Financial Markets and Risk Management

Take Home Assignment

Note: If you need to value an option, please feel free to use any online calculator or other software, but you must
(a) specify clearly the inputs to that calculator, and (b) show any workings that were used to arrive at those inputs.
For any instrument other than an option, show your workings.

Part A
Suppose the spot exchange rate is |60/$, the US interest rate is 3%, the Indian interest rate is 8%, and the volatility
of the rupee-dollar exchange rate is 10%. Suppose also that ABC Ltd has an $100,000 import payment falling due
in 3 months.

1. If ABC chooses to lock-in the rupee payment for this import, what will be the rupee outflow that it will have
at the due date?
2. If ABC wants a hedge that will cap its rupee outflow at |6.2 million while benefiting from favourable move-
ments in the exchange rate, what instrument will you recommend and what will it cost?
3. ABC is unwilling to pay the cost of the above hedge (cap), but is prepared to accept a floor on its rupee
outflow. Determine the floor value that ABC must accept for it to obtain the above cap at zero cost. Use trial
and error to find the floor value to the nearest |5,000.

Part B
Consider any financial risk that your organization was exposed to in 2019 (I have deliberately chosen this period
to ensure that I do not have to read anything more about Covid-19).

• Briefly describe the risk

• Explain why you think your organization should or should not have hedged this risk.
• Explain what financial hedges your organization could have used to hedge the risk.

Note 1: You may disguise some of the numbers or other details to avoid divulging any confidential information.
Also, you do not need to disclose what your organization actually did to deal with the risk. In particular, your
recommendation need not be the same as your organization’s actual choice.
Note 2: If your organization did not face any exchange rate, interest rate or commodity price risk in 2019, you
could choose an earlier time period (including if necessary the previous organization that you worked for).