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Interest Rate Swaps
This is a transaction which allows a company to exploit different interest rates in different
markets for borrowing and thereby reduce or alter the timing of interest payments. Interest rate
swaps are based on single currency.
Swaps are used where different firms in the market has different credit rating or borrowing strengths. A
poor credit rating firm will borrow at fixed interest rate and anticipate a decline in future interest rate. It will therefore prefer a floating interest rate loan to take advantage of lower interest rate.
A good credit rating firm will borrow at floating or variable interest rate and anticipate an increase
in interest rate thus would prefer a fixed interest rate obligation to protect itself against an upward side risk.
Kavungya answered the question on April 16, 2021 at 18:28
- A Kenyan company has agreed to sell goods to an importer in Zedland at an invoiced price of
Z 150,000 (Zed (Z) is the currency of...(Solved)
A Kenyan company has agreed to sell goods to an importer in Zedland at an invoiced price of
Z 150,000 (Zed (Z) is the currency of Zedland). Of this amount, Z 60,000 will be payable on
shipment, Z 45,000 one month after shipment and Z 45,000 three months after shipment.
The quoted foreign exchange rates (Z per KSh.) at the date of shipment as as follows:
Spot 1.690 - 1.692
One month 1.687 - 1.690
Three months 1.680 - 1.684
The company decides to enter into appropriate forward exchange contracts through a bank in
order to hedge these transactions.
Required:
i) State the advantages of hedging in this way.
ii) Calculate the amount in Kenya Shillings that the Kenyan Company would receive.
iii) Comment with hindsight on the wisdom of hedging in this instance, assuming that the spot rates at
the dates of receipt of the two instalments of Z 45,000 were as follows:
Fist instalment 1.69 - 1.69
Second instalment 1.700 - 1.704
Date posted: April 16, 2021. Answers (1)
- The Lakeside Company Limited is considering investing in a project requiring an initial outlay of Sh.100
million. The project life is two years after which there...(Solved)
The Lakeside Company Limited is considering investing in a project requiring an initial outlay of Sh.100
million. The project life is two years after which there would be no expected salvage value. The possible
incremental after-tax cash flows and associated probabilities of occurrence as as follows:
The company‟s required rate of return for this investment is 12%.
Required:
a) i) The expected net present value of the project.
ii) Suppose that the possibility of abandonment exists and that the abandonment value of the project at
the end of the first is Sh.50 million after taxes is abandonment the right choice?
iii) Calculate the new expected net present value assuming that the company would abandon the project if it
is advantageous to do so. What are the implications of this calculation to you as a Finance Manager?
b) Identify the case for and against Sensitivity Analysis as a method of handling risk in capital budgeting.
Date posted: April 16, 2021. Answers (1)
- The Kenyan economy has been performing poorly in the recent past and many companies have
retrenched workers while yet others have closed their operations. Many product...(Solved)
The Kenyan economy has been performing poorly in the recent past and many companies have
retrenched workers while yet others have closed their operations. Many product and skilled people
are having to start their own small enterprises.
As a consultant for small and medium size firms, write a brief report, explaining the various ways
in which small and medium size enterprises can raise capital for investment.
Date posted: April 16, 2021. Answers (1)
- In the recent past, the government has been aggressively wooing multinational companies to
come and invest their resources in Kenya.
Analyze the key decision areas that a...(Solved)
In the recent past, the government has been aggressively wooing multinational companies to
come and invest their resources in Kenya.
Analyze the key decision areas that a financial analyst would have to advise a company that
is considering making direct investment in Kenya and discuss the risks involved.
Date posted: April 16, 2021. Answers (1)
- The governments of many less developed countries have experienced problems in recent years as their
debt levels have risen leading to what has been called a...(Solved)
The governments of many less developed countries have experienced problems in recent years as their
debt levels have risen leading to what has been called a “global debt crisis”.
