Question Tag: Foreign Exchange Risk

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  • 12 Marks

FM -NOV 2024 – L2 – Q3a – Foreign Exchange Risk Management

Explaining foreign exchange risk types and calculating the impact of forward contract hedging.

a) Dadisen PLC manufactures and sells pharmaceutical products in Ghana. It imports a significant portion of its pharmaceutical inputs from the USA. However, it only sells its products in Ghana. The company is considering establishing its foothold in The Gambia, Liberia, and Sierra Leone markets.

i) Dadisen PLC reports its results in its home currency. It pays for its purchases from the USA in US dollars but receives payments for its sales in Ghana cedis. All sales from Gambia, Liberia, and Sierra Leone are expected to be transferred into US dollar accounts each week. On average, the company generally takes 90 days to pay its suppliers and receives payment from its debtors within 60 days. In paying its suppliers, the company relies on bank overdrafts at an annual rate of 10%.

Over the last few years, the company has found that sales have been quite predictable, and it has been possible to plan sales levels and purchases of goods in advance. However, the company does not have adequate management skills for its foreign currency exposure. As a result, the company has reported exchange rate losses since 2020. The company is currently considering whether the forex exposure could be better managed.

Required:

Describe the following types of foreign currency exposure, giving examples of how they could impact the financial statements of Dadisen PLC:

  • Transaction risk
  • Translation risk
  • Economic risk

ii) The company estimates that it will need to borrow $1 million in three months’ time for a period of six months but is concerned about expected fluctuations in the exchange rate. The company is considering hedging this exposure using a currency forward contract. The company’s banker, GCB, has agreed to sell the US dollar forward for 9 months at GH¢17 to the dollar.

Required:
Compute the effect of the currency forward transaction on profitability if the spot exchange rate in 9 months is:

  • GH¢22
  • GH¢15

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  • 10 Marks

SCS – Nov 2020 – L3 – Q7 – International financial management

Explain how to handle ethical conflicts and assess the impact of transaction risk on GGOH’s ability to repay its loan.

ABGL that the loan will be paid within the period specified.

Required:
i) In reference to the IFAC suggested model for dealing with ethical conflicts and using your judgement, explain how you will undertake this assignment with integrity. (5 marks)

ii) Assess the impact of transaction risk on the ability of GGOH to repay its loan, with relevant calculations. (5 marks)

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  • 6 Marks

SCS – May 2020 – L3 – Q6 – International Financial Management

Explain a suitable foreign currency risk hedging method for Customer Focused Ltd in relation to the Look and Like Ltd contract.

Customer Focused Ltd has received a proposal from a potential supplier, Look and Like
Ltd, to provide fresh produce (Exhibit 2a) and is considering whether to accept. Kpakpo
Armah has written a note (Exhibit 2b) about Look and Like Ltd.
Required:
Using the information available, including information you feel relevant from your answer
to Section A:

Describe an appropriate foreign currency risk management hedging method for the risk the company might face in the future as described in Exhibit 2b.

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  • 15 Marks

AFM – Nov 2016 – L3 – Q5a – Hedging against financial risk: Non-derivative techniques

Demonstrate how YSL can hedge currency risk using futures contracts and calculate the result of the hedge.

YSL is a company located in the USA that has a contract to purchase goods from Japan in two months’ time on 1st September. The payment is to be made in yen and will total 140 million yen. The managing director of YSL wishes to protect the contract against adverse movements in foreign exchange rates and is considering the use of currency futures. The following data are available:

  • Spot foreign exchange rate: $1 = 128.15 yen
  • Yen currency futures contracts on SIMEX (Singapore Monetary Exchange)
    • Contract size: 12,500,000 yen
    • Contract prices (US$ per yen):
      • September: 0.007985
      • December: 0.008250

Assume that futures contracts mature at the end of the month.

