The CEO requires a forecast of the one year and two year exchange rates for the $/£ calculated based on purchasing power parity (PPP) and with the International Fisher Effect (IFE).
Calculate the one year forward $/£ exchange rate based on PPP in the space provided below:
(2 marks)
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Calculate the two year forward $/£ exchange rate based on PPP in the space provided below:
(2 marks)
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Calculate the one year forward $/£ exchange rate based on IFE in the space provided below:
(2 marks)
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School of Accounting, Economics and Finance EXAMINATION CASE STUDY ANSWER SHEET End of Semester 1 & Trimester 1A, 2021 FNCE3004 INTERNATIONAL FINANCE This paper is for Bentley Campus, Curtin Mauritius, Miri Sarawak Campus and Singapore students This is an OPEN BOOK examination Examination DurationTo be completed in number of days and completion time provided. It has to be submitted via Turntin once completed Total Marks50 Instructions to Students Answer All the questions in the examination paper case study scenario Student Number|__|__|__|__|__|__|__|__| Family Name_____________________ First Name_____________________ Please complete the following declaration before you proceed with the Exam Case Study by ticking the boxes for each of the statements: Declaration Please tick here I understand and agree that this assessment should be completed without assistance from any other person. I agree not to share my answers or to discuss any of the questions with anyone during or after the assessment. I agree not to record, copy, communicate or distribute the intellectual property contained in this assessment. I agree that if I violate any of these conditions, I am committing Academic Misconduct and I accept that appropriate actions will be taken as per Curtin University policy. Question 1: (10 Marks) The CEO requires a forecast of the one year and two year exchange rates for the $/£ calculated based on purchasing power parity (PPP) and with the International Fisher Effect (IFE). Calculate the one year forward $/£ exchange rate based on PPP in the space provided below: (2 marks) Calculate the two year forward $/£ exchange rate based on PPP in the space provided below: (2 marks) Calculate the one year forward $/£ exchange rate based on IFE in the space provided below: (2 marks) Calculate the two year forward $/£ exchange rate based on IFE in the space provided below: (2 marks) Explain the conditions under which the forward exchange rates calculated by you will be unbiased predictors of the future spot exchange rate. Use the space provided below. (2 marks) Question 2: (10 Marks) The CEO is afraid interest rates will increase by 0.5% in the United Kingdom. The U.K. subsidiary has a current short term loan of £1,000,000 that expires 90 days from now, but it will have to borrow the same amount again after expiry for operational expenses that will be incurred. Calculate the expected outcome of a 90 day forward rate agreement entered into in the United Kingdom to hedge against the increase in interest rates on £1,000,000. The current risk free United Kingdom rate is to be used as the agreed rate for the calculation. Also assume the settlement rate is the current risk free rate plus 0.5%. Advise the CEO whether HighTech should take a long or short position to hedge the risk of the increasing interest rates. Show your calculation by applying the correct formula in the space provided below: 6 marks Question Your answer Do you recommend that HighTech should be the seller or buyer of the forward rate agreement? (1 mark) Briefly explain how the forward rate agreement will assist Hightech in terms of the interest rate that it will have to pay if it borrows £1,000,000 again for 90 days after expiry of the current loan. (3 marks) Question 3: (16 marks) a. The profit generated by the subsidiary in the U.K. is considered as a good source of money to be used to pay for the import of manufacturing equipment from Japan for the electronic component plant in the U.S.A. The CEO has already entered into negotiations with the Japan supplier of the equipment. The supplier is willing to provide HighTech 3 years to pay for the equipment that will be shipped to HighTech, but the payments must be conducted with quarterly instalments of 5,250,000 Yen by the U.K. subsidiary. This is why the CEO wants you to construct a currency swap arrangement where the profits of the U.K. subsidiary can be used to pay for the equipment. You have to apply the swap bank quotes to conduct this three year swap and also depict the swap graphically for the CEO to see how the swap will work. Workings: Calculation of the notional principal of the hedge in Japanese yen: Provide your answers in the cells below Marks Payments to be conducted by HighTech subsidiary in the U.K. 0.5 mark How often? Monthly = 12/ Quarterly = 4/Semi-annual = 2 0.5 mark Swap bank Yen bid rate 0.5 mark Therefore, notional Yen principal calculated with information above 0.5 mark Calculation of the notional principal of the hedge in British pounds: Provide your answers in the cells below Marks Spot exchange rate $/Yen ask rate 0.5 mark Spot exchange rate $/GBP bid rate 0.5 mark Therefore, British pound notional principal calculated with information above. 0.5 mark Swap bank 3 year GBP ask rate 0.5 mark U.K. subsidiary pays quarterly: 0.5 mark GBP/Yen Exchange rate locked in for three years: 0.5 mark Question 3 continued: Complete the diagram below to show the swap transaction graphically by inserting the correct interest rate or currency values below: (6 marks) Japanese exporter Notional GBP swap principal UK subsidiary GBP notional principal = Notional Yen swap principal Yen notional principal = notional principal = ¥3,925,233,644.86 Swap bank b. Explain to the CEO what forfaiting is, why it is possible that forfaiting of the transaction can occur and the implication that it will have on the swap transaction. (4 marks) Provide your answers in space provided below: Question Your answer What is forfaiting? (Give an explanation). (3 marks) Why can forfaiting occur? (1 mark) Implication on the swap transaction (State whether it impacts the swap or not and the reason for it). (1 mark) Question 4: (14 marks) The banks of Australian and Canadian companies that purchase electronic tools from HighTech provides letters of credit and are required to conduct payment within 180 days after the goods have been shipped to them. Therefore, the banks issue bankers acceptances to HighTech’s bank. There are currently two bankers acceptances that HighTech can request his bank to discount: Bankers acceptance one is from Canada. It’s maturity value is $1,500,000 and it will mature in 45 days. The bankers acceptance commission is 1.35% and the market rate is 1.50%. The other bankers acceptance is from Australia. It’s maturity value is $3000,000 and it will mature in 120 days. The bankers acceptance commission is 0.95% and the market rate is 1.25%. The CEO mentions that HighTech’s pays an average of 1.1% on existing loans. He requires information of whether it is viable to discount any of the bankers acceptances or not. Calculate the bond equivalent rate that HighTech will receive for each of the bonds when they are discounted and compare it to the average cost of HighTech’s debt to determine whether any of the bankers acceptances should be discounted. Calculate the value of the Canadian bankers acceptance at maturity by applying the correct formula in the space below: (2 marks) Calculate the discounted value of the Canadian bankers acceptance at maturity by applying the correct formula in the space below: (2 marks) Calculate the bond equivalent rate of the Canadian bankers acceptance by applying the correct formula in the space below: (2 marks) Should the Canadian bankers acceptance be discounted if you compare it to the average cost of existing loans to HighTech? Provide one reason for your answer in the space below: (1 mark) Calculate the value of the Australian bankers acceptance at maturity by applying the correct formula in the space below: (2 marks) Calculate the discounted value of the Australian bankers acceptance at maturity by applying the correct formula in the space below: (2 marks) Calculate the bond equivalent rate of the Australian bankers acceptance by applying the correct formula in the space below: (2 marks) Should the Australian bankers acceptance be discounted if you compare it to the average cost of existing loans to HighTech? Provide one reason for your answer. (1 mark) Page 7 of 7