To devise a prudent hedging strategy for Wonderworld Co's D27,000,000 investment in Algeria,

we must carefully consider the potential interest rate fluctuations, namely an increase of 1.1% or
a decrease of 0.6%. A thorough evaluation of the available hedging instruments - Forward Rate
Agreements (FRAs), Interest Rate Futures, and Options on Interest Rate Futures - is essential to
tailor an effective risk mitigation approach.

Let's delve into the specifics of each hedging choice. Firstly, Forward Rate Agreements (FRAs)
present a straightforward tool to lock in future interest rates. By calculating the adjusted rates
post a 1.1% increase or 0.6% decrease, we can align them with the local bank's FRA rates for 4–
9 months (5.02%) or 5–10 months (5.10%). This comparison will unveil the cost-effectiveness of
using FRAs to secure a predetermined interest rate for the investment period (Schuler, 2021).

Secondly, Harzing (2018) examining Interest Rate Futures is crucial in understanding how these
contracts can be leveraged to hedge against potential interest rate movements. The prices of
Dinar futures for December 2017 (94.84), March 2018 (94.78), and June 2018 (94.66) provide
insights into market expectations. Assessing the impact of interest rate changes on these futures
will aid in determining the viability of taking a position to mitigate risk.

Thirdly, Options on Interest Rate Futures introduce a layer of flexibility. By evaluating call and
put options for various months, such as December, March, and June, we can explore their
potential in offering protection against adverse interest rate movements. Calculating the cost of
premiums and understanding the risk-return profile of these options will contribute to a well-
rounded hedging strategy (Myloni, 2021).

In crafting an overall strategy, the synergy of these instruments should be considered. A

diversified approach, combining elements of FRAs, Interest Rate Futures, and Options, might
offer an optimal balance between cost and effectiveness. It is paramount to discuss the
advantages and drawbacks of each instrument, factoring in the level of certainty, associated
costs, and potential gains under different interest rate scenarios (Dowling, 2019).

A meticulous examination of these hedging choices will empower the treasury team to make
informed decisions aligning with Wonderworld Co's risk management objectives. The real-world
implications of each strategy must be carefully weighed, and potential synergies between these
instruments explored for a comprehensive and robust hedging approach (Harzing, 2018).

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Within the context of formulating a hedging strategy for Wonderworld Co's D27,000,000
investment in Algeria, several key assumptions form the bedrock for decision-making. Firstly,
the treasury's investment strategy serves as a guiding principle, emphasizing an inclination to
invest at the central bank base rate less 30 basis points. This strategic choice provides a
benchmark for evaluating the appropriateness and cost-effectiveness of various hedging
instruments (Schuler, 2021).

Turning our attention to the local bank, crucial assumptions are made regarding the Forward
Rate Agreements (FRAs) offered. The rates presented for 4–9 months (5.02%) and 5–10 months
(5.10%) become pivotal metrics in assessing the feasibility of hedging through this avenue. The
discrepancy between these rates and the treasury's investment strategy will impact the cost-
benefit analysis, influencing the ultimate choice of hedging instruments (Harzing, 2018).

Additionally, Rosenzweig (2018) suggests that in this intricate decision-making process, the
information on Dinar futures and options plays a vital role. The prices quoted for Three-month D
futures (e.g., December 2017 at 94.84) and the associated premiums for call and put options at
different months offer tangible data points for evaluating risk exposure. Assumptions about the
settlement at the end of each month, the diminishing basis to zero, and the absence of basis risk
and margin requirements provide a framework for understanding the operational dynamics of
these instruments.

To illustrate, Dowling (2019) emphasizes that consider the scenario where the treasury team's
investment strategy aligns with a desire to secure an interest rate lower than the central bank's by
30 basis points. If the local bank's FRA rates for 4–9 months or 5–10 months offer a more
favorable rate, this could potentially make FRAs an attractive hedging choice. Conversely, if the
market dynamics indicate a potential appreciation of the Dinar in the futures market, a strategic
position in Dinar futures could serve as a hedge against currency risk

The assumptions surrounding the treasury's investment strategy, local bank FRA rates, and the
provided information on Dinar futures and options collectively form the foundational pillars for
crafting a robust and effective hedging strategy. Each assumption introduces variables that will
be critical in the subsequent evaluation and selection of hedging instruments, aligning them with
Wonderworld Co's risk management objectives and market dynamics (Brewster, 2018).