Required:
a) Explain briefly why these problems amount to a “crisis.
b) Discuss the approaches that have been used to overcome the problems.
c) Outline the benefits to multinational business enterprises of resolving the current global debt problems.
Date posted: April 16, 2021. Answers (1)
- KK Ltd. and KT Ltd. are two companies in the printing industry. The companies have the same business
risk and are almost identical in all respects...(Solved)
KK Ltd. and KT Ltd. are two companies in the printing industry. The companies have the same business
risk and are almost identical in all respects for their capital structures and total market values. The companies
capital structures are summarized below:
KT‟s ordinary shares are trading at Sh.170 and debentures at Sh.100. Annual earnings
before interest and tax for each company is Sh.50 million.
Corporate tax is at the rate of 30%.
Required:
a) If you owned 4% of the ordinary shares of KT Ltd. and you agreed with the arguments of
Modigliani and Miller, explain what action you would take to improve your financial position.
b) Estimate by how much your financial position is expected to improve. Personal taxes may be
ignored and assumptions made by Modigliani and Miller may be used.
c) If KK Ltd. was to borrow Sh.40 million, compute and explain the effect this would have on the
company‟s cost of capital according to Modigliani and Miller. What implications would this suggest
for the company‟s choice of capital structure?
Date posted: April 16, 2021. Answers (1)
- Gome Drug Products Ltd. (GDPL) is faced with several possible investment projects. For each, the total
cash outflows required will occur in the initial period. The...(Solved)
Gome Drug Products Ltd. (GDPL) is faced with several possible investment projects. For each, the total
cash outflows required will occur in the initial period. The cash outflows, expected net present values and
standard deviations are as follows:
All projects have been discounted at a risk-free rate of 8% and it is assumed that the distribution of
their possible net present values are normal.
Required:
a) construct a risk profile for each of these projects in terms of the profitability index.
b) Ignoring size problems, do you find some projects clearly dominated by others? Should size problem be ignored?
c) What is the probability that each of the projects will have a net present value ≥0
Date posted: April 16, 2021. Answers (1)
- Maendeleo Industries is concerned about interest rates rising. It needs to borrow in the bond market
three months hence. The company believes that an option on...(Solved)
Maendeleo Industries is concerned about interest rates rising. It needs to borrow in the bond market
three months hence. The company believes that an option on treasury bond futures is the best
hedging device.
i) Should the company buy a put option or a call option? Explain.
ii) Presently, the futures contract trades at Sh.1,000 and 3 month put and call options
both involve premiums of 1½ per cent based on this strike price. During the 3 months,
interest rates rise, so that the price on a treasury bond futures contract goes to Sh.950. What
is your gain or loss on the option per Sh.1,000,000 contract?
Date posted: April 16, 2021. Answers (1)
- Futures contracts and options on futures contracts can be used to modify risk.
Required:
Identify the fundamental distinction between a futures contract and an option on a...(Solved)
Futures contracts and options on futures contracts can be used to modify risk.
Required:
Identify the fundamental distinction between a futures contract and an option on a futures
contract and explain the difference in the manner that futures and options modify portfolio risk.
Date posted: April 16, 2021. Answers (1)
- Jabali Ltd. is a quoted company which is financed by 10,000,000 ordinary shares and Sh.50,000,000 of
irredeemable 8% debentures. The market value of the shares is...(Solved)
Jabali Ltd. is a quoted company which is financed by 10,000,000 ordinary shares and Sh.50,000,000 of
irredeemable 8% debentures. The market value of the shares is Sh.20 each ex-div and an annual dividend of
Sh.4 per share is expected to be paid in perpetuity. The debentures are considered to be risk-free and are
valued at par.
Mr. Jabali the managing director of the company is wondering whether to invest in a project which cost
Sh.20 million and yield Sh.3.8 million a year before tax in perpetuity. The project has an estimated beta value
of 1.25. The return from a well-diversified market portfolio is 16%.
