Advanced financial management revision question and answer

Advanced Financial Management Block Revision Mock Exams

(a) Globalisation has resulted in several organizations engaging in corporate alliances and the establishment of several trading blocks. The advent of e-commerce has enabled companies to greatly expand their markets.

Required:
Identify and elaborate on five factors that complicate financial management in multi-national firms.
(10 marks)

(b) Highspeed Electronics Limited has taken delivery of 50,000 electronic devices from an American company. The seller is in a strong bargaining position and has priced the devices in American dollars at $12.00 each.

Highspeed Electronics Limited has been granted three months credit. Assume that interest rates in America are 3% per quarter (three months). Highspeed electronics Limited has all its money tied up in its operations but it could borrow in dollars at 3% per quarter if necessary.

A three month dollar call option for US$ 600,000 is available at a premium of US$15,000.

Required:
(i) Using suitable computations, illustrate two hedging strategies available to High speed Electronics Limited.
(ii) Distinguish between a currency option and a currency swap.

ANSWER
(b) The exchange rate is in form of indirect quote which indicates the amount of foreign currency (US $) per unit of domestic currency ( Ksh.)

(i) Forward contract
The firm could contract to buy $600,000 at an agreed 3 month forward exchange rate. This rate is given as $0.0154/ Ksh.


(ii) Leading
The Kenyan importer may opt to pay the $600,000 “now” but the Ksh. is appreciative against the $ which is advantageous to the Kenyan importer. This is not a viable option but would be if the evaluated amount is paid now, the Ksh. payable would be


assuming the firm does not have this money, it would borrow and pay interest in Kenya for 3 months so that future value would be Ksh. 46,153,846 ( 1 + r) where r = 3 month Kenyan interest rate.

(iii) Money market hedge
The firm has a liability of $600,000. It needs to create an asset depositing some money in U.S.A. This hedging would arise as follows:
(a) Deposit some dollars in USA “now” which will, together with interest, equal $600,000 in 3 months time. The amount to deposit today


This amount would be borrowed in Kenya now and assuming this could be borrowed at 3% for 3 months, the future value of Ksh. 44,809,559 would be 44,809,559 (1.03) = Ksh. 46,153,849.

(c) Meanwhile, at end of 3 months, the deposited $ will mature to $600,000 and used to pay the USA seller.

(iv) Use of options
The examiner did not give the strike or exercise price but assuming the forward rate of $0.0154/ Ksh. then,

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