Currency Risk – Knowsia

BMIS – L1 – QC1 – The external environment

Explain the meaning of 'currency risk' as stated by the president of a car manufacturing company.

Question

The president of a Japanese car manufacturing company, TCM, recently stated that his suit would not expand its production capacity any further at its factory in Nigeria. This factory produces TCM cars for the African market with sales agreed in the local currency of the target market.

The president explained that the reason for this decision was the currency risk. The company was concerned about its competitiveness in the African market. It had a 5% share of the Nigeria cars market, but only a 1% share of the market in the rest of Africa.

Required

Explain what the company president meant by the term ‘currency risk’

Answer

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Tags: African market, Currency Risk, Exchange Rates, International Business, Market competitiveness
Level: Level 1

Topic: The external environment

FM – L2 – Q101 – Hedging with options

Calculate min net interest rate cost for a company borrowing $5m using options with a strike price of 94.50.

Question

It is May and a company intends to borrow $5m for 3 months commencing in September. Options are available on 3 month Canadian interest rate futures with a strike price of 94.50 and are quoted as follows:

Expiry month	Calls	Puts
June	0.10	0.31
September	0.46	0.67
December	0.63	0.84

The contract size of the 3-month Canadian interest rate future is $1 million.
Required
Calculate the minimum net interest rate cost for the company if it hedges using options with a strike price of 94.50.

Answer

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Tags: Borrowing, Currency Risk, Effective interest rate, Financial Risk Management, Futures, Hedging, Interest rate options, Options pricing, SOFRA, Treasury management
Level: Level 2

Topic: Hedging with options

FM – L2 – Q100 – Hedging with futures, Hedging with options

Firestone Ltd plans to borrow $5M and hedge interest rate risk using futures and options, calculating effective borrowing rates.

Question

Firestone Ltd, a Nigerian company, needs to borrow in US dollars to fund its US operations, but the chief financial officer is concerned that interest rates may be volatile given the current US political and economic environment.
It is now March and Firestone intends to borrow $5 million for a period of three months commencing in September.
Futures and options quotes for 3-month US secured overnight financing rate (SOFRA) are given below. Assume that Firestone can borrow at the three-month SOFRA rate.

3 month SOFRA futures price – contract size = $1,000,000

June	September
93.55	93.28

Traded options on 3-month SOFRA futures – contract size = $1,000,000 (premiums quoted are annual rates)

Strike	June (Calls)	September (Calls)	June (Puts)	September (Puts)
93.25	0.437	0.543	0.083	0.187
93.50	0.276	0.387	0.168	0.282
93.75	0.163	0.263	0.302	0.407

Required:
a) Discuss the relevant considerations to be considered when deciding between futures and options to hedge the company’s interest rate risk. (5 marks)
b) Assume that in September 3 month SOFRA is 7% and at that point in time September futures are quoted at 93.96.

Calculate the effective borrowing rate using a futures hedge
Calculate the effective borrowing rate when hedging with options using each of the three available strike prices

Answer

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Tags: Borrowing, Currency Risk, Effective borrowing rate, Financial Risk Management, Futures, Hedging Strategies, Interest rate hedging, Options, SOFRA, Treasury management
Level: Level 2

Topic: Futures and hedging with futures

FM – L2 – Q99 – Hedging with futures

Recommend futures/options to hedge interest rate risk for a company's loan, tender bid, and deposit scenarios.

Question

Three-month euro interest rate futures are available on a derivative exchange. Available delivery months for the future are March, June, September, and December, and the contract size for the future is €1,000,000.

Provide a justified recommendation for the most appropriate futures or options transaction in order to hedge interest rate risk in the following situations:

a) A company, Starlight Ltd, is taking out a loan of €3 million for 6 months from June to fund working capital for a new venture.

b) A company, BrightFuture Ltd, has tendered for a large government project. If it is the successful bidder, it will need to borrow €12 million for three months starting in September to cover initial costs.

c) It is June, a company, Horizon Enterprises, has €7 million on deposit with a bank for one year at 3-month money market rates. The company has become concerned about the possibility that money market interest rates may fall dramatically.

