Download may 2013 treasury management 2 solutions

MAY 2013 TREASURY MANAGEMENT 2 SOLUTIONS
1.
(a) Briefly explain the significance of the following terms in the Commodity Markets:-
(b)
.
(i)
Bid bonds offer protection to the purchaser by mitigating supplier default risk.
These are issued by the supplier’s bank, irrevocably guaranteeing that the bank
will pay the purchaser the value of the bond should the seller not fulfill its
obligations before signing the contract.
(2)
(ii)
Performance bonds offer protection to the purchaser by mitigating supplier default
risk. These are issued by the supplier’s bank, irrevocably guaranteeing that the
bank will pay the purchaser the value of the bond should the seller not fulfill its
obligations after the contract is signed.
(2)
(iii)
Letters of Credits offer protection to the seller against possible default by the
purchaser. They are issued by the purchaser’s bank and irrevocably commit the
bank to honour payment obligations by the seller provided the terms of payment
are met.
(2)
Distinguish between a Base Currency and Counter Currency and give examples to support
your answer
(4)
A Base Currency is the fixed unit in the quotation of currency pricing while the Counter
Currency is the variable amount in the quotation of currency pricing which fluctuates as the
market price of one currency changes against another. For example, in the pricing of
USD/MWK, the USD is the Base Currency and the MWK is the Quoted Currency. Thus if
USD/MWK=339.9875, USD1.00=MWK339.9875.
(c)
i.
Define a Cross Exchange rate
A Cross Exchange Rate is the exchange rate between two currencies, neither of
which is the USD.
(1)
ii.
Given that GBP/USD = 1.6450/1.6455 and USD/ZAR = 8.4950/8.5150, what is the
GBP/ZAR?
(2)
GBP/ZAR = (1.6450*8.4950)/ (1.6455/8.5150)
= 13.9743/14.0114
iii.
What is the GBP/AUD Cross rate given that GBP/USD = 1.5950/55 and AUD/USD
= 0.5890/00?
(2)
GBP/AUD = (1.5950/0.5900)/ (1.5955/0.5890)
= 2.7034/2.7088
1
2.
(a)
Jombo Bank issues a primary Certificate of Deposit (CD) of MWK5, 000,000.00
to Isaac Phiri at a rate of 28.0 % for 273 days. Calculate the maturity value of the CD. (2)
= 5,000,000 * 0.28*273/365
= MWK6, 047,123.29
(b)
On its daily CD screen, Jombo Bank displays the following rates:6 months
9 months
Bid
29.0%
31.0%
Offer
23.0%
22.0%
Why does the Bank show a higher bid rate than the offer rate?
(5)
Unlike the normal deposit rate market, the bid refers to the bank buying the CD and
therefore lending cash while the offer refers to the bank selling the CD and therefore taking
cash from an investor
(c)
Suppose that in 2 (a) above Isaac Phiri decides to sell the CD to Thofu Bank after 91 days.
The following is the CD screen of Thofu Bank on the day of trading of the CD.
Bid
Offer
3 Months
30.0%
25.0%
4 Months
31.0%
25.75%
6 Months
33.0%
27.25%
Calculate the secondary market proceeds of the CD.
= 6,047,123.29 divided by 1+ (0.33*182)/365
= MWK5, 192,892.48
(8)
3. (a)
In its yearly statistical bulletin for 2011, the Reserve Bank of Kawanda released the
following short term money market yields for different tenors
Yield
Tenor
18%
30
17.00%
60
16%
91
15.50%
182
13.90%
273
Sketch a yield curve for the above statistics and illustrate the results.
2
13%
365
(4)
Yield
20%
18%
16%
14%
12%
10%
8%
6%
4%
2%
0%
Yield
1
(b)
2
3
4
Contrast between a Clean Price and Dirty Price of a bond.
5
6
(2)
The dirty price is the price of a bond including any interest that has accrued since issue or the most
recent coupon payment. This is to be compared with the clean price, which is the price of a bond
excluding the accrued interest.
(c)
A corporate bond has a coupon rate of 18.0% per annum and pays interest twice a year,
on the 30th of June and 30th December. A 2 year bond for MWK20, 000,000.00 par value
is settled on 30th June 2012 for a price of 87.25.
(i)
Calculate the accrued interest on 27 September 2012
(4)
Accrued interest = 18*(145/365)
= 7.15
(ii)
Calculate the dirty price of the said bond on 27 September 2012
(2)
Dirty Price = 87.25 + 7.15
= 94.40
(iii)
Establish the total cost of the bond on the same date
(3)
Total Cost = 20,000,000.00 * 94.40/100
= MWK18, 880,000.00
4.
(a)
Define a Foreign exchange Swap
(2)
A foreign exchange swap is a simultaneous purchase or sale of the same amount of a
given currency for two different dates, against a sale and purchase of another. Simply put,
one currency is swapped for another and then swapped back.
(b)
On 3rd June 2012, Jombo Bank entered into a Forex Swap Agreement of EUR for USD
with Bwengu Bank to mature on 04 July 2012. Given that the EUR interest rate is 4.5 %
and USD interest rate is 2.5 % and that the current Spot rate is 1.3585, calculate the Forex
Swap points.
(7)
3
Use the following formulae and adjust all your calculations to four decimal places:-
5.
(c)
Explain the role of Speculators and Arbitrageurs in the Foreign Exchange Markets.
(4)
These engage in foreign exchange trading to obtain profit by taking certain positions in
currency expecting exchange rate movements to work in their favour. They are normally
individuals, large corporations and banks and they could generate substantial profits from
foreign exchange speculation.
(d)
Mention two functions of foreign currency swaps

