Question 5 Foreign Exchange Exposure (20 marks)

Assume that you provide financial advice to Minelli Enterprises Limited. The companys management has come to you for guidance over a foreign exchange transaction. The company, based in New Zealand, has sold GBP$ 4,500,000 worth of equipment to a customer in Great Britain. The payment has been deferred for six (06) months. The following information has been provided:

Spot exchange rate = NZD 1.9639/GBP

Six-month forward rate = NZD 1.9613/GBP

New Zealand lending rate = 3.12% p.a.

New Zealand deposit rate = 2.22% p.a.

Great Britain lending rate = 1.22% p.a.

Great Britain deposit rate = 0.86% p.a.

Risk free rate in New Zealand = 0.68% p.a.

Risk free rate in Great Britain = 0.92% p.a.

Required:

5.1 Calculate the expected spot rate in 6 months, assuming the Interest Rate Parity holds between the two countries. (Round off calculations to four decimals.) (3 marks)

5.2 Calculate the expected value of the sale in New Zealand dollars using the expected spot rate calculated in 5.1 above, assuming they do not hedge. Based on your result, should the company hedge? Why? (2 marks)

5.3 Calculate the value of the proceeds from the sale if the company enters a forward rate agreement. (2 marks) - 5 -

5.4 Assuming the company entered a forward market hedge contract, calculate the foreign exchange loss or gain that would be recorded in the books of accounts if the transaction had been recorded in the books at the spot rate at the time of purchase. (3 marks) 5

.5 Explain and calculate the net amount receivable by Minelli Enterprises Limited Ltd if money market hedge is used. (Show workings.) (8 marks)

5.6 Based on your calculations above, which alternative would you recommend and why? (2 marks)