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In the realm of hedging strategies for Wonderworld Co's D27,000,000 investment in Algeria,
Forward Rate Agreements (FRAs) stand out as a significant financial instrument. To begin with,
a meticulous calculation of potential interest rates becomes imperative, especially in light of the
predictions indicating a possible increase of 1.1% or a decrease of 0.6% in the central bank base
rate. These calculations serve as the foundation for evaluating the impact of interest rate
fluctuations on the investment (Schuler, 2021).

Simultaneously, Dowling (2019) aligning the FRA rates with the treasury's investment strategy
adds a layer of precision to the decision-making process. Given the treasury's inclination to
invest at the central bank base rate less 30 basis points, it becomes crucial to identify the FRA
rate that mirrors this strategic objective. This alignment ensures that the hedging instrument
complements the overarching investment philosophy, providing a seamless and coherent risk
mitigation strategy.

As Wonderworld Co assesses the local bank's FRA rates for different periods, such as 4–9
months at 5.02% and 5–10 months at 5.10%, a comparative analysis comes into play. The
treasury team must weigh the cost of entering into an FRA against potential gains or losses
resulting from interest rate movements. For instance, if the local bank's FRA rates are lower than
the anticipated interest rate after an increase, utilizing FRAs could prove advantageous as a
means of fixing a favorable rate for the investment period. On the other hand, if the rates are
higher than expected, the cost implications may prompt a reevaluation of the hedging strategy
(Schuler, 2021).

To illustrate, suppose the central bank base rate is initially 4.2%, and after a 1.1% increase, the
adjusted rate becomes 5.3%. If the local bank's FRA rate for 4–9 months is 5.02%, it aligns
closely with the treasury's investment strategy, potentially making it an attractive hedging choice
(Schuler, 2021).

The evaluation of Forward Rate Agreements involves a careful interplay of calculated interest
rates, strategic alignment with the treasury's investment philosophy, and a comparative
assessment of costs in relation to the FRA rates provided by the local bank. This holistic
approach ensures that the chosen hedging instrument not only mitigates risk but also harmonizes
with Wonderworld Co's overarching financial objectives (Myloni, 2021).

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In the intricate landscape of hedging strategies for Wonderworld Co's D27,000,000 investment in
Algeria, Interest Rate Futures emerge as a pivotal instrument. The initial step in this evaluation
process involves a meticulous assessment of Dinar futures prices at key junctures - December
2017, March 2018, and June 2018. These quoted prices, such as 94.84 in December 2017,
provide a glimpse into the market's anticipation of future interest rate movements (Brewster,
2018).

Consider, for instance, the Dinar futures price of 94.84 in December 2017. If the treasury team
expects interest rates to rise, and consequently, the Dinar to depreciate, taking a long position in
futures becomes a strategic move. By locking in the current rate through a futures contract,
Wonderworld Co safeguards against potential losses resulting from a higher future interest rate
(Brewster, 2018).

Conversely, Dowling (2019) stresses that if there is an anticipation of a decrease in interest rates,
the treasury team may choose not to take a position in Dinar futures, allowing the investment to
benefit from potential gains due to a stronger Dinar. This flexibility highlights the nuanced
decision-making involved in selecting Interest Rate Futures as a hedging tool.

To illustrate further, if the futures prices indicate a decline, say to 94.66 in June 2018, and the
treasury team anticipates a corresponding drop in interest rates, refraining from taking a position
in futures could be a strategic move. This decision aligns with the belief that allowing the
investment to remain unencumbered by a futures contract might capitalize on the positive impact
of lower interest rates on returns (Schuler, 2021).

The assessment of Interest Rate Futures involves a comprehensive analysis of quoted prices at
various intervals, guiding the treasury team in making strategic decisions. Whether to take a
position in futures hinges on the team's outlook on future interest rate movements and the
potential impact on the Dinar's value. This adaptability ensures that the chosen hedging strategy
remains aligned with Wonderworld Co's risk management objectives and market dynamics.

As Wonderworld Co navigates the complexities of hedging its D27,000,000 investment in

Algeria, a nuanced examination of Options on Interest Rate Futures becomes paramount. The
evaluation process begins by scrutinizing the call and put options available for different months,
specifically December, March, and June. The annual percentage premiums associated with these

4
options, such as 0.417 for December call options and 0.071 for December put options, offer
insights into the cost of potential hedging strategies (Schuler, 2021).

