On 27 th February 2019 UK company Mahoney Chemicals Plc signed a contract to supply polypropylene fabrics to an American company Under the financial terms of the agreement, Mahoney was set to receive payment in three instalments of US dollars The payments were set to occur on the following dates 1 $1 2 million on 27 th March 2019 2 $2 3 million on 26 th April 2019 3 $3 7 million on 26 th June 2019 Mahoney also has US dollar denominated trade debts and plans to use proceeds from the polypropylene fabric sale to pay these suppliers The company's Treasury estimates that 30 of the March payment will be held on account to pay creditors, 20 of the April payment and 50 of the June payment Two years ago (27 th February 2017) Mahoney borrowed 156 million via a five year floating rate, non callable, note issue The notes were sold at par (100) and offer a coupon rate of LIBOR plus 240 basis points Interest is payable semi annually on 27 th February and 27 th August The coupon rate is based on the six month LIBOR at the start of each payment cycle Task 1 Exchange Rate Risk Management 1 Explain Mahoney's exchange rate exposure and generate measures of over the counter forward rates for each payment based on covered interest rate parity The day count convention applying to sterling money market transactions is actual 365 days, whilst for US dollar money market transactions it is actual 360 days In the absence of interest rates corresponding to the terms of the transactions, use the available data to interpolate a suitable rate ( 10 marks ) 2 Show how Mahoney could use currency futures to hedge the effects of exchange rate uncertainty associated with each payment ( 10 marks ) 3 Assume that on 27 th March 2019 the GBP USD spot rate is $1 3900 1 3905 Assess the efficiency of the futures contract hedge for the 27 th March payment if the futures price on the day is $1 3917 ( 10 marks ) 4 On 27 th February a bank offers a two month GBP USD forward exchange rate of $1 3300 Show how an arbitrageur could profit and comment on the forward rate in relation to the principle of covered interest rate parity (You might find the point easier to discuss by assuming the arbitrageur puts into play a specific sum of money) ( 10 marks ) 5 Discuss the relative merits for Mahoney of the over the counter and exchange traded methods of hedging currency risk (Link the analysis to the specifics of your numerical analysis of Mahoney's risk management options Analysis limited to textbook style generalisations will not be well rewarded) ( 10 marks )

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On 27 th February 2019 UK company Mahoney Chemicals Plc signed a contract to supply polypropylene fabrics to an American company. Under the financial terms

On 27^thFebruary 2019 UK company Mahoney Chemicals Plc signed a contract to supply polypropylene fabrics to an American company. Under the financial terms of the agreement, Mahoney was set to receive payment in three instalments of US dollars. The payments were set to occur on the following dates:

1.$1.2 million on 27^thMarch 2019

2.$2.3 million on 26^thApril 2019

3.$3.7 million on 26^thJune 2019

Mahoney also has US dollar-denominated trade debts and plans to use proceeds from the polypropylene fabric sale to pay these suppliers. The company's Treasury estimates that 30% of the March payment will be held on account to pay creditors, 20% of the April payment and 50% of the June payment.

Two years ago (27^thFebruary 2017) Mahoney borrowed 156 million via a five-year floating-rate, non-callable, note issue. The notes were sold at par (100) and offer a coupon rate of LIBOR plus 240 basis points. Interest is payable semi-annually on 27^thFebruary and 27^thAugust. The coupon rate is based on the six-month LIBOR at the start of each payment cycle.

Task 1: Exchange Rate Risk Management

1.Explain Mahoney's exchange rate exposure and generate measures of over-the-counter forward rates for each payment based on covered interest rate parity.

The day-count convention applying to sterling money market transactions is actual/365 days, whilst for US dollar money market transactions it is actual/360 days.
In the absence of interest rates corresponding to the terms of the transactions, use the available data to interpolate a suitable rate.

(10 marks)

2.Show how Mahoney could use currency futures to hedge the effects of exchange rate uncertainty associated with each payment.

(10 marks)

3.Assume that on 27^thMarch 2019 the GBP/USD spot rate is $1.3900-1.3905. Assess the efficiency of the futures contract hedge for the 27^thMarch payment if the futures price on the day is $1.3917.

(10 marks)

4.On 27^thFebruary a bank offers a two-month GBP/USD forward exchange rate of $1.3300. Show how an arbitrageur could profit and comment on the forward rate in relation to the principle of covered interest rate parity.

(You might find the point easier to discuss by assuming the arbitrageur puts into play a specific sum of money).

(10 marks)

5.Discuss the relative merits for Mahoney of the over-the-counter and exchange-traded methods of hedging currency risk.

(Link the analysis to the specifics of your numerical analysis of Mahoney's risk management options. Analysis limited to textbook-style generalisations will not be well rewarded).

(10 marks)