RISK MANAGEMENT

ABC Company Case

The directors of ABC Co expect that interest rates will fall over the next year and they are looking forward to paying less interest on the company$$s debt finance.

The dollar is the domestic currency of ABC Co$.$

The company has a number of different kinds of debt finance, as follows:

LOAN NOTES LOAN NOTES BANK LOAN OVERDRAFT

Denomination Currency Dollar Peso Dollar Dollar

Nominal value $ $20$ million $300$ m pesos $ $4$ million $ $3$ million Interest rate $\%$ p$.$a$.7\%10\%8\%10\%$

Interest payment type Fixed rate Fixed rate Variable rate Variable rate

Interest due period $6$ months $6$ months $6$ months $1$ month

Redemption $8$ years$$ time at $8$ years$$ time at

Nominal valueI Nominal valueI stalments Continuing

atcurrent level

Settlement date ANY ANY ANY IF NEEDED BANK REGULATED

The $7\%$ loan notes were issued domestically while the $10\%$ loan notes were issued in a foreign country.

The interest rate on the long$-$term bank loan is reset to bank base rate plus a fixed percentage at the end of each year.

The annual payment on the bank loan consists of interest on the year$-$end balance plus a capital repayment.

Relevant exchange rates are as follows :

OFFER BID

Spot rate $($Pesos$/$$$)58\mathrm{.}33558\mathrm{.}345$

$6-$month forward rate $($Pesos$/$$$)56\mathrm{.}58556\mathrm{.}597$

Future contract size $100,000100,000$

Financial institution $($bank$)$ for settlement Peso Bank Dollar Bank

ABC Co can place pesos on deposit at $3\%$ per year and borrow dollars at $10\%$ per year. The company has no cash available for hedging purposes.

Evaluate the risk faced by ABC Co on its peso$-$denominated interest payment in six months$$ time and advise how this risk might be hedged!

$2.$ Calculate the $6-$month dollar cost of the interest payment!

Question $2$Select one:

a$.$$ $530,176$

b$.$$ $514,271$

c$.$$ $514,183$

d$.$$ $530,063$

e$.$$ $5,530,063$

Evaluate the risk faced by ABC Co on its peso$-$denominated interest payment in six months$$ time and advise how this risk might be hedged!

$3.$ By how much interest cost payment has changed $($increased$/$decreased$)?$

Question $3$Select one:

a$.$Increased, by $ $15,905$

b$.$Decreased, by $ $15,905$

c$.$Decreased, by $ $15,880$

d$.$Increased, by $ $15,880$

e$.$Not possible to calculate, more data needed

$4.$ABC Co can use a money market hedge by placing pesos on deposit now, financed by borrowing dollars for repayment in six$-$months$$ time. To find answer you need to calculate the six$-$month interest rate for placing pesos on deposit.

Pesos interest rate is: Question $4$Select one:

a$\mathrm{.}1\mathrm{.}5\%$

b$\mathrm{.}3\mathrm{.}0\%$ c$\mathrm{.}6\mathrm{.}0\%$

d$\mathrm{.}5\mathrm{.}0\%$

e$\mathrm{.}4\mathrm{.}5\%$

$5.$ABC Co can use a money market hedge by placing pesos on deposit now, financed by borrowing dollars for repayment in six$-$months$$ time. To find answer you need to calculate the six$-$month interest rate for borrowing dollars. The interest rate $(6-$months$)$ for borrowing dollars is: Question $5$Select one:

a$\mathrm{.}5\mathrm{.}0\%$

b$\mathrm{.}1\mathrm{.}5\%$

c$\mathrm{.}6\mathrm{.}0\%$

d$\mathrm{.}7\mathrm{.}0\%$

e$\mathrm{.}4\mathrm{.}5\%$

$6.$ABC Co can use a money market hedge by placing pesos on deposit now, financed by borrowing dollars for repayment in six$-$months$$ time.How much pesos do you need to deposit now?Question $6$Select one:

a$\mathrm{.}29,556,650$ pesos

b$\mathrm{.}506,671$ pesos

c$\mathrm{.}532,005$ pesos d$\mathrm{.}30,450,000$ pesos

e$\mathrm{.}30,000,000$ pesos

$7.$ABC Co can use a money market hedge by placing pesos on deposit now, financed by borrowing dollars for repayment in six$-$months$$ time.

How much dollars do you need to have $($to borrow now$)$ for buying pesos now?

Question $7$Select one:

a$.$$ $506,671$

b$.$$ $532,005$

c$.$$ $514,271$

d$.$$ $530,1768.$ABC Co can use a money market hedge by placing pesos on deposit now,now, financed by borrowing dollars for repayment in six$-$months$$ time.

How much shall be the dollar cost of hedging the peso interest payment after $6$ months?

Question $8$Select one:

a$.$$ $532,005$

b$.$$ $506,671$

c$.$$ $530,176$ d$.$$ $530$