Question Paper Treasury & Forex Management (MB351F): October 2005 Section A : Basic Concepts (30 Marks) • • • •
1.
Maximum time for answering Section A is 30 Minutes.
It is a document document of title to a time time deposit There is no lock-in period for transferring it to others It is not subject to the reserve requirement requirement of the bank It is transferable by endorsement and delivery The maximum maturity period is one year.
The net worth and total debt of Modern Threads Ltd. are Rs. 300 lakh and Rs. 500 lakh respectively. The EBIT of the company is Rs.160 lakh. The earning power of the company is (a) 12%
3.
(b) 15%
(d) 20%
(e) 24%.
(b) Rs.17,225 (e) Rs.20,625.
(c) Rs.18,750
For a firm, if the current ratio remains constant and the quick ratio decreases during the same period, then, which of the following is indicated for the firm? (a) (b) (c) (d) (e)
5.
(c) 18%
< Answer >
Rs.1,00,000 was borrowed at an interest rate of 10 percent per annum. The amount has to be repaid with < Answer > interest in ten equal annual installments. Each installment is payable at the end of every year. What will be the amount of each installment? (a) Rs.16,273 (d) Rs.19,375
4.
< Answer >
Which of the following is not a feature of certificate of deposit issued by a bank? (a) (b) (c) (d) (e)
2.
This section consists of questions with serial number 1 - 30. Answer all questions. Each question carries one mark.
< Answer >
The proportion of total debt relative to total assets is decreasing The proportion of total debt relative relative to net worth is decreasing The proportion of net worth relative to total assets is increasing The liquidity is decreasing The profitability is increasing. < Answer >
The following data pertain to Mehta & Co: Cost of goods sold = Inventory turnover = Closing stock =
Rs.80 lakh 4 Rs.25 lakh
The opening stock is (a) Rs.5 lakh (d) Rs.20 lakh 6.
(b) Rs.10 lakh (e) Rs.25 lakh.
(c) Rs.15 lakh
The data on the current assets and current liabilities of Fitmark Ltd. for the financial year 2004-05 are given below:
< Answer >
(Rs. in lakh) Beginning Closing
Debtors 80 100
Cash balance 50 60
Inventory 10 25
Current liabilities 40 35
What is the change in net working capital? (a) Rs.10 lakh (d) Rs.25 lakh 7.
(b) Rs.15 lakh (e) Rs.50 lakh.
(c) Rs.20 lakh
Which of the following is true with regard to the degree of financial leverage (DFL)? (a) (b)
DFL of a company is constant irrespective of the earnings before interest and taxes (EBIT) DFL is equal to zero at the financial break-even point 1
< Answer >
(c) (d) (e) 8.
Equity capital Debenture capital Accrued wages Term loan Preference capital.
Other things remaining the same, if the average stock of raw materials is increased to two times its original level, then the raw materials storage period (a) (b) (c) (d) (e)
10.
< Answer >
Which of the following is a spontaneous source of financing current assets? (a) (b) (c) (d) (e)
9.
DFL is less than zero if EBIT lies below the financial break-even point DFL increases increases as EBIT increases above the financial break-even point The change in output does not influence the DFL.
< Answer >
Reduces to half of the original period Increases to two times the original period Reduces unpredictably Increases to four times the original period Reduces to one-fourth of the original period. < Answer >
Consider the following data about SKF Ltd: Annual credit purchases Opening balance of accounts payable Closing balance of accounts payable (Assume 1 Year = 365 Days)
Rs.52, 92,500. Rs.15, 50,000. Rs.27, 00,000.
The average payment period (in days) for SKF Ltd. is (a) 126 11.
(b) 13.02%
(c) 14.25%
< Answer >
(e) 15.33%. < Answer >
< Answer >
(b) International Fisher effect (d) Price-specie-flow mechanism
Which of the following theories of international trade explains the trade between two countries having similar factor endowments and consumer tastes?
< Answer >
International product life cycle theory Imitation gap theory Theory of absolute advantage Theory of comparative advantage Heckscher – Ohlin model.
The system under which the exchange rates are determined by the demand and supply position for the currencies in the foreign exchange market is known as (a) (c) (e)
16.
(d) 14.33%
The process of correction of imbalance in international receipts and payments between the two countries is known as
(a) (b) (c) (d) (e) 15.
(e) 196.
Purchase of gold by Minerals and Metals Trading Corporation (MMTC) from a Swiss Bank Repatriation of dividends by an MNC Investment by an Indian Mutual Mutual Fund in the the UK Foreign exchange earned by Minerals and Metals Metals Trading Corporation (MMTC) Remittance to USA by an American executive based at New Delhi.
