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FURTHER TEST BANK QUESTIONS
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FURTHER QUESTIONS TO TEST BANK NUMBER ONE
A.
The six-month interest rate or the Canadian $ is 9% when the six-month
interest rate for the US $ is 6.75%. At the same time the spot Canadian $ quotation
in New York is US $0.9100 and the six-month forward rate is US $0.9025.
(a)
Is interest rate parity holding? Why?
(b)
If not, how could advantage be taken of the situation?
(c)
If a large number of operators decide to do the arbitrage suggested
under (b), what will the effect be upon spot and forward quotations and
upon interest rates for the two currencies?
B.
Imagine that you are a trader working for a New York bank. The spot
exchange rate against the Canadian $ is US $0.9968 and the one-month and oneyear forward rates are respectively US $0.9985 and US $1.0166. Twelve-month
interest rates in the USA and Canada may be taken as 6.45% and 4.46%
respectively.
(a)
What is the forward premium as an annual percentage?
(b)
Which currency is at a premium? Why?
You become party to some inside information which suggests that US interest
rates will rise by 1 per cent per annum during the next month. The bank has a rule
that in the foreign exchange markets ‘buy equals sell’. This means that for any
currency the total of long positions must equal the total of short positions – but this
aggregation disregards maturity.
(c)
Indicate the mechanics of two operations by which you may trade in
expectation of profit for the bank should the inside information turn out
to be well-founded.
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C.
On 27 March 2004 the following applied:
£/krone spot value 3.79–3.80
£ three-month interest 1311/16–139/16
Krone three-month interest 61/16–515/16
£/krone three-month forward 71/8–7pm
(The ensuing three months consists of 90 days)
The treasurer of a £-based company decided to hedge a krone receivable
due in three months time. What are two alternative methods, and what are the
effective interest rates for each? Why are they not the same?
D.
A UK company has a requirement for krone for 3 months. A proposition is put
that the currency should be borrowed direct due to the low interest rate. At 27 March
2004:
£/krone spot 3.2075–3.2175
£/krone three-month forward 2.75–2.25 cents pm
£ three-month interest 1311/16–139/16
krone three-month interest 57/8–53/4
Should the proposition be carried?
E.
Given the exchange rate and interest rate information below, what quote
would you expect for buying and selling forward Doppels:
(a)
for one month forward?
(b)
for two months forward?
(c)
if the quotes obtained were different from these what factors would
determine the corporate response to the existence of such differentials
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Exchange Rate
£/Doppel spot
£1  3.331/4  3.341/4
Eurocurrency Interest Rates
one month
three months
Sterling
101/4–101/8
10–915/16
Doppel
41/2–45/8
41/2–45/8
F.
You are a Foreign Exchange Dealer in a large UK-based company, in which
the treasury is a profit centre. Your dealing limit is £10m. You are given the following
quotes:
£/$
$/Doppel
Spot
12 month Forward
£1  $1.5802/12
515/505
$1  DP2.0065/75
359/354
£/Doppel
1763/1728
You are also aware of the following 12-month euro interest rates:
£
131/16–1215/16
$
93/8–91/4
Doppel
(a)
75/16–73/16
If your only objective is to generate a profit, what would you do
and why?
(b)
Does this course of action involve any drawbacks for the company?
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FURTHER QUESTIONS TO TEST BANK NUMBER TWO
G.
You are Treasurer of a large UK plc in a segment of the consumer durable
industry which is dominated by three companies: yourselves, a Swiss and a German
company. Your Board of Directors has recently entered discussions with the other
two companies concerning the establishment of a joint venture manufacturing
company to exploit a market opportunity.
The joint venture company will have its assets and its domicile in Switzerland.
Maximum use will be made of debt.
The likely structure of ownership is shown below, together with estimates of
sales by currency and costs by currency.
Currency of
Currency of
Ownership %
Sales %
Costs %
UK
40
10
20
Switzerland
15
5
40
West Germany
35
20
15
US
5
35
10
Japan
5
30
15
Country
You have been asked to produce a paper which outlines alternative currency
structures appropriate for financing the joint venture, and makes a recommendation.
(a)
What are the factors to be considered?
(b)
What would your recommendation be, giving your reasons?
(Association of Corporate Treasurers: Part II, September 1987, Paper in Currency
Management)
H.
Domestic Group plc has until now been a group entirely located in the UK, in
terms of its sourcing, manufacturing and trading. I has bought all its supplies,
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incurred all its cost, and faced all its competition from within the UK, from UK based
competitors.
