FINANCIAL DECISION MAKING

Section 1 contains mini-scenario with short questions. scenario contains 5 short questions each worth 2 marks (a total of 10 marks)

s = sage, where: S1 = Expected spot rate (country f : country in So = Current spot rate (country f : country h) i; = Expected ination rate in country f in = Expected ination rate in country h This Indicates that. in countries that have high ination rates, currency values decline more compared to the currencies of countries with lower ination rates. The basic principle is that changes in the spot and forward rates are mainly driven by differences in interest rates. If the interest rate is known, the forward rate can be calculated as: R=e$ where: E; = Expected spot rate (country f : country h) .5") = Current spot rate (country f : country h) if = Interest rate in country f if; = Interest rate in country it Formula Sheet for Financial Decision Making Cost of capital Cost of equity Ke = Do (1+9) + 9 Po or Ke = Rf + B(Rm - Rf) WACC Ve + ka (1 - t)v.+ Vd Va Ke vetVa Parity theory PPPT (1+if) S1 = So ( 1tin) IRPT Fo = So7 (1+if) (1+ in) Financial arithmetic Effective annual rate of interest [1 +"]"-1 Present value of I [1 + r]-n Present value of an annuity of I 1-(1+r)-nMini-scenario 2 Maple Machinery {MM}, a business based on the outskirts of Toronto, whose home currency is the Canadian Dollar (C$), trades regularly with customers and suppliers in a number of different countries and currencies. Among many other transactions, MM expects to receive C$275,000 from a US customer in one months' time and to pay 500,000 to a Spanish supplier in three months\" time. Current exchange rates between the C$ and the E are as follows: Spot exchange rate: (3351 = 0.7655 0.7699 3-month forward exchange rate: 0351 = 0.6987 0.7010 Annual interest rates in Canada and Spain for the next year are expected to be as follows. Canada 1.7% 2.0% Spain 0.4% 0.6% in addition to the use of money market products and derivatives to hedge any foreign exchange risk exposure, the CFO of MM is considering 'internal' methods such as invoicing all customers in C$, insisting that suppliers invoice MM in (335 and 'leading' or 'lagging' payments. Required: 1. What type of foreign exchange risk exposure is MM exposed to in relation to the receipt in one months' time from a US customer? (2 marks) A. Transaction risk B. Translation risk C. No risk What is the gain or loss in C$ compared to its current 015 vaiue which MM will incur by taking out a forward exchange contract for the future payment to the Spanish supplier? Show all workings. (2 marks} What is the payment in C$ if MM uses a money market hedge to hedge the payment to the Spanish supplier in three months' time? Show ail workings. (2 marks} With reference to MM making foreign currency purchases, if the C$ is expected to weaken against the should MM 'lead' or 'Iag' in its management of the anticipated payment? Explain your answer (2 marks} If MM decided to invoice all its customers in C$, which of the following statements isfare faise? A. Invoicing customers in C$ will eliminate all foreign exchange risk that MM is exposed to B. Invoicing customers in 035 will pass translation risk to the customer C. Insisting on being invoiced in C$ is a cost-free way of reducing risk exposure related to foreign suppliers (2 marks)