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International Finance Question Paper
International Finance
Course:Bachelor Of Commerce
Institution: Kca University question papers
Exam Year:2009
1
UNIVERSITY EXAMINATIONS: 2009/2010
SECOND YEAR STAGE 3 EXAMINATION FOR THE DEGREE OF
BACHELOR OF COMMERCE
CFM 204:INTERNATIONAL FINANCE
DATE: DECEMBER 2009 TIME: 2 HOURS
INSTRUCTIONS: Answer ONE and Any other TWO Questions
QUESTION ONE
a) A U.S. exporter has future receivable of Euro 4,000,000 in one year. It must decide whether to
use options or a money Market hedge this position. The following information is available;
Spot rate $0.80=Euro 1
Forward rate $0.82=Euro 1
One-year put option
Exercise price $0.83=Euro 1
Premium $0.04 per Euro
Dollar deposit rate 0.08 per annum
Dollar borrowing rate 0.09 per annum
Euro deposit rate 0.05 per annum
Euro borrowing rate 0.06 per annum
Forecast one year spot rate $0.80 $0.83 $0.88
Probability 0.20 (20%) 0.55 (55%) 0.25 (25%)
2
Required:
i) Assuming that the exporter’s objective is to maximize the value of expected Euro
receivables, what would you recommend the exporter to do? Support your answer by
estimating the dollar revenues to be received in one year under all possible alternatives.
(10 Marks)
ii) What non-financial and financial factors may influence the exporter’s decision in choosing
between the hedging instruments? (5 Marks)
b) Consider a currency that sells for $1,000 today. A forward contract on this currency that
expires in two years is currently priced at $1,100. The annual rate of interest is 6.75 percent.
Assume that this is an off-Market forward contract. Calculate the value of the forward contract
today, V0(0, T), and indicate whether payment is made by the long to the short or vice versa.
(5 Marks)
c) Consider a two-period binomial model in which a currency currently trades at a price of
Ksh.70. The currency price can go up 20 percent or down 15 percent each period. The risk-free
rate is 5 percent. Calculate the price of a European call option expiring in two periods with an
exercise price of $65. Also, calculate the price of a European put option expiring in two periods
with a $75 strike. (8 Marks)
d) Distinguish between currency futures and forward contracts (2 Marks
QUESTION TWO
A U.K. importer has future payables of DM 20,000,000 in one year. It must decide whether to use
options or a money Market to hedge this position. The following information is available:
Sport rate £0.74=DM
One year call option
Exercise price £ 0.76=DM
Premium £0.04 per DM
One year put option
Exercise price £0.77=DM
Premium £0.02 per DM
Sterling deposit rate 8% per annum
3
Sterling borrowing rate 9% per annum
Mark deposit rate 6% per annum
Mark borrowing rate 7% per annum
Forecast one-year spot rate £0.70 £0.77 £0.70
Probability 25% 55% 20%
Required:
a) Assuming that the importer’s objective is to minimize the sterling value of DM payables.
Which of the hedging instruments would you recommend? Verify your answer by
estimating the sterling cost for each type of hedge. Compare cost of hedging with nonhedging.
(15 Marks)
b) Name any 5 sources of short-term finance in the importation business
(5 Marks)
QUESTION THREE
Assume that Carbondale Company expects to receive S $500,000 in one year. The existing spot rate of
Singapore dollar is Ksh.60. The one-year forward rate of the Singapore dollar is Ksh.62. Carbondale
created a probability distribution for the future spot rate in one year as follows:
Future Sport Rate Probability
$.61 20%
.63 50
.67 30
Assume that one-year put options on S$ are available, with an exercise price of Ksh.63 and a
premium of Ksh04 per unit. One-year call options on S$ per unit are available with an exercise
price of Ksh.60 and premium of Ksh.03 per unit. Assume the following money Market rates.
Kenya Singapore
Deposit rate 8% 5%
4
Borrowing rate 9 6
a) Given this information, determine whether a forward hedge, money Market, or currency
options hedge would be most appropriate. Then, compare the most appropriate hedge to an
unhedged strategy, and decide whether Carbondale should hedge its receivable position.
(10 Marks)
b) Assume that Baton Rough Inc. expects to need S$1million in one year. Using any relevant
information in Part (a) of this question, determine whether a forward hedge, money Market
hedge, or a currency option hedge would be most appropriate. Then, compare the most
appropriate hedge to an unhedged strategy, and decide whether Baton Rough should hedge its
payables position. (10 Marks)
QUESTION FOUR
a) Explain any five factors that affect currency option premiums (5 Marks)
b) Longer-term currency options are becoming more popular for hedging exchange rate risk. Why
do you think some firms decide to hedge by using other techniques instead of purchasing
longer-term currency options (3 Marks)
c) Write brief notes on the following terminology:
i) Purchasing power parity (4 Marks)
ii) International fisher effect (4 Marks)
iii) Interest rate parity (4 Marks)
QUESTION FIVE
a) Assume that the Canadian dollar’s spot rate is Ksh.0.85 and that the Canadian and Kenyan
inflation rates are similar. Then assume that Canada experiences 4% inflation, while Kenya
experiences 3% inflation. According to the purchasing power parity, what will be the new
value of Canadian dollar after it adjusts to the inflationary changes? (6 Marks)
b) Briefly describe how various economic factors can affect the equilibrium exchange rate of the
US dollar value with respect to the Kenya shilling. (8 Marks)
c) Distinguish between accounting exposure , economic exposure and transaction exposure in the
context of international finance. (6 Marks)
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