Following a period of acquisition-led growth, Domestic Group now has two
companies operating in international markets. Both are based in the UK, operating
entirely domestically, except for the following: the first sells specialist scientific
equipment, largely to West Germany; while the second buys commodity-type
materials, largely from West Germany. Given that the euro values of trade are
roughly similar, what are the exposure risks, and how should they be managed?
I.
You are Treasurer of a group with subsidiaries in several countries. The
closing rate method is used for translating non-sterling balance sheets and profit and
loss accounts into sterling or consolidation purposes. Throughout the last year, one
subsidiary’s local currency has strengthened significantly versus sterling, against the
long term trend. The currency concerned is, however, expected to revert to its
previous trend.
The group is a net borrower in a variety of currencies. The subsidiary has
positive net assets and is at present holding cash.
(a)
What impact will the strengthening local currency have on the group’s
consolidated accounts?
(b)
What are the advantages and disadvantages of the alternative
methods of hedging this translation exposure?
(Association of Corporate Treasurers: Part II, September 1990, Paper in Currency
Management)
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FURTHER QUESTIONS TO TEST BANK NUMBER THREE
J.
Your company has recently decided to cease manufacture of a particular
product and instead buy in from either a Far Eastern manufacturer or a Middle
Eastern trader. As your markets are exclusively domestic, this represents your
company’s first contact with the foreign exchange market. Your Managing Director
asks how to buy foreign currency and how and where to pay for it. He appears to be
of the view that the best course of action is to delegate this area to the company’s
sole clearing bank.
Assuming the currencies concerned are freely tradable, how would you
advise him?
(Association of Corporate Treasurers: Part II, September 1985, Paper in Currency
Management)
K.
A UK company has excess cash for a period of 3 months. A proposition is put
that it should be invested in the Batavian drac (a fully convertible currency) due to
the high interest rate.
When the decision is to be made the rates are as follows:
£1  2,5071/2–2,5081/2
£/drac spot
£/drac 3-month forward
9–13 dis
£ 3-month interest
121/2–123/8%
Euro-drac 3-month interest
141/4–133/4%
What would you do and why?
L.
Your company is a large consumer of dollar denominated commodity
products. As a matter of policy the dollars are always bought on the spot market.
You know that your next purchase will be in three or four months’ time. However, the
exact time will be determined by the way spot prices move, or are expected to move.
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How would you manage the currency risk inherent in this situation?
(Association of Corporate Treasurers: Part II, September 1985, Paper in Currency
Management)
M.
“Swap transactions are the sure route to cheaper long-term finance for the
corporate treasurer”. Explain your reasons for agreeing or disagreeing with this
statement.
(Association of Corporate Treasurers: Part II, September 1986, Paper in Funding
Management)
N.
As Treasurer of a major company you are approached by the Finance
Director of one of your UK-based subsidiaries which is in the business of supplying a
service to customers worldwide. The subsidiary is about to submit a quote for a
major contract to be awarded in three months’ time. The customer is a Saudi
company and the major competitors are based in Germany and the US. The
subsidiary is anxious to secure the business, but needs to ensure some, if minimal,
level of profit.
Make recommendations outlining the currency considerations in pricing and
risk evaluation and the methods of mitigating the risk.
(Association of Corporate Treasurers: Part II, September 1986, Paper in Currency
Management)
O.
Over the past three years, the value of the £ in $ terms has ranged between
1.65 and 1.05.
How would you evaluate a decision to invest in capacity to enable one of your
UK subsidiaries to manufacture a product destined solely for the US market?
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What factors will have determined whether UK suppliers to the US market
have been able to survive this volatility?
(Association of Corporate Treasurers: Part II, September 1986, Paper in Currency
Management)
P.
You have been appointed as European Treasurer for Global Materials Group
plc. One of Global’s main products is an industrial product which is made from
naturally occurring minerals in the UK. After extraction by the UK subsidiary the
semi-processed material is shipped on to the German subsidiary where it is further
processed and refined. It is then transported to a specialist distribution subsidiary in
Denmark. The three subsidiaries have no other business, although very small
amounts of semi-finished product are sold to third parties.
There is a world market for the product, which is normally sold in US$. Each
of the subsidiaries in the UK and Germany invoice their fellow subsidiaries in their
home currency, and raise all debt in their own currencies. At present, Global
Materials plc is aware that there are currency risks involved, but are unsure as to
where they arise, what issues are raised, and how the risks should be managed.