Required:
i) Illustrate how YSL might hedge its foreign exchange risk using currency futures. (5 marks)
ii) Explain the meaning of basis risk and show what basis risk is involved in the proposed hedge. (5 marks)
iii) Assuming the spot exchange rate is 120 yen/$1 on 1 September and that basis risk decreases steadily in a linear manner, calculate what the result of the hedge is expected to be. Briefly discuss why this result might not occur. (5 marks)
(Margin requirements and taxation may be ignored.)

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  • 5 Marks

AFM – May 2016 – L3 – Q2b – Hedging against financial risk: Non-derivative techniques, Hedging against financial risk: Derivatives

Describe four approaches that a company can use to hedge against foreign exchange risk.

b) As a trading company, Joewoka exports and imports merchandise in many countries for which it receives and makes payment in foreign currency. This exposes the company to foreign exchange risk.

As a Financial Consultant to the company, suggest FOUR approaches that the company can use to hedge against foreign exchange exposure. (5 marks)

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  • 10 Marks

AFM – May 2016 – L3 – Q1b – Hedging against financial risk: Non-derivative techniques, Hedging against financial risk: Derivatives, The use of financial derivatives to hedge against interest rate risk

Explain how to hedge a foreign exchange risk exposure using forward and money markets with calculations.

b) A Ghanaian Food and Beverage company has recently imported raw materials from China with an invoice value of US$264,000 payable in three months’ time. Due to the company’s efficient production capacity, it has finished production and exported finished products to Germany. Consequently, the German customer has been invoiced for US$75,900 payable in three months’ time. Below is the current spot and forward rates for the transactions:

  • USD/GHS Spot: 0.9850 – 0.9870
  • 3 Months Forward: 0.9545 – 0.9570

Current Money Market rates per annum are as follows:

  • US$ (USD): 11% – 13.2%
  • Gh¢ (GHS): 12.7% – 14.3%

Required:
i) Demonstrate with relevant calculations how the Ghanaian company can hedge its exposure to foreign exchange risk using the Forward Markets. (3 marks)
ii) Demonstrate with relevant calculations how the Ghanaian company can hedge its exposure using the Money Markets. (4 marks)
iii) Determine which of the above markets is the best hedging technique. (3 marks)

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  • 20 Marks

FM – NOV 2016 – L2 – Q4 – Foreign exchange risk and currency risk management

Explains types of foreign exchange risks, calculates equity cost using different models, and distinguishes between repos and reverse repos.

a) You have been appointed as the Finance Manager of Jaja Ltd and the expectation of the board is for you to provide education and working solution to their foreign exchange losses problem which your predecessor had no clue.

How will you explain the following? i) Foreign Exchange Risk (2 marks)
ii) Transaction Risk (2 marks)
iii) Translation Risk (2 marks)
iv) Economic Risk (2 marks)

b) Kaluu Ltd is a listed company on the Ghana Stock Exchange Market and showed the following performance. The following information was made available to you:

  • Current market price per share (as at 31/12/15): GH¢ 10
  • Dividend per share 2015: GH¢ 1
  • Expected growth rate of dividend: 20% per annum
  • The average market returns: 27%
  • The risk-free government rate: 24%
  • The beta factor of Kaluu Ltd: 1.4

Required: i) What is the estimated cost of equity using the dividend growth model? (3 marks)
ii) What is the estimated cost of equity using the Capital Assets Pricing model? (3 marks)

c) i) Distinguish between repurchase agreement (repos) and reverse repos. (3 marks)

ii) A company enters into an agreement with a bank and it sells GH¢10 million government bonds with an obligation to buy back the security in 60 days. If the rate is 8.2%, what is the repurchase price of the bond? Assume 365 days in a year. (3 marks)

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  • 20 Marks

FM – NOV 2021 – L2 – Q3 – Foreign exchange risk and currency risk management

Computation of future value of deposits under different scenarios, currency risk hedging strategy, and explanation of swap contracts.

a) You are the assistant to the Finance Manager of Kunta Medical Centre. Your boss is negotiating a deal with an investment company investing GH¢500,000 over 3 years. The main terms of the proposed investment deal are that if the amount is deposited now and invested continuously for 3 years, it would attract an 18% annual interest rate with quarterly compounding. However, if the initial deposit of GH¢500,000 is maintained and additional deposits of GH¢50,000 each are made at the beginning of year 2 and year 3, the deposits would attract 18.0% annual interest in year 1, 18.5% in year 2, and 19% in year 3, all with quarterly compounding.