Consider, for instance, the evaluation of call options. If the treasury team anticipates a scenario
where interest rates are expected to rise, the purchase of call options for a future month, such as
March or June, could serve as a safeguard. By holding call options, the company gains the right,
but not the obligation, to purchase Dinar futures at a predetermined rate, protecting against
potential losses resulting from higher interest rates (Myloni, 2021).

On the flip side, evaluating put options is crucial when considering a hedge against adverse
interest rate movements. Suppose the team foresees a potential decrease in interest rates, leading
to a stronger Dinar. Purchasing put options, such as those for March with a premium of 0.393,
allows Wonderworld Co to secure the right to sell Dinar futures at a predetermined rate. This
protective measure helps mitigate potential losses in a scenario where interest rates decline,
affecting the investment's returns.

The decision-making process extends beyond merely evaluating options based on market
expectations. It involves a meticulous consideration of the cost associated with premiums, which
represent the price paid for the right to exercise these options. For example, if the premium for a
call option is high, the overall cost of implementing the hedge increases. The treasury team must
weigh this cost against the potential benefits of the hedge (Brewster, 2018).

To illustrate, if the premium for June call options is significantly lower than the anticipated
increase in Dinar futures prices, it could be a cost-effective way to guard against potential losses.

The Options on Interest Rate Futures strategy demands a thorough evaluation of call and put
options, considering the potential impact of interest rate movements on the investment. The
decision to purchase options is intricately tied to market expectations, the outlook on interest
rates, and a judicious consideration of the associated premium costs. This approach ensures that
the chosen hedging instrument aligns seamlessly with Wonderworld Co's risk management
objectives and provides an effective shield against adverse market conditions (Schuler, 2021).

In devising an overall strategy for hedging Wonderworld Co's D27,000,000 investment in

Algeria, a thoughtful combination of financial instruments emerges as a prudent approach. This
entails considering Forward Rate Agreements (FRAs), Interest Rate Futures, and Options on

5
Interest Rate Futures to create a diversified hedging strategy. Each instrument plays a unique role
in addressing different aspects of interest rate and currency risk.

In evaluating the cost and effectiveness of each strategy under varying interest rate scenarios, the
treasury team must perform meticulous calculations. By adjusting the interest rate after a
potential 1.1% increase or a 0.6% decrease, the team gains insights into the anticipated returns on
the investment. These calculations serve as a foundation for comparing the cost of hedging
through FRAs, gauging the impact of Interest Rate Futures on Dinar values, and assessing the
cost-effectiveness of Options on Interest Rate Futures (Brewster, 2018).

Sample calculations can further illustrate the decision-making process. For instance, assuming
the central bank base rate is initially 4.2%, an increase to 5.3% or a decrease to 3.6% would
guide the team in comparing these rates with the FRA rates provided by the local bank. This
comparative analysis determines the potential cost of hedging and informs the decision-making
process.

In examining Dinar futures, calculations would involve determining gains or losses based on
changes in interest rates and their impact on the Dinar's value. The treasury team must weigh the
potential benefits of taking positions in futures against the associated risks and costs (Myloni,
2021). Additionally, when delving into Options on Interest Rate Futures, evaluating the cost of
premiums becomes crucial. The team needs to consider the trade-off between premium costs and
the potential gains or losses associated with different interest rate scenarios. A strategic
combination of call and put options can offer flexibility and effectiveness in managing risk as
highlighted by Rosenzweig (2018).

The discussion on pros and cons of each hedging instrument further refines the overall strategy.
The level of certainty, cost, and potential gains associated with each instrument must be
considered in the context of Wonderworld Co's risk tolerance and financial objectives. The
impact on the company's financials under different interest rate scenarios is a pivotal
consideration, allowing the team to assess the overall effectiveness of the chosen hedging
strategy (Schuler, 2021).

In conclusion, the comprehensive approach to devising an overall strategy involves not only
calculations based on adjusted interest rates but also a nuanced discussion on the strengths and

6
weaknesses of each hedging instrument. By considering a combination of these instruments and
evaluating their impact under various scenarios, Wonderworld Co can craft a balanced and
effective hedging strategy tailored to its specific risk profile and financial goals. Consulting
financial experts or utilizing financial modeling tools is recommended for precise calculations
and informed decision-making.