(a) J-curve effect (c) Quantity theory of money (e) Dornbush sticky price theory. 14.
(d) 186
Which of the following items represents a credit entry in India’s Balance of Payments statement? (a) (b) (c) (d) (e)
13.
(c) 176
Dell Ltd has Rs100 preference shares redeemable at a premium of 10% with 15 years maturity. The preference dividend rate is 12%. The cost of the preference capital assuming that shares were issued at par with floatation cost of 5% is (a) 12.43%
12.
(b) 147
Target zone arrangement system Fixed exchange rate system Currency board system.
(b) Crawling peg system (d) Floating exchange rate system
Any increase or decrease in the value o f a foreign liability in terms of the domestic currency is called (a) Country risk
< Answer >
(b) Currency risk 2
< Answer >
(c) Transaction risk 17.
(d) Financial risk
Bank of America of New York is maintaining a rupee account with State Bank of India in Mumbai. Bank of America in New York calls this account as (a) Nostro account (c) LORO account
18.
(b) Vostro account (d) Special account
< Answer >
In terms of US dollars per unit of any other currency In terms of number of units of any other currency per unit of US dollar In terms of number of units of any other currency per unit of British pound In terms of number of units of any other currency per unit of Euro Both (a) and (c) above.
The exposure that arises from the need to convert values of assets and liabilities denominated in a foreign currency into the domestic currency is called (a) Transaction exposure (c) Translation exposure (e) Financial exposure.
20.
< Answer >
(e) Mirror account.
A quote is called as European quote, if the exchange rate is expressed (a) (b) (c) (d) (e)
19.
(e) Interest rate risk.
< Answer >
(b) Transformation exposure (d) Operating exposure < Answer >
The following are the exchange rates quoted in Singapore S$/Euro : 2.0118/21 S$/US$ : 1.7384/86 The synthetic rates of US $/Euro are (a) 1.1572/73 (d) 0.8639/42
21.
(b) 1.1571/74 (e) 3.4977/79.
If the Euro is quoted $ 1.1410 today and the inflation rates are 2% in Euro-zone and 3% in USA, what should be the $/Euro quote after 3 months? (a) $ 1.1382/Euro (d) $ 1.1300/Euro
22.
(b) Rs.81.86
(b) Rs.43.02
< Answer >
(e) Rs.81.82.
(c) Rs.43.10
(d) Rs.43.06
(e) Rs.43.12.
(b) Asset markets theory (d) Interest rate parity theory
Which of the following strategies is classified as production strategies to manage the economic exposure? (b) Plant location (e) Pricing strategy.
Which of the following is true under a currency board system? (a)
< Answer >
< Answer >
Discount, be at a forward premium Discount, also be at a forward discount Premium, also be at a forward premium Premium, be at a forward discount Discount, be stable.
(a) Market selection (d) Promotional strategy 27.
(d) Rs.81.83
If U.K. interest rates are higher than Japanese interest rates, the theory of covered interest arbitrage would suggest that in the £/Yen exchange markets the Yen would be at a forward _________ and the pound would ___________. (a) (b) (c) (d) (e)
26.
(c) $ 1.1522/Euro
The relationship between the exchange rate and the prices of tradeable goods is kn own as the (a) Purchasing power parity theory (c) Portfolio balance theory (e) Fisher open condition.
25.
(c) Rs.81.81
< Answer >
A banker who relied on the inter bank rate of Rs./$ 43.06/10 is requested by an Exporter for purchase of < Answer > dollars. What is the rate to be quoted if the banker wants a margin of 0.10%? (a) Rs.43.14
24.
(b) $ 1.1438/Euro (e) $ 1.1466/Euro.
The pound sterling quote of a bank is Rs.81.79 / 84. If the banker agrees to quote a better rate by 2 paise to an Exporter, who is selling £200000, the rate quoted is (a) Rs.81.77
23.
(c) 0.8640/41
The interest rates are automatically automatically set set by the market market mechanism mechanism 3
< Answer >
(c) Product strategy < Answer >
(b) (c) (d (e) 28.
Denominated in yen and issued outside Japan Denominated in a currency other other than yen and issued to the public in Japan Denominated in yen and issued under private placement placement by non-Japanese borrowers in Japan Denominated in yen and issued by non-Japanese borrowers to the public in Japan Denominated in yen and issued issued by Japanese borrowers in US.
If interest rate parity holds and the transaction costs are zero, covered foreign financing will result in an effective borrowing rate that is (a) (b) (c) (d) (e)
30.
< Answer >
Samurai bond is a bond (a) (b) (c) (d) (e)
29.
