Question 1

SECTION B: ADVISORY REPORT

This question is worth 25 marks.

CeresAgri is a multinational agricultural technology (AgriTech) firm based in the United States. The company has recently expanded its operations into Brazil and has committed to purchasing specialized drone and sensor equipment from a local Brazilian manufacturer.

CeresAgri must make a payment of BRL 150 million (Brazilian Real) in exactly six months. The central treasury team is concerned about the recent volatility of the BRL against the US Dollar (USD) and wishes to hedge this exposure.

EXHIBIT 1: Foreign Exchange Data
Current Spot Rate: BRL 5.0500 - 5.0650 / USD
Six-month Forward Rate: BRL 5.1200 - 5.1450 / USD

Currency Options (Over-The-Counter):
CeresAgri's bank has offered a six-month OTC currency option to buy BRL 150 million at a strike price of BRL 5.1000 / USD. The premium for this option is USD 450,000, payable immediately.

Money Market Rates (Annualized):
US Dollar (USD): Borrowing 4.5%, Deposit 3.0%
Brazilian Real (BRL): Borrowing 11.0%, Deposit 9.0%

EXHIBIT 2: Interest Rate Exposure
In addition to the FX exposure, CeresAgri recently took out a USD 50 million floating-rate loan to fund a new R&D facility. The loan has a 4-year maturity, and interest is payable semi-annually at SOFR + 2.0%. 
The treasury team is worried that SOFR (Secured Overnight Financing Rate) will rise over the next four years. A bank has offered CeresAgri an interest rate swap where CeresAgri would pay a fixed rate of 3.8% and receive SOFR.

REQUIREMENTS:

(a) Evaluate the following hedging strategies for the BRL 150 million payment, calculating the expected USD cost for each:
(i) Forward Exchange Contract
(ii) Money Market Hedge
(iii) OTC Currency Option (assuming the spot rate in six months is BRL 5.0000 / USD and BRL 5.2000 / USD).
Recommend the most appropriate hedging strategy for CeresAgri. (14 marks)

(b) Explain how the proposed interest rate swap would function to hedge CeresAgri's USD 50 million loan. Calculate the effective annual interest rate CeresAgri will pay if they enter into the swap. (6 marks)

(c) Discuss the advantages and disadvantages of CeresAgri managing its foreign exchange and interest rate risks through a centralized treasury function rather than allowing regional subsidiaries to manage their own risks. (5 marks)

Accepted Answer

For part (a), calculate the forward cost by dividing the BRL amount by the lower forward rate. For the money market hedge, discount the BRL amount by the BRL deposit rate, convert at the spot rate, and compound by the USD borrowing rate. For the option, calculate the cost at the given spot rates versus the strike rate, add the future value of the premium, and compare. For part (b), set up a simple table showing the cash flows: Pay lender, Receive swap, Pay swap, and sum them up. For part (c), list standard pros (netting, expertise, scale) and cons (loss of local knowledge, IT costs) of central treasuries.

Question 2

What mistakes do candidates make on this ACCA question?

Accepted Answer

Students frequently multiply instead of divide when using indirect quotes. Another common error is using the wrong interest rate in the money market hedge (e.g., borrowing BRL instead of depositing BRL). In options, students often forget to calculate the future value of the premium to make it comparable to the future cash flows.

How to approach this question

Full Answer

Common mistakes

Practice the full ACCA AFM — Advanced Financial Management Practice Exam 5

More questions from this exam