- 15 Marks
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
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