When there is a higher demand for the anchor currency, currency, the reserves reserves with the currency board gets enhanced Lending to either the government government or the domestic banks by the currency board is allowed The board can act as the lender of the last resort Exchange rates are unstable.
Less than domestic interest rate Greater than domestic interest rate Equal to domestic interest rate Less than domestic interest rate if forward rate is in discount Negative. < Answer >
Overtrading means (a) (b) (c) (d) (e)
< Answer >
The firm has disproportionately high amount of working capital capital with respect to the level of sales The firm has disproportionately low amount of working capital with respect to the level of sales The firm has disproportionately high level of receivables with respect to total assets The firm has disproportionately high level of cash with respect to total assets The firm has been experiencing low turnover of working capital. capital.
END OF SECTION A
4
Section B : Problems/Caselet (50 Marks) This section consists of questions with serial number 1 – 5. Answer all questions. Marks are indicated against each question. Detailed workings/explanations should form part of your answer. Do not spend more than 110 - 120 minutes on Section B. 1.
Hong Kong Bank can borrow $10 million at 5% annualized. The treasury manager wants to use the loan amount to invest in euro at 4% annualized over a fortnight period considering the following information. Interest rates $ - 4.5% – 5% Euro – 4%- 4.3% Current rate
$/Euro 1.2840 / 45
Expected rate after fortnight
$/Euro 1.2885 / 92
You are required to compute the loss or gain if the treasury manager decides to implement his decision for covered interest arbitrage. Show your workings up to the last unit. (10 marks) < Answer > 2.
The cash flows associated with a project are given below: Year Cash flows (Rs. ‘000s)
0
1
2
3
4
5
(2200)
900
850
700
650
500
The cost of capital is 15%. You are required to find out the following: a. Net present value. b. Benefit cost ratio. c. Internal rate of return. (3 + 2 + 3 = 8 marks) 3.
< Answer >
A multinational company in New Zealand proposes to invest its surplus funds of NZ$3 million for three months. The treasury manager has collected the following information from his banker to invest in currencies other than that of home currency to earn more interest on the funds without exposing the investment to exchange risk by covering the amounts under forward rates. Spot
NZ $/$
1.5522/24
Euro/£ 1.4650/52 $/£ 1.7960/62 3 months forward NZ $/$ 1.5663/65 Euro/£ 1.4570/72 $/£ 1.7885/87 3 month interest rates (p.a.) NZ $ : 3.2% – 3.6% $ : 2.4% – 2.8% Euro : 3.0% – 3.4% £ : 2.8% – 3.2% You are required to determine the currency in which the company should invest to have more retur ns. (10 marks) < Answer >
5
4.
Pragati Fabrication Company requires steel for its fabrication work. The probability distributions of the daily usage rate and the lead time for procurement are given below: Daily usage rate (in tonnes) 5 7 9
Lead time (in days) 15 25 30
Probability
0.3 0.4 0.3
Probability
0.5 0.3 0.2
The stock out cost and the carrying cost are estimated as Rs.4,500 and Rs.1,200 per tonne respectively. You are required to find out the following: a. b.
Probability of stock out. Optimum level of safety stock. (6 + 6 = 12 marks)
< Answer >
Caselet Read the caselet carefully and answer the following question: 5.
Discuss the factors that affect a country’s exports of goods and services. (10 marks) < Answer >
India's foreign exchange reserves zoomed by over $12 billion in five weeks ending March 19, 2005. According to banking sources familiar with Reserve Bank of India data, the major accretion has been on account of invisibles and external commercial borrowings (ECBs). In invisibles, the areas that have contributed the most are private transfers, software and export-related services. In ECBs, the number of borrowers have gone up although funds raised are not very high. The balance of payment data, yet to be released by the RBI for the fourth quarter of financial year ended March 2005, are likely to show a current account surplus as against deficits in last two quarters, said sources. Non resident Indian (NRI) deposits’ kitty, which has been drying down with net outflows, has started improving after the government decided to continue with the tax exemption in the last Union budget. Under capital flows, portfolio investments stood at over $ 2 billion. While there has been positive accretion in the foreign direct investment, investment of around $900 million by Holcim was the largest FDI for the quarter, said sources. For the week ended March 25, the foreign exchange reserves stood at around $141 billion. The comforting factor in the data is the fact that the foreign exchange inflows are no longer dependent on the interest rate sensitive flows like portfolio investments. Although there has not been much growth in foreign institutional investor inflows, overall growth in the forex reserves has been phenomenal. In the third quarter, the current account deficit continued further inflated by clocking $5.4 billion as against $4 billion in the second quarter 2004-05, according to the balance of payment data released by the Reserve Bank of India. This has been due to steady expansion in trade deficit taking it to historic heights of $11.8 billion as against $9.8 billion in the second quarter. The last BoP data showed that the capital account remains in surplus at $ 12 billion as against $ 4.6 billion , primarily due to surge in FII inflows, sharp rise in external commerial borrowings, short-term credits and overseas borrowings by banks. While foreign investment has gone down to $7.3 billion as against $10.1 billion the same quarter last year, ECBs grew to $ 4.1 billion as against a negative accretion of $3.4 billion. Short-term credit was at $ 2.7 billion. Non-resident Indian deposits, on the other hand, fell by $1.3 billion as against a growth of $3.7 billion. The components boosting foreign exchange reserves during the third quarter were a 40 per cent growth in foreign investment, 22.5 per cent growth in ECBs, 3.8 per cent growth in external assistance, 14.8 per cent growth in short credit. Net invisibles were marginally down to $6.3 billion as against $7.2 billion in the corresponding quarter last year.
