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Exercise Meeting 7
Exercise Meeting 7
MAF603
A. TXM Bhd, a Malaysian manufacturing company has decided to purchase two high-
tech machineries to increase its production efficiency. After receiving quotations
from few suppliers, TXM Bhd chose to buy from a company in Germany. The price
of the machinery is quoted at €350,000.
The exchange rate at the time of placing the order is MYR1 = €0.2142. Payment is
due in three months’ time. Based on the current economic situation, the Malaysian
Ringgit is expected to depreciate further in relation to Euro.
Required:
The spot exchange rate between the Turkish Lira (TRY) and Russian Ruble (RUB)
is quoted as TRY/RUB 0.1244 – 0.1282. The company can deposit in Russian
Ruble (RUB) for 6 months at 8.00% per annum and can borrow Turkish Lira (TRY)
for 6 months at 7.00% per annum.
The corporation plans to manage the exchange rate risk associated with this
transaction using the money market hedging technique.
Required:
C. Viva Energy Group Limited is a diversified and key player in the global commodity
market located in Australia. It needs to exchange £20,000 from an overseas sale
into Australian Dollar. The exchange rate quoted by an Australian bank is:
Required:
a. Calculate how much AUD will be received by Viva Energy Group Limited.
b. The firm has just bought machinery from a Malaysian supplier for
MYR100,000 with payment due in 3 months’ time. Exchange rates are quoted
as follows:
If the actual current spot rate in 3 months’ time is MYR/AUD 2.9416 – 2.9425,
discuss whether Viva Energy Group Limited would gain an advantage from
utilizing a forward contract within a 3-month time frame.
SOLUTION
A.
a. TXM Bhd is dealing with transaction risk. Transaction risk involves a future receipt
or payment in foreign currency when engaging in import or export businesses. The
movement in the exchange rate at the placement order date and the settlement
date may cause TXM Bhd to pay higher or lower MYR for the needed machinery in
three months’ time.
b. If Ringgit depreciates by 4%, the exchange rate would be RM1 = €0.2056 (0.2142
x 0.96 = 0.2056)
Thus, the company would receive RUB 15,675,989 from this method.
If the company does not use a forward contract and pays using the actual
current spot rate, it would have to pay:
MYR100,000/2.9416 = AUD33,995
Thus, the use of forward contract does not benefit Viva Energy as the
payment using actual spot rate is lower than using forward rate.
Required:
Explain TWO (2) risk management methods that Topper Bhd can use to hedge the
company from currency risk.
SOLUTION
• Enter into a forward exchange contract. When the time comes to pay the debt,
Topper knows how much exactly it will have to pay regardless of the actual spot
rate at that time.
Company Transactions
Gateway Ltd Expected receipt of £360,000 in one month’s time
Gateway Ltd Expected payment of £210,000 in one month’s time
Modern Pte Ltd Expected receipt of £380,000 in three months’ time
Required:
SOLUTION
A. a.
1. Borrow in £ today = £380,000 / (1+ (0.06/4)
= £380,000 / (1.015)
= £374,384.24
£150,000/0.55229 = AUD$271,596.44
JULY 2020 – QUESTION 6
Below is the excerpt of The Edge Financial Daily, 20th April 2020:
RHB Investment Bank Bhd advised investors to avoid developers with high gearing, an
unsold completed inventory as well as unsold stocks from ongoing projects as it believes
these remaining unsold development projects will be slow moving going forward, tying
up developers’ cash flow.”
(Source: extracted from https://www.theedgemarkets.com/article/grim-1q-earnings-outlook-selected-industries)
Required:
Briefly explain two (2) reasons why RHB Investment Bank Bhd advise investors to avoid
investing in property developers with high gearing.
SOLUTION
Two (2) reasons why RHB Investment Bank Bhd advise investors to avoid investing in
property developers with high gearing:
1- The amount available for dividends will be more volatile – highly geared
property developers have to pay high interest. Since the economic condition is
bad, there will be adverse effects on the sales of properties. As shareholders have
residual claims after bondholders, dividend will be volatile due to uncertain
income and high interest payment
2- There is the risk that if interest cannot be paid the company will be wound
up – It is expected that the saleability of properties will be slow and affect the
cash flow of the company. As a result, the company could not afford to pay
interest and will be liquidated through bankruptcy.