Using the following information, how would you advise them on the currency
risks?
Currency Analysis (£ million equivalent)
GBP
EUR
DKK
USD
Total
UK
Costs
63
2
0
1
66
subsidiary
Sales
85
2
1
2
90
West German
Costs
60
55
2
3
120
subsidiary
Sales
2
173
2
3
180
Danish
Costs
4
176
15
0
195
subsidiary
Sales
8
10
2
180
200
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All in £ million equivalent
UK
Germany
24
60
5
3
85
176
117
198
40
Stock  Debtors – Creditors
27
27
40
Total Debt
54
117
40
Total Equity
90
108
40
Profit before Interest & Tax
Raw Material cost
Fixed Assets
Q.
Denmark
The following is a summary of the published accounts (and notes thereto) of
Sample plc. Sample plc is UK based and produces a range of food and household
products with approximately 50 percent of its business overseas.
Notes:
Sample plc: Consolidated Balance Sheet 31 March 1988
£mn
Fixed Assets:
Tangible and intangible:
716
Investments:
105
(Including: Company securities held as long term trade investments
valued at £2.80mn)
Current Assets:
Investments:
(Comprising short term deposits)
Other (Stock, Debtors, Cash)
81.2
966
Creditors due within one year:
Loans
Bank loans and overdrafts
Bills of exchange payable
Other (trade creditors, accruals)
(20)
(209.6)
(40)
(546)
Total assets less current liabilities:
1052.6
Creditors due after more than one year:
(1)
Loans 112
Bank Loans
136.6
Shareholders’ funds
804
1052.6
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Notes:
(1)
Loans are composed as follows:
61/2% unsecured loan stock 1987/92
Other medium term loans
Commercial notes, issued in the USA and Holland with maturities
between 30 and 90 days but classified as due after more than one
year because it is the company’s intention to refinance them on a
continuing basis. Medium term committed backup facilities have
been arranged with US and UK banks in support of these notes
£mn
30
20
62
112
(a)
(b)
(c)
What types of interest rate risk arise in this company?
Identify the information which you would request from Sample plc in
order to provide a thorough analysis of its interest rate risk
Advise Sample plc’s Board on the main methods of managing interest
rate risk, commenting on the advantages and limitations of the
methods.
(Association of Corporate Treasurers: Part II, September 1988, Paper in Liquidity
Management)
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FURTHER QUESTIONS TO TEST BANK NUMBER FIVE
R.
Hi-Tech Tractors is a manufacturer of agricultural tractors and earth moving
equipment. It has experienced a period during which it has lost market share, with
consequent decline of profitability, due to problems with its product line. During this
time its indebtedness has increased and it is approaching what Hi-Tech has
assessed to be the limit of its debt capacity. One cause of its increasing
indebtedness has been the cost of a new product development programme which is
now complete.
Traditionally Hi-Tech has found the majority of its sales in the home market
and has little experience of exporting. However, the company expects substantial
overseas sales from its new product line both in developed and less developed
countries and is mounting a sales drive accordingly based upon credit terms of 90
days in developed countries and up to two years in less developed countries.
Hi-Tech is investigating methods of export finance for its expected overseas
sales. What methods of export finance would you recommend to Hi-Tech and why?
(Association of Corporate Treasurers: Part II, September 1988, Paper in Liquidity
Management)
S.
What factors would you take into account in establishing your company’s
borrowing capacity if you were finance director of a major plc:
(a)
in the advertising industry
(b)
in a production line manufacturing business
(c)
in a mixed construction, housing, property group
(Association of Corporate Treasurers: Part II, September 1989, Paper in Corporate
Finance)
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T.
(i)
(a)
Explain what is meant by the yield curve and sketch the principal
shapes it may take.
(b)
Explain what are the implications for interest rates of:

a flat yield curve for three months which rises gradually
thereafter

a yield curve over six months which rises by 1/16% for each
month

a sterling yield curve for seven days with 13% for overnight rates
and 10% thereafter
(ii)
Your company has £1 million to deposit for three months and receives
the following quotes:
(a)
a bank deposit of 15% pa (with interest paid at the end)
(b)
a trade bill with a rate quoted of 151/16%
(c)
a certificate of deposit with a rate quoted of 14 15/16%
Which provides the best post-tax return?
Briefly discuss other issues which the Treasurer should consider in assessing these
potential investments.
(Association of Corporate Treasurers: Part II, September 1990, Paper in Liquidity
Management)
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