END OF SECTION B
Section C : Applied Theory (20 Marks) This section consists of questions with serial number 6 - 7. Answer all questions. Marks are indicated against each question. Do not spend more than 25 -30 minutes on section C.
6
6.
There are some problems which may hinder a meaningful analysis of the financial statements. Explain briefly the problems encountered in financial statement analysis. (10 marks) < Answer >
7.
The various techniques available to hedge a foreign exchange exposure can be categorized as internal and external hedging techniques. Explain how a firm can hedge transaction and translation exposures through external hedging techniques. (10 marks) < Answer >
END OF SECTION C END OF QUESTION PAPER
Suggested Answers Treasury & Forex Management (MB351F): October 2005 Section A : Basic Concepts 1.
< TOP >
Answer : (c) Reason : Certificate of deposit (CD) is a financial instrument where an investor has has to invest a certain sum to get a fixed amount (principal and accrued interest) on maturity at the contracted rate.So it is similar to a time deposit. CDs are transferable simply by endorsement and delivery by the holder without any restriction, whereas its maturity period ranges from 15 days to one year. But as it is a liability to the issuing banks, CDs are also subjected to the reserve requirements of the bank
2.
< TOP >
Answer : (d) EBIT Assets Reason : Earning power = Total As
=
160 30 0 + 5 00
=
160 800
= 0.2
Hence, earning power of the company = 20% 3.
< TOP >
Answer : (a) 1, 00, 000 A(10%,10 ,10 years) Reason : The amount amount of each installment installment will be = PVIFA(1
=
1, 00, 000 6.145
= 16,273.393
= 16,273(approx) 4.
< TOP >
Answer : (d) Reason : Current ratio is defined as the ratio between between the current assets assets and current liabilities. While Quick Ratio is calculated by dividing current assets minus inventories by current liabilities. Now, among the components of the current assets, inventories are the least liquid instruments. So, a decreasing quick ratio and same value of the current ratio implies the increasing volume of inventory, thereby indicating the decreasing level of liquidity.
5.
< TOP >
Answer : (c) Cos t of Good Goodssol ssold d Average Inventory =4 Reason : Inventory turnover = AverageInventory Now, COGS = Rs.80 lakh, hence average inv entory will be = Rs.20 lakh But the amount of closing stock = Rs.25 lakh Therefore the amount of opening stock will be = (20 x 2) – 25 = Rs.15 lakh
6.
< TOP >
Answer : (e) Reason : Change is net working capital can can be calculated as : (100 +60 +25 – 35) –(80 + 50 +10 – 7
40) = 150 – 100 = Rs.50 lakh 7.
< TOP >
Answer : (c)
EBIT Reason : Degree of Financial Leverage Leverage (DFL) =
EBIT − I −
Dp 1− T D
Now, at the financial break – even point, EBIT= I + 1 − T Dp I+ − 1 T , DFL will be negative. If EBIT <
8.
< TOP >
Answer : (c) Reason : Spontaneous Spontaneous sources of financing financing current assets assets arise in the course of of day to day business business and they do not entail any cash outflows. Equity capital, debenture capital, term loan and preference capital are not spontaneous sources because they do not arise in the course of day to day business and they entail cash outflows. However, accrued wages are a spontaneous source of financing current assets because they arise in the course of day to day business and they do not entail any cash outflows.
9.
< TOP >
Answer : (b) Reason : If the average stock of raw materials materials is increased to two times its original level then the raw materials storage period increases to two times the original level.
10.
< TOP >
Answer : (b) Average balance of trade creditors Average Average dailypurchase =
Reason : Average payment period Average balance of trade creditors
Average daily purchases
opening creditors + closing creditors 2 = = 21,25,000 Annual Credit Purchases Number of days in a year
=
=
52,92,500 = 14,500 365 21, 21, 25,000 5dayss ≈ 147da 7days = 146.55day = 14,500
Average payment period 11.