They are used to hedge against rate differential risks

They are used to speculate on interest rate differentials

Used for arbitrage activities

Managing positions and changing settlement dates
(2)
Discuss in detail the Country Risk Management Process, clearly giving examples to its relevance
to a firm of your choice in Malawi.
(20)
 Effective oversight by Senior Managers
 Appropriate risk management policies and procedures
 An accurate system for reporting change in country risk and potential exposures
 An effective process of analyzing country risk
 A country risk rating system to be in place
 Regular monitoring of country conditions
 Appropriate internal controls and accounting functions to deal with international
exposure
6. (a)
(b)
Mention two commonly traded Government Securities on the Malawi money market. (2)
Treasury bills and Treasury bond
If the 182 days GBB LIBOR rate is 9.5% and the 365 days GBP LIBOR rate is 11.25 %,
calculate the 6 by 12 FRA rate.
(4)
Use the following formulae and adjust all your calculations to four decimal places:-
4
(c)
What are the major functions of FRAs in treasury management?
(2)
 They are used to manage interest rate risks
 They are also used for speculative purposes
(d)
Distinguish between Short-term, Medium-term and Long-term Money market securities. (3)
Short term instruments mature within one year, Medium term instruments mature between
1 year and 5 years while Long term instruments mature after 5 years. Examples of short
term instruments are treasury bills, medium and long term instruments are normally bonds
and debentures.
(e)
Discuss the three major factors affecting Country risk.
(9)
 Macroeconomic factors like size and structure of the country’s external debt in
relation to its economy, level of international reserves, potential of extreme
adverse exchange rate movements, current and forecast GDP growth and inflation
rates etc. For answers refer to manual page 103 and 104
 Socio political factors – For answers refer to manual page 104
 Institution specific factors – For answers refer to manual page 104
7. The current Chairman of the Common Market for Eastern and Southern Africa (COMESA) of which
Malawi is a member has proposed that the member countries should adopt an identical currency
for its trading operations in the next two years. In your opinion, why should Malawi join this
arrangement? Further discuss your fears for not joining this arrangement.
(20)
For answers refer to manual page 73 and 74. – pros and cons of an
identical/common currency regime
8.
(a)
Contrast between Devaluation and Depreciation of a Currency
(4)
Devaluation is an official reduction in the value of the local currency in relation to foreign
currency while Depreciation is the market determined reduction in the value of local
currency in relation to foreign currency.
(b)
The Malawi Government adopted a Free-floating Exchange rate regime on 7th May 2012
and with it came a lot of economic hardships to the importing sector and the common
Malawian. The President has all along asked Malawians to be patient as thing will get
worse before they get better. As Chief Economic Advisor to the President you are asked to
defend this policy decision in a public debate. Discuss.
(8)
5
 Trade balance: A devalued currency means imports are more expensive, and on
the assumption that the volume of imports and exports change little immediately,
this causes a depreciation of the current account (a bigger deficit or smaller
surplus). After some time, though, the volume of exports may start to rise because
of their lower more competitive prices to foreign buyers, and domestic consumers
may buy fewer of the costlier imports. Eventually, if this happens, the trade
balance may improve on what it was before the devaluation.
 Market determined exchange rates will result into convergence of the Black market
rates and the Official exchange rates thereby limiting foreign currency circulation
on the Black market. Most forex will be channeled through the Banks and
therefore used for importation of strategic commodities.
 IMF programme on track which means more future aid from both bilateral and
multilateral donor partners to improve the import cover.
 Real value for exporters and thereby encouraging export oriented production in the
medium term to long term.
(c)
Determine the relationship between the level of money supply in an economy like Malawi
and the exchange rate.
(4)
An increase in the level of money supply results into increased demand of both local and
foreign goods and services. Since Malawi is a predominantly importing country, the
resultant increase in effective demand for imported goods and services creates pressure
on the exchange rate due to increased forex demand and this results into a depreciation of
the local currency. A decrease in the level of money supply results into reduced demand
for foreign goods and services and therefore reduced pressure on foreign currency
demand.
(d)
Describe the major tool that the Reserve Bank of Malawi uses to control the level of money
supply in Malawi and how effective it is in achieving the goal.
(4)
RBM uses the Bank rate to determine the level of interest rates in the economy in a bid to
control the level of money supply. An increase in the Bank rate is meant to reduce the level
of money supply by limiting the extension of new credit while a decrease in the Bank rate
results into cheaper credit extension thereby increasing the level of money supply.
6