UMAD5T-International Financial Management

SECTION A

1. You have the following currency pairs quotes:

Which currency pair is the most liquid? Justify your answer. (8 marks)

2. You have the following information:

Using the Relative Purchasing Power Parity, Calculate the expected exchange rate in a year’s time. Justify your answer. (8 marks)

3. The CHFJPY spot rate is 123.77. You know that the annual nominal interest rates are -0.57% and 0.13% in the Switzerland and Japan, respectively. In equilibrium, what should be the 6-month forward rate? Justify your answer. (8 marks)

4. A French firm is planning to build a new wind power plant in Scotland. The firm is still waiting for government approval and will not know if the project is approved until six months from now. The firm will need British pounds to cover the investment but has set a budget for the project in Euros. Explain how the firm can use the options market to protect itself against exchange rate exposure. (8 marks)

5. Assume the following information about the borrowing costs of Good and Bad Companies in the pound and the dollar:

Given this information, determine the comparative advantage of both companies. Would an interest rate swap be beneficial to Good Company and Bad Company? Justify your answer. (8 marks)

SECTION B

1. Inditex is one of the largest international companies in the fashion retail industry. The company has transactions denominated in several currencies. Being a Spanish company, the domestic currency used for valuation is the Euro.

In six (6) months, Inditex is due to receive a 35.2m USD reimbursement from a major subsidiary in the USA.

You have the following information:

Table 1: Bank’s spot and forward rates (in points)

BidAskEURUSD1.11411.1146EURUSD 6M FWD58.9562.95

Table 2: CME Currency Futures

SettlementContract UnitsEURUSD 6M1.2137125,000

Table 3: OTC Currency Options

StrikeCall (in £)Put (in £)EURUSD1.20920.0210.019

The spot exchange rate in 6 months is expected to be either 1.2050 or 1.2350.

1.1. Calculate the outcome of hedging using forwards. (3 marks)

1.2. Calculate the outcome of hedging using futures. (5 marks)

1.3. Calculate the outcome of hedging using options. (5 marks)

1.4. Recommend a strategy to Inditex under the two scenarios briefly discussing the differences between each strategy. (7 marks)

(Total 20 marks)

2. Sinopec is a Chinese multinational oil and gas company. Being a Chinese company, the domestic currency used for valuation is the Chinese yuan.

In 9 months, CNPC is due to make 55.1 QAR payment to a Qatari drilling company. Due to the limited liquidity of the CNYQAR pair, the company has limited access to financial hedging techniques and can use either the Money Market or OTC options.

You have the following information:

Table 1: Bank’s spot rates

Table 2: Money Market rates (source: Moody’s Analytics)

2.1. Build a Money Market hedge for Sinopec short-term transactions in QAR showing the effective exchange rate of the strategy. (8 marks)

Sinopec wants to set up a new offshore drilling site in Canadian territory and estimate this project will cost C$7.8m. Sinopec is considering financing this project using debt. Enbridge, a Canadian oil and gas company, is also considering expanding in the Chinese market and wants to hire local experts to study the feasibility of the project. The study costs CNY38.99m. The amounts required by the two companies are roughly the same at the current exchange rate. Both companies are quoted the following borrowing costs by their respective banks.

Table 3: Sinopec and Enbridge borrowing costs

2.2. Design a swap where HSBC, acting as a dealer, charges both companies a total fee of 0.05% per annum as a fee and offers attractive borrowing costs to Sinopec and Enbridge. (5 marks)

2.3. Evaluate the different risks facing HSBC from arranging this swap. (7 marks)

(Total 20 marks)

3. BMW is a German multinational manufacturer of luxury vehicles and motorcycles. Being a German company, the domestic currency used for valuation is the Euro.

The company wants to assess its economic exposure to changes in the EURJPY exchange rate and has forecasted the possible operating income and costs in three economic states as follows:

Table 1: Economic States – Exchange rates and European operations (in millions)

3.1. Estimate the sensitivity of BMW’s net euro cash flows to changes in the EURJPY. (8 marks)

3.2. Discuss the different operating hedging strategies that BMW could use to reduce its economic exposure to the Japanese yen. (7 marks)

The company wants to diversify its currency exposure by expanding to Mexico. Based on the initial analysis of Mexico, BMW has identified the following key political and financial risk factors that may influence its expansion decision.

Table 2: Country Risk – Political, financial, and economic risks ratings and weights

BMW has assigned an overall rating of 50% to political risk, 30% to financial risk, and 20% to economic risk. It is not willing to consider Mexico for investment if the country risk rating is below 2.7.

3.3. Based on the country risk analysis, assess whether BMW would consider expanding to Mexico. (5 marks)

(Total 20 marks)

4. BP is a British multinational oil and gas company headquartered in London, England. It is one of the world's seven oil and gas "supermajors".

BP wants to invest in a new solar farm in the USA and aims to raise the required funds in the New York Stock Exchange (NYSE) as follows:

- A bond issue of 9,000,000 bonds at a price of 97 USD per bond. The bonds carry a 3.5% coupon and a yield-to-maturity of 3.24%.

- An equity issue of 800,000 shares at a price of 525 USD per share. BP shares have a beta of 0.85.

Over the past 10 years, the S&P500 Index return was on average 4.55%. A US Treasury bond’s return is 0.75%. The corporate tax rate in the USA is 21%.

4.1. What capital structure is used to finance this project? (5 marks)

4.2. What is the project’s total cost of capital? (8 marks)

4.3. How much should the project generate annually for BP to reach break-even? Assume an annuity of 15 years. (7 marks)

(Total 20 marks)