< TOP >
Answer : (b) Reason : Cost of preference preference capital can be be calculated from from the following: following: Po =
n
∑ t =1
Dt t
+
Pn
(1 + k ) (1 + k ) p
p
n
where symbols are in their standard use. Substituting the vine values, we get 95 = 12 × PVIFA (k p,15) + 110 × PVIF (k p, 15) At k p = 13% RHS = 12 × 6.462 +110 ×0.160 = 95.144 AT k p = 14% RHS = 12 × 6.142 +110 ×0.140 = 89.10 Interpolating, Interpolating, we get
k p
=
95.144 − 95.00 ×1% 95.144 − 89.10
13% +
= 13.02% 8
12.
< TOP >
Answer : (d) Reason : Foreign exchange by MMTC represents a credit entry in India’s Balance of Payments Statement. Options in a,b,c and e are debit entries in India’s Balance of Payments Statement.
13.
< TOP >
Answer : (d) Reason : The process of correction of imbalance in international receipts and payments between the two countries is known as price-specie flow mechanism. Options in a,b,c and e are not correct.
14.
< TOP >
Answer : (b) Reason : (a)
International product life cycle theory explains the various various stages stages in the the life a new product and the resultant international trade.
(b) According to Imitation Imitation gap theory, the resulting resulting inventions and innovations innovations in existing products give rise to trade between such countries. (c)
According to the theory theory of absolute absolute advantage advantage international international trade takes place because one country may be more efficient in producing a particular good than another country which is able to produces some other good more efficiently than the first one. This provides an incentive to trade as both countries can benefit from specialization.
(d) According to the theory of comparative advantage, trade is possible as long as the country experiencing the disadvantage is not equally less efficient in producing all the products, that is both the countries enjoy comparative comparative advantage in atleast one of the products. (e)
15.
According to Heckscher-Ohlin Heckscher-Ohlin model, model, the reason for two countries countries benefiting benefiting from the trade is the differences in their factor endowments. Hence the correct answer is (b). < TOP >
Answer : (d) Reason : The exchange rates under floating exchange rate system are determined by the demand and supply position for the currencies in the foreign exchange market. (a)
When a group group of countries countries get together together and agree agree to maintain maintain the exchange exchange rates rates between the currencies within a certain band around fixed central exchange rates, then it is called a target zone arrangement. arrangement.
(b) A crawling peg system is a hybrid of fixed and flexible exchange rate system. Under this system, while the value of a currency is fixed in terms of a reference currency, this peg itself keeps changing in accordance with the underlying economic fundamentals. (c) Under fixed exchange rate system, the value of a currency in terms of another is fixed and it is determined by Governments or Central banks of the respective countries. (e)
16.
Under a currency board system, a country fixes the rate of its domestic currency in terms of a foreign currency and its exchange rate in terms of other currencies depends on the exchange rates between the other currencies and the currency to which the domestic currency is pegged. < TOP >
Answer : (b) Reason : Any increase or decrease in the value of a foreign liability in terms of the domestic currency is called currency risk.
17.
Answer : (a) Reason : Nostro account means, our account with you. For Citibank Newyork, the account is called as Nostro account.
< TOP >
18.
Answer : (b) Reason : (a)
< TOP >
A quote in terms of U.S. dollars per unit of any other currency is called an American quote.
(b) A quote in terms of number of units of any other currency per U.S. dollar is called an European quote. (c) & (d) are examples of currencies quoted in American terms. 9
19.
< TOP >
Answer : (c) Reason : The exposure that arises from the need to convert values of assets and liabilities denominated in a foreign currency into the domestic currency is called translation exposure.
20.
< TOP >
Answer : (b) Reason : The synthetic synthetic rates of US $/Euro are =
(US$/S$)bid × (S$/Euro) bid
=
1 × (S$ (S$ / Euro) Euro)bid (S$ / US$) US$)ask
=
1 × 2.0118 1.7386 = 1.1571.
Similarly (US$/Euro)ask =
1 × 2.0121 1.7384 = 1.1574.
(US $/Euro) bid
US$/Euro = 1.1571/74. 21.
0.03 1+ 4 ×1.1410 1 + 0.02 4 Reason : Reason : = 22.
< TOP >
Answer : (b)
$ 1.1438/Euro. < TOP >
Answer : (c) Reason : Bid rate for pound is Rs.81.79. This means banker gives Rs.81.79 to take one pound. If banker agrees to quote a better rate he pays still more by 2 paise to take one pound. So 2 paise is to be added to the bid rate. Correct answer is Rs.81.81.