2.0 Distinguishing between political and political risk; describing sovereign risk

Country risk

Country risk is the likelihood that a foreign government will not fulfill its financial
commitments, or that foreign investments will be uncertain as a result of social, political,
economic, or other upheavals. Country risk quantifies the probability of a country's financial
commitments being defaulted upon for reasons other than the risks associated with a loan. In this
sense, the nation will suffer more from increased risks. Therefore, country risk refers to the
danger of losing money on investments by considering a wide range of political, financial, legal,
macroeconomic, and social issues that might affect the returns on securities sold in a foreign
nation. The general assumption upon which all other hazards are built is known as "country risk."

Political Risk

Political risk can be summed up as "the possible harm to a business operation resulting from
political behavior." Danger or possible injury are two definitions of risk. Political risk is
described by economists as "the danger that the actions of governments might reduce the cash-
flows that investors expect from their investments" ( economist June 8, 2017). Hence, it implies
risks associated with a downturn in the economy that might lead to inflationary pressures or an
economic slump, which would impact the actual and financial value of assets. Unrest or turmoil
in society, frequent political changes that cause instability across the nation, and the lack of a
favorable environment are examples of unfavorable political occurrences. Hence, political trend
volatility might lead to instability, which would be bad for the nation's economy and the returns
on investments made by investors.

Sovereign Risk

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Sovereign risk is defined as "the risk that repayments from foreign borrowers may be interrupted
because of interference from foreign governments" by (Saunders and Cornett 2019,). Joseph
(2006) defines sovereign risk as the probability that a foreign or sovereign government would be
unable to repay its obligations. "Sovereign credit risk" is the danger that a government won't be
able to perform its contractual obligations, including making timely principle and interest
payments or keeping its word to give guarantees to both public and private sector organizations.
(Černohorský, 2011).

Political instability, excessive government spending through debt to tax revenues to cover capital
expenditures, and the need to control aggregate demand are all potential causes of sovereign debt
default. The monetary authorities of a nation, usually the central bank, may also be responsible
for sovereign risk. For example, they may modify monetary policy in a way that affects foreign
currency interest rates, so devaluing foreign exchange contracts. If investors are wary about
giving loans or buying government bonds and treasury bills, future borrowing prospects would
be hindered. Alternatively, they can raise interest rates as a premium for a higher chance of
default.

Economic variables that indicate country risk for a particular country

Current Account Movements

As stated by Wajda-Lichy (2015), the current account of the balance of payments provides
information on cross-border investments, transfer payments, and international fund inflows and
outflows from imports and exports. A current account deficit will thus result from
disequilibrium, which takes the shape of an excess of the financial value of imports over exports.
This might suggest that there is a chance that the nation's reserves will be depleted in order to
pay for imports, increasing the likelihood that a nation could default on its debt.

Debt to GDP Ratio

The ratio takes into account the market value of all products and services produced domestically
in a given year in relation to the amount of outstanding public debt in that nation. The debt to
GDP ratio provides information on the stability of the nation's economy (Muscal, 2002). Rising
debt levels are a sign that a country may not be able to pay back its sovereign loans if all GDP
cash inflows are allocated to debt payments. Similarly, it can portend that a nation would soon

8
switch from producing goods for domestic consumption to exporting them in order to pay off its
foreign debt.

Debt Service Ratio

DSR is equal to interest plus debt/export amortization. According to Yousaf and Mukhtar (2020),
this ratio gives information on the amount of export profits utilized for both short-term and long-
term repayment of outstanding principal and interest on foreign debt. As a result, as it shows
what percentage of export revenue may go toward debt repayment, it aids in assessing a nation's
solvency and liquidity risk. A drop in export revenue would indicate a reduction in the ability to
repay debt, which would increase risk and affect the creditworthiness of the nation. According to
Uppal (2017), a growing ratio suggests an excessive correlation between foreign debt and the
economy's primary source of external revenue, suggesting that the nation may face difficulties
fulfilling its debt commitments in the future. Since debt levels and a nation's marginal cost of
borrowing are substantially positively connected, this is detrimental to the nation's capacity to
withstand short- and long-term economic shocks.

Investment Ratio (INVR)

Real investment divided by GDP is INVR. A country's level of real, productive investment
relative to its level of consumption expenditure is indicated by its investment ratio. It would
seem that there is an inverse relationship between the investment ratio and the likelihood of the
country having to reschedule its debt because a higher investment ratio is predictive of higher
future economic productivity and, therefore, lowers the probability of that happening (Saunders
& Cornett, 2019).

