i) Show the economics of a futures transaction if the price of cattle at delivery date is $0.40 per pound, $0.60 per pound, or $0.80 per pound. ii) Is this a risk-reducing transaction? iii) Would your answer to (b) be different if the treasurer were investing in oil futures? What about interest rate futures? 2 Marks Each ci) Show how one can replicate a one-year pure discount bond with a face value of $100 using a share of stock, a put and a call. ii) Suppose that S = $100, P = $10, and C = $15. What must be the one-year interest rate? iii) Show that if the one year risk-free interest rate is lower than your answer to part (ii), there would be an arbitrage opportunity. 2 Marks Each 3a) Suppose that soft cola, a multinational soft drinks company is thinking about opening a plant in a developing country. The exchange rate in that country is pegged to the dollar but due to economic and political problems in that country, there are restrictions on the convertibility and repatriation of profits to the United States. Also, the level of these restrictions is liable to change with the whims of those in power. The CEO of soft cola calls you a financial economist to evaluate the risks involved in such a venture. i) Would soft cola face exchange rate risks if it decided to open a plant in this developing country? What risk would it face and how could it avoid this risk? 5 Marks ii) If the CEO decides to go ahead and open a plant in the developing country, what in effect has been soft cola's risk management strategy? 5 Marks b) You have been hired in the risk management division in a multinational beverage company, and have recently been put in charge of managing the franc / dollar exchange rate risks that the company faces. Consider the company's operations in France and the United States. i) Suppose monthly revenues in France average Ffr. 100 million and monthly production and distribution costs average Ffr. 80 million. If the resulting profits are repatriated to the production unit in the United States monthly, what risk does this production unit face? How might it hedge this risk? 3 Marks i) Show the economics of a futures transaction if the price of cattle at delivery date is $0.40 per pound, $0.60 per pound, or $0.80 per pound. ii) Is this a risk-reducing transaction? iii) Would your answer to (b) be different if the treasurer were investing in oil futures? What about interest rate futures? 2 Marks Each ci) Show how one can replicate a one-year pure discount bond with a face value of $100 using a share of stock, a put and a call. ii) Suppose that S = $100, P = $10, and C = $15. What must be the one-year interest rate? iii) Show that if the one year risk-free interest rate is lower than your answer to part (ii), there would be an arbitrage opportunity. 2 Marks Each 3a) Suppose that soft cola, a multinational soft drinks company is thinking about opening a plant in a developing country. The exchange rate in that country is pegged to the dollar but due to economic and political problems in that country, there are restrictions on the convertibility and repatriation of profits to the United States. Also, the level of these restrictions is liable to change with the whims of those in power. The CEO of soft cola calls you a financial economist to evaluate the risks involved in such a venture. i) Would soft cola face exchange rate risks if it decided to open a plant in this developing country? What risk would it face and how could it avoid this risk? 5 Marks ii) If the CEO decides to go ahead and open a plant in the developing country, what in effect has been soft cola's risk management strategy? 5 Marks b) You have been hired in the risk management division in a multinational beverage company, and have recently been put in charge of managing the franc / dollar exchange rate risks that the company faces. Consider the company's operations in France and the United States. i) Suppose monthly revenues in France average Ffr. 100 million and monthly production and distribution costs average Ffr. 80 million. If the resulting profits are repatriated to the production unit in the United States monthly, what risk does this production unit face? How might it hedge this risk? 3 Marks