Question : 14

BTL Co is in usa and expects to pay €750,000 to a supplier in the European Union in six months’ time.

The following commercial interest rates are available to BTL Co:

Deposit rate Borrow rate

Euros 7·0% per year 8·0% per
Dollars 3·0% per year 3·5%
year per
year
BTL Co does not have any surplus cash to use in hedging the future euro receipt.

Euro/US Buy Rate Sell Rate

Spot Rate €2·582 €2·795

Forward Rate @ 3-month €2·419 €2·782

Forward Rate 9-months €2.324 €2.555

Required:

1. What would be the dollar value of forward market hedge in six months?(round off to the nearest
thosound)
$316,000

2. What would be the expected payment in dollar using money market hedge ?(round off to the nearest
hundred)

285,600

3. Which of the following are true or false?

Transaction risk is the TRUE FALSE
short form of economic
risk
Economic risk is not an TRUE FALSE
actual outflow of cash until
disposal of subsidiary.

4. If BTL co use an internal hedge of lead payment,what is the expected payment in dollar ? ( round off to
nearest thousand)
$ 296,000

5. Which of the following is/are over the counter derivative contracts to hedge the risk.
 Forward Contract
 Future Contract
  Money market hedge
 Currency Swaps
QUESTION : 15

TLQ Co, whose home currency is the dollar, trades regularly with customers in a number of different
countries. The company expects to receive €1,200,000 in six months’ time from a foreign customer.
Current exchange rates in the home country of TLQ Co are as follows:

Spot exchange rate: 4·1780–4·2080euros per $

Six-month forward rate: 4·2302–4·2606 euros per $

Twelve-month forward rate 4·2825–4·3132 euros per $

Required:

1. Calculate the loss or gain compared to its current dollar value which TLQ Co will incur by taking out a
forward exchange contract
-$
$3,521

2. If the interest rate in the home country of TLQ Co is 4% per year, calculate the annual interest rate in the
foreign customer’s country implied by the spot exchange rate and the twelve-month forward exchange
rate.

A. 6.6%

3. Which of the following is not the internal hedging method of foreign currency risk.
A. Matching and Invoice in Home Currency
B. Money market hedging
C. Netting and Do Nothing
D. Creating Assets and Liabilities in foreign.

4. What is of the following is/are the characteristic of future contract. (Shade the circle)
 It’s not a leveraged instrument
 It have flexible closeout date
 Trade on open market
 It has fixed date of settlement
 Tick is the smallest movement of forward contract

5. What is true for Currency swap transaction?

Initial value of swap contract is TRUE FALSE
always positive for one party and
negative for other party
The counterparties exchange TRUE FALSE
notional principals in the two
currencies
Swap contract have No default TRUE FALSE
risk like forward contract.

Currency swaps like future TRUE FALSE

contracts are traded on
exchanges.

Question 16

A recent article has been published at WSJ stating that the term structure of interest rates is revealed by the
redemption yield data. As the maturity increases, the redemption yield also increases, producing what is known as
the normal upward sloping yield curve. The shape of the yield curve can be explained by many theories like liquidity
preference theory, expectation theory and market segmentation theory.

Two trainees at finance department recently recruited are discussing the theories, one of the trainee, Steve said
that “Liquidity Preference theory requires extra compensation in the form of an enhanced yield if they are to invest
for the long term”. Michel said that “under expectations theory if the yield curve becomes steeper, this indicates
that interest rates are likely to fall and if it becomes less steep interest rates are likely to rise therefore shape of
yield curve is important”

Sherlock, the assistant finance director is analyzing the interest rate data provided in exhibit 1 and is confused
whether the yield curve is becoming steeper or flatter. We want to evaluated the interest rate risk for bond
portfolio he is managing.

Redemption yield (%) As at 1/1/X7 As at 1/1/X6

Treasury 20X8 5.21 5.17
Treasury 20Y0-Y2 5.58 5.49
Exchequer 20Y6 6.46 6.33

Large company is heavily indebted company which is keen to protect the interest payments on $10 million of
borrowing which will be required in 3 months for a period of 4 months. The company has discovered that the
following forward rate agreements are currently available to it:

3v4 7.45-7.34

3v7 7.53-7.43

4v7 7.58-7.45

Additionally Large Company is keen to protect itself against interest rate movements on some of its debt. However
the finance director cannot distinguish between futures and options on futures and hence is unsure what to use.

1. With regard of interest rate theories, who is correct?

A. Michel
B. Steve
C. Both are correct
D. None of them

2. According to market segmentation theory, the market is split into segments based on?
A. Borrowing
B. Lending
C. Borrowing and Lending
D. Systematic and Unsystematic

3. Given the change in the redemption yield between two years, it appears that the yield curve is becoming
and interest rates are expected to?
A. Steeper and decrease
B. Less steeper and increase
C. Steeper and increase
D. Less steeper and decrease
4. What is the appropriate forward rate agreement and net cost to large company it actual interest is 7.76% in
three months?
A. 3 v 7 and $251000
B. 3 v 7 and $258667
C. 3 v 7 and $7667
D. 4 v 7 and $258667

5. Based on the expectation of interest rates in question no 3, it is recommended to Large Company to get into
transaction by using?( chose from the drop down list)
• Future contract
• Options on future
• Both future and options on future