A foreign currency option gives the buyer of the option the right, but not the obligation, to buy or
sell a currency at a specified rate of exchange at a specified time.
Advantages
(i) Foreign currency options limit downside risk whilst allowing companies to take advantage of
favourable foreign exchange rate movements.
They are a useful hedge against risk when a company is unsure whether a future foreign exchange
risk will occur, for example when tendering for a contract which it might not get, or issuing a price
list in foreign currencies.
They provide an effective currency hedge, especially when foreign exchange markets are volatile.
Disadvantages
(i) Cost. A premium is payable when the option is arranged, no matter whether or not the option is
exercised.
(ii) Exchange traded options are only available in a small number of currencies with specific expiry dates
(OTC options are much more flexible).
Kavungya answered the question on April 22, 2021 at 15:23
- You are required to discuss whether a multinational company should hedge translation exposure by incurring transaction exposure.(Solved)
You are required to discuss whether a multinational company should hedge translation exposure by incurring transaction exposure.
Date posted: April 22, 2021. Answers (1)
- A company operating in a country having the dollar as its unit of currency has today invoiced sales to the
United Kingdom in sterling, payment being...(Solved)
A company operating in a country having the dollar as its unit of currency has today invoiced sales to the
United Kingdom in sterling, payment being due three months from the date of invoice. The invoice
amount is £3,000,000 which, at today's spot rate of 1.5985 is equivalent to USD4,795,500.
It is expected that the exchange rate will decline by about 5% over the three month period and in
order to protect the dollar proceeds from the sale, the company proposes taking appropriate
action through either the foreign exchange market or the money market.
The USD/£ three-months forward exchange rate is quoted as 1.5858-1.5873. the three-months
borrowing rate for Eurosterling is 15.0% and the deposit rate quoted by the company's own
bankers is currently 9.5%.
You are required to
Explain the alternative courses of action available to the company, with relevant calculations to four
decimal places, and to advise which course of action should be adopted.
Date posted: April 22, 2021. Answers (1)
- Fidden is a medium-sized UK company with export and import trade with the USA. The following transactions are due with the next six months. Transactions...(Solved)
Fidden is a medium-sized UK company with export and import trade with the USA. The following transactions are due with the next six months. Transactions are in the currency specified.
Purchases of components, cash payment due in three months: £116,000
Sales of finished goods, cash receipt due in three months: USD 197,000
Purchase of finished goods for resale, cash payment due in six months: USD 447,000
Sale of finished goods, cash receipt due in six months: USD 154,000
Assume that it is now December with three months to expiry of the March contract and that the option
price is not payable until the end of the option period, or when the option is exercised.
You are required:
(i) to calculate the net sterling receipts/payments that Fidden might expect for both its three and
six month transactions if the company hedges foreign exchange risk on:
the forward foreign exchange market; the money market.
(ii) If the actual spot rate in six months time was with hindsight exactly the present six months forward
rate, calculate whether Fidden would have been better to hedge through foreign currency
options rather than the forward market or money market.
(iii) to explain briefly what you consider to be the main advantage of foreign currency options.
Date posted: April 22, 2021. Answers (1)
- Provincial plc is contemplating a bid for the share capital of National plc. The following statistics are available:
Provincial plc?s plan is to reduce the scale...(Solved)
Provincial plc is contemplating a bid for the share capital of National plc. The following statistics are available:
Provincial plc's plan is to reduce the scale of National plc's operations by selling off a division
which accounts for Sh.1,500,000 of National plc's latest earnings, as indicated above. The estimated
selling price for the division is Sh.10.2 million.
Earnings in National plc's remaining operations could be increased by an estimated 20% on a
permanent basis by the introduction of better management and financial controls. Provincial plc does not anticipate
any alteration to National plc's price/earnings multiple as a result of these improvements in earnings.
To avoid duplication, some of Provincial plc's own property could be disposed of at an
estimated price of Sh.16 million.
Rationalization costs are estimated at Sh.4.5 million.
You are required:
(a) to calculate the effect on the current share price of each company, all other things being equal, of a two-for nine share offer by Provincial plc, assuming that Provincial plc's estimates are in line with
those of the market;
(b) to offer a rational explanation of why the market might react to the bid by valuing National plc's
shares at (i) a higher figure and (ii) a lower figure than that indicated by Provincial plc's offer
even though the offer is in line with market estimates of the potential merger synergy.
(c) Assume that Provincial plc is proposing to offer National plc shareholders the choice of the two-fornine
share exchange or a cash alternative.
