FOREIGN CURRENCY RISK & ITS MANAGEMENT

Review Questions
Question 1
On 1 January a Tanzania firm enters into a contract to sell a piece of equipment to Kenya for
KES100,000. The invoice is to be settled on 31 March. The exchange rate on 1 January is
TZS20/KES. However by 31 March the TZS may have:
o Weakened to TZS22/KES, or
o Strengthened to TZS18/KES, or
o Remain unchanged, TZS20/KES
Required:
Explain the risk faced by the Tanzania firm.

Question 2
A Tanzania exporter sell product in Zambia on a cost plus basis. The selling price is based on a
Tanzania price of TZS.16,000 to cover costs and provide a profit margin. The current exchange
rate is Zkw.1,260/TZS.
Required:
Explain the risk faced by the Tanzania exporter if the TZS strengthened to Zkw.1,310/TZS?

Question 3
A and B are respectively UK and US based subsidiaries of a German based holding company. At
31st December, 2011, A owed B €300,000 and B owed A €220,000.
Required: Show how bilateral netting can reduce the value of intercompany debts

Question 4
The ABC Plc, a Tanzanian company, (TZ) purchases Sugar from Brazil and sells it through sales
affiliates in Burundi (BU), the Kenya (KE), and Uganda (UG). For a recent month, the following
payments matrix of inter-affiliate cash flows, stated in Tanzania shillings (TZS million), was
forecasted.
Receiving Subsidiaries Paying Subsidiaries

TZ BU KE UG Total

TZS TZS TZS TZS TZS

TZ - 40 75 55 170

BU 8 - - 22 30

KE 15 - - 17 32

UG 11 25 9 - 45

Total payments 34 65 84 94 277

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Required:
a. Show how ABC Plc can use multilateral netting to minimize the foreign exchange
transactions necessary to settle inter-affiliate payments.
b. If foreign exchange transactions cost the company 0.5 percent, what savings result from
netting?

Question 5
ABC Plc, a company based in the UK, imports and exports to USA. On 1 st May it signs two
agreements, all of which are to be settled on 31st October:
1. A sale to a US customer of goods for US$205,500.
2. A purchase from a US supplier for US$875,000.
Required:
Compute the net amount receivable or payable.

Question 6
A UK Company, ABC Plc, buys goods from a German supplier, XYZ Plc, on 90 days credit at a
total value of €500,000. The three months interest rates in the UK are currently 14 percent. Due
to political uncertainty, it is feared that the sterling will weaken these three months period to a
level of €1.30/£. The current spot exchange rate is €1.45/£.
Required:
Calculate the cost to UK Company, if it decides to lead on payment to the German supplier.

Question 7
Assume you are a Tanzania manufacturer, exporting to Kenya. You have agreed a sale worth
KES500,000 to be received in three months, and wish to hedge (reduce your risk) against
currency movements using the forward market. The following information is available

Spot TZS/KES 22 – 28

Three-month forward rate TZS/KES 24 – 26

Required:
What action would you take?

Question 8
ABC Plc, a company based in the UK, imports and exports to USA. On 1 st May it signs three
agreements, all of which are to be settled on 31st October:

1. A sale to a US customer of goods for US$205,500.

2. A sale to another US customer for £550,000.
3. A purchase from a US supplier for US$875,000.

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On 1st June the US$/£ spot rate is 1.5500 – 1.5520 and the October forward rate is at premium of
4.00 – 3.95 cents per £.

Required:
Compute the net amount receivable or payable in pounds (£) if the transactions are covered on
the forward market.

Question 9
XYZ, a US manufacturing company, sells electrical equipment to ABC, a British buyer for
£1,000,000. The payment is due three months later. The following quotes are available:

Spot exchange rate US$1.7640/£

3-month forward rate US$1.7540/£
UK 3-months borrowing rate 10 % pa
UK 3-months investing rate 8 % pa
US 3-months borrowing rate 8 % pa
US 3-months investing rate 6 % pa

XYZ’s foreign exchange advisory service forecast that the spot rate in three months would be
US$1.7600/£.
Required:
Show how hedging in the forward market and money market can be used to minimize XYZ’s
transaction exposure risk

Question 10
ABC Plc, a British importer company, buys electrical equipment from AQQ Plc, a USA seller
for US$1,000,000. The payment is due three months later. The following quotes are available:

Spot exchange rate US$1.7640/£

3-month forward rate US$1.7540/£
UK 3-months borrowing rate 10 % pa
UK 3-months investing rate 8 % pa
US 3-months borrowing rate 8 % pa
US 3-months investing rate 6 % pa

ABC Plc’s foreign exchange advisory service forecast that the spot rate in three months would be
US$1.7600/£.
Required:
Show how hedging in the forward market and money market can be used to minimize ABC Plc’s
transaction exposure risk

Question 11
A UK company needs to pay a French creditor €3,500,000 in three months time. The spot
exchange rate is €7.5509/£ – €7.5548/£.The company can borrow in sterling for three months at
8.60% per annum and can deposit euro at 10% per annum.

