The Morgan Holding Company is a multinational group of companies, with its headquarters in Iceland.

The Morgan Holding Company consists of a number of fully-owned subsidiaries and AIA Co, an associate company based in the USA, in which Morgan Holding Company owns 30% of the ordinary equity share capital.

Balances owing between the parent, Morgan Co, and its subsidiaries, and between subsidiaries, are settled by multilateral netting. Transactions between the parent and AIA Co are settled separately.

Transactions with AIA Co

Morgan Co wishes to hedge transactions with AIA Co which are due to be settled in four months' time in US$. Morgan Co will owe AIA Co US$3.7 million for a major purchase of supplies and AIA Co will owe Morgan Co US$10.15 million for non-current assets. Morgan Holding Company's treasury department is considering whether to use money markets or exchange-traded currency futures for hedging.

Annual interest rates available to Morgan Co:

	Investing rate	Borrowing rate
Iceland	2.7%	3.9%
USA	2.5%	3.7%

Exchange traded currency futures

Contract size 125,000, price quotation USD ($) per 1

Three-month expiry: 1.1213

Six-month expiry: 1.1204

Netting

The balances owed to and owed by members of Morgan Co when netting is to take place are as follows:

Owed by	Owed to	Local currency
Morgan (Iceland)	Redcircle (UK)	EUR15.9
Morgan (Iceland)	NTT (Japan)	EUR4.46
Redcircle (UK)	Innovation (USA)	GBP24.89
Redcircle (UK)	NTT (Japan)	GBP18.57
Innovation (USA)	Morgan (Iceland)	USD27.08
Innovation (USA)	NTT (Japan)	USD5.68
NTT (Japan)	Morgan (Iceland)	JPY38.8
NTT (Japan)	Redcircle (UK)	JPY51.2

Spot rates are currently as follows:

	EUR()	GBP()	USD ($)	JPY()
EUR()	1.000	0.846	1.1268	130.2085

The group members will make settlement in EURO. Spot mid-rates will be used in calculations. Settlement will be made in the order that the company owing the largest net amount in EURO will first settle with the company owed the smallest net amount in EURO.

Transfer price arrangements

The Morgan Co board has been reviewing the valuation of inter-group transactions, as it is concerned that the current system is not working well. Currently inter-group transfer prices are mostly based on fixed cost plus a mark-up negotiated by the buying and selling divisions. If they cannot agree a price, either the sale does not take place or the central treasury department determines the margin.

The board has the following concerns:

12. Both selling and buying divisions have claimed that prices are unfair and distort the measurement of their performance.
13. Significant treasury department time is being taken up dealing with disputes and then dealing with complaints that the price it has imposed is unfair on one or the other division.
14. Some parts of the group are choosing to buy from external suppliers rather than from suppliers within the group.

As a result of the review, the Morgan Holding Companys board has decided that transfer prices should in future be based on market prices, where an external market exists.

Required

Prepare the report for the board of directors of the Morgan Holding Company which:

1. Advise on, and recommend an appropriate hedging strategy for the USD ($) cash flow it is due to receive from, or pay to, AIA Co

1. Calculate the inter-group transfers which are forecast to take place.
2. Discuss the advantages of multilateral netting by a central treasury function within the Morgan Holding Company
3. (b) Evaluate the extent to which changing to a market-price system of transfer pricing will resolve the concerns of the Morgan Co board.