You are required to advice Provincial plc whether the cash alternative should be more or less
than the current value of the share exchange, giving your reasons.
(d) Assume now that Provincial plc, instead of making a two-for-nine share exchange offer, wishes
to offer an exchange which would give National plc shareholders a 10% gain on the existing
value of their shares.
You are required to calculate what share exchange would achieve this effect, assuming the same
synergy forecasts as before.
Date posted: April 22, 2021. Answers (1)
- The board of directors of Rutherford plc is arguing about the company's dividend policy.
Director A is infavour of financing all investment by retained earnings and...(Solved)
The board of directors of Rutherford plc is arguing about the company's dividend policy.
Director A is infavour of financing all investment by retained earnings and other internally generated funds.
He argues that a high level of retentions will save issue costs, and that declaring dividends always results in a
fall in share price when the shares are traded ex div.
Director B believes that the dividend policy depends upon the type of shareholders that the company
has, and that dividends should be paid according to shareholders' needs. She presents data
relating to the company's current shareholders.
She argues that the company‟s shareholder „clientele‟ must be identified, and dividends
fixed according to their marginal tax brackets.
Director C agrees that shareholders are important, but points out that many institutional shareholders
and private individuals rely on dividends to satisfy their current income requirements, and prefer a known
dividend now to an uncertain capital gain in the future.
Director D considers the discussion to be a waste of time. He believes that one dividend policy is as good as
other, and that dividend policy has no effect on the share price.
You are required to discuss critically the arguments for each of the four directors using both
the information provided and any other evidence on the effect of dividend policy on share price that
you consider to be relevant.
Date posted: April 22, 2021. Answers (1)
- The managing director of Wemere, a medium -sized private company, wishes to improve the
company's investment decision-making process by using discounted cash flow techniques. He is
disappointed...(Solved)
The managing director of Wemere, a medium -sized private company, wishes to improve the
company's investment decision-making process by using discounted cash flow techniques. He is
disappointed to learn that estimates of a company‟s cost of capital usually require information on
share prices which, for a private company, are not available. His deputy suggests that the cost of equity
can be estimated by using data for Folten Ltd., a similar sized company in the same industry whose shares
are listed on the SE, and he has produced two suggested discount rates for use in Wemere's future
investment appraisal. Both of these estimates are in excess of 17% per year which the managing director
believes to be very high, especially as the company has just agreed a fixed rate bank loan at 13% per year to
finance a small expansion of existing operations. He has checked the calculations, which are numerically
correct, but wonders if there are any errors of principle.
Estimate 1: capital asset pricing model
Data have been purchased from a leading business school:
Equity beta of Folten 1.4
Market return 18%
Treasury bill yield 12%
The cost of capital is 18% +(18% - 12%)1.4 = 26.4%.
This rate must be adjusted to include inflation at the current level of 6%. The recommended discount rate is 32.4%.
Notes:
(1) The current ex-div share price of Folten plc is Sh.13.80.
(2) Wemere's board of directors has recently rejected a take-over bid of Sh.10.6 million.
(3) Corporate tax is at the rate of 35%.
You are required:
(a) to explain any errors of principle that have been made in two estimates of the cost of capital
and produce revised estimates using both of the methods.
State clearly any assumptions that you make.
(b) to discuss which of your revised estimates Wemere should use as the discount rate for capital
investment appraisal.
Date posted: April 22, 2021. Answers (1)
- A division of Bewcast plc has been allocated a fixed capital sum by the main board of directors for its
capital investment during the next year....(Solved)
A division of Bewcast plc has been allocated a fixed capital sum by the main board of directors for its
capital investment during the next year. The division's management has identified three capital
investment projects, each potentially successful, each of similar size, but has only been allocated enough
funds to undertake two projects. Projects are not divisible and cannot be postponed until a later date.
The division's management proposes to use portfolio theory to determine which two projects
should be undertaken, based upon an analysis of the projects‟ risk and return. The success of
the projects will depend upon the growth rate of the economy. Estimates of project returns at different
levels of economic growth are shown below:
You are required:
(a) to use the above information to evaluate and discuss which two projects the division is likely to
undertake. All relevant calculations must be shown.
(b) What are the weaknesses of the evaluation technique used in (a) above, and what further information
might be useful in the evaluation of these projects?
(c) Suggest why portfolio theory is not widely used in practice as a capital investment evaluation technique.
(d) Recommend, and briefly describe, an alternative investment evaluation technique that might be
applied by the division.
