Case 2

Somalax Group is an Italy company. Like other businesses, the company business operation has been severely affected by the pandemic and is reported to be half of the previous year. The operating director of Somalax is concerned that the company cannot afford to lose money. In two recent deals, components have been bought from Rainbay with amount of 3,000,000 Rainbay dinar due payable in three months. Finished products have been sold to Greecoast and the receipts of Greecoast rupiah due to be receivable in six months.

The sales manager, Clement, commented that there is substantial foreign exchange rate exposure in the Rainbay whilst no foreign exchange rate exposure involved in the Greecoast deal because the value of the Greecoast rupiah is linked directly to the US dollar.

The US dollar has been quiet stable relative to Euro in the recent months.

Current inflation rates

Italy 3%

Rainbay 6%

Greecoast 12%

USA 20%

Current annual interest rates available to Somalax

Investing Borrowing

Italy. 4.5% 10%

Rainbay 6% 12%

Greecoast 12.5% -

USA 15% -

Exchange rates

Spot market 290 Rainbay dinar / 1

1.4640 US$ / 1 228 Greecoast rupiah / US$1

Forward Market US$/1

3 months forward: 1.4805 6 months forward: 1.4876

There is no forward foreign exchange market for the Rainbay dinar or the Greecoast rupiah

Somalax can negotiate currency call options for Rainbay dinar at a premium of 25 dinar per Euro with an exercise price of 300 francs per Euro and a three months maturity date.

Question 2

(a) Discuss Somalaxs exposure to the foreign exchange rate risk. Your discussion should include the validity of the view of Clement.

(b) Show how Somalaxs treasury director might protect the company against

Include all relevant calculations.

1. (i) the risks of each of the two (2) foreign currency deals; and

2. (ii) the risks other than currency exposure.