1 SECTION A (COMPULSORY QUESTION) QUESTION ONE Ama Amelicans Groups PLC holds a subsidiary company called DontTell Limited. DontTell Limited, is based in Zambia and has commenced production of a local brew called Chibwantu. Recently, DontTell begun exporting Chibwantu to South Africa and expects to receive R500,000 in six months time. DontTell Limited plans to take action to hedge against the exchange rate risk arising from its South African exports. DontTell could put cash on deposit in South Africa at an annual interest rate of 3% per year. It could also borrow from South Africa at 5% per year. The company could also put cash on deposit in its Zambian Bank Account at an annual interest rate of 4% per year, and borrow from its financiers at 6% per year. Inflation in South Africa runs at 3% per year, while inflation in Zambia is currently running at 4.5% per year. In addition the foreign exchange board shows the following: Spot Rate (ZAR/ZMW) = 2.000 Six-month forward exchange rate (ZAR/ZMW) = 1.990 One-year forward exchange rate (ZAR/ZMW) = 1.981 Required:

a) Calculate; i. The six-month expected (future) spot rate and explain briefly the relationship between the expected (future) spot rate and the current forward exchange rate. (4 marks)