ACCA FM Syllabus G. Risk Management - Money Market Hedges - payment - Past Papers ^{2 / 6}

ZPS Co, whose home currency is the dollar, took out a fixed-interest peso bank loan several years ago when peso interest rates were relatively cheap compared to dollar interest rates. ZPS Co does not have any income in pesos. Economic difficulties have now increased peso interest rates while dollar interest rates have remained relatively stable.

ZPS Co must pay interest on the dates set by the bank. A payment of 5,000,000 pesos is due in six months’ time. The following information is available:

What is the dollar cost of a forward market hedge?

A. $390,472
B. $387,928
C. $400,000
D. $397,393

ZPS Co, whose home currency is the dollar, took out a fixed-interest peso bank loan several years ago when peso interest rates were relatively cheap compared to dollar interest rates. ZPS Co does not have any income in pesos. Economic difficulties have now increased peso interest rates while dollar interest rates have remained relatively stable.

ZPS Co must pay interest on the dates set by the bank. A payment of 5,000,000 pesos is due in six months’ time. The following information is available:

What are the appropriate six-month interest rates for ZPS Co to use if the company hedges the peso payment using a money market hedge?

An investor plans to exchange $1,000 into euros now, invest the resulting euros for 12 months, and then exchange the euros back into dollars at the end of the 12-month period. The spot exchange rate is €1·415 per $1 and the euro interest rate is 2% per year. The dollar interest rate is 1·8% per year.

Compared to making a dollar investment for 12 months, at what 12-month forward exchange rate will the investor make neither a loss nor a gain?

A. €1·223 per $1
B. €1·412 per $1
C. €1·418 per $1
D. €1·439 per $1

TGA Co, a multinational company, has annual credit sales of $5·4 million and related cost 
of sales are $2·16 million. Approximately half of all credit sales are exports to a European country, which are invoiced in euros. Financial information relating to TGA Co is as follows:

TGA Co plans to change working capital policy in order to improve its profitability. This 
policy change will not affect the current levels of credit sales, cost of sales or net working capital. As a result of the policy change, the following working capital ratio values are expected:

Required:

TGA Co expects to receive €500,000 from export sales at the end of three months. 
A forward rate of €1·687 per $1 has been offered by the company’s bank and the spot rate is €1·675 per $1. TGA Co can borrow short term in the euro at 9% per year.

Calculate the dollar income from a forward market hedge and a money market hedge, and indicate which hedge would be financially preferred by TGA Co.

(4 marks)