Specimen Copy

Academic Session 2023

September 2023

ASSIGNMENT

BBF308/03 International Financial Management

Instructions to candidates:

1. This assignment is the final assessment to replace the final proctored

examination.

2. This assignment consists of FOUR (4) questions. Answer ALL questions.

3. You are allowed the maximum of one attempt to submit your assignment.

4. The assignment will be made available from 30th October 2023, Monday
(00:00) until 20th November 2023, Monday (23:59).

5. Completed assignment must be submitted by 20th November 2023,

Monday (23:59)

Copyright © 2023 WOU

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PART A (100 Marks)

Answer ALL questions.

QUESTION 1 (25 MARKS)

(a) You are appointed by your boss to explain on foreign exchange market
participants to your new colleague Suzy. Elaborate to her any FOUR (4)
market participants.
(12 marks)

(b) Explain Vernon’s product life-cycle theory of Foreign Direct Investment.

Then elaborate the strength and weakness of the theory.
(13 marks)

QUESTION 2 (25 MARKS)

(a) Suppose that the current spot exchange rate is EUR1.50/GBP and the one-
year forward exchange rate is EUR1.60/GBP. The one-year interest rate is
5.4% in euros and 5.2% in pounds. You can borrow at most €1,000,000 or
the equivalent pound amount, i.e., GBP666,667, at the current spot
exchange rate.

(i) Show how you can realise a guaranteed profit from covered interest
arbitrage. Assume that you are a euro-based investor. Determine the
size of the arbitrage profit.
(12 marks)

(ii) Discuss how the interest rate parity may be restored as a result of the
above transactions.
(3 marks)
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(b) A company based in the United Kingdom has an Italian subsidiary. The
subsidiary generates EUR25,000,000 a year, received in equivalent
semiannual installments of EUR12,500,000. The British company wishes to
convert the euro cash flows to pounds twice a year. It plans to engage in a
currency swap in order to lock in the exchange rate at which it can convert
the euros to pounds. The current exchange rate is EUR1.5/GBP. The fixed
rate on a plain vanilla currency swap in pounds is 7.5 percent per year, and
the fixed rate on a plain vanilla currency swap in euros is 6.5 percent per
year.

(i) Determine the notional principals in euros and pounds for a swap with
semi-annual payments that will help achieve the objective.
(5 marks)

(ii) Determine the semi-annual cash flows from this swap.

(5 marks)

QUESTION 3 (25 MARKS)

(a) Examine some of the pros and cons of countertrade from the country’s
perspective and the firm’s perspective.
(15 marks)

(b) Banks find the necessary to accommodate their clients’ needs to buy or sell
FX forward, in many instances for hedging purposes. Discuss ways the bank
eliminates the currency exposure it has created for itself by accommodating
a client’s forward transaction.
(10 marks)
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QUESTION 4 (25 MARKS)

Assume that Thanex Corporation imported goods from New Zealand and needs
NZD100,000 180 days from now. It is trying to determine whether to hedge this
position. Thanex has developed the following probability distribution for the New
Zealand dollar:
Possible Value of Probability
New Zealand Dollar in 180 Days
USD0.4000 5%
USD0.4500 10%
USD0.4800 30%
USD0.5000 30%
USD0.5300 20%
USD0.5500 5%

The 180-day forward rate of the New Zealand dollar is USD0.5200. The spot rate of
the New Zealand dollar is USD0.4900. Develop a table showing a feasibility analysis
for hedging. That is, determine the possible differences between the costs of hedging
versus no hedging.

(a) Calculate the probability that hedging will be more costly to the firm than not
hedging.
(15 marks)

(b) Determine the expected value of the additional cost of hedging.

(10 marks)

END OF QUESTION PAPER