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Required:
What is the cost in pounds if money market hedge is used to and what effective forward rate
would this represent?

Question 12
A group of companies controlled from the US has subsidiaries in UK, Japan, and France. Below,
these subsidiaries are referred to as UK, JP, and FR respectively.

On 30th June, 2012, inter company indebtedness is as follows:

Debtor Creditor Amount

UK JP ¥240,000,000
UK FR €480,000
FR JP ¥180,000,000
JP UK £74,000
JP FR ¥375,000

It is the company’s policy to net off inter-company balances to the greatest extent possible. The
central treasury department is to use the following exchange rates for this purpose: US$1 equals
¥1,680, £0.6800, and €5.880.
Required
Calculate the net payments to be made between subsidiaries after netting off inter-company
balances.

Question 13
How are translation gains and losses handled differently according to the current rate method in
comparison to the other three methods, that is, the current/noncurrent method, the
monetary/nonmonetary method, and the temporal method?

Question 14
Suppose you provided with the following information

Spot exchange rate US$1.25/£

One-year forward rate US$1.20/£
UK interest rate 11.56%
US interest rate 9.82%

You are to receive £100,000 on a shipment of Madonna album in one year. You want to fix the
amount you must pay in dollars to avoid foreign exchange risk.
Required:
a. Form a forward market hedge.
b. Form a money market hedge.
c. Are these currency and currency money in equilibrium? How would you arbitrage the
difference from the parity condition?

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Question 15
The rates for the US$/£ are quoted as follows:

Spot 1.4690 – 1.4695

1 month 1.4686 – 1.4691
3 months 1.4672 – 1.4678
6 months 1.4649 – 1.4657

Today is 5 March. ABC Plc, a UK company has to pay US$245,000 to a supplier at the end of
first week of June, and wants to fix a rate of exchange now.
Required:
a. Show the hedge set up.
b. What would the cost to ABC Plc be, in £?

Question 16
BQQ Plc, a UK company sells products worth US$1,000,000 to a customer in USA, with the
payment to be made in 3 months. Information is as follows:

Current spot rate US$ per 1£ 1.4920 – 1.5020

3 month interest rates per annum:

Deposits Borrowing
£ 5 3/32% 5 3/16%
US$ 4 5/16% 4 9/16%
Required:
How might the company set up a money market hedge for the transaction exposure?

Question 17
CQQ Plc, a UK company buys products worth US$1,000,000 from a supplier in USA, with the
payment to be made in 3 months. Information is as follows:

Current spot rate US$ per 1£ 1.4920 – 1.5020

3 month interest rates per annum:
Deposits Borrowing
£ 5 3/32% 5 3/16%
US$ 4 5/16% 4 9/16%
Required:
How can a money market hedge be constructed to hedge the exposure to currency risk?

Question 18
ABC Plc sells shoes to Tanzania. A shipment has just been made to a major Tanzanian customer,
who has been invoiced in Tanzanian shilling, payable in three months’ time. The amount due is
TZS.56 million. ABC Plc financial director has the following information about foreign
exchange rates and interest rates:

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Exchange rate, TZS/£
Spot 2,320 - 2,322
3 Months Forward 15 - 23 dis

Interest rates

£ TZS
Deposit Borrowing Deposit Borrowing
6% pa 8% pa 10% pa 12% pa

Required
a) What course of action would you recommend to finance director, so as to maximize sterling
receipts from the shipment?
b) How your advice would differ, if at all, was ABC Plc also due to make a payment of TZS.30
million to a Tanzanian supplier, in three months?

Question 19
ABC Plc is a Tanzania importer of TV sets from UK. The company has been contracted to
purchase 300 TV sets at a unit price of £560. Three months credit is allowed before payment is
due.

The following information is available:

(i) The current exchange rates:

Sport rate: TZS/£ 1,970 – 1,990

1 month forward rate 25 – 15 dis
3 months forward rate 45 – 35 dis

(ii) The current bank interest rates:

UK 4% pa 8% pa
Tanzania 8% pa 12% pa

The interest rates are not expected to change during the next three months.
Required
a) Calculate the expected TZS cost of the sterling pound payment in three months using the
forward market hedge and the money market hedge and advice ABC Plc which among the
two should be used.
b) If the UK supplier is to offer 2.5% discount on the purchase price for payment within one
month evaluate whether you would alter your recommendation in (a) above.

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Question 20
ABC Plc is a Tanzania based firm, it imports laptops for a variety of users. It also exports goods
extensively in the USA and the UK. During the month of December, 2015 the company made the
following credit transactions:

Month Transaction Unit Unit price

Exports 1,000 US$100
December, 2015 Imports 1,000 US$80
Exports 1,000 £100
December, 2015 Imports 1,000 £50

Customers are allowed one month credit while payments to foreign suppliers of laptops are made
two months after purchase. In December, 2015 the bankers of ABC Plc provided the company
with the following rates:
TZS per US$ TZS per £
Spot rate 1,500 – 1,560 2,500 – 2,550
1 month forward 30 – 10 dis 60 – 30 dis
2 month forward 40 – 20 disc 65 – 45 dis

Required
Calculate the net TZS amount received or paid by ABC Plc from its transactions assuming it
covers the transaction risks in the forward market.

