Advanced financial management revision question and answer

Advanced Financial Management Block Revision Mock Exams

Cotts Importers Ltd, a company based in Kenya, has been a regular importer of goods from the United States of America (USA). The Kenyan currency is the Shilling (Sh.) while the USA currency is the dollar ($)

ON 1 June 2004, Cotts Ltd imported a consignment of goods from a supplier in the USA. The consignment cost $1,000 and was payable on 1 September 2004.

The spot rates on 1 June and 1 September 2004 were as follows:

September 2004 shilling futures were trading at $0.00625/Sh (contract size Sh.1,194,000) as at 1 June 2004.

Required:

i) Show how Cotts Ltd could have used a futures contract as a hedging tool, indicating any
hedging profit or loss.
ii) How many futures contracts would Cotts Ltd. have purchased if the contract size was Sh.2
million?
ANSWER
) Since the contract is in Ksh. And the amount payable in dollars, convert the dollars into Kenya shillings at spot exchange rate on June

– Since contracts must be whole, 119.6 = 120 contracts
– Cotts Ltd will need to sell Ksh/ buy dollars therefore it needs to sell Ksh. Futures contracts on 1/6 and to close out on 1/9, it will need to buy the futures back.

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