Date posted: April 22, 2021. Answers (1)
- Ceder Ltd has details of two machines which could fulfill the company's future production
plans. Only one of these machines will be purchased.
The standard model costs...(Solved)
Ceder Ltd has details of two machines which could fulfill the company's future production
plans. Only one of these machines will be purchased.
The standard model costs Sh.50,000, and the deluxe Sh.88,000, payable immediately. Both
machines would require the input of Sh.10,000 working capital throughout their working lives, and both
machines have no expected scrap value at the end of their expected working lives of four years for the
standard machine and six years for the deluxe machine.
The forecast pre-tax operating net cash flows associated with the two machines are:
The de-luxe machine has only recently been introduced to the market and has not been fully tested in
operating conditions. Because of the higher risk involved, the appropriate discount rate for the de-luxe
machine is believed to be 14% per year, 2% higher than the discount rate for the standard machine.
The company is proposing to finance the purchase of either machine with a term loan at a fixed interest
rate of 11% per year.
Taxation at 35% is payable on operating cash flows one year in arrears, and capital allowances are available
at 25% per year on a reducing balance basis.
You are required:
(a) to calculate for both the standard and the de-luxe machine:
(i) pay-back period;
(ii) net present value
Recommend, with reasons, which of the two machines Ceder Ltd should purchase.
(Relevant calculations must be shown)
(b) If Ceder Ltd were offered the opportunity to lease the standard model machine over a four year
period at a rental of Sh.15,000 per year, not including maintenance costs, evaluate whether the
company should lease or purchase the machine.
Date posted: April 22, 2021. Answers (1)
- You are presented with the following different views of stock market behaviour.
(1) If a company publishes an earnings figure that is better than the market...(Solved)
You are presented with the following different views of stock market behaviour.
(1) If a company publishes an earnings figure that is better than the market expects, the shares of that
company will usually experience an abnormally high return both on the day of the earnings
announcement and over the two or three days following the date of the announcement.
(2) The return on professionally managed portfolios of equities is likely to be no better than that which
` could be achieved by a naïve investor who holds the market portfolio.
(3) Share prices usually seem to rise sharply in the first few days of a new fiscal year. However, this can
be explained by the fact that many investors sell loosing stocks just before the fiscal year end in
order to establish a tax loss for Capital Gains Tax purposes. This causes abnormal downward
pressure which is released when the new fiscal year begins.
You are required:
(a) to describe the three forms of the Efficient Market Hypothesis;
(b) to discuss what each of the above three statements would tell you about the efficiency of the stock
market. Where appropriate relate your comments to one or more forms o f the Efficient Market Hypothesis.
Date posted: April 22, 2021. Answers (1)
- The annual reports of commercial corporations increasingly contain details of share option schemes.
You are required:
(a) To discuss whether share option schemes for either directors or...(Solved)
The annual reports of commercial corporations increasingly contain details of share option schemes.
You are required:
(a) To discuss whether share option schemes for either directors or employees generally, can benefit the
interest of the shareholders in the company;
( b) Contrast share option schemes with other schemes for relating managers' rewards to the financial
performance of the company;
(c) Describe the treatment of share option schemes in calculations of earnings per share.
Date posted: April 22, 2021. Answers (1)
- Describe the main types of foreign exchange rate system. Briefly discuss how such systems might affect the
ability of financial managers to forecast exchange rates.(Solved)
Describe the main types of foreign exchange rate system. Briefly discuss how such systems might affect the
ability of financial managers to forecast exchange rates.
Date posted: April 22, 2021. Answers (1)
- The following data relates to a large company operating in the electronics industry:
A major institutional shareholder has criticized the level of dividend payment of the...(Solved)
The following data relates to a large company operating in the electronics industry:
A major institutional shareholder has criticized the level of dividend payment of the company suggesting that it should be substantially increased.
Required:
(a) Briefly discuss the factors that are likely to influence the company's dividend policy, and
(b) Discuss whether or not the institutional shareholder's criticism is likely to be valid.
Date posted: April 22, 2021. Answers (1)
- Discuss the arguments for and against the introduction of statutory controls on corporate governance.(Solved)
Discuss the arguments for and against the introduction of statutory controls on corporate governance.
Date posted: April 22, 2021. Answers (1)
- The objective of financial management is to maximize the value of the firm.
You are required to discuss how the achievement of this objective might be...(Solved)
The objective of financial management is to maximize the value of the firm.
You are required to discuss how the achievement of this objective might be compromised by the conflicts which may arise between the various stakeholders in an organization.