A Malaysian company has agreed to buy a Canadian asset, thus it will need to buy
Canadian Dollars and sell Ringgit Malaysia (RM) to execute the transaction. Assuming,
the Malaysian company believes the Canadian Dollar is expected to appreciate against
RM when payment is due by the end of July 2020.
Required:
SOLUTION
If the Malaysian company believes the Canadian Dollar is appreciating against Ringgit
Malaysia, the Malaysian company should accelerate the transaction or choose
leading strategy before the price of the Canadian asset increases in RM terms.
Hence, make payment when it is due by the end of July 2020.
Prolab Bhd (Prolab) is frequently imported chemical products from companies in the
United States of America (US). Prolab is required to make payment of $USD200,000 to
the US suppliers at the end of October 2020. Today, is at the end of July 2020, the current
exchange rate is $0.30 per Ringgit Malaysia (RM).
Required:
If Prolab decides to adopt lagging strategy, determine how much Prolab would benefit
from the strategy.
SOLUTION
By adopting lagging approach which delaying the payment, Prolab Bhd will benefit
the amount of saving of RM12,328 (RM647,249-RM634,921).
Managing the interest rate risk aims at capturing the risks arising from the maturity and
re-pricing mismatches and is measured from both the earnings and economic value
perspective.
Required:
SOLUTION
Interest rate can be managed using internal hedging in the form of asset and liability
management, matching and smoothing or using external hedging instruments, such as
forward rate agreements and interest rate derivatives.
B. A Korean firm importing goods from a Chinese manufacturer. The Korean firm has
a strong opinion that Yuan rate (¥) will fall next month. The payment of ¥150,000 is
due in one month’s time. Current exchange rate is ₩1 = ¥0.0058 and next month’s
rate is expected to be at ₩1 = ¥0.007
Required:
ii. Based on the strategy in (i) above, calculate the total saving or loss the
Korean firm will receive if Yuan fall.
C. Price of a cup of Starbuck coffee in United States (US) is $USD3.59. The inflation
rate in US is reported at 2% whilst Malaysia has reported an inflation rate of 1%.
Assuming that the US dollar and Malaysian Ringgit are at Purchasing Power Parity,
and the current spot rate is $USD1.00 for every MYR4.20 (spot rate quoted in US
Dollar):
Required:
D. The following excerpt from the website “The Balance.Com” on article entitled “US
Trade Deficit with China and Why It’s So High!!” updated 12 October 2020.
The U.S. trade deficit with China in 2019 was $345.6 billion. That's 18% less than
2018's $418.9 billion deficit. The trade deficit exists because U.S. exports to China
were only $106.6 billion while imports from China were $452.2 billion. A lot of these
imports are from U.S. manufacturers that send raw materials to China for low-cost
assembly. Once shipped back to the United States, they are considered imports.
China produces goods at lower cost and most economists agree that China’s
competitive pricing is a result of relaxing its peg on Yuan ( ¥) value in 2016. In effort to
manage the deficit, President Donald Trump began imposing tariffs on China imports
in 2018.
Required:
ii. Discuss the impact of the imbalance trade to the currency value of both
countries; US Dollar ($) and China Yuan (¥).
iii. Recommend three (3) mechanisms that could be implemented by countries
facing with trade deficits like the U.S. country.
SOLUTION
B. i. The Korean firm may adopt a lagging strategy because the Yuan value
will be smaller/fall next month.
Alternative:
1+1% x RM4.20 = RM4.16 (future spot rate)
1+2%
D.
i. The condition balance of payment between US and China witnessed the U.S. trade
deficit with China in 2019 was $345.6 billion. That's 18% less than 2018's
$418.9 billion deficit. The trade deficit exists because U.S. exports to China were
only $106.6 billion while imports from China were $452.2 billion. Thus, US country
has a current account deficit where its imports exceed the exports causes trade
imbalance or trade deficit.
ii. The balance of trade influences currency exchange rates through its effect on the
supply and demand for foreign exchange. Since currencies are required to finance
international trade, changes in the demand and supply of the currency will lead to
changes in exchanges rates or capital flows between economies.
US may expect to see its exchange rate depreciate, since the supply of the
currency (imports) will exceed the demand for the currency (exports). US imports
more than it exports, there is relatively less demand for its currency, so prices
should decline. In the case of currency, it depreciates or loses value. This will cause
a country to borrow capital from foreign sources to cover the deficit.
