Question 1

WaterQuay Engineering Ltd (WQEL) is a big player in the yacht industry in the United

Kingdom (UK). WQEL customers in the UK, account for a third its revenue, the rest are

based in Europe.

WQEL has the expertise locally to construct its yachts, but sources all the required

components and materials from Germany.

Following UK's withdrawal from the European Union (EU), the UK government has

increased taxes imports. WQEL's main competitors who are based in France and

Germany. There are no import tariffs between France and Germany due to the EU trade

agreements.

Local governments have also increased berthing costs by 20% on all mariners and

harbours in the South.

Over the last three months, the EURO/GBP (/) rate has ranged from 0.8566 - 0.9230,

the previous 52 weeks range was 0.8603 - 0.9429. The UK economy has been deeply

affected by the COVID-19 pandemic in the last year. As we go to the press the markets

seem to be reacting positively to the UK's COVID-19 vaccination programme and

government stimulus.

The Finance Director is concerned about the impact that economic risk will have on the

business.

WQEL expects to make a payment of 7,500,000 to its main supplier in six months' time.

The following market information is available:

Spot Euro/GBP is 0.8630 - 0.8649

6-month Euro interest rate is 7 - 9% per annum

6-month GBP interest rate is 5 - 8% per annum

European call Options Euro/GBP Strike price is 0.8685

Option fee 0.01/Euro

Euro/GBP Forward contract in September is 0.8734 - 0.8753

3

Required:

a) Describe what you understand by the term, 'economic risk' and explain how it is

distinguished from 'transaction risk'.

(5 marks)

b) Given your answer in (a) discuss the impact that economic and transaction risk could

have on WQEL's business.

(5 marks)

c) Explain using relevant calculations how this risk may be managed given the market

information above.

Give a critical opinion on the best course of action.

(15 marks)