Your boss has asked you to do some computations to inform her about the growth of the deposits based on the terms of the proposed deal.

Required:
i) Suppose GH¢500,000 is deposited now, and there are no top-up deposits in the future; Compute the future value of the deposit at the end of the third year. (3 marks)

ii) Suppose the initial deposit of GH¢500,000 is made now, and the top-up deposits of GH¢50,000 each are made in the future per the terms of the proposed investment deal;

  • Compute the future value of the initial deposit at the end of the third year. (3 marks)
  • Compute the aggregate future value of the top-up deposits at the end of the third year. (3 marks)
  • Compute the aggregate future value of all the deposits at the end of the third year. (1 mark)

b) Sesamu Dried Fruits Ltd is a fruits processing company in Ghana. The company has exported raw mangoes to a distributor in Japan. The invoice value of JP¥20 million is to be collected in three months. The exchange rate between the Ghanaian cedi (GH¢) and the Japanese yen (JP¥) is currently GH¢0.0584/JP¥1. It is expected that the Ghana cedi may appreciate against the JP¥ in the coming months.

Required:
Using the leading and lagging strategy for hedging currency risk exposure, is it advisable for the company to lag the collection of the JP¥ invoice value? (5 marks)

c) COVID-19 has led to volatility in the international money market. Although international business has seen some improvement, progress has been very slow. As a result, the risk of losing part of an investment due to exchange rate and currency value fluctuations are very high.

Required:
Explain how Interest Rate Swap and Currency Swap can be used to mitigate the effects of market volatility. (5 marks)

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  • 12 Marks

FM -NOV 2024 – L2 – Q3a – Foreign Exchange Risk Management

Explaining foreign exchange risk types and calculating the impact of forward contract hedging.

a) Dadisen PLC manufactures and sells pharmaceutical products in Ghana. It imports a significant portion of its pharmaceutical inputs from the USA. However, it only sells its products in Ghana. The company is considering establishing its foothold in The Gambia, Liberia, and Sierra Leone markets.

i) Dadisen PLC reports its results in its home currency. It pays for its purchases from the USA in US dollars but receives payments for its sales in Ghana cedis. All sales from Gambia, Liberia, and Sierra Leone are expected to be transferred into US dollar accounts each week. On average, the company generally takes 90 days to pay its suppliers and receives payment from its debtors within 60 days. In paying its suppliers, the company relies on bank overdrafts at an annual rate of 10%.

Over the last few years, the company has found that sales have been quite predictable, and it has been possible to plan sales levels and purchases of goods in advance. However, the company does not have adequate management skills for its foreign currency exposure. As a result, the company has reported exchange rate losses since 2020. The company is currently considering whether the forex exposure could be better managed.

Required:

Describe the following types of foreign currency exposure, giving examples of how they could impact the financial statements of Dadisen PLC:

  • Transaction risk
  • Translation risk
  • Economic risk

ii) The company estimates that it will need to borrow $1 million in three months’ time for a period of six months but is concerned about expected fluctuations in the exchange rate. The company is considering hedging this exposure using a currency forward contract. The company’s banker, GCB, has agreed to sell the US dollar forward for 9 months at GH¢17 to the dollar.

Required:
Compute the effect of the currency forward transaction on profitability if the spot exchange rate in 9 months is:

  • GH¢22
  • GH¢15

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  • 10 Marks

SCS – Nov 2020 – L3 – Q7 – International financial management

Explain how to handle ethical conflicts and assess the impact of transaction risk on GGOH’s ability to repay its loan.