In contrast, it will be vice versa where China exports more than it imports, there is
a high demand for its goods, and thus, for its currency. The economics of supply
and demand dictate that when demand is high, prices rise and the currency
appreciates in value.
iii.
• Imposing foreign exchange barriers when designing effective national and
international trade policies in support of the circular economy. However,
sometimes these will affect macro variables such as inflation, interest
rates, and income levels.
• Imposing foreign trade barriers. To manage the large U.S. trade deficit
with China, President Donald Trump began imposing import tariffs on
China imports in 2018. The US implemented the trade protectionism.
Required:
i. Calculate the expected hedged value for forward contract and money market
transaction.
ii. Based on answer in (i), advise Lancer Bhd the suitable hedging technique to
mitigate the exposure.
C. The risk management for interest rate is equally important as the foreign exchange
rate risk in which the variability of interest rate risk may affects the cash flow of the
firm. The following information was extracted from The Star news portal dated 8
July 2021 on Overnight Policy Rate (OPR) and interest rates in Malaysia:
Based on the excerpt report above:
KUALA LUMPUR: Bank Negara Malaysia decided to maintain the Overnight Policy Rate
(OPR) at 1.75% on Thursday, which was in line with economists’ expectations.
The economists agree that a cut in interest rates is not likely to help to stimulate the economy
due to inflationary pressure amid the pandemic. The current interest rate is sufficient to
accommodate the economy. The OPR level will influence interest rates in other markets,
including credit market as OPR is the primary reference rate. The emergence of COVID-19
outbreak contributes to two consecutive reductions in the year 2020 which brought down
OPR from 3.00% to 2.75% in January 2020 and was further reduced to 2.75% in March 2020.
(Source: https://www.thestar.com.my/business/business-news/2021/07/08)
a. Briefly discuss how changes in the Overnight Policy Rate (OPR) by Bank
Negara Malaysia and interest rates might affect companies.
SOLUTION
A
i. Forward Contract:
Hedged value = USD220,000 x MYR3.8900 = MYR855,800
The USD receivables (USD220,000) will be collected and used to pay the USD
loan USD207,547.16 x 1.06 = USD220,000) and used it to deposit in MYR now
(spot rate).
In this way, the amount received from the MYR investment could be higher.
ii. As this is a receivable, the choice between forward and money market hedge
(MMH) is based on which method provides the higher receivable. The better
hedging technique is Money Market hedging because the hedged value is
MYR926,540.32 higher than forward market hedge MYR855,800.
C.
a. The OPR level will influence interest rates in other markets, including credit
market as OPR is the primary reference rate. An exposure to the interest rate
arises due to the anticipated income and payment in the future are depending on
the interest rate at that time plus an asset whose market value changes whenever
market interest rates change. When OPR is reducing from 3.00% to 1.75%, both
companies be it as borrowers (loan) or lenders (deposit) are facing with
exposures if their liabilities or assets is highly sensitive to the interest rate
changes.
B. Garage3 Ltd, a Thailand firm imports goods from a Philippine manufacturer. The
analyst of Garage3 believes that Thai Baht (THB) will depreciate in value as
compared to Philippine Peso (PHP). The most recent purchase amounted to
PHP500,000 and payment is due in one month’s time. The current exchange rate
is THB1 = PHP1.56 while next month’s rate is expected to be at THB1 = PHP1.51.
Required:
b. Assuming that Garage3 undertook the payment strategy in (a), calculate the
total savings or loss for the company if the actual spot rate one month from
now is THB1 = PHP1.62.
Required:
Based on the interest rate parity theory:
a. Determine the six-months forward rate between the two currencies.
D. Calico Berhad is in high growth stage and has substantial amount of debt in its
capital structure. Concerned with the risk associated with interest rate, one of the
directors suggested that the company should only borrow at fixed rate instead of
floating interest rate. He argues that the company has nothing to lose if it only
borrows at fixed interest rate.
Required:
Evaluate the director’s argument and suggest an alternative way to hedge against
interest rate risk.
SOLUTION
B. Garage3
a. Garage3 Ltd may adopt a leading strategy because the PHP is expected to
appreciate.
