FM303 GROUP ASSIGNMENT Nestle is a multinational Fiji company that manufactures a variety of products. To conduct its manufacturing, they import certain ingredients from countries like Japan and South Korea. The market for the manufactured goods are the U.S.A, Australia, Papua New Guinea, Canada and United Kingdom (U.K). However, the majority of sales is in the U.K where majority of our Fijian British Armies are based. Therefore, the company has already established a subsidiary in the U.K. It resells and distribute the products to different businesses. The quarterly net profit after tax generated by the subsidiary is 500,000. The exports to Canada and Australia are to other independent distributing companies that buys their products at wholesale prices from Nestle. Nestle is also considering opening up of a business manufacture and to plant ingredients locally to eliminate the risks and costs associated with the current importing from countries like Japan and South Korea. Nestle already has sufficient manufacturing space available and only has to import manufacturing equipment of 63,000,000 Yen from Japan. The installation of the machinery will be conducted by local Fiji company and will cost $1000,000. Part A In your brief report to the Board: Provide the CEO important information that will assist him with his decision. Provide any relevant theory that is most applicable that will assist him in his understanding. Working and reference to be attached as an appendix. (2000-3000 words max). (10 marks) 1) information to assist him with determining the extent of exchange rate risk and the availability of funds to conduct the multinational transactions: a forecast of the one year and two-year exchange rates for the $/ calculated based on purchasing power parity (PPP) and with the International Fisher Effect (IFE) with the following existing available information: Current $/ spot exchange rate $1.3036/ Fijis expected annual inflation 0.37% Expected annual British inflation 0.20% Fiji expected one-year interest rate 0.140% Expected British one-year interest rate 0.077% 2. The CEO is afraid interest rates will increase by 0.5% in the U.K. The U.K. subsidiary has a current short term loan of 1,000,000 that expires 90 days from now, but will have to borrow the same amount again after expiry for operational expenses that will be incurred. Calculate the expected outcome of a 90-day forward rate agreement entered into in the United Kingdom to hedge against the increase in interest rates on 1,000,000. The current risk free United Kingdom rate is to be used as the agreed rate for the calculation. Also assume the settlement rate is the current risk free rate plus 0.5%. Use the following information for your calculations: Annual risk free interest rates: Fiji 0.140% Japan 0.025% South Korea 0.664% Canada 0.166% UK 0.077% Australia 0.112% South Africa 4.545% a. Advise the CEO whether Nestle should take a long or short position to hedge the risk of the increasing interest rates b. Explain to the CEO whether you recommend that Nesite should be the seller or buyer of the forward rate agreement? c. Briefly explain to him how the forward rate agreement will assist Nestle in terms of the interest rate that it will have to pay if it borrows 1,000,000 again for 90 days after expiry of the current loan. 3. The profit generated by the subsidiary in the U.K. is considered as a good source of money to be used to pay for the import of manufacturing equipment from Japan for the new company in Fiji to locally manufacture its ingredients. The CEO has already entered into negotiations with the Japan supplier of the equipment. The supplier is willing to provide Nestle 3 years to pay for the equipment that will be shipped to Fiji, but the payments must be conducted with quarterly instalments of 5,250,000 Yen by the U.K. subsidiary. This is why the CEO wants you to construct a currency swap arrangement where the profits of the U.K. subsidiary can be used to pay for the equipment. (you are not required to provide the calculation) Explain to the CEO what forfaiting is, why it is possible that forfaiting of the transaction can occur and the implication that it will have on the swap transaction. FM303 GROUP ASSIGNMENT Nestle is a multinational Fiji company that manufactures a variety of products. To conduct its manufacturing, they import certain ingredients from countries like Japan and South Korea. The market for the manufactured goods are the U.S.A, Australia, Papua New Guinea, Canada and United Kingdom (U.K). However, the majority of sales is in the U.K where majority of our Fijian British Armies are based. Therefore, the company has already established a subsidiary in the U.K. It resells and distribute the products to different businesses. The quarterly net profit after tax generated by the subsidiary is 500,000. The exports to Canada and Australia are to other independent distributing companies that buys their products at wholesale prices from Nestle. Nestle is also considering opening up of a business manufacture and to plant ingredients locally to eliminate the risks and costs associated with the current importing from countries like Japan and South Korea. Nestle already has sufficient manufacturing space available and only has to import manufacturing equipment of 63,000,000 Yen from Japan. The installation of the machinery will be conducted by local Fiji company and will cost $1000,000. Part A In your brief report to the Board: Provide the CEO important information that will assist him with his decision. Provide any relevant theory that is most applicable that will assist him in his understanding. Working and reference to be attached as an appendix. (2000-3000 words max). (10 marks) 1) information to assist him with determining the extent of exchange rate risk and the availability of funds to conduct the multinational transactions: a forecast of the one year and two-year exchange rates for the $/ calculated based on purchasing power parity (PPP) and with the International Fisher Effect (IFE) with the following existing available information: Current $/ spot exchange rate $1.3036/ Fijis expected annual inflation 0.37% Expected annual British inflation 0.20% Fiji expected one-year interest rate 0.140% Expected British one-year interest rate 0.077% 2. The CEO is afraid interest rates will increase by 0.5% in the U.K. The U.K. subsidiary has a current short term loan of 1,000,000 that expires 90 days from now, but will have to borrow the same amount again after expiry for operational expenses that will be incurred. Calculate the expected outcome of a 90-day forward rate agreement entered into in the United Kingdom to hedge against the increase in interest rates on 1,000,000. The current risk free United Kingdom rate is to be used as the agreed rate for the calculation. Also assume the settlement rate is the current risk free rate plus 0.5%. Use the following information for your calculations: Annual risk free interest rates: Fiji 0.140% Japan 0.025% South Korea 0.664% Canada 0.166% UK 0.077% Australia 0.112% South Africa 4.545% a. Advise the CEO whether Nestle should take a long or short position to hedge the risk of the increasing interest rates b. Explain to the CEO whether you recommend that Nesite should be the seller or buyer of the forward rate agreement? c. Briefly explain to him how the forward rate agreement will assist Nestle in terms of the interest rate that it will have to pay if it borrows 1,000,000 again for 90 days after expiry of the current loan. 3. The profit generated by the subsidiary in the U.K. is considered as a good source of money to be used to pay for the import of manufacturing equipment from Japan for the new company in Fiji to locally manufacture its ingredients. The CEO has already entered into negotiations with the Japan supplier of the equipment. The supplier is willing to provide Nestle 3 years to pay for the equipment that will be shipped to Fiji, but the payments must be conducted with quarterly instalments of 5,250,000 Yen by the U.K. subsidiary. This is why the CEO wants you to construct a currency swap arrangement where the profits of the U.K. subsidiary can be used to pay for the equipment. (you are not required to provide the calculation) Explain to the CEO what forfaiting is, why it is possible that forfaiting of the transaction can occur and the implication that it will have on the swap transaction