AFF 621 Lecture Notes - Lecture 1: Foreign Exchange Spot, Exchange Rate, Foreign Exchange Market

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2 May 2016

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Transaction exposure is the sensitivity of realized domestic currency values of the firm"s contractual cash flows denominated in foreign currencies to unexpected exchange rate changes. Currency forward contracts is the most direct and popular way of hedging transaction exposure. Translation exposure is the sensitivity of the firm"s consolidated financial statements to unexpected changes in the exchange rate. Sell 1m forward using 16 contracts at the forward rate of . 29 per 1. Buy 750,000 forward using 12 contracts at the forward rate of. Sell 1m forward using 16 contracts at the forward rate of . 25 per 1. 150,000,000 forward using 12 contracts, at the forward rate of . 00 = 120. 1,156,804. 73 borrow 970,873. 79 in one year you owe 1m, which will be financed with the receivable. Convert 970,873. 79 to dollars at spot, receive ,165,048. 54. Convert dollars to pounds at spot, receive 728,155. 34. Ch8 the firm will realize ,140,000 on the sale net of the cost of hedging money market hedge ,653,833.

Related Questions

A current account deficit commonly is accompanied by:

a) a financial account deficit and a government budget surplus

b) a financial account deficit and a government budget deficit

c) a financial account surplus and a government budget deficit

d) a financial account surplus and a government budget surplus

In hedging foreign currency receivables, the outcome from a forward position will be identical to the outcome from a money market hedge (also known as a spot transaction hedge) if

a) purchasing power parity holds

b) interest rate parity holds

c) either purchasing power parity or interest rate parity holds

d) both purchasing power parity and interest rate parity hold

An American multinational wants to hedge a euro receivable. Which of the following strategies does

NOT provide a hedge for the euro receivable?

a)buy put options on the euro with strike prices in dollars

b)buy put options on the euro with strike prices in pounds

c) buy call options on the euro with strike prices in pounds

d) buy call options on the euro with strike prices in dollars

In the spot market in New York, $0.80 may be exchanged for one Canadian dollar and $1.60 may be exchanged for one pound sterling. You may assume that bid and ask quotes are the same. If you can only exchange currency in New York, how many Canadian dollars would you receive in exchange for 1 pound sterling?

a) 0.5

b) 1.0

c) 1.6

d) 2.0

Observe the following dealer quotes for the euro in the New York spot market: The bid is $1.30 and the ask is $1.31. The dealer quotes for the euro in the Frankfurt spot market are the following: The bid is $1.28 and the ask is $1.29. Given these quotes, which of the following strategies would you employ to profit from an arbitrage opportunity?

a) Simultaneously buy euro in New York and sell euro in Frankfurt

b) Simultaneously buy euro in Frankfurt and sell euro in New York

c) Buy euro in Frankfurt and wait for euro to appreciate in Frankfurt before selling euro

d) Sell euro in New York and wait for euro to depreciate in New York before buying euro

Coleman needs 100,000 euros in 1 year, then it could convert dollars to euros and deposit the euros in a bank today.The Coleman purchasing team received this price quote of â¬100,000 today where the current spot rate was $1.1800/â¬, which equates to the U.S. dollar price of $118,000.
Coleman's director of finance now wondered if the firm should hedge against more fluctuation in the exchange rate.
Three approaches were possible:
1) Hedge in the forward market. The 1-year forward exchange quote was $1.20/â¬.
2) Hedge in the money market. Coleman could borrow U.S. dollars from its U.S. bank at 7.00% per annum. The EU investment rate is 9.00% per annum.
3) Hedge with foreign currency options. The day the Euros are needed the call options at $1.2000/â¬ could be purchased for a premium of $0.03. (Note: First you need to figure out the option premium in percentage. The spreadsheet cell D32 is not set-up for USD)
Discuss if Coleman should hedge its transaction exposure of EUR 100,000. If you recommend that the company should hedge, which of the hedging alternatives would better serve Northwind shareholders?

Assumptions		Value
1-year A/P in â¬		?
Spot rate, ($/â¬)		?
1-year forward rate, ($/â¬)		?
EU investment rate		?
borrowing rate, USD, per annum		?
Coleman's WACC		10.000%
Time to maturity (in months)		12.00

Options on Euro: 1-year Strike price, ($/â¬)		Call Option
Strike price ($/Â£)		?
Option premium ? Solve this using step by step calculations

mauvecricket484

Short Answer 1-8 [10 points each and each about 1/2 â 1 page double-spaced]:

1. If the spot rate for the Swiss Franc is that 1.05 SF is equal to 1 US $, and the annual interest rate on fixed rate one-year deposits of SF is 0.15% and for US$ is 1.5%, what is the nine-month forward rate for one dollar in terms of SFs? Assuming the same interest rates, what is the 18-month forward rate for one SF in US$s? Is this an indirect or a direct rate? If the forward rate is an accurate predictor of exchange rates, in this case will the SF get stronger or weaker against the dollar? What does this indicate about the marketâs inflation expectations for Switzerland as compared to the United States economy?

2. On June 1st, 2017, Sandoz expects to ship 3 million units of a new drug from its Swiss plant to the US that it will sell through pharmacies on 270-day terms at $95 each. Therefore Sandoz will receive payment from these outlets on February 25th, 2018. Assuming that Sandoz needs to cover its expenses in Switzerland and thus wants to hedge its SF/US$ exposure using a forward contract with a Swiss bank, what is the minimum amount of Swiss Francs they should receive on February 25th, 2018 given 9-month forward rate you calculated in problem one for one US $ in terms of SF? What are two other ways Sandoz might hedge its SF/US$ exposure?

3. In his book Manias, Panics and Crashes (see the Introduction and Chapters posted on the class website) Charles Kindleberger explains the three stages of how a financial crisis develops and evolves over time. Please briefly explain these stages and how the Baltic and Mexican Tequila Crises as presented in Hill text and class case presentation follow this economic pattern or paradigm.

4. Toyota, whose global sales are generally dollar denominated, finds it has excess cash of $85,000,000,000, which it can invest for up to three years. It has determined that its best options are either a three-year Euro-dollar ($) deposit paying 2.65% or a three-year Yen denominated deposit paying 1.55% since it expects the Yen to appreciate 1.2% per annum against the dollar over the next three years. Using cash flow analysis determine the best currency option in which Toyota should invest. Be sure to show your complete calculations of the annual return on each investment possibility at the end of the three-year term. Assume that the annual interest amount is reinvested, i.e. compounds, at the same annual interest rate. Would your answer change if Toyota revised its outlook for the Yen to appreciate 1.1% per year? Show all calculations!!!

5. Country A has 20,000 units of labor and can produce 2 goods, manufactures and food. Aâs producers take 5 units of labor to produce one unit of manufactures and 2 units to produce one unit of food. Country B has 30000 units of labor and takes 3 units to produce one unit of manufactures and 3 units to produce one unit of food. What is price of manufactures in terms of food at which A and B would respectively supply manufactures? What would B export in Adam Smithâs world? What is the amount it could supply?

6. Companies can be hurt by rapid changes in exchange rates even if their initial hedging actions appear reasonable. Explain how the VW case reflects this situation and what it could have done differently to manage the adverse impact of dollar depreciation. 7. Explain how Timberland developed global supply chain problems and then how they developed new logistical and partner relationships that used both IT and a changed physical distribution system to solve these issues.

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AFF 621 Lecture Notes - Lecture 1: Foreign Exchange Spot, Exchange Rate, Foreign Exchange Market

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