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CODE : P17




1. There are FIVE questions in this paper.

2. Attempt all the FIVE questions.

3. Marks are shown at the end of each question.

4. Submit all your working with your answer book(s).

5. Cleary state any assumption made in your answers.

6. Mathematical tables will be provided where needed.

7. This question paper comprises 6 printed pages.


000. She tells you that she has managed to collect the following information:  Currently the spot rate of British pound is $ 1. One dollar is currently worth 1. 20 marks) 2 .  The annual interest rates are 4% and 6% in the USA and UK respectively. what will be the net payment? (3 marks) (iv) What will be the total payment in Swiss francs by the borrower of USA dollars for year 3? (2 marks) (v) What will be the total payment in USA dollars by the borrower of Swiss francs for year 3? (2 marks) (Total. The American dollar payer will provide $500.000 to invest for three months. She is contemplating between investing in the USA and the UK and has approached you for advice. and the Swiss franc rate is 8 percent. Required: (i) Advice your aunt on where to invest the $10. The swap calls for a life of three years with annual payments. Required: (i) How much will the provider of the dollar pay at the outset? (2 marks) (ii) If the interest rates do not change. The interest rate on the dollar is 9 percent.800 while the 90-day forward rate is $1. what is the equilibrium UK interest rate? (2 marks) (b) Two counter parties agree to enter a foreign currency swap between American dollars and Swiss francs. what would be the equilibrium 90-day forward exchange quotation? (2 marks) (iii) Given the spot rate.4 francs.000 to maximize the yield with no foreign exchange risk. the UK interest rate and the spot rate. the 90-day forward rate and the USA interest rate.78. what is the annual dollar interest payment for the foreign borrower of dollars? (2 marks) (iii) If a net payment is recorded for interest in year one and exchange rates do not change.QUESTION 1 (a) Your aunt who lives in the United States of America (USA) has US $10. (5 marks) (ii) Given the USA interest rate.

Required: Evaluate whether the UK Co.0000 on working capital.000 on equipment and £50. Kenya Year Sales Variable Contributio Fixed Profit (Millions of Costs n (Millions Costs (Millions KES) (Millions of KES) (Millions of KES) of KES) of KES) 1 60 36 24 8 16 2 70 42 28 8 20 3 80 48 32 8 24 The fixed costs include an annual charge of KES 2 million for depreciation. The expected economic life of the project is 3 years. should invest in Tanzania or Kenya. The current spot exchange rates of the Tanzanian Shilling and Kenyan Shilling are: TZS 2040/£ and KES 210/£ respectively. The project would involve a current outlay of £200. The profits from the project in each country would be as follows: Tanzania Year Sales Variable Contributio Fixed Profit (Millions of Costs n (Millions Costs (Millions TZS) (Millions of TZS) (Millions of TZS) of TZS) of TZS) 1 500 300 200 60 140 2 600 360 240 60 180 3 700 420 280 60 220 The fixed costs include an annual charge of TZS 10 million for depreciation. The annual rates of inflation in the three countries in the coming three years are estimated as follows: YEAR UNITED KINGDOM (%) TANZANIA (%) KENYA (%) 1 2 5 4 2 3 6 5 3 4 7 8 The UK Company requires a 20% return on any foreign investment.QUESTION 2 (a) A UK Company is considering an investment either in Tanzania or Kenya. Ignore taxation. (11 marks) 3 .

Suxess Company’s bank has offered to arrange an interest rate swap for one year with a company that has obtained floating rate finance at London Interbank Offered Rate (LIBOR) plus 1¼%. The company’s treasury believes that inters rates are going to fall. savings in interest with the swap arrangement.000 and the proposed terms of the swap are that Suxess Company will pay LIBOR plus 1. (5 marks) (ii) The LIBOR falls to 9% after six months. Required: Discuss the two main elements on which the theory of comparative advantage is based. which it can produce more efficiently and buys those goods. and state whether the swap would be beneficial to Suxess Company if. Required: Assuming the LIBOR is 10% at the beginning of the year. (i) The LIBOR remains at 10% for the whole year. The bank will charge each of the companies an arrangement fee of £21. The corporate tax is at 35% per annum and the arrangement fee is a tax allowable expense. (b) What is political risk in as far as foreign direct investments is concerned? Provide examples of political risk faced by multinationals carrying out foreign direct investments in different countries and explain how these companies manage such risks prior to and during investment. (5 marks) (b) The theory of comparative advantage assumes that all countries are better off if each specializes in the production of those goods.75%. (4 marks) (c) What are the main uses of currency options and what are their major drawbacks? (6 marks) (Total: 20 marks) 4 . (9 marks) (Total. which other countries produce more efficiently. calculate the net interest rate incurred. 20 marks) QUESTION 3 (a) Suxess Company.5% to the other company and receive from the company 11. a London based company has £11 million of fixed rate loans at an interest rate of 13% per year which are due to mature in one year. but does not wish to redeem the loans because large penalties exist for early redemption.

000. What are the main advantage and disadvantages of a floating or flexible exchange rate system? (6 marks) (c) Harith International Company has recently purchased a consignment of a cleaning fluid from a UK supplier for £30.490.000 payable in three month’s time.QUESTION 4 (a) A successful exchange system is necessary to stabilize the international payment system.000 at an exercise price of TZS 1.5 marks) (ii) Explain to the financial director the nature of the foreign exchange risk cover provided by the call option and calculate the exact future spot rate at which the option will start to give a cheaper cost than the forward contract. (5 marks) (Total: 20 marks) 5 . Required: (i) Calculate the net cost of the transaction assuming it was covered in:  The forward foreign exchange market (2.2 premium Money Market Base rates are 18% per annum in both the UK and Tanzania. Discuss the three main conditions that are necessary for an exchange system to be successful. Recently the company has experienced foreign exchange losses on similar deals and the financial director has decided that henceforth all transaction exposure will be covered.5 marks)  The money market (2. Harith International Company can borrow at 2% above and deposit at 2% below the relevant base rate in either country.1505 Three Months 1 . After discussions with the company’s bank in Dar es Salaam the following data have been made available: Foreign Exchange Market TZS/£ Spot Rate 1500 . The option premium is TZS 300. Option Market The bank has offered a call option on the £30. (4 marks) (b) A floating or flexible exchange rate is an exchange rate which fluctuates according to market forces.

1.7/Tshs. What exchange rate gain or loss will be made by the Tanzanian exporter? (4 marks) (ii) Suppose a six-month forward contract alternative is available at Ushs. 100m worth of maize to a company in Uganda.59/Tshs.6/Tshs. The consignment is invoiced in Ugandan shilling at the prevailing spot rate of Ushs.QUESTION 5 (a) Explain the advantages and disadvantages of each of the following ways of conducting international business: (i) Exporting (4 marks) (ii) Licensing (4 marks) (iii) Joint venture (4 marks) (b) On July 1st 2005 a Tanzanian firm exported Tshs. 1. 1. (4 marks) (Total: 20 marks) **************** 6 . Required (i) Suppose the spot exchange rate in six months is Ushs. Show how risk can be reduced using the forward contract. The settlement is due six months from the invoice date.