RISK MANAGEMENT

QUIZ 1

Name:

Section:

You have 15 mins to answer the following questions. There is no partial credit. You may use your notes
and calculator. Total Points: 5. Points per Question: 1

A firm in Nigeria is exporting oil to Belarus. The currency in Nigeria is the Naira and the currency in
Belarus is the Ruble. As part of the export, the Nigerian company will receive 3M Rubles in 3 months
from now. Assume the CCIR in Nigeria is 8% and the CCIR in Rubles is 7%. The current exchange rate
is 1 Naira=0.006 Rubles.

a. The firm in Nigeria wants to hedge the risk, how can the firm hedge the risk using forward
contracts?
The firm will receive Rubbles, to hedge the risk, we firm can lock in a price to sell rubbles and receive
Nairas instead
b. Compute the forward exchange rate if the company wants to hedge the risk. Assume T=3/12.
Define the rate the way you want, just be consistent.
3
(7%−8%)×
𝐹 3 = 0.006 × 𝑒 12 = 0.005985
0,
12

So this rate is 1 Naira=𝐹0, 3 Rubbles

12

c. Suppose the firm entered the forward in a) at a forward price in b). At t=1/12 (1 month), the
exchange rate changes to 1 Naira=0.01 Rubles. Compute the value of the existing forward.
To compute the value, need to act as if we are undoing the initial contract. So, enter a new long forward.
3 1
At 𝑡 = , using the short: sell 3M Rubbles and receive × 3𝑀 Nairas
12 𝐹 3
0,
12

1
Using the long forward: buy 3M Rubbles and pay × 3𝑀 Nairas.
𝐹1 3
,
12 12

1 1
The payoff at 3 months from doing this is: 3𝑀 × (𝐹 −𝐹 )
3 1 3
0, ,
12 12 12

With
2
(7%−8%)×
𝐹1 3 = 0.01 × 𝑒 12
,
12 12
 2
1 1
The value at t=1/12 is then 3𝑀 × (𝐹 −𝐹 ) × 𝑒 −12×8%
3 1 3
0, ,
12 12 12

d. Compute the value of the existing forward at inception, t=0.

0
e. At t=1/12, because the CEO of the Nigerian Company is under pressure from the shareholders,
the Nigerian company has to exit the forward in b) if the PV of the losses from the short forward
are more than 100 M Naira. At which exchange rate at t=1/12 would the company like to exit the
forward entered in a)?

Let 𝑀 1 denote the number of Rubbles per 1 Naira. The firm will want to exit if:
12

1 1 2
3𝑀 × ( − ) × 𝑒 −12×8% < −100𝑀 𝑁𝑎𝑖𝑟𝑎𝑠
0.005985 𝐹 1 3
,
12 12

Solving for 𝐹 1 , 3 leads to:

12 12

1
𝐹1 3 < 2
, 1 100
12 12 + × 𝑒 12×8%
0.005985 3
Or

(7%−6%)×
2 1
𝑀1 ×𝑒 12 < 2
1 100
12 + × 𝑒 12×8%
0.005985 3
Thus,
2
𝑒 −(7%−6%)×12
𝑀1 < 2 =𝑋
12 1 100 ×8%
+ 3 ×𝑒 12
0.005985
So, the lowest rate is 1 Naira=X Rubbles.
f. Bonus: Two dice are thrown simultaneously. What is the probability of getting two numbers
whose product is even?
a. ¼
b. ¾
c. 3/8
d. 5/16

b). There are 27 outcomes out of 36 possible events in total. So Prob=27/36.