Answer

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Tags: Currency Risk, Derivative exchange, Euro interest rates, Financial Risk Management, Futures, Hedging Strategies, Interest rate hedging, Options, Risk Mitigation, Treasury management
Level: Level 2

Topic: Futures and hedging with futures

FM – L2 – Q92 – Foreign exchange risk and currency risk management

Calculate unhedged ZMW value of $35M receivable with 5% ZMW depreciation and compare to initial value.

Question

Riverfront Plc has just delivered a major export order to a customer in Canada at a price of $35 million payable in six months’ time and as the company’s finance director you are concerned about the potential impact of currency volatility on the profitability of this particular order.
You have obtained the following exchange rate and interest rate data at the close of business today:

Spot rate (ZMW/$)	ZMW 5 – ZMW 6
6-month forward rate (premium)	0.08 – 0.12

Annual interest rates:

	Deposit	Borrowing
Zambia	10%	14%
Canada	5%	6%

Riverfront Plc’s bank has quoted a premium of ZMW 10,000 (payable up-front) for a $35 million six-month over-the-counter currency put option with an exercise price of ZMW 5.6 = $1.
Riverfront Plc has the ZMW 10,000 available on deposit at the current time and would leave it on deposit for the next six months if it was not used to purchase the currency put option.

Required
(a) Calculate the unhedged ZMW value of the $35 million receivable if, in six months’ time, ZMW has depreciated by 5%. Explain how this compares to the ZMW value of the sale when it was made.

(b) Calculate the hedged ZMW value of the $35 million receivable if Riverfront Plc chooses to use a forward exchange contract.

(c) Calculate the hedged ZMW value of the $35 million receivable if Riverfront Plc chooses to use a money market hedge and calculate the effective forward exchange rate achieved.

(d) Calculate the hedged ZMW value of the $35 million receivable if Riverfront Plc chooses to use an over-the-counter currency put option and the spot exchange rate in six months’ time is:

(1) ZMW 5 = $1

(2) ZMW 6 = $1

Answer

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Tags: Currency Options, Currency Risk, Exchange Rates, Hedging, Put Option
Level: Level 2

Topic: Foreign exchange risk and currency risk management

FM – L2 – Q91 – Foreign Exchange Risk Management

Explain how a UK company can hedge USD payment risk using a forward contract and calculate the sterling cost in 3 months.

Question

A UK company, BrightHorizon Ltd, expects to pay $750,000 to a supplier in three months’ time. The following exchange rates are available for the dollar against sterling (GBP/USD):

| Spot | 1.8570 | 1.8580 |
| 3 months forward | 1.8535 | 1.8543 |

The company is concerned about a possible increase in the value of the dollar during the next three months and would like to hedge its FX risk.

Required:
(A) Explain how the exposure to currency risk might be hedged, and the amount that BrightHorizon Ltd will have to pay in sterling in three months’ time to settle its liability.

(B) Calculate EuroTech GmbH’s income in euros from settlement of the forward contract in two months’ time.

Answer

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Tags: Currency Risk, Foreign Exchange, Forward Contract, Hedging, Transaction risk, USD/GBP
Level: Level 2

Topic: Foreign exchange risk and currency risk management

FM – L2 – Q87 – Foreign exchange risk and currency risk management

Explain four differences between forward and futures contracts for AB Enterprises.

Question

AB Enterprises, a company whose domestic currency is the cedi, has imported a consignment of tomato paste from Spain at a cost of EUR540,000, which is payable in three months’ time. Ama Kofi, the company’s finance director, is concerned about the company’s exposure to currency risk, and she is considering the use of forward contracts or currency futures to hedge the risk.

