A Zambian mining company imports machinery from China and bills are settled in dollars. However, management at the company is worried about the volatility of ZMW/$ exchange rate which has an explicit impact on its payment for imports. The company has imported machinery worth $100,000 and will pay in 3 months. Assume that the spot rate is K18/$ and 3-month forward rate is K18.5/$.

a) Advice the management on how they would hedge this foreign exchange risk in the forward market?

b) If after 3 months, the spot rate is K19/$, evaluate whether the company is better off or worse off by hedging the $100, 000 position

Question Two

A speculator feels that the spot rate of the Pound in three months will be lower than todays three months forward rate of the Pound of $1.98. How can the speculator use 10, 000 for speculation in the forward exchange market? What happens if the spot rate of the Pound in three months is $1.90 and if it is $2.10?

Question Three

Chapa is a hedge fund manager based in South Africa. He is planning to invest in Zambian Treasury bills. This is because 3-month Treasury bills in Lusaka offer 4% interest rate compared to treasury bills in Cape Town offering 2% interest rate (On a quarterly basis). Given that the spot rate of Rand is K0.8;

a) Explain how Chapa can undertake uncovered interest arbitrage?

b) What happens to his returns if the spot rate in 3 months is K0.792?

c) Given that the spot rate of the Rand is K0.8 and the 3-month forward rate is K0.76, calculate the Covered Interest Arbitrage Margin (CIAM).

d) Give two factors which could prevent Chapa from taking advantage of the CIAM