a) Explanation of the Money Market Hedge and Forward Contract Hedge
To mitigate foreign exchange risk, AML can use the following hedging strategies:

1. Money Market Hedge

A money market hedge involves borrowing and investing in money markets to create a synthetic forward contract.

• AML can:
• Invest in USD today to match future receipts or
• Borrow GHS today, convert to USD, and invest in USD deposits.
• This approach locks in an effective exchange rate but requires capital availability for deposits.

2. Forward Contract Hedge

• A forward contract hedge involves an agreement to exchange USD for GHS at a predetermined rate (forward rate).
• AML locks in an exchange rate today for settlement in three months.
• This is simple and requires no upfront capital, but AML forgoes potential exchange rate gains.

b) Money Market Hedge

1. Calculate PV of the foreign currency using the borrowing rate of 4%

PV=10,000,0001+(4%×312)=10,000,0001.01=US$9,900,991\begin{aligned} \mathrm{PV} &= \frac{10,000,000}{1 + \left(4\% \times \frac{3}{12}\right)} = \frac{10,000,000}{1.01} \\ &= \mathrm{US\$ 9,900,991} \end{aligned}PV​=1+(4%×123​)10,000,000​=1.0110,000,000​=US$9,900,991​

2. Convert into domestic currency

$$US\$9,900,991\times 12.5=GHS123,762,387.50$$

3. Calculate the FV of the domestic currency using the deposit rate

=GHS123,762,387.50×(1.018×312)=GHS129,331,694.94\begin{aligned} &= \mathrm{GHS 123,762,387.50 \times \left(1.018 \times \frac{3}{12}\right)} \\ &= \mathrm{GHS 129,331,694.94} \end{aligned}​=GHS123,762,387.50×(1.018×123​)=GHS129,331,694.94​

c) Forward contract hedge calculation
using the forward rate:

GHSforward=10,000,000×12.10=122,000,000\mathrm{GHS}_{\text{forward}} = 10,000,000 \times 12.10 = 122,000,000GHSforward​=10,000,000×12.10=122,000,000

d) Comparison and Recommendation

Alternatively

Recommendation: AML should use the Money Market Hedge, as it provides a higher GHS amount (129.33M GHS) compared to the forward contract (122M GHS).

e) Three Internal Hedging Techniques for AML
AML can also mitigate foreign exchange risk using internal hedging techniques, including:

1. Natural Hedging

• Strategy: AML can match USD revenues with USD expenses by making payments (e.g., supplier contracts, loan repayments) in the same currency in which revenues are earned.
• Example: AML buys mining equipment and repays international loans in USD to reduce exposure to GHS depreciation.

2. Leading and Lagging

• Strategy: Adjusting the timing of foreign currency inflows and outflows to benefit from exchange rate fluctuations.
• Leading: Collect USD payments earlier if GHS is expected to depreciate.
• Lagging: Delay USD receipts if GHS is expected to appreciate.
• Example: If USD is projected to strengthen, AML can delay converting USD earnings to GHS.

3. Currency Diversification

• Strategy: AML can hold multiple currencies (USD, EUR, CNY) to reduce reliance on GHS-only transactions.
• Example: AML can maintain foreign currency reserves in USD to hedge against Cedi depreciation.

4. Contracting with Local Suppliers in Foreign Currency

• Strategy: AML can negotiate contracts with local suppliers in USD or a stable foreign currency, reducing the need to convert GHS into USD.
• Example: AML can pay international logistics and equipment suppliers in USD, reducing exchange rate risk.

5. Adjusting Pricing Strategies

• Strategy: AML can incorporate foreign exchange clauses into its pricing models for international buyers.
• Example: If the GHS is expected to depreciate, AML can increase contract prices in GHS to account for expected losses.

6. Holding Foreign Currency Reserves

• Strategy: AML can keep a portion of its profits in USD reserves rather than converting all earnings into GHS.
• Example: AML can maintain USD-denominated bank accounts to protect earnings from exchange rate losses.
  (Any 3 relevant points @ 2 marks each = 6 marks)

EXAMINER’S COMMENTS
Question 4(a) required candidates to explain the concepts of the money market hedge and forward contract hedge respectively, and how AML can use each to mitigate its exchange rate risk. This was poorly answered since majority of the candidates were clueless about the two concepts. To say this is surprising is a gross understatement because one expects candidates in the final level of professional accounting examination to know these concepts.

In question 4(b), candidates were required to calculate the amount AML needs to borrow or invest today in both USD and GHS under the money market hedge to fully hedge the future receipt of USD 10 million. Very simple question that required candidates to find the present value but most candidates failed to do so.

Question 4(c) required candidates to calculate the Cedi (GHS) amount AML would receive if it chooses the forward contract hedge instead. Another simple question which required the candidates to multiply the amount expected to be received (USD10 million) by the forward exchange rate but most candidates simply did not attempt. Candidates were to compare the GHS amounts received under the money market hedge and forward contract hedge in question 4(d). This was also answered poorly since the question flow from the answers to question 4(b) and (c).

Finally, in question 4(e) candidates were to discuss three internal hedging techniques AML can employ to mitigate the depreciation of the Ghana Cedi against the US Dollar. Although another common area in exchange risk hedging, yet many candidates were found wanting. The common internal hedging techniques include leading and lagging, matching receipts and payments, netting, invoicing in the company’s currency, etc.