Required:
(i) Explain to Ama Kofi FOUR differences between a forward contract and a futures contract.
(ii) Currency risk exposure may be transaction risk, economic risk, or translation risk. Which of the three kinds of currency risk exposure is AB Enterprises facing in relation to the EUR540,000 tomato paste consignment?
(iii) Explain to Ama Kofi, THREE disadvantages of hedging the euro exposure with futures hedge.

Answer

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Tags: Basis risk, Currency Risk, Financial instruments, Forward contracts, Futures contracts, Futures hedging, Hedging, Transaction risk
Level: Level 2

Topic: Futures and hedging with futures

FM – L2 – Q85 – Forwards

Briefly describe a forward contract as a financial instrument.

Question

Briefly describe the following financial instrument:

(a) Forwards

(b) Futures

Answer

Find Related Questions by Tags, levels, etc.

Tags: Currency Risk, Financial instruments, Hedging, Options
Level: Level 2

Topic: Hedging with options

Tag (SQ): Currency Risk

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BMIS – L1 – QC1 – The external environment

Explain the meaning of 'currency risk' as stated by the president of a car manufacturing company.

FM – L2 – Q101 – Hedging with options

Calculate min net interest rate cost for a company borrowing $5m using options with a strike price of 94.50.

FM – L2 – Q100 – Hedging with futures, Hedging with options

Firestone Ltd plans to borrow $5M and hedge interest rate risk using futures and options, calculating effective borrowing rates.

FM – L2 – Q99 – Hedging with futures

Recommend futures/options to hedge interest rate risk for a company's loan, tender bid, and deposit scenarios.

FM – L2 – Q92 – Foreign exchange risk and currency risk management

Calculate unhedged ZMW value of $35M receivable with 5% ZMW depreciation and compare to initial value.

FM – L2 – Q91 – Foreign Exchange Risk Management

Explain how a UK company can hedge USD payment risk using a forward contract and calculate the sterling cost in 3 months.

FM – L2 – Q87 – Foreign exchange risk and currency risk management

Explain four differences between forward and futures contracts for AB Enterprises.

FM – L2 – Q85 – Forwards

Briefly describe a forward contract as a financial instrument.

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BMIS – L1 – QC1 – The external environment

Explain the meaning of 'currency risk' as stated by the president of a car manufacturing company.

You're reporting an error for "BMIS – L1 – QC1 – The external environment"

FM – L2 – Q101 – Hedging with options

Calculate min net interest rate cost for a company borrowing $5m using options with a strike price of 94.50.

You're reporting an error for "FM – L2 – Q101 – Hedging with options"

FM – L2 – Q100 – Hedging with futures, Hedging with options

Firestone Ltd plans to borrow $5M and hedge interest rate risk using futures and options, calculating effective borrowing rates.

You're reporting an error for "FM – L2 – Q100 – Hedging with futures, Hedging with options"

FM – L2 – Q99 – Hedging with futures

Recommend futures/options to hedge interest rate risk for a company's loan, tender bid, and deposit scenarios.

You're reporting an error for "FM – L2 – Q99 – Hedging with futures"

FM – L2 – Q92 – Foreign exchange risk and currency risk management

Calculate unhedged ZMW value of $35M receivable with 5% ZMW depreciation and compare to initial value.

You're reporting an error for "FM – L2 – Q92 – Foreign exchange risk and currency risk management"

FM – L2 – Q91 – Foreign Exchange Risk Management

Explain how a UK company can hedge USD payment risk using a forward contract and calculate the sterling cost in 3 months.

You're reporting an error for "FM – L2 – Q91 – Foreign Exchange Risk Management"

FM – L2 – Q87 – Foreign exchange risk and currency risk management

Explain four differences between forward and futures contracts for AB Enterprises.

You're reporting an error for "FM – L2 – Q87 – Foreign exchange risk and currency risk management"

FM – L2 – Q85 – Forwards

Briefly describe a forward contract as a financial instrument.

You're reporting an error for "FM – L2 – Q85 – Forwards"

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