Required:
a) The weighted average cost of capital of the company.
b) The beta of the company.
c) The beta of an equivalent ungeared company ignoring taxes.
d) Advise the company whether/or not the project should be accepted. In your explanation, highlight
the significance of your calculations in (a), (b) and (c) above.
Date posted: April 16, 2021. Answers (1)
- Company A is considering investing in a project which has a three year life. The project would involve an initial investment of Sh.20 million. The...(Solved)
Company A is considering investing in a project which has a three year life. The project would involve an initial investment of Sh.20 million. The finance manager has come up with expected probabilities for various possible economic conditions as follows:
Required:
Assuming a discount rate of 15% should company A invest in the project?
Date posted: April 16, 2021. Answers (1)
- Assume all things are held constant other than the item in question, for each of the
companies below:
A company with a large proportion of insider ownership...(Solved)
Assume all things are held constant other than the item in question, for each of the
companies below:
A company with a large proportion of insider ownership all of whom are high-income
individuals. A growth company with an abundance of good investment opportunities.
A company experiencing ordinary growth that has high liquidity and much unused borrowing
capacity. A dividend paying company that experiences an unexpected drop in earnings from a trend.
A company with volatile earnings and high business risk.
Required:
Explain whether or not you would expect each company to have a medium/high or a low dividend payment
ratio and the reasons for such categorization.
Date posted: April 16, 2021. Answers (1)
- Explain the factors that finance managers should analyze before making a dividend decision.(Solved)
Explain the factors that finance managers should analyze before making a dividend decision.
Date posted: April 16, 2021. Answers (1)
- Highlight the limitations of using commercial paper as a form of short-term credit.(Solved)
Highlight the limitations of using commercial paper as a form of short-term credit.
Date posted: April 16, 2021. Answers (1)
- Mr. Kobe is contemplating acquiring Mfalme Flower Company. Incremental cash flows arising from the acquisition are expected to be the following:
Mfalme has an all -equity...(Solved)
Mr. Kobe is contemplating acquiring Mfalme Flower Company. Incremental cash flows arising from the acquisition are expected to be the following:
Mfalme has an all -equity capital structure. Its beta is 0.8 based on the past 60 months of data
relating its excess returns to that of the market. The risk free rate is 9% and the expected return on
the market portfolio is 14%.
Required:
What is the maximum price that Kobe should pay for Mfalme?
Date posted: April 16, 2021. Answers (1)
- Chuma Company Ltd is considering various levels of debt. Currently it has no debt. It has a total
market value of Sh.30 million. By undertaking debt...(Solved)
Chuma Company Ltd is considering various levels of debt. Currently it has no debt. It has a total
market value of Sh.30 million. By undertaking debt it believes that it can achieve a net tax advantage
equal to 20% of the amount of debt. However the company will incur bankruptcy and agency costs
as well as lenders increasing their interest rate if it borrows too much. The company‟s
managing director believes that the company can borrow up to Sh.10 million without incurring
any of these costs. However, each additional Sh.10 million increment in borrowing is expected to
result in the three costs cited being incurred. Moreover, the three costs are expected to increase at
an increasing rate with leverage. The present value cost of various levels of debt is as follows:
Required:
Advise the managing director on the optimal amount of debt for Chuma Company.
Date posted: April 16, 2021. Answers (1)
- Mr. Mlachake is currently holding a portfolio consisting of shares of four companies quoted on the Bahati Stock Exchange as follows:
The current market return is...(Solved)
Mr. Mlachake is currently holding a portfolio consisting of shares of four companies quoted on the Bahati Stock Exchange as follows:
The current market return is 14% per annum and the treasury bills yield is 9% per annum.
Required:
(i) Calculate the risk of Mlachake‟s portfolio relative to that of the market.
(ii) Explain whether or not Mlachake should change the composition of his portfolio.
Date posted: April 16, 2021. Answers (1)
- Briefly explain three practical uses of the capital asset pricing model.(Solved)
Briefly explain three practical uses of the capital asset pricing model.
Date posted: April 16, 2021. Answers (1)