ABGL that the loan will be paid within the period specified.

Required:
i) In reference to the IFAC suggested model for dealing with ethical conflicts and using your judgement, explain how you will undertake this assignment with integrity. (5 marks)

ii) Assess the impact of transaction risk on the ability of GGOH to repay its loan, with relevant calculations. (5 marks)

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  • 6 Marks

SCS – May 2020 – L3 – Q6 – International Financial Management

Explain a suitable foreign currency risk hedging method for Customer Focused Ltd in relation to the Look and Like Ltd contract.

Customer Focused Ltd has received a proposal from a potential supplier, Look and Like
Ltd, to provide fresh produce (Exhibit 2a) and is considering whether to accept. Kpakpo
Armah has written a note (Exhibit 2b) about Look and Like Ltd.
Required:
Using the information available, including information you feel relevant from your answer
to Section A:

Describe an appropriate foreign currency risk management hedging method for the risk the company might face in the future as described in Exhibit 2b.

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  • 15 Marks

AFM – Nov 2016 – L3 – Q5a – Hedging against financial risk: Non-derivative techniques

Demonstrate how YSL can hedge currency risk using futures contracts and calculate the result of the hedge.

YSL is a company located in the USA that has a contract to purchase goods from Japan in two months’ time on 1st September. The payment is to be made in yen and will total 140 million yen. The managing director of YSL wishes to protect the contract against adverse movements in foreign exchange rates and is considering the use of currency futures. The following data are available:

  • Spot foreign exchange rate: $1 = 128.15 yen
  • Yen currency futures contracts on SIMEX (Singapore Monetary Exchange)
    • Contract size: 12,500,000 yen
    • Contract prices (US$ per yen):
      • September: 0.007985
      • December: 0.008250

Assume that futures contracts mature at the end of the month.

Required:
i) Illustrate how YSL might hedge its foreign exchange risk using currency futures. (5 marks)
ii) Explain the meaning of basis risk and show what basis risk is involved in the proposed hedge. (5 marks)
iii) Assuming the spot exchange rate is 120 yen/$1 on 1 September and that basis risk decreases steadily in a linear manner, calculate what the result of the hedge is expected to be. Briefly discuss why this result might not occur. (5 marks)
(Margin requirements and taxation may be ignored.)

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  • 5 Marks

AFM – May 2016 – L3 – Q2b – Hedging against financial risk: Non-derivative techniques, Hedging against financial risk: Derivatives

Describe four approaches that a company can use to hedge against foreign exchange risk.

b) As a trading company, Joewoka exports and imports merchandise in many countries for which it receives and makes payment in foreign currency. This exposes the company to foreign exchange risk.

As a Financial Consultant to the company, suggest FOUR approaches that the company can use to hedge against foreign exchange exposure. (5 marks)

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  • 10 Marks

AFM – May 2016 – L3 – Q1b – Hedging against financial risk: Non-derivative techniques, Hedging against financial risk: Derivatives, The use of financial derivatives to hedge against interest rate risk

Explain how to hedge a foreign exchange risk exposure using forward and money markets with calculations.

b) A Ghanaian Food and Beverage company has recently imported raw materials from China with an invoice value of US$264,000 payable in three months’ time. Due to the company’s efficient production capacity, it has finished production and exported finished products to Germany. Consequently, the German customer has been invoiced for US$75,900 payable in three months’ time. Below is the current spot and forward rates for the transactions:

  • USD/GHS Spot: 0.9850 – 0.9870
  • 3 Months Forward: 0.9545 – 0.9570

Current Money Market rates per annum are as follows:

  • US$ (USD): 11% – 13.2%
  • Gh¢ (GHS): 12.7% – 14.3%

Required:
i) Demonstrate with relevant calculations how the Ghanaian company can hedge its exposure to foreign exchange risk using the Forward Markets. (3 marks)
ii) Demonstrate with relevant calculations how the Ghanaian company can hedge its exposure using the Money Markets. (4 marks)
iii) Determine which of the above markets is the best hedging technique. (3 marks)

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  • 20 Marks

FM – NOV 2016 – L2 – Q4 – Foreign exchange risk and currency risk management

Explains types of foreign exchange risks, calculates equity cost using different models, and distinguishes between repos and reverse repos.

a) You have been appointed as the Finance Manager of Jaja Ltd and the expectation of the board is for you to provide education and working solution to their foreign exchange losses problem which your predecessor had no clue.