23.
< TOP >
Answer : (b) 0.10
Reason : Profit margin of 0.10% is to be deducted from the bid rate. That is 43.06 × 100 = Rs.0.04 Spot bid rate = 43.06 – 0.04 = 43.02. 24.
< TOP >
Answer : (a) Reason : The relationship relationship between the exchange exchange rate and the prices prices of tradeable goods goods is known as the purchasing power parity theory.
25.
< TOP >
Answer : (d) Reason : If U.K interest rates are higher than Japanese interest rates, the theory of covered interest arbitrage would suggest that in the £/yen exchange markets, the yen would be at a forward premium and the pound would be at a forward discount.
26.
Answer : (b) Reason : Options in a, c, d and e are marketing strategies for management management of economic exposure. Option in b is the production strategy for management of economic exposure.
< TOP >
27.
Answer : (a)
< TOP >
Reason : In the currency board system, the board does not have any discretionary powers over the monetary policy; the interest rates are automatically set by the market mechanism. Options (b), (c), (d) and (e) are not true. 28.
< TOP >
Answer : (d) Reason : Samurai bond is a bond denominated in yen and issued by non-Japanese borrowers to the public in Japan.
29.
< TOP >
Answer : (c) Reason : According to the Interest Interest rate parity or the covered interest interest parity condition, condition, the cost of borrowing money or the rate of return on financial investments, when adjusted for the cost of covering foreign exchange risk is equal across different currencies.
30.
< TOP >
Answer : (b) 10
Reason : Overtrading means that the firm has disproportionately disproportionat ely low level of working capital with respect to the level of sales. To define it as a state in which the firm has disproportionately high level of working capital with respect to sales or a disproportionately high level of receivables with respect to total assets or a disproportionately high level of cash with respect to total assets or low turnover of working capital is incorrect. Hence, alternative (b) is answer.
Section B : Problems 1.
If treasury manager borrows $10 million, the amount payable after a fortnight with interest at 5%pa. = =
10000000 × (1 + .05/24) $10020833.33.
Convert $10 million into euro at $1.2845 /euro and invest at 4% pa for a fortnight. 10000000
Inflow of Euro with interest
1.2845 x (1 + .04/24)
= =
Euro 7798105.618
Convert Euro into $ at 1.2885 $/Euro. =
7798105.618 x 1.2885
=
$10047859.09.
Repay the loan with interest Gain =
=
10047859.09 – 10020833.33
$27025.76. < TOP >
5
2.
a.
NPV =
CF
∑ (1 + it) t t =1
– 2200
=
900 850 700 650 500 + + + + 2 3 4 (1.15) (1.15) (1.15) (1.15) (1.15) 5 – 2200
=
305.820 (in Rs.’000s)
=
305.82 × 1000 = Rs.3,05,820 Pr esent value of benefits
b.
Benefit cost ratio
= c.
=
Initial investment
305820 + 2200000 2200000 = 1.14 (approx.)
Let IRR be ‘r’.
∴
900 850 700 650 500 + + + + 2 (1 + r ) 3 (1 + r ) 4 (1 + r ) 5 2200 = (1 + r ) (1 + r )
For r = 19%; RHS = 2305.593 r = 21%; RHS = 2215.496 r = 22%; RHS = 2172.692
∴
22 − 21 r = 21 + (2172.692 − 2215.496) (2200 – 2215.496)
=
21.36%
∴ Internal rate of return = 21.36% < TOP >
3.
The company can invest in home currency (NZ $) at 3.2%, US $ at 2.4%, £ at 2.8% and Euro at 3.0% for 3 months. 11
I.
II.
