Finance Answers

Question 1
a.
Expected gain = 10,000,000(1.10 – 1.05)
= 10,000,000(0.05)
= 500,000
b.
based on the expected gain, I would advise hedging. The reason is that
the company stands a chance of increasing the expected dollar receipt by
$500,000 while also eliminating the exchange risk.
c.
Yes. I would still recommend hedging since in this case the risk will still
be eliminated without sacrificing dollar receipt.
d.
Expected gain = 10,000,000(1.10 – 1.17)
= 10,000,000(-0.07)
= -700,000
The negative implies a falling price and in this case I would not
recommend hedging but giving out some of the stock early enough.
Question 2
The company in this scenario has advance knowledge that it will get a
certain minimum dollar amount no matter the kind of fluctuations that
might affect the Dollar-Euro exchange rate. Also, in case of value increase
of the German mark, the company stands to be the beneficiary of the
appreciating euro.
Question 3
Firstly, the company should try diversifying the market- this can include
exploring other markets in Europe and other parts of the globe like Africa
and Asia and not selling its cars just in Spain
Also the company should consider locating production facilities in Spain
and source inputs locally.
The company should look at taking its production facilities to regions
where production cost is low like manufacturing in Mexico and export to
Spain.
Question 4
Advantages
Creates global presence
Another advantage of establishing multiple manufacturing sites is its
effectiveness in managing exchange risk exposure
Leads to production flexibility to maximize low-cost benefits of currency
depreciation
It leads to business stability due less exposure to exchange rate volatility
Disadvantages
The company is unable to have long-term currency fluctuation prediction
It can be costly since the company may not be able to take advantage of
the economy of scale due to increased production costs
Increased risk due to varied political and social factors
Question 5
In case of conflict between the two, it is recommendable to focus on
transaction exposure because it involves real cash flows unlike translation
exposure which only has a realizable impact on net investment upon the
liquidation or sale of assets.
Derivatives hedge and balance sheet hedge are the two common
translation exposure methods. The derivatives hedge is not really a hedge,
but rather a speculative position. This is because the size of the “hedge”
is based on the projected spot rate of exchange for the exposure currency
with the reporting currency. On the other hand, a balance sheet hedge
entails equating the quantity of exposed assets in an exposure currency
with the exposed liabilities in that currency so that the net exposure
amounts to zero.
Question 6
Because the settlement rate is less than the agreement rate, the buyer
will be paying the FRA’s absolute value to the seller.
Finding the FRA’s absolute value dollars ($):
= 3,000,000 * [(0.04875-0.055) * (92/360)]/ [1 + (0.04875 * 92/360)]
= 3,000,000 * [(-0.001597/1.012458)]
= 4,732.05 dollars
Question 7
Collateralized debt obligation(CDO) is a corporate entity prepared to hold
fixed income assets portfolio as collateral. The fixed assists’ portfolio is
subdivided into different tranches with each one standing for a different
risk class. The format of the risk classes is AAA, AA-BB, and unrated.
Collateralized debt obligation serves as a vital source of funds for fixed-
income securities. Investing in collateralized debt obligation is positioning
oneself in the cash flows of a given tranche instead of directly investing in
the fixed-income securities. CDOs allow combining of the risk of debt
instruments which makes it possible to recycle debt. As a result, it leads
to unregulated borrowing by regulated institutions leading to credit
crunch.
Question 8
The amount of the first coupon payment = 0.5 *(0.072 + 0.0025) * 1000
= 37.25 dollars
Question 9
Implicit SF/$ exchange rate at maturity = Swiss Franc value/price at
maturity
=SF1000/$666.67
=SF1.5/$1
When the exchange rate is SF1.35/$1 how much will Swiss franc/U.S.
dollar dual-currency bonds pay?
=SF1000/ SF1.35/$1
=1000/1.35
= $740.74
Therefore, at the exchange rate at maturity at SF1.35/$1 the dual
currency bond investor is worse off with $666.67 because the dollar is at
a depreciated level compared to at SF1.5/$1.
Question 10
I would recommend the bank to issue the Floating-Rate Note (FRN)
instrument.
The reason is because the Eurobank plans to go for the bond proceeds to
finance Eurodollar loans, which are floating-rate loans. This means that
there will a correspondence between the interest rate the bank pays for
funds and the interest rate it receives from its loans.