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Risk Management Assignment - (Solved)

   

Added on  2020-05-16

13 Pages2287 Words80 Views
RUNNING HEAD: RISK MANAGEMENTINTERNATIONAL FINANCE

RISK MANAGEMENT 11.Given information are as follows:Domestic Country is Peru (PEN)Foreign Country is Canada(CAD)Spot Price = 0.40 PEN/CADPut options on sole has 1year expiration periodExercise Price = 0.45 PEN/CADPremium = CAD 0.07 per unit1million Peruvian SolesAnnual Interest Rates:Peru = 5%Canada = 3%Annual Inflation Rates:Peru = 3%Canada = 2%a)Forward Contract Hedge:In forward Contract, an exchange rate is quoted today for settlement at a future date.E (S1) = Exercise Price * No. of unitsTaken information from above figures, expected amount of CAD received after one year using forward contract hedge = 10,00,000 * 0.45 = CAD 4,50,000b)Purchasing Power Parity (PPP):Purchasing power parity focuses on ‘inflation-exchange rate’ relationship.E (S1) = Current Spot rate * expected difference in inflation rates E (S1) = So *(1 + Id)

RISK MANAGEMENT 2 (1 + If)WhereE (S1) = Expected Spot Rate at end of expiration period i.e. 1yearSo = Current Spot Rate i.e. 0.40 PEN/CAD Id = Inflation rate in domestic currency i.e. 3%If = Inflation rate in foreign currency i.e. 2%Thus, expected amount of CAD received after one year using PPP:E (S1) = 0.40 * (1 + 3%) = 0.4039 PEN/CAD (1 + 2%)E (S1) = 0.4039 * 10,00,000 = CAD 4,03,900c)Put option Hedge:In put option, gives buyer the right, but not the obligation, to sell a specified no. of units of commodity or currency to seller of option at a fixed price on or up to a specified date.Premium is also paid by the buyer at the inception of the contract. Therefore, Premium Amount received = CAD 0.07 per sole * 10, 00,000 soles = CAD 7,00,00If Expected spot price is greater than exercise price, then buyer do not exercise put optionbut where Expected spot price is less than exercise price, then buyer exercise put option. In both cases, Buyer has to pay premium amount.2.Below is the explanation of transaction exposure and Economic exposure with examples and measures to reduce transaction and economic exposures in Multi-national companies:

RISK MANAGEMENT 3a.Transaction Exposure: Transaction exposure measures the exchange gains and losses in cash flows in the value of domestic currency, which is denominated in foreign currency (Shapiro, 2010). Transaction exposure is also called as Transaction risk.Example: Suppose that a company based in US signs a contract with a company based in Belgium to purchase a product. The contract states that payment should be madeon supplier’s country currency i.e. Payment should be made in Euros (€). US Co. agrees to pay to Belgium co. $1.5/€ for every product purchased. After the completion of agreement, sale might not take place immediately then there is a possibility of change in ratios of dollars to Euros (which could be favorable change or adverse change or no change) before the final sale is happened. Thus, this risk of change is the transaction exposure.In other words, greater the time between agreement and settlement of contract, greateris the risk of Transaction Exposure. Measures to reduce Transaction Exposure in MNC: Multi-national Corporation should enter a contract in forward exchange rate, which lowers the risk of transaction exposure.b.Economic Exposure: Economic exposure measures the impact of exchange rate fluctuations on operating cash flows through the sales price, sales volume and production cost (Shapiro, 2010).Economic Exposure is also called as Operating Exposure.

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