FIN 351 : the fundamental of finane

Question 1

An exporter in the US has sold 20 million (in Pounds) in goods to one company in UK. Payment is due in 180 days.

Spot rate (USD/GBP): 1.7500 – 50

180-day forward rate (USD/GBP) 1.8050 – 90

180-day USD interest rate 3.00 – 4.00% p.a.

180-day GBP interest rate 1.50 – 2.00% p.a.

Required:

a. What is the hedged value of this exporter’s receivable using the money market hedge?

b. What is the hedged value using forward contracts?

c. Which of the hedging alternatives analysed in parts (a) and (b) would you recommend to the exporter and explain the reason why this alternative is chosen?

Question 2

Alpha and Beta Companies can borrow for a five-year term at the following rates:

Alpha Beta

Fixed-rate borrowing cost 9% 12.0%

Floating-rate borrowing cost LIBOR LIBOR + 2%

Required:

a. Calculate the quality spread differential (QSD).

b. Develop an interest rate swap in which both Alpha and Beta have an equal cost savings in their borrowing costs. Assume Alpha desires floating-rate debt and Beta desires fixed-rate debt. No swap bank is involved in this transaction.

Question 3

a. Please explain all possible ways to hedge the transaction exposure, and discuss any potential weakness with each hedging method

b. Please discuss the translation exposure that a multinational corporation may face and the four methods can be used to cover this exposure.

Question 4

A US Multinational is considering a European investment opportunity. The size and timing of the after-tax cash flows are as follows: Initial investment required is €800. The cash flows of the following 3 years are €300, €300 and €200. The inflation rate in the euro zone is 2%, and the inflation rate in dollars is 5%. The rate of return required by this US firm is 12%. The current exchange rate is 1.25$/€.

Required:

Please describe the two methods which can be used to calculate the net present value (NPV) to determine if this is a good investment for the US firm. (No calculations required).

Question 5

The table below shows the bid-ask quotations from three dealers.

Dealer Quotations

Bid

Ask

Dealer A: $:£

$1.3500

$1.3550

Dealer B: $:€

$1.1700

$1.1750

Dealer C: €:£

€1.1470

€1.1480

Required:

Ignoring transaction costs, is there an arbitrage opportunity based on these quotations? If there is an arbitrage opportunity, what steps would be taken to make an arbitrage profit, and how much would be the profit if $1,000,000 is available for this purpose?

Question 6

Please discuss the implications of interest rate parity (IRP), purchasing power parity (PPP) and international fisher effect (IFE). (hint: the answers are related to what we can use with each parity)