C. IRPT
F0 = 0.362 x (1 + 0.035)
(1 + 0.02)
= 0.3673 (MYR1 = NZD0.3673)
b. IRPT predicts that the country with the higher interest rate will see the forward rate
for its currency subject to a depreciation. Thus, NZD forward rate is expected to
depreciate because New Zealand has a higher interest rate than Malaysia.
D. Interest rate risk is the risk of incurring losses due to adverse movements in interest
rates. Therefore, the director’s argument is not correct. This is because there is
also a possibility of interest rate falling.
Although interest for fixed rate borrowing is fixed and predictable, the company
might end up paying more interest when market interest rate falls. On the other
hand, if the company has floating rate debt, it will pay less when market interest
rate falls.
Thus, a better way to hedge against interest rate risk would be to have a
combination of both fixed and floating rate debt.
Required:
Briefly explain to the group treasurer the difference between bilateral netting and
multilateral netting.
B. Jasper is a parent company residing in Malaysia. It has two subsidiaries: Opal in
Thailand, and Topaz in Brunei. The following cash flows are due between Jasper
and its subsidiaries:
Exchange rates between Ringgit Malaysia, Thai Baht, and Brunei Dollar are:
RM1.00 = THB7.98
RM1.00 = BND0.32
Jasper and its subsidiaries agreed to undertake multilateral netting to minimize the
number of transactions between them.
Required:
Using multilateral netting, calculate the amount that each company will receive or
pay between Jasper and its subsidiaries.
C. In a light dinner, the managers of MAE Co and VDT Co, a UK-based company are
discussing their strategies for foreign exchange rate risks. Both companies are
having risk-averse profiles.
MAE Co: My company usually trades imports and exports to companies among
members of the European Union. We always invoiced them in sterling (£) to
prevent foreign exchange losses.
VDT Co: We are not engaged in any form of foreign trade as the supply of materials
is easily obtained from local companies, thus foreign exchange rate risk is irrelevant
to my company. However, our supplier frequently has foreign trades with various
companies overseas.
Required:
i. Discuss the foreign exchange rate risks and exposures faced by them.
ii. State the type of hedging strategies applies
D. On 30 June 2022, The Board of Directors High-Hill Bhd (High-Hill) approved the
proposal of RM15 million, 6 months fixed-rate term loan to finance the operating
expenditure starting from 1 October. High-Hill wishes to hedge its exposure against
the interest rate rise in the 6 months between the end of June and 1 October using a
forward rate agreement (FRA).
Details on the FRA are as follows:
i. FRA Period is “3-9”. It is for a period beginning after 3 months’ time and ends
in 9 months' time.
ii. FRA rate is 6% on 30 June
iii. FRA reference rate is 6 months KLIBOR market rate.
Required:
Calculate the interest payable if in three months’ time the KLIBOR market rate is:
a. 8%
b. 3%
SOLUTION
A. In the case of bilateral netting, only two companies are involved. The lower
balance is netted off against the higher balance and the difference is the
amount remaining to be paid. Alternatively, the credit balances are netted off
against the debit balances so that only the reduced net amounts remain due to
be paid by actual currency flows.
B. Multilateral netting:
In RM Paid to (Receipt)
Paid by (Payment) Jasper Opal Topaz
Jasper 6,266 62,500 68,766
Opal 75,000 75,000
Topaz 8,145 8,145
Total receipt 75,000 14,411 62,500
Total payment (68,766) (75,000) (8,145)
Net receipt (payment) 6,234 (60,589) 54,355
Therefore:
Opal will pay RM6,234 to Jasper
Opal will pay BND17,394 @ RM54,355 to Topaz
C.
i. Discuss the foreign exchange rate risks and exposures faced by them.
Mae Co: This company only trades in Europe. As the import and export are
contracted to be paid or received in sterling (£), there is no exchange rate risk
with such transactions. However, this eliminates the transaction risk for the
MAE Co because it is a one-sided technique but the other parties (your
customer @ importer) to the transaction will always have all the exchange rate
risk. For a long-term period, the strategy may not be applicable in the
competitive environment.
VDT Co: Although this company is not engaged in foreign trade, the foreign
exchange rate risks are still relevant indirectly. One form of foreign exchange
risk is economic exposure which is related to the unexpected changes in the
exchange rates on future cash flows which may affect the company’s supplier.
If the supplier increases the price of materials due to unfavorable changes in
the exchange rates, this could directly affect the cost of production for VDT Co
and its selling price.
D.
The FRA: 8% 3%