25/3.29 % USD
Spot basis: 0.7116/20



Note:

Premiums are paid in AUD. The cost of funding the AUD premium is 1%.
(i) Nominate the most appropriate
option based
hedge to use and calculate the premium cost of the option used in this strategy.
(3 marks)

(ii) Assuming the swap pricing from Bank AAA and Bank BBB is still current, calculate the cashflows resulting from both an options based and FEC based strategy.
(4 marks)

(iii) Which is the most appropriate hedging method? Why?
(2 marks)

Show

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calculations.
(iv) If the boardfelt that the currency woulddepreciate to 0.6600 rather than their view stated earlier, which strategy would provide the best outcome? Why?
Show

all

calculations.
(3 marks)

(b) Explain one (1) advantage and one (1) disadvantage of purchasing an out of the money option, ratherthan the ATMF options used above
(2 marks)

Criteria-based marking guide for Question 6

Excellent (Mark range: 10.5–14 marks)	Satisfactory (Mark range: 5.5–10 marks)	Unsatisfactory (Mark range: 0–5 marks)
(a)	? Clear and thorough explanation of most appropriate hedging method ? Detailed, substantiated and relevant justification of choice ? All calculations shown correctly ? Clear, correct and substantiated view expressed of preferred new strategy ? All correct calculations shown and integrated in justification of preferred strategy	? Clear and adequate explanation of most appropriate hedging method ? Adequate and relevant justification of choice ? Most calculations shown correctly ? Adequate and correct view expressed of preferred new strategy ? Adequate and mostly correct calculations shown and integrated in justification of preferred strategy	? Unclear or incorrect explanation of most appropriate hedging method ? Little or no satisfactory or relevant justification of choice ? Incorrect, incomplete or no calculations shown ? Unclear, incorrect or unsubstantiated view expressed of preferred new strategy ? Incorrect, few or no calculations shown and integrated in justification of preferred strategy
(b)	? Full and thorough explanation of one (1) advantage and one (1) disadvantage of using an open strike rate which is out-of-the-money ? Integrated within the answer is a clear and detailed explanation of using this option rather than the ATMF options used previously	? Adequate and correct explanation of one (1) advantage and one (1) disadvantage of using an open strike rate which is out-of-the-money ? Integrated within the answer is an adequate explanation of using this option rather than the ATMF options used previously	? Poor, incorrect or irrelevant explanation of one (1) advantage and one (1) disadvantage of using anopen strike rate which is out-of-the-money ? Unclear, little or no explanation and integration within the answer of using this option rather than the ATMF options used previously

Insert your answers to Question 6(a)–(b) below this line

End of answers to Question 6(a)–(b) End of Assignment