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Pure Steel is a Zimbabwean steel manufacturing company that imports steel products
from South Africa and sells them locally in US Dollars after some value addition. The
company has been trading for the past five years and their Finance Director Mr. Peter
Shortfuse has approached Sol Bank, a local bank which they have been banking with for
the past five years. The company demands that as their bankers, and in line with one of
their values “Innovation and Tailor Made Solutions”, Sol Bank provides them with a
forward contract as they expect to make a payment for ZAR 15 million three months
from now. Previously, the company had approached Sol bank only to be told that there
is no bank offering any Forward Exchange Contracts (FECs) in the Zimbabwean market.
Given previous loss experiences, the company insists that the bank provide a solution or
they will vote with their feet. Pure Steel is in the bank’s top 5 customers contributing
significantly to the bank’s profitability.
You are the head of Treasury for Sol Bank and you have promised to structure a solution
to your customer that will help them hedge their exposure. You scan the local market
and confirm that no local bank is willing to enter into any forward exchange rate
agreements with your bank. However, your correspondent bank, Rand Merchant Bank
quotes you as follows:
This is a direct quote so we deduct the
Spot USD/ZAR 14.3050/14.3250 discount from buying and selling exchange
FWD Discount points 720/750 rates in order to ascertain forward rates
Question 1
Required
1. What are the practical problems that Solution Bank has in this case?
2. Show how you can take advantage of the quote by the offshore bank to structure
an innovative solution to your customer’s problem assuming Solution bank puts a
0.25% margin on their transactions
3. Calculate any profit that Sol Bank can make if any from undertaking this
innovation.
4. Your Credit committee is worried about the default risk in the given transaction
given that the volume Pure Steel are looking for and that they have not done such
a huge import at once before. Discuss how you will calm their nerves as an
addition to the solution above.
USD
RMB
On value date Sol Bank will receive US$1,056,531.48 from Pure Steel, Give Pure
Steel ZAR 15, million, immediately transfer US$1,053,888.85 to RMB and get
ZAR 15 million from RMB.
Question 3
Your Credit committee is worried about the default risk in the given transaction
given that the volume Pure Steel are looking for and that they have not done such
a huge import at once before. Discuss how you will calm their nerves as an
addition to the solution above.
Identify the potential risks in the structure and highlight them to the
committee
List and explain the ways you can manage the said risks.
Question 2
The facts in 1 above remain the same. However you are given the following:
Spot USD/ZAR 14.3050/14.3250
FWD premium points 910/950
Required
i. Explain how you would structure an innovative solution that will meet the
customer’s unique needs
ii. Structure a forward contract in line with your brief description
iii. If your bank policy allows a margin of 1.5% on the quoted rates, calculate
the profit or loss clearly showing the cash flows involved.