Variance of Export Revenue

(VAREX) VAREX = σ2ER

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Two risk variables, quantity risk and price risk, can have a significant impact on a nation's export
earnings (Saunders & Cornett, 2019). The first results from variations in the nation's output of
the raw materials it exports, whereas the latter is caused by changes in global prices as a result of
supply and demand volatility. Therefore, creditors are less assured that a country will be able to
honor its debt commitments at any given time in the future the more volatile the country's export
profits are. As a result, σ2ER and the likelihood of rescheduling would be positively correlated.

Domestic Money Supply

Growth (MG)
Domestic Money Supply Growth

(MG) MG = ΔM/M

Measured against its starting level M, ΔM/M represents the change in the money supply (ΔM).
In the country, the rate of inflation increases with the pace of expansion in the money supply.
Reliance on hard currencies for both domestic and international payments increases when the
currency weakens in both domestic and international markets and runs the danger of losing
credibility as a medium of exchange, which might hurt real production (Saunders & Cornett,
2019). Growth in the domestic money supply, the likelihood of rescheduling, and the three
factors of inflation, production, and payment impacts are all positively correlated, according to
the authors.

Three elements of political risk

Modifications to Government Law and Policy Modifications

Law changes have the potential to negatively impact company activity and the business climate.
Consumer prices might rise as a result of regulatory changes to interest rates, minimum wage
laws, or import taxes (Campisi & Caprioni, 2017). These measures could also increase the cost
of products and services. Regulations that alter the business environment might potentially have

10
an impact on it. For instance, requiring certain permits or making them expensive could deter
potential investors from entering the market.

Hazard of Expropriation

Expropriation or nationalization of privately held property by a government is a possibility,

therefore businesses operating abroad run the danger of being taken over by the government and
used for national purposes, either with or without compensation (Hoops et al., 2015). Since it
indicates a loss of resources and anticipated revenue, this might be detrimental to the impacted
company. According to Andoh (2007), referenced in Mark and Nwaiwu (2015, p. 3), “most, if
not all, of these American companies had no recourse for getting the money back” following the
expropriation of American-owned properties and businesses by Fidel Castro's government in
1959.

Corruption, Unrest in Politics, and Upheavals

Investors are exposed to the risk of loss when there is political unrest in a nation because of
increased insurance premiums and the expense of replacing or repairing damaged property.
"Adverse political actions can range from very detrimental, such as widespread destruction due
to revolution, to those of a more financial nature, such as the creation of laws that prevent the
movement of capital," according to Mark and Nwaiwu (2015, p. 3). The efficient and effective
operation of company is hampered by corruption since it allows fair practice regulations to be
circumvented.

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REFERENCES

Dowling, P. J., Festing, M., & Engle, A. D. (2019). International Human Resource Management.
Cengage Learning.

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Schuler, R. S., Jackson, S. E., & Tarique, I. (2021). Global Talent Management and Global
Talent Challenges: Strategic Opportunities for IHRM. Journal of World Business, 46(4),
506-516.

Briscoe, D. R., & Schuler, R. S. (2020). International Human Resource Management: Policies
and Practices for Multinational Enterprises. Routledge.

Harzing, A. W., & Ruysseveldt, J. V. (Eds.). (2018). International Human Resource

Management. Sage Publications.

Sparrow, P., Brewster, C., & Chung, C. (2019). Globalizing Human Resource Management.
Routledge.

Dowling, P., Festing, M., & Engle, A. D. (2021). From Domestic to Global: The Challenges of
Expatriate Management. Organizational Dynamics, 42(3), 167-175.

Scullion, H., & Collings, D. G. (Eds.). (2019). Global Talent Management. Routledge.

Rosenzweig, P., & Nohria, N. (2018). Influences on Human Resource Management Practices in
Multinational Corporations. Journal of International Business Studies, 25(2), 229-251.

Myloni, B., Harzing, A. W., & Mirza, H. (2021). Host Country Specific Factors and the Transfer
of Human Resource Management Practices in Multinational Companies. International
Journal of Manpower, 25(6), 518-534.

Brewster, C., Sparrow, P., & Vernon, G. (2018). International Human Resource Management:
Contemporary Issues in Europe. Routledge.

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