ACCA AFM Syllabus E. Treasury And Advanced Risk Management Techniques - Netting - Past Papers ^{12 / 13}

The Adverane Group is a multinational group of companies with its headquarters in Switzerland. The Adverane Group consists of a number of fully-owned subsidiaries and Elted Co, an associate company based in the USA in which Adverane Group owns 30% of the ordinary equity share capital.

Balances owing between the parent, Adverane Co, and its subsidiaries and between subsidiaries are settled by multilateral netting. Transactions between the parent and Elted Co are settled separately.

Transactions with Elted Co
Adverane Co wishes to hedge transactions with Elted Co which are due to be settled in four months’ time in US$.

Adverane Co will owe Elted Co US$3·7 million for a major purchase of supplies and Elted Co will owe Adverane Co US$10·15 million for non-current assets. Adverane Group’s treasury department is considering whether to use money markets or exchange-traded currency futures for hedging.

Annual interest rates available to Adverane Co

Exchange traded currency futures
Contract size CHF125,000, price quotation US$ per CHF1
Three-month expiry: 1·1213
Six-month expiry: 1·1204

Netting
The balances owed to and owed by members of Adverane Group when netting is to take place are as follows:

The group members will make settlement in Swiss francs. Spot mid-rates will be used in calculations. Settlement will be made in the order that the company owing the largest net amount in Swiss francs will first settle with the company owed the smallest net amount in Swiss francs.

Transfer price arrangements
The Adverane Group board has been reviewing the valuation of inter-group transactions, as it is concerned that the current system is not working well. Currently inter-group transfer prices are mostly based on fixed cost plus a mark-up negotiated by the buying and selling divisions.

If they cannot agree a price, either the sale does not take place or the central treasury department determines the margin. The board has the following concerns:

– Both selling and buying divisions have claimed that prices are unfair and distort the measurement of their performance.
– Significant treasury department time is being taken up dealing with disputes and then dealing with complaints that the price it has imposed is unfair on one or the other division.
– Some parts of the group are choosing to buy from external suppliers rather than from suppliers within the group.

As a result of the review, the Adverane Group board has decided that transfer prices should in future be based on market prices, where an external market exists.

Note: CHF is Swiss Franc, 3 is Euro, US$ is United States dollar and BRL is Brazilian Real.

Required:

The Armstrong Group is a multinational group of companies. Today is 1 September. The treasury manager at Massie Co, one of Armstrong Group’s subsidiaries based in Europe, has just received notification from the group’s head office that it intends to introduce a system of netting to settle balances owed within the group every six months.

Previously inter-group indebtedness was settled between the two companies concerned.

The predicted balances owing to, and owed by, the group companies at the end of February are as follows:

Settlement will be made in dollars, the currency of Armstrong Group, the parent company. Settlement will be made in the order that the company owing the largest net amount in dollars will first settle with the company owed the smallest net amount in dollars.

Note: D Kr is Danish Krone, SA R is South African Rand, US $ is United States dollar and € is Euro.

Required:
(a) (i) Calculate the inter-group transfers which are forecast to occur for the next period. (8 marks)
(ii) Discuss the problems which may arise with the new arrangement. (3 marks)

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).

Exchange rates available to Kenduri Co

Currency options available to Kenduri Co

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

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

Annual interest rates available to Kenduri Co and subsidiaries

Required:

Calculate, using a tabular format (transactions matrix), the impact of undertaking multilateral netting by Kenduri Co and its three subsidiary companies for the cash flows due in three months. Briefly discuss why some governments allow companies to undertake multilateral netting, while others do not. (10 marks)