How will you explain the following? i) Foreign Exchange Risk (2 marks)
ii) Transaction Risk (2 marks)
iii) Translation Risk (2 marks)
iv) Economic Risk (2 marks)

b) Kaluu Ltd is a listed company on the Ghana Stock Exchange Market and showed the following performance. The following information was made available to you:

  • Current market price per share (as at 31/12/15): GH¢ 10
  • Dividend per share 2015: GH¢ 1
  • Expected growth rate of dividend: 20% per annum
  • The average market returns: 27%
  • The risk-free government rate: 24%
  • The beta factor of Kaluu Ltd: 1.4

Required: i) What is the estimated cost of equity using the dividend growth model? (3 marks)
ii) What is the estimated cost of equity using the Capital Assets Pricing model? (3 marks)

c) i) Distinguish between repurchase agreement (repos) and reverse repos. (3 marks)

ii) A company enters into an agreement with a bank and it sells GH¢10 million government bonds with an obligation to buy back the security in 60 days. If the rate is 8.2%, what is the repurchase price of the bond? Assume 365 days in a year. (3 marks)

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  • 20 Marks

FM – NOV 2021 – L2 – Q3 – Foreign exchange risk and currency risk management

Computation of future value of deposits under different scenarios, currency risk hedging strategy, and explanation of swap contracts.

a) You are the assistant to the Finance Manager of Kunta Medical Centre. Your boss is negotiating a deal with an investment company investing GH¢500,000 over 3 years. The main terms of the proposed investment deal are that if the amount is deposited now and invested continuously for 3 years, it would attract an 18% annual interest rate with quarterly compounding. However, if the initial deposit of GH¢500,000 is maintained and additional deposits of GH¢50,000 each are made at the beginning of year 2 and year 3, the deposits would attract 18.0% annual interest in year 1, 18.5% in year 2, and 19% in year 3, all with quarterly compounding.

Your boss has asked you to do some computations to inform her about the growth of the deposits based on the terms of the proposed deal.

Required:
i) Suppose GH¢500,000 is deposited now, and there are no top-up deposits in the future; Compute the future value of the deposit at the end of the third year. (3 marks)

ii) Suppose the initial deposit of GH¢500,000 is made now, and the top-up deposits of GH¢50,000 each are made in the future per the terms of the proposed investment deal;

  • Compute the future value of the initial deposit at the end of the third year. (3 marks)
  • Compute the aggregate future value of the top-up deposits at the end of the third year. (3 marks)
  • Compute the aggregate future value of all the deposits at the end of the third year. (1 mark)

b) Sesamu Dried Fruits Ltd is a fruits processing company in Ghana. The company has exported raw mangoes to a distributor in Japan. The invoice value of JP¥20 million is to be collected in three months. The exchange rate between the Ghanaian cedi (GH¢) and the Japanese yen (JP¥) is currently GH¢0.0584/JP¥1. It is expected that the Ghana cedi may appreciate against the JP¥ in the coming months.

Required:
Using the leading and lagging strategy for hedging currency risk exposure, is it advisable for the company to lag the collection of the JP¥ invoice value? (5 marks)

c) COVID-19 has led to volatility in the international money market. Although international business has seen some improvement, progress has been very slow. As a result, the risk of losing part of an investment due to exchange rate and currency value fluctuations are very high.

Required:
Explain how Interest Rate Swap and Currency Swap can be used to mitigate the effects of market volatility. (5 marks)

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