Capitec Bank is a South African commercial bank. It is one of the locally controlled banks licensed by the South African Reserve Bank. To build on its good track record of customer service, the bank decided to upgrade its computers used by staff in all its branches so that the speed and efficiency with which customers could be assisted could be enhanced. The computers will be imported from Dell Computers in India at a cost of INR9,980,000. The money market interest rates and the foreign exchange rate are as follows:

Indian Interest Rate 8.0% per annum

SA Interest Rate 5.5% per annum

The Spot Exchange Rate R0.2008/INR

The (3-month) Forward Exchange Rate R0.1888/INR

(a) Assume that Capitec opts to use the Forward market to hedge the SA Rand value of the debt that arises out of this order from Dell Computers. Describe each of the steps the CFO at Capitec will follow to set up and conclude the forward contract. At each step indicate what the SA rand and Indian Rupee balance would be, stating the cash flows(+/-). Show all working where appropriate. (8 marks).

(b) The CEO of Capitec is not too happy with the CFOs decision to use a Forward Market Hedge for this transaction. He would have preferred an Option Market Hedge instead, maintaining that it limits downside risk whilst maintaining the upside potential. Explain what he means by this statement. (4 marks)

(c) Using a financial hedge such as a Money Market hedge, Forward Market hedge or an Options Market hedge is not an effective way to manage operations exposure. Explain why these instruments are not suited for this purpose. (2 marks)