‘The following exhibits, available on the left-hand side of the screen, provide information relevant to the question’ 1. Frongoch Co hedging a payment 2. Alternative exchange rate scenarios ~ scenarios as at 1 August This information should be used to answer the question requirements within your chosen response option(s). Frongoch Co is an American company, with a centralised treasury function based in the US. However, Frongoch Co's board is currently considering whether to establish additional treasury functions in some, or all, of the other countries in which Frongoch Co operates. Today's date is 1 March. Frongoch Co's treasury team is currently looking at hedging a payment ‘of €18,250,000 to a German supplier, which Frongoch Co is due to make on 1 August. ‘The following market data have been obtained. Exchange rates (quoted as USS per €1) Spot as at 1 March 1-1488-1-1497 Five months forward 1-1528-1-1544 Currency futures (contract size €125,000, price quoted as US$ per €1) September 41-1560 Currency options (contract size €125,000, exercise price quoted as US$ per €1, Calls Puts Exercise price March June September March June September 1-1540 054 061 069 079 «090 © 1-02 Futures and options contracts mature at the month end. The treasury team has also been asked to consider two scenarios for what the exchange rates could be on 1 August, and also the significance of basis risk in deciding how the risk should be hedged. The scenarios are as follows: Scenario (i) Exchange rates (quoted as US$ per €1) Spot as at 1 August 11519-11534 Five months forward 11565-1-1581 Currency futures (contract size €125,000, price quoted as USS per €1) September 41552 Scenario (i) Exchange rates (quoted as US$ per €1) Spot as at 1 August 1-1592-1-1549 Five months forward 1-1566-1:1584 Currency futures (contract size €125,000, price quoted as USS per €1) September 11563© resemerts 8 mt] (@) Recommend, on financial grounds, a hedging strategy for the €18,250,000 payment using the market data available ‘on 1 March (exhibit 1) and assuming the options are exercised, Assume basis diminishes to zero at contract maturity at 2 constant rte, based on monthly intervals. (@marks) (©) Evaluate the impact on the results of using the threo hedging instruments being considered if the rates and futures prices are as per scenarios () and (i) on 1 August (exhibit 2) (marks) (6) Explain what is meant by basts and basis risk, and discuss the impact of basis risk on the hedging decision being ‘considered in (a) and (b). (4mars) (4) Explain the reasons why local treasury functions may be established in countries where Frongoch Co operates, (marks)