1. Intervention Effects on Corporate Performance. Assume you have a subsidiary in Australia. The subsidiary sells mobile homes to local consumers in Australia, who buy the homes using mostly borrowed funds from local banks. Your subsidiary purchases all of its materials from Hong Kong. The Hong Kong dollar is tied to the U.S. dollar. Your subsidiary borrowed funds from the U.S. parent, and must pay the parent US$200,000 in interest each month. Australia has just increased its interest rate in order to curb domestic consumption, and the value of its currency increases (Australian dollar, A$). In each case below state whether these actions would increase, decrease, or have no effect on the following:
a. The volume of your subsidiary’s sales in Australia (measured in A$) 4 Marks
b. The cost to your subsidiary of purchasing materials (measured in A$) 4 Marks
c. The cost to your subsidiary of making the interest payments to the U.S. parent (measured in A$). 4 Marks
Also, briefly explain why in each answer.
2. PPP and Cash Flows. Boston Co. will receive 1 million euros in one year from selling exports. It did not hedge this future transaction. Boston believes that the future value of the euro will be determined by purchasing power parity (PPP). It expects that inflation in countries using the euro will be 12% next year, while inflation in the U.S. will be 7% next year. Today the spot rate of the euro is $1.46, and the one-year forward rate is $1.50.
a. Estimate the amount of U.S. dollars that Boston will receive in one year when converting its euro receivables into U.S. dollars.
3. IFE and Forward Rate. The one-year Treasury (risk-free) interest rate in the U.S. is presently 6%, while the one-year Treasury interest rate in Switzerland is 13%. The spot rate of the Swiss franc is $.80. Assume that you believe in the international Fisher effect. You will receive 1 million Swiss francs in one year.
a. What is the estimated amount of dollars you will receive when converting the francs to U.S. dollars in one year at the spot rate at that time? 4 Marks
b. Assume that interest rate parity exists. If you hedged your future receivables with a one-year forward contract, how many dollars will you receive when converting the francs to U.S. dollars in one year? 4 Marks
4. Exposure of a Portfolio of Currencies. Volusia, Inc. is a U.S.-based exporting firm that expects to receive payments from sales denominated in both euros and Canadian dollars in one month. Based on today’s spot rates, the dollar value of the funds to be received is estimated at $300,000 U.S. for the euros and $700,000 U.S. for the Canadian dollars. Based on data for the last fifty months, Volusia estimates the standard deviation of monthly percentage changes to be 10 percent for the euro and 5 percent for the Canadian dollar. The correlation coefficient between the euro and the Canadian dollar is 0.40. Assuming that on average, the currencies appreciate each month; 0.12 % percent per month for the euro and 0.15% per month for the Canadian dollar. This means average return due to currency fluctuations is 0.12% for euro, and 0.15% for Canadian dollar.
a) Describe why holding a portfolio of two foreign currencies with a correlation coefficient of 0.30 could be considered low risk. 2 Marks
b) What is the expected % rate of return on the euro for the next month? How much is that in US dollars? 1 Mark
c) What is the expected % rate of return on the Canadian dollar for the next month? How much is that in US dollars. 1 Mark
d) What is the expected % rate of return on the portfolio in the next month? 2 Marks
e) What is the portfolio’s standard deviation? 6 Marks
f) What is the maximum one-month loss of the currency portfolio? State % and US dollars? 4 Marks
g) What is the new maximum one-month loss of the currency portfolio if the correlation coefficient between the euro and the Canadian dollar is now 0.80 instead of 0.40? State % and US dollars. 2 Marks
Hint: Use a Z factor based on 95 percent confidence level and assume the probability of the monthly percentage changes for each currency are normally distributed.
Total 18 Marks
5. Vogl Company is a U.S. firm conducting a financial plan for the next year. It has no foreign subsidiaries, but more than half of its sales are from exports. Its foreign cash inflows to be received from exporting and cash outflows to be paid for imported supplies over the next year are shown in the following table:
Currency Total Inflow Total Outflow
Canadian dollars (C$) C $35,000,000 C $4,000,000
New Zealand dollars (NZ$) NZ $5,000,000 NZ $1,000,000
Mexican pesos (MXP) MX.P. 12,000,000 MX.P. 10,000,000
Singapore dollars (S$) S $4,000,000 S $10,000,000
The spot rates and one-year forward rates for these currencies as of today are as follows:
Currency Spot Rate One-Year Forward Rate
C$ $ 0.75 $ 0.80
NZ$ 0.60 0.58
MXP 0.18 0.15
S$ 0.65 0.60
a. Based on the information provided, determine the net exposure of each foreign currency in US dollars. 8 Marks
b. Given the forecast of the Canadian dollar along with the forward rate of the Canadian dollar, what is the expected increase or decrease in US dollar cash flows that would result from hedging the net cash flows in Canadian dollars one year forward? Would you hedge the Canadian dollar position? Why?
c. Given the forecast of the Singapore dollar along with the forward rate of the Singapore dollar, what is the expected increase or decrease in US dollar cash flows that would result from hedging the net cash flows in Singapore dollars one year forward? Would you hedge the Singapore dollar position? Why?
Total 18 Marks
6. Measuring Economic Exposure. Assume you live in the U.S. Using the following cost and revenue information shown for DeKalb, Inc.,
a) determine how the costs, revenue, and net cash flow would be affected by three possible exchange rate scenarios for the New Zealand dollar (NZ$):
1) NZ$ = $0.55,
2) NZ$ = $0.60, and
3) NZ$ = $0.65.
b) What is your conclusion?
Forecasted Net Cash Flows: DeKalb Inc.
(in millions of U.S. dollars and New Zealand dollars)
U.S. Business Business
Sales $800 NZ$800
Cost of Materials 500 100
Operating Expenses 300 0
Interest Expense 100 0
Cash Flow ($100) NZ$700