Date posted: April 22, 2021. Answers (1)
- Fuelit plc is an electricity supplier in the UK. The company has historically generated the majority of its
electricity using a coal fueled power station, but...(Solved)
Fuelit plc is an electricity supplier in the UK. The company has historically generated the majority of its
electricity using a coal fueled power station, but as a result of the closure of many coal mines and
depleted coal resources, is now considering what type of new power station to invest in. The alternatives
are a gas fueled power station, or a new type of efficient nuclear power station.
Both types of power station are expected to generate annual revenues at current prices of Sh.800 million.
The expected operating life of both types of power station is 25 years.
Other information:
(i) Whichever power station is selected, electricity generation is scheduled to commence in three
years time.
(ii) If gas is used most of the workers at the existing coal fired station can be transferred to the new
power station. After tax redundancy costs are expected to total Sh.4 million in year four. If nuclear
power is selected fewer workers will be required and after tax redundancy costs will total Sh.36
million, also in year four.
(iii) Both projects would be financed by Euro-bond issues denominated in Euros. The gas powered
station would require a bond issue at 8.5% per year, the bond for the nuclear project would be
at 10% reflecting the impact on financial gearing of a larger bond issue.
(iv) Costs of building the new power stations would be payable in two equal installments in one and two
years time.
(v) The existing coal fired power station would need to be demolished at a cost of Sh.10 million in
three years time.
(vi) The company‟s equity beta is expected to be 0.7 if the gas station is chosen and 1.4 if
the nuclear station is chosen. Gearing (debt to equity plus debt) is expected to be 35% with gas
and 60% with nuclear fuel.
(vii) The risk free rate is 4.5% per year and the market return is 14% per year. Inflation is currently 3%
per year in the UK and an average of 5% per year in the member countries of the Euro bloc in
the European Union.
(viii) Corporate tax is at the rate of 30% payable in the same year that the liability arises.
(ix) Tax allowable depreciation is at the rte of 10% per year on a straight line basis.
(x) At the end of twenty-five years of operations the gas plant is expected to cost Sh.25 million
(after tax) to demolish and clean up the site. Costs of decommissioning the nuclear plant are
much less certain, and could be anything between Sh.500 million and Sh.1,000 million (after tax)
depending upon what form of disposal is available for nuclear waste.
Required:
(a) Estimate the expected NPV of EACH OF investment in a gas fueled power station and
investment in a nuclear fueled power station.
State clearly any assumptions that you make.
(NB: It is recommended that annuity tables are used wherever possible)
(b) Discuss other information that might assist the decision process.
Date posted: April 22, 2021. Answers (1)
- Excluding foreign exchange risks, discuss, with examples, how the risks of foreign trade might be managed.(Solved)
Excluding foreign exchange risks, discuss, with examples, how the risks of foreign trade might be managed.
Date posted: April 22, 2021. Answers (1)
- Justify and criticize the usual assumption made in financial management literature that the objective of a
company is to maximize the wealth of its shareholders. (Do...(Solved)
Justify and criticize the usual assumption made in financial management literature that the objective of a
company is to maximize the wealth of its shareholders. (Do not consider how this wealth is to be measured).
Date posted: April 21, 2021. Answers (1)
- Discuss how government actions can influence the tasks of the financial manager and explain how these actions can affect the attainment of financial objectives.(Solved)
Discuss how government actions can influence the tasks of the financial manager and explain how these actions can affect the attainment of financial objectives.
Date posted: April 21, 2021. Answers (1)
- Maltec plc is a company that has diversified into five different industries in five different countries. The investments are each approximately equal in value. The...(Solved)
Maltec plc is a company that has diversified into five different industries in five different countries. The investments are each approximately equal in value. The company's objective is to reduce risk
through diversification, and it believes that the return on any investment is not correlated with the return on any other investment. The estimated risk and return (in present value terms) of the five investments are shown below:
Required:
(a) Estimate the risk and return of the portfolio of five investments, and briefly explain the significance of your results.
(b) Discuss the validity to investors of Maltec's objective of risk reduction through international
diversification.
Date posted: April 21, 2021. Answers (1)
- Discuss the main features of:
(i) Corporate share repurchases (buy-backs); and
(ii) Share (stock) splits;
and why companies might use them. Include in your discussion comment on the...(Solved)
Discuss the main features of:
(i) Corporate share repurchases (buy-backs); and
(ii) Share (stock) splits;
and why companies might use them. Include in your discussion comment on the possible effects on share
price of share repurchases and share (stock) splits in comparison to the payment of dividends.
Date posted: April 21, 2021. Answers (1)