EXAMINATION OFFICE

January – June 2020 (Session)

END SEMESTER EXAMINATIONS
(24th June – July 2020)
Code: ACFN678

FINANCIAL RISK MANAGEMENT

TIME ALLOWED: 3 HOURS
EXAMINER: Samba DIARRA
DATE: 29th June 2020
CLASS: MBA 3 (FM)
INSTRUCTIONS: Answer all the questions. You have three (3) hours to answer all the questions. Carrying of digital diaries, Mobile
phones, calculators, laptops etc. are not allowed in the examination hall. Cheating may lead to disqualification.

QUESTIONS
Question 1
The rate quoted is 1 GBP = 1.4330 - 1.4325
 Company A wants to buy 100,000 USD in exchange for GBP. (1.4330)
 Company B wants to sell 200,000 USD in exchange for GBP. ( 1.4325)
Required:
What rate will the bank offer each company? (2 marks)

Question 2
A US company has to pay EUR 100,000 for a machine. You have the following information:
GBP 1/ EUR 1.5300
GBP 1 / USD 1.8700
Required:
What is the cost of the machine in dollars? (2 marks)
100,000 x 1.5300 = GBP 1530,000
153,000 /1.870 = $81,818

Question 3
A company may wish to forecast exchange rates for a number of short-term and long-term
reasons. These may include:
 Foreign debtors and creditor balances
 Working capital
 Investment appraisal of foreign subsidiaries
 Pricing
Three theories help to predict exchange rate movements
(1) Purchasing Power Parity Theory (PPPT)
(2) Interest Rate Parity Theory (IRPT)
(3) The international Fisher Effect
Spot USD 1/ EUR 0.9050
Interest rates p.a. on short-term government securities
US 6.0%
Eurozone 4.5%

Inflations
US 2.0%
Eurozone 1.3%

Required:
Calculate using the parity relationships (PPPT and IRPT) the theoretical correct forward
rates. Determine the reasons for a difference between the two, if one arises.
(8 marks)

- PPPT
FR = Spot rate x (1+IF)/ (1+IH)
FR = 0.9050 x (1+2%)/(1+1.3%)
FR= 0.91%

- IRPT
FR = Spot rate x (1+IF)/ (1+IH)
FR= 0.9050 x (1+6%)/(1+4.5%)
FR= 0.92%
The difference is due to the fact that in PPPT, we use inflation rate which tends to
fluctuate to predict the exchange rate while in IRPT, we use interest which is fixed.

Question 4:
DD Ltd (a UK company) is required to make payment of EUR 1.3 million in six months’ time.
The company treasury has established the following rates going forward:
Spot rate GBP 1 = EUR 1.5095 – 1.5050
Six month GBP 1 = EUR 1.5162 – 1.4895
Money market rates (p.a.):
Loan Deposit
Euro 4.0% 2.5%
Sterling 4.6% 3.1%
Required:
What is the GBP cost of making the payment using?
(a) a money market hedge?
Step 1:Borrow the PV of the money at a discount factor
PV = 1,300,000/ (1+(4%/2)) = 1274509.8 €
Step 2:Sell the PV and collect local deposit
Translate at Spot rate : 1274509.8 x 1.5050= £191,8137.3

Step 3 :Deposit in a local currency account and collect interest

1918137.3 x ( 1+ (3.1%/2) = £191,8138.3

(b) a forward contract hedge? (12 marks)

