Question: Good day Tutor,

Kindly assist with the questions below,

Q.1 Assume that Jarret Co. (a U.S. firm) expects to receive 1 million euros in 1 year. The spot rate of the euro is $1.20. The 1-year forward rate of the euro is $1.21. Jarret expects the spot rate of the euro to be $1.22 in 1 year. Assume that 1-year put options on euros are available , with an exercise price of $1.23 and premium of $0.04 per unit.

Assume the following money market rates:

United state Eurozone

Deposit rate 8% 5%

Borrowing rate 9% 6%

a) Determine the dollar cash flows to be received if Jarret uses a money market hedge. (assume Jarret does not have any cash on hand) 5 marks

b) Determine the dollar cash flows to be received if Jarret uses a put option hedge.5 marks.

Q 2.ABC Ltd, a U.K. multinational enterprise is contemplating making a foreign capital expenditure in South Africa. The initial cost of the project is ZAR50 million. The annual cash flows over the five -year economic life of the project are estimated to be ZAR13 million, ZAR18 million, ZAR25 million, ZAR10 million and ZAR9 million. ABC Ltd' s cost of capital in Pounds is 7.5 percent. The long -run inflation rate is forecasted to be 4 percent per annum in the U.K.. and 12 percent in South Africa. The current spot foreign exchange rate is ZAR/pound = 15.56.

Required

a) Calculate the NPV in ZAR using the ZAR equivalent cost of capital according to the Fisher Effect and then convert the ZAR NPV to Pounds at the current spot exchange rate.

b) Convert all cash flows from ZAR to pounds at Purchasing Power Parity forecasted exchange rates and then calculate the NPV at the compound cost of capital.

c) What is the NPV in pounds if the actual pattern of ZAR/pound exchange rates is : S(0)= 15.56, S(1)= 14.56, S(2) = 16.72, S(3) = 15.78, S(4)= 16.54 and S(5) = 16.32? Explain the difference in the actual and the forecasted NPV.

Thank you.