RedDot is a multinational Singapore company that performs diverse activities. It manufactures electronic tools like hand-held digital electronic microscopes, digital multimeters, voltage testers etc.

To conduct this manufacturing, they import certain electronic components from countries like Japan and South Korea.

The markets for the manufactured tools are Australia, Canada and United Kingdom (U.K). However, the majority of sales is in Australia. Therefore, the company has already put up a subsidiary in Australia. It resells and distributes the products to different businesses. The quarterly net profit after tax generated by the subsidiary is AUD500,000. The exports to Canada and United Kingdom (U.K) are to other independent distributing companies that buy the tools at wholesale prices from RedDot.

RedDot is also considering the construction of an electronic component manufacturing plant in Singapore to eliminate the risks and costs associated with the current importing of electronic components from countries like Japan and South Korea.

RedDot already has sufficient manufacturing space available and only has to import manufacturing equipment of 740,000,000 WON from South Korea. The installation of the machinery will be conducted by local Singapore companies and will cost SGD2,000,000.

The Chief Executive Officer (CEO) of RedDot, requests the following information to assist him with determining the extent of exchange rate risk and the availability of funds to conduct the multinational transactions:

1. The CEO requires a forecast of the two-year and four-year exchange rates for the SGD/AUD calculated based on Purchasing Power Parity (PPP) and International Fisher Effect (IFE) with the following existing available information:

Current SGD/AUD spot exchange rate	SGD$0.95/AUD
Expected annual Singapore inflation	1.23%
Expected annual Australia inflation	0.85%
Expected Singapore one-year interest rate	0.258%
Expected Australia one-year interest rate	0.106%

The CEO requires a forecast of the two-year and four-year exchange rates for the SGD/AUD calculated based on Purchasing Power Parity (PPP) and International Fisher Effect (IFE).

Calculate the two-year forward SGD/AUD exchange rate based on PPP in the space provided below: (2 marks)

Calculate the four-year forward SGD/AUD exchange rate based on PPP in the space provided below: (2 marks)

Calculate the two-year forward SGD/AUD exchange rate based on IFE in the space provided below: (2 marks)

Calculate the four-year forward SGD/AUD exchange rate based on IFE in the space provided below: (2 marks)

Explain the conditions under which the forward exchange rates calculated by you will be unbiased predictors of the future spot exchange rate. Use the space provided below. (2 marks)

2. The CEO is afraid interest rates will increase by 0.85% in Australia. The Australia subsidiary has a current short-term loan of AUD2,200,000 that expires 60 days from now but will have to borrow the same amount again after expiry for operational expenses that will be incurred. Calculate the expected outcome of a 60 day forward rate agreement entered into in Australia to hedge against the increase in interest rates on AUD2,200,000. The current risk-free Australia rate is to be used as the agreed rate for the calculation. Also assume the settlement rate is the current risk-free rate plus 0.85%. Advise the CEO whether RedDot should take a long or short position to hedge the risk of the increasing interest rates. Information from the following table can be used for your calculations:

Annual risk-free interest rates:
Singapore	0.258%
Japan	0.025%
South Korea	0.664%
Canada	0.166%
UK	0.106%
Australia	0.112%
South Africa	4.545%

Show your calculation by applying the correct formula in the space provided below: 6 marks

Question
Do you recommend that RedDot should be the seller or buyer of the forward rate agreement? (1 mark)
Briefly explain how the forward rate agreement will assist RedDot in terms of the interest rate that it will have to pay if it borrows AUD2,200,000 again for 60 days after expiry of the current loan. (3 marks)