1 + 0.032 4 3000000 ×
Investment in NZ $ Return after 3 months
=
= 3024000 3024000 – 3000000
=
NZ$24000
Investment in US $ Surplus of NZ$3 million is to be converted into US dollars and is invested in US dollars at 2.4%. The amount in US $ is coverted into NZ $ by covering at 3 month forward rate. NZ $ 3000000 converted into US$ at the NZ $/$ 3000000
Spot selling rate
1.5524
=
Amount received in US$ =
1932491.63
Says $1932492
Invest at 2.4% for 3 months =
=
1 + 0.024 4 1932492 ×
$1944086.95 Says $1944087
Convert into NZ$ at 3 months forward buying rate of 1.5663 = =
1944087 × 1.5663 $3045023.47 says $3045023
Return after 3 months = 3045023 – 3000000 = NZ $45023 III. Investment in £ NZ $/£ spot bid rate = 1.5522 × 1.7960 = 2.7878 NZ $/£ spot ask rate = 1.5524 × 1.7962 = 2.7884 NZ $/£ 3 months forward bid rate = 1.5663 × 1.7885 = 2.8013 NZ $/£ 3 months forward ask rate = 1.5665 × 1.7887 = 2.8020 Surplus of NZ $ 3 million is to be converted into pounds and the amount is invested at 2.8% for 3 months by covering at 3 month forward rate. NZ$3000000 converted into pounds at NZ$/£ spot selling rate 3000000
= Amount received receive d in pounds
Invest at 2.8% for 3 months
2.7884
=
1075885.81
says £1075886
=
1 + 0.028 4 1075886 ×
=
£1083417.20
says £1083417
Convert into NZ$ at 3 months forward buying rate of 2.8013
Return after 3 months IV. Investment in Euro
=
1083417 × 2.8013
=
3034976.04
=
3034976 – 3000000 =
says NZ$ 3034976 NZ$ 34976
1
NZ$ / Euro spot bid rate = 1.5522 × 1.7960 × 1.4652
=
1.9026
=
1.9034
1
NZ$ / Euro spot ask rate = 1.5524 × 1.7962 × 1.4650
1
NZ$ / Euro 3 months forward bid rate = 1.5663 × 1.7885 × 1.4572 =
12
1.9224
1
NZ$ / Euro 3 months forward ask rate = 1.5665 × 1.7887 × 1.4570 =
1.9231
Surplus of NZ$ 3 million is to be converted into Euro and the amount is invested in Euro at 3% for 3 months by covering at 3 months forward rate. 3000000
NZ$ 3000000 converted into euro at NZ$ / Euro spot selling rate Amount received in Euro = 1576126.93
Invest at 3% for 3 months
=
1.9034
say 1576127
=
1 + 0.03 4 1576127 ×
=
1587947.95
says 1587948
Convert into NZ$ at 3 months forward buying rate of 1.9224
Return after 3 months
= =
1587948 × 1.9224 3052671.24 says NZ$ 3052671
= =
3052671 – 3000000 NZ$ 52671
The company should invest in Euro, since the return in investment is more when compared to the others. < TOP >
4.
a.
Normal consumption during the lead time =
(Expected daily usage rate) x (Expected lead time in days) Expected daily usage = 5(0.3) + 7(0.4) + 9(0.3) = 7 Expected lead time = 15(0.5) + 25(0.3) + 30(0.2) = 21 Normal consumption = 7 x 21 = 147 tonnes Since the normal consumption during the lead time is 147 tonnes, stockouts can occur only if the consumption during the lead time is more than 147 tonnes. The lead time consumption of more than 147 tonnes along with their respective probabilities of occurrence can be identified from the following table:
Possible levels of usage
Daily usage rate
Units
5
7
Probability
0.3
0.4
Lead time in days
Possible levels of usage
Units
Probability
Units
Probability
15
0.5
75
0.15
25
0.3
125
0.09
30
0.2
150
0.06
15
0.5
105
0.20
0.3
175
0.12
0.2
210
0.08
25
30
13
Safety stock (tones)
Stockouts (tonnes)
Probability
123 78 63
0 45 60 15
0 0.06 0.06 0.09
28
95 50 35
0.06 0.09 0.08
120 75 60 25
0.06 0.09 0.08 0.12
123 78 63 28 3
0.06 0.09 0.08 0.12 0.06
3
0
Expected stock out (tonnes) 0 2.70 3.60 1.35 4.95 5.70 4.50 2.80 13 7.20 6.75 4.80 3.00 21.75 7.38 7.02 5.04 3.36 0.18 22.98
stockout cost Rs. (4) × 4500 = (5) 0 12,150 22,275 22,2 75
cost (Rs.) (1) × 1200 = (6)
(Rs.) (5 + 6) = (7)
1,47,600 93,600 75,600
1,47,600 1,05,750 97,875
58,500
33,600
92,100
97,875
3,600
1,01,475
1,03,410
0
1,03,410
The total cost is least when the safety stock is maintained at 28 tonnes. ∴The optimal safety stock level is 28 tonnes. < TOP >
5.
Exports of goods and services are affected by the following factors :
• The prevailing exchange rate of the domestic currency : A lower value of the domestic currency results in the domestic price getting translated into a lower international price. This increases the demand for domestic goods and services and hence their export. This is likely to result in a higher demand for the domestic currency. A higher exchange rate would have an exactly opposite effect.
