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Question 3a

Kenduri Co is a large multinational company based in the UK with a number of subsidiary companies around the world. Currently, foreign exchange exposure as a result of transactions between Kenduri Co and its subsidiary companies is managed by each company individually.

Kenduri Co is considering whether or not to manage the foreign exchange exposure using multilateral netting from the UK, with the Sterling Pound (£) as the base currency. If multilateral netting is undertaken, spot mid-rates would be used.

The following cash flows are due in three months between Kenduri Co and three of its subsidiary companies. The subsidiary companies are Lakama Co, based in the United States (currency US$), Jaia Co, based in Canada (currency CAD) and Gochiso Co, based in Japan (currency JPY).

Owed by Owed to Amount
Kenduri Co Lakama Co US$ 4.5 million
Kenduri Co Jaia Co CAD 1.1 million
Gochiso Co Jaia Co CAD 3.2 million
Gochiso Co Lakama Co US$ 1.4 million
Jaia Co Lakama Co US$ 1.5 million
Jaia Co Kenduri Co CAD 3.4 million
Lakama Co Gochiso Co JPY 320 million
Lakama Co Kenduri Co US$ 2.1 million

Exchange rates available to Kenduri Co

US$/£1 CAD/£1 JPY/£1
spot 1.5938-1.5962 1.5690-1.5710 131.91-133.59
3 month forward 1.5996-1.6037 1.5652-1.5678 129.15-131.05

Currency options available to Kenduri Co

Contract size £62,500, Exercise price quotation: US$/£1, Premium: cents per £1

Exercise Call options
3-month expiry
Call options
6-month expiry
Put options
3-month expiry
Put options
6-month expiry
1.60 1.55 2.25 2.08 2.23
1.62 0.98 1.58 3.42 3.73

It can be assumed that option contracts expire at the end of the relevant month

Annual interest rates available to Kenduri Co and subsidiaries

Borrowing rate Investing Rate
UK 4.0% 2.8%
United States 4.8% 3.1%
Canada 3.4% 2.1%
Japan 2.2% 0.5%


Required:

Advise Kenduri Co on, and recommend, an appropriate hedging strategy for the US$ cash flows it is due to receive or pay in three months, from Lakama Co. Show all relevant calculations to support the advice given. (12 marks)