Interest rate in New Zealand and U.S.

Question 1 The one-year interest rate in New Zealand is 6 percent. The one-year U.S. interest rate is 10 percent. The spot rate of the New Zealand dollar (NZ$) is $.50. The forward rate of the New Zealand dollar is $.55. Assume that the U.S. investor can borrow up to $1,000,000. Should she do a covered interest rate arbitrage? If yes, how much profit can she earn? (20 Marks) Question 2 A Singapore subsidiary of a U.S. parent firm is instructed to bill an export to the parent in U.S. dollars. The Singapore subsidiary records the accounts receivable in Singapore dollars and notes a profit on the sale of goods. The company can hedge its foreign exchange risk by using a money market hedge or a foreign currency forward contract. Explain how these two types of hedges are used to eliminate receivables exposure. (10 Marks) Question 3 Transaction exposure measures gains or losses that arise from the settlement of existing financial obligations. Toy World is a U.S. – based company delivers a large shipment of Educational Toys to a major customer in France on open account. The receivable of €1 million, is due in 1 year. The following information is collected by the Treasury Department of Toy World. Current spot rate (€ / $) € / $ 1.2300 Estimated future spot rate (€ / $) € / $ 1.2500 1-year forward rate (€ / $) € / $ 1.2450 1-year borrowing rate on € 2% per annum 1-year interest rate on $ 2.80 % per annum a) Evaluate the position of Toy World if the spot rate after 3 months is $ 1.2200 / €. (10 Marks) b) Analyze how the company can manage its transaction exposure to protect the home currency value of its receivable by using a Forward market hedge. (20 Marks) Part B -1 Assessing Transaction Exposure Transaction exposure measures gains or losses that arise from the settlement of existing financial obligations. Green Garden Systems is a U.S. – based company that sells and installs Garden sprinkler equipment. Green Garden Systems sold a system to Honda PLC, a major customer in Japan on open account. The receivable of ¥ 5 million, is due in 90 days. The following information is collected by the Treasury Department of Green Garden Systems. Current spot rate ($ / ¥) ¥ 116.50 / $ Estimated future spot rate ($ / ¥) ¥ 117.60 / $ 90-day forward rate ($ / ¥) ¥ 118.00 / $ 90-day borrowing rate on ¥ 2 % per annum 90-day interest rate on $ 2.5 % per annum You have been retained as a Consultant by the Treasury Department to oversee the hedging methods for Green Garden. Prepare a memo listing the different types of hedging methods available to Green Garden Systems and which is the most suitable method for them to use. Your memo needs to cover the following points. (a) Evaluate the position of Green Garden Systems if the spot rate after 3 months is $ / ¥ 118.50. Would it be in the best interests of the Green Garden to get the ¥5 million after 90-days? With clear calculations, show why or why not? (10 Marks) (b) With clear calculations, analyze how Green Garden Systems can utilize the money market hedge) to manage its transaction exposure to protect the home ($) currency value of its receivable. Is there any other payment arrangement that the two companies can enter to ensure that Green Garden Systems does not lose on this transaction? Briefly explain (no calculations necessary) another hedging method that Green Garden Systems can utilize to protect itself (10 Marks) 2- Translation Exposure / Strategic Decision Making in International Finance Currency Risk and Translation Exposure Management: Refer to the IBM Global Case and Answer the Following Questions. Translation exposure is the potential for an increase / decrease in parent’s net worth and reported income due to change in exchange rates since the last transaction IBM Global is a U.S. giant tech firm has numerous subsidiaries in Latin America, Africa, Asia, Oceania, Europe and Middle East. IBM Global needs to translate or restate subsidiary financial statements in the US$ at year-end from the various local currencies in line with International Accounting Standards. The following Balance Sheet from IBM Europe needs to be re-stated in US$ terms: Balance Sheet of IBM Europe as at 31/12/2017 Particulars Amount Assets Cash €3,200,000 Account Receivable 6,400,000 Inventory 4,800,000 Net Plant and Equipment 9,600,000 €24,000,000 Liabilities Account Payables €1,600,000 Short Term Loan 3,200,000 Long Term Debt 3,200,000 Common Stock 3,600,000 Retained Earnings 12,400,000 €24,000,000 ? Euro depreciated by 16.67% or moved from €1.00 / $1.20 in Dec 2016 to $1.00 / €1.00 in Jan 2017 ? The functional currency of the subsidiary € and the currency of the parent (IBM Global) is US$ ? Property, Plant and Equipment common stock, and long-term debt were acquired by IBM Europe at a past rate of €1.00 / $1.2760 ? Inventory on hand was purchased or manufactured when average exchange rate was €1.00 / $1.2180 (a) Evaluate IBM Global’s translation loss / gain just after the depreciation. Is it better to convert the subsidiary Balance Sheet before or after the depreciation? (5 Marks) (b) Evaluate, through calculations, the consequences for IBM Global if the Euro (€) appreciates to €1.00 / $1.32 instead of depreciating. (5 Marks) (c) When conducting capital budgeting, a domestic firm needs to consider various factors before coming to a decision on whether to invest in a project or not. When conducting cross border capital budgeting, an MNC like IBM Global firm faces additional factors that further complicate the capital budgeting process. Name and discuss five (5) additional factors IBM Global needs to consider in its capital budgeting decisions that purely domestic firms do not face.        

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