1,300,000 x 1.4895 = £193,6350

Question 5:
You are the financial manager of Multidrop (Group) a European based company which has
subsidiary businesses in North America, Europe and Singapore. Its has also foreign currency
outstanding with two non-group companies in UK and Malaysia. Last year the transaction costs
of ad-hoc settlements both within the group and non-group companies where significant and
this year you have reached agreement with the non-group companies to enter into a netting
agreement to clear indebtedness with the minimum of currency flows. It has been agreed that
Multidrop (Europe) will be the principal in the netting arrangement and that all settlements will
be made in Euros at the prevailing spot rate.
The summarised list of the year end indebtedness is as follows:
Owed by: Owed to:
Multidrop (Europe) Multidrop (US) US$6.4 million
Multidrop (Singapore) Multidrop (Europe) S$16 million
Alposong (Malaysia) Multidrop (US) US$5.4 million
Multidrop (US) Multidrop (Europe) €8.2 million
Multidrop (Singapore) Multidrop (US) US$5.0 million
Multidrop (Singapore) Alposong (Malaysia) Rm25 million
Alposong (Malaysia) NewRing (UK) £2.2 million
NewRing (UK) Multidrop (Singapore) S$4.0 million
Multidrop (Europe) Alposong (Malaysia) Rm8.3 million

Currency cross rates (mid-market) are as follows:

Currenc UK £ US $ Euro Sing $ Rm
y
1 UK £ = 1.0000 1.4601 1.0653 2.1956 5.3128
1 US $ = 0.6849 1.0000 0.7296 1.5088 3.6435
1 Euro = 0.9387 1.3706 1.0000 2.0649 4.9901
1 Sing $ = 0.4555 0.6628 0.4843 1.0000 2.4150
1 Rm = 0.1882 0.2745 0.2004 0.4141 1.0000
You may assume settlements will be at mid-market rates quoted. You should convert all
amounts to the settlement currency first.

Required:
a. Calculate the inter group and inter-company currency transfers that will be required for
settlement by Multidrop (Europe)
(6 marks)
b. Discuss the advantages and disadvantages of netting the arrangements with both group
and non-group companies.
(3 marks)
c. Discuss whether Multidrop (Europe) should adopt a policy of invoicing overseas
customers in its home currency (Euro (2 marks)
(11 marks)
Question 6

It is 15 October and a treasurer has identified the need to convert euros into dollars to pay a US
supplier USD 12 million on 20 November. The treasurer has decided to use December euro
futures contracts to hedge with the following details:
 Contract size EUR 200,000.
 Prices given in USD per EUR (i.e. EUR1=…)
 Tick size USD 0.0001 or USD 20 per contract.

He opens a position on 15 October and closes it on 20 November. Spot and relevant futures
prices are as follows:
Date Spot Futures price
15 October 1.3300 1.3350
20 November 1.3190 1.3240

Required:
Calculate the financial position using the hedge described. (9 marks)

Question 7

The death of, or serious injury to, a member of staff at work would best fit which category
on a risk map?
A. Low likelihood; low consequence
B. High likelihood; low consequence
C. Low likelihood; high consequence
D. High likelihood; high consequence (2 marks)
Question 8
A risk identified as having a low frequency and a high severity should be managed by:
A. Avoiding
B. Accepting
C. Transferring
D. Reducing (2 marks)
Question 9
P company is a large international fast food retailer with plans to expand on a global scale. J is a
manager who has relocated to country X to begin an aggressive standardised expansion plan.
Five restaurants have opened so far in the cities of Country X but the response from the local
population has been poor. Initial sales targets have not been met and the Board of P Company
believes that further expansion into Country X is at risk and it is possible the plan will be
abandoned.
J believes that the restaurants have not been immediately successful because the population of
Country X, although affluent and well educated are not used to the concept of ‘fast food’.
Restaurants in Country X are typically expensive and serve fresh food to order.
Which of the following are appropriate risk management responses for J to discuss with
The Board? Select all that apply.
A. P Company should embark on a marketing campaign within Country X.
B. The menus of restaurants in Country X should be modified to reflect local tastes with
more fresh food included.
C. P Company should stop expansion plans in Country X and choose a more appropriate
location.
D. P Company should replace J as the manager of expansion in Country X.
E. P Company should abandon their standardised plan in Country X and instead tailor their
branding and products to be in line with successful local restaurants. (2 marks)

*****GOOD LUCK*****