Question 21
XYZ Plc, a Tanzania firm, has sold goods worth KES.30,000 to Kenya customer and also has
sold goods worth ZKW.200,000 to Zambia customer both receivable at the end of 30 days.
Assume that a forward market is only available.

a) XYZ Plc wants to eliminate the risk that the KES will extremely appreciate relative to the
TZS during this 30-day period.
Required
Describe the currency transaction that XYZ Plc will undertake to eliminate currency risk over the
30-day period.
b) XYZ Plc wants to eliminate the risk that the ZKW will extremely depreciate relative to the
TZS during this 30-day period.
Required
Describe the currency transaction that XYZ Plc will undertake to eliminate currency risk over the
30-day period.

Question 22
ABC plc is a UK-based company which has the following expected transactions:

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 One month expected receipt US$240,000
One month expected payment US$140,000
Three months expected receipts US$300,000

The finance manager has collected the following information:

Spot rate (US$ per £) 1.7820 ± 0.0002
One month forward rate (US$ per £) 1.7829 ± 0.0003
Three months forward rate (US$ per £) 1.7846 ± 0.0004

One year sterling interest rate (%) 4.9 4.6

One year dollar interest rate (%) 5.4 5.1

Assume that it is now 1 April.

Required:
(a) Explain how inflation rates can be used to forecast exchange rates.
(b) Calculate the expected sterling receipts in one month and in three months using the forward
market.
(c) Calculate the expected sterling receipts in three months using a money-market hedge and
recommend whether a forward market hedge or a money market hedge should be used.

Question 23
Pan Plc is a multinational group of companies. Today is 1 September. The treasury manager at
Massie Co, one of Pan’s subsidiaries based in Europe, has just received notification from the
group’s head office that it intends to introduce a system of netting to settle balances owed within
the group every six months. Previously inter-group indebtedness was settled between the two
companies concerned.
The predicted balances owing to, and owed by, the group companies at the end of February are
as follows:
Owed by Owed to Local currency (Mil)
Pan Plc (USA) Horan Plc (South Africa) US$12.17
Horan Plc (South Africa) Massie Plc (Europe) SAR42.65
Giffen Plc (Denmark) Pan Plc (USA) DKr21.29
Massie Plc (Europe) Pan Plc (USA) US$19.78
Pan Plc (USA) Massie Plc (Europe) €1.57
Horan Plc (South Africa) Giffen Plc (Denmark) DKr16.35
Giffen Plc (Denmark) Massie Plc (Europe) €1.55

The predicted exchange rates, used in the calculations of the balances to be settled, are as
follows:
DKr US$ SAR €
1 DKr = 1.0000 0.1823 1.9554 0.1341
1 US$ = 5.4855 1.0000 10.7296 0.7358
1 SAR = 0·5114 0·0932 1.0000 0·0686

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 1€= 7.4571 1·3591 14·5773 1.0000
Settlement will be made in dollars, the currency of Pan Plc, the parent company. Settlement will
be made in the order that the company owing the largest net amount in dollars will first settle
with the company owed the smallest net amount in dollars.
Note: DKr is Danish Krone, SAR is South African Rand, US$ is United States dollar and € is
Euro.
Required:
a. Calculate the inter-group transfers which are forecast to occur for the next period.
b. Discuss two problems which may arise with the new arrangement.

Question 24
You are provided with the following financial statements of SWS Plc, a Swiss Subsidiary, which
keeps its books in Swiss Francs (SFr). ABC Plc, the parent company is a UK based company, its
reporting currency is sterling pound (£). The financial statements were recorded at SFr.3.00/£
Statement of financial position as on 31st December, 2016

SFr
Cash 2,100.00
Inventory 1,500.00
Net Non-Current Assets 3,000.00
Total Assets 6,600.00
Current Liabilities 1,200.00
Non-Current Liabilities 1,800.00
Common Equity 2,700.00
Retained Earnings 900.00
Total Liabilities and Equity 6,600.00

Income statement for the year ended 31st December, 2016

SFr
Revenue 10,000.00
Cost of goods sold 7,500.00
Depreciation 1,000.00
Net operating income 1,500.00
Income tax (40%) 600.00
Income after tax 900.00
Dividends -
Retained Earnings 900.00

ABC plc wants to consolidate financial statements at the time the exchange rate is SFr.4.00/£
Required:
a. Assist ABC Plc to translate SWS Plc’s financial statements using the current/non-current
method.
b. Is there a foreign exchange gain or loss in (a) above? How could this be avoided?
Demonstrate using the above financial statements
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