• Inflation rate : The inflation rate in an economy vis-à-vis other economies affects the international competitiveness of the domestic goods and hence their demand. Higher the inflation, lower the competitiveness and lower the demand for domestic goods. Yet, a lower the demand for domestic goods and services need not necessarily mean a lower demand for the domestic currency. If the demand for domestic goods is relatively inelastic, then the fall in demand may not offset the rise in price completely, resulting in an increase in the value of exports. This would end up increasing the demand for the local currency. For example, suppose India exports exports 100 quintals of wheat to the US at a price of Rs. 500 per quintal. Further, assume that due to domestic inflation, the price increases to Rs. 530 per quintal and there is a resultant fall in the quantity demanded to 96 quintals. The exports would increase from Rs. 50,000 to Rs. 52,800 instead of falling.
• World prices of a commodity : If the price of a commodity increases in the world market, the value of exports for that particular product shows a corresponding increase. This would result in an increase in the demand for the domestic currency. A fall in the demand for domestic currency would be experienced in case of a reduction in the international price of a commodity. This impact is different from the previous one. The previous example considered an increase in the domestic prices of all goods produced in an economy simultaneously, while this one considers a change in the international price of a single commodity due to some exogenous reasons.
• Incomes of foreigners : There is a positive correlation between the incomes incomes of the residents of an economy to which the domestic goods are exported, and exports. Hence, other things remaining the same, an increase in the standard of living (and hence, an increase in the incomes of the residents) of such an economy will result in an increase in the exports of the domestic economy. Once again, this would increase the demand for the local currency.
• Trade barriers : Higher the trade barriers erected by other economies against the exports from a country, lower will be the demand for its exports and hence, for its currency. < TOP >
Section C: Applied Theory 6.
Problems Encountered in Financial Statement Analysis
14
Analysis of financial statements using ratios can be very helpful in understanding a company’s financial performance and condition. Yet there are certain problems which come in the way of such an analysis. Development of benchmarks
Many companies have operations spread across a number of industries. As there may not be any other company having a presence in the same industries, that too in the same proportion, development of a benchmark becomes a problem. Even when the company is not a diversified one, figures for the various firms are needed in addition to the industry average, in order to draw a meaningful conclusion. Window-dressing
Firms may window-dress the financial statements in order to show a rosy picture. In such a case, the whole exercise of analyzing the statements becomes useless. In order to draw some meaningful results out of the analysis, the average figures over a period of time should be looked into. Price level changes
Financial statements do not take into account changes in price levels. Analysis of such statements may not give a true picture of the state of affairs. Differences in accounting policies
Different companies may follow different accounting policies in respect of depreciation, stock valuation etc. Comparison between the ratios of two firms following different policies may not give the true result. Interpretation of results
A problem may arise on two accounts – interpretation of ratios on its own, and interpretation of all the ratios taken together. It is difficult to decide the optimum level of a ratio, inspite of the presence of industry averages. For e.g. it is difficult to say whether a high current ratio shows a good liquidity position or an unnecessarily high level of inventories. Secondly, some ratios may be in favor of a company, while some others may be against it. In such a case, it may be difficult to form an overall opinion about the company. Correlation among ratios
There may be a high degree of correlation among the various ratios calculated, due to the presence of some common factor. This may make interpretation of all the ratios confusing. Hence, it becomes essential to choose a few ratios which can convey the required information. < TOP >
7.
The various external hedging techniques used for hedging transaction and translation exposures are Forward Market
In a forward market hedge, a company that is long on a foreign currency will sell the foreign currency forward, whereas a company that is short on a foreign currency will buy the currency forward. In this way the company can fix the domestic currency value of future foreign currency cash flow, regardless of what happens to the future spot rate. Futures Market
To hedge in the futures market, go short in futures if you are long in the currency and vice versa. Hedging through futures has an effect similar to hedging through a forward contract. As the loss/gain on the underlying transaction has an offsetting impact the gain/loss on the futures contract, the exposure gets almost eliminated. Options Market
Hedging through options is much more beneficial than hedging through futures or forwards. This is because in an option contract, the loss is limited whereas the profit is unlimited. Since the firm has the right to buy or sell the foreign currency currency but not the obligation, it can let the option expire by not exercising its right in case the exchange rates move in its favor, thereby making the profits it would not have made had it hedged through forwards or futures. If there is a receivable, buy a put option. In the case of a payable, buy a call option. Money Market
A money market hedge involves simultaneous borrowing and lending activities in two different currencies to lock in the domestic currency value of a future foreign currency cash flow. By doing this, the firm knows its total cost in advance in the form of principal and interest it needs to repay in the domestic markets. For example, a firm has a dollar payable after three months. It can borrow in the domestic currency now, convert it at the spot rate into dollars, invest these dollars in the money markets and use the proceeds to pay the payable after three months. < TOP >
< TOP OF THE DOCUMENT >
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