Risk Management

**Section A** The current spot exchange rate between the Euro (EUR) and the Brazilian Real (BRL) is EUR 1 = BRL 5.50. Annual inflation is expected to be 2% in the Eurozone and 8% in Brazil. According to Purchasing Power Parity (PPP), what is the expected spot rate in one year? (Round to two decimal places).

**Section A** TitaniumTech imports rare-earth metals and frequently faces foreign exchange transaction risk. The treasury team is debating whether to use forward exchange contracts or currency options to hedge a large upcoming payment. Which of the following is a distinct advantage of using a currency option over a forward contract?

**Section B - Case 3: GlobalCart** *Scenario:* GlobalCart is a UK-based cross-border e-commerce company. Its functional currency is the British Pound (GBP). GlobalCart imports electronics from the US and exports them to Europe. The company expects to receive EUR 500,000 in 3 months from European customers. It also needs to pay USD 300,000 in 6 months to its US suppliers. **Question:** The risk that the GBP value of the EUR 500,000 receipt will fall between now and the settlement date in 3 months is known as what type of risk?

**Section B - Case 3: GlobalCart** *Scenario:* GlobalCart is a UK-based cross-border e-commerce company. Its functional currency is the British Pound (GBP). GlobalCart imports electronics from the US and exports them to Europe. The company expects to receive EUR 500,000 in 3 months from European customers. It also needs to pay USD 300,000 in 6 months to its US suppliers. **Question:** GlobalCart decides to hedge the EUR 500,000 receipt using a forward contract. The current spot rate is EUR/GBP 1.1500 - 1.1540. The 3-month forward premium is 0.0020 - 0.0015. What forward rate will the bank offer GlobalCart to sell its Euros?

**Section B - Case 3: GlobalCart** *Scenario:* GlobalCart is a UK-based cross-border e-commerce company. Its functional currency is the British Pound (GBP). GlobalCart imports electronics from the US and exports them to Europe. The company expects to receive EUR 500,000 in 3 months from European customers. It also needs to pay USD 300,000 in 6 months to its US suppliers. **Question:** GlobalCart is considering a money market hedge for the USD 300,000 payment due in 6 months. Which of the following represents the correct sequence of steps for a money market hedge for a **future foreign currency payment**?

**Section B - Case 3: GlobalCart** *Scenario:* GlobalCart is a UK-based cross-border e-commerce company. Its functional currency is the British Pound (GBP). GlobalCart imports electronics from the US and exports them to Europe. The company expects to receive EUR 500,000 in 3 months from European customers. It also needs to pay USD 300,000 in 6 months to its US suppliers. **Question:** GlobalCart's finance director is comparing exchange-traded currency futures with over-the-counter (OTC) currency options. Which TWO of the following statements are correct?

**Section B - Case 3: GlobalCart** *Scenario:* GlobalCart is a UK-based cross-border e-commerce company. Its functional currency is the British Pound (GBP). GlobalCart imports electronics from the US and exports them to Europe. The company expects to receive EUR 500,000 in 3 months from European customers. It also needs to pay USD 300,000 in 6 months to its US suppliers. **Question:** The current spot rate is GBP 1 = USD 1.2500. The 6-month interest rate in the UK is 4% per annum. The 6-month interest rate in the US is 6% per annum. Using Interest Rate Parity (IRP) theory, what is the theoretical 6-month forward rate? (Round to four decimal places).

Section A A corporate treasurer has entered into a '4 v 9' Forward Rate Agreement (FRA) to hedge against rising interest rates on a future borrowing. What does the term '4 v 9' indicate regarding the timing of the FRA?

Section A Two companies, Firm A and Firm B, enter into an interest rate swap. Firm A has a comparative advantage in borrowing at fixed rates, while Firm B has a comparative advantage in borrowing at floating rates. Which of the following risks is introduced specifically by entering into this swap agreement?

Section B - Case 3: Nexus Co Nexus Co is a UK-based manufacturer of specialized robotics. The company exports to Europe and imports components from Japan. The home currency is the GBP (£). Nexus Co is due to receive €500,000 from a European customer in 3 months. Exchange rates available: Spot rate (EUR/GBP): 1.1520 - 1.1560 3-month forward rate (EUR/GBP): 1.1450 - 1.1500 If Nexus Co uses a forward market hedge, what will be the guaranteed GBP receipt?

Section B - Case 3: Nexus Co Nexus Co also needs to pay a Japanese supplier ¥50,000,000 in 6 months. The treasurer is considering a Money Market Hedge. Which of the following steps are required to set up a Money Market Hedge for a future foreign currency PAYMENT? (Select ALL that apply)

Section B - Case 3: Nexus Co Nexus Co is forecasting exchange rates for its strategic planning. The current spot rate is ¥160 / £1. Annual inflation in the UK is expected to be 3%. Annual inflation in Japan is expected to be 1%. Using Purchasing Power Parity (PPP), calculate the expected spot rate in one year's time (¥ per £1). (Round to two decimal places).

Section B - Case 3: Nexus Co Nexus Co has a large floating-rate bank loan. The treasurer is concerned about rising interest rates but also wants to benefit if rates fall. To achieve this while minimizing upfront premium costs, the treasurer decides to use interest rate options to create a 'Collar'. How is an interest rate collar constructed for a borrower?

Section B - Case 3: Nexus Co Nexus Co's board is discussing the long-term impact of the Japanese Yen depreciating significantly against the British Pound over the next 5 years. They are worried that their Japanese competitors will be able to sell robotics in Europe at much cheaper prices, permanently damaging Nexus Co's market share. What type of foreign exchange risk is the board describing?

'RareEarth Imports' is based in the UK and must pay a supplier in USD in 3 months. The finance manager is choosing between a forward exchange contract and a money market hedge. Which of the following is a characteristic of a forward exchange contract compared to a money market hedge?

'MicroLend', a microfinance institution, is analyzing exchange rates. The current spot rate is 1.5000 USD/GBP. The 1-year interest rate in the US is 4%, and the 1-year interest rate in the UK is 6%. According to Interest Rate Parity (IRP), calculate the 1-year forward exchange rate (USD/GBP). (Enter your answer to four decimal places, e.g., 1.2345)

CASE 3: GLOBALBEAN CO GlobalBean Co is a coffee exporter based in the US (reporting in USD). The company frequently sells coffee beans to European buyers, invoicing in Euros (EUR). GlobalBean expects to receive EUR 500,000 in three months. The company is concerned about foreign exchange risk and interest rate risk on a floating rate loan it holds. The risk that the EUR 500,000 receipt will be worth fewer USD when it is actually received and converted in three months is known as what type of risk?

CASE 3: GLOBALBEAN CO GlobalBean Co is a coffee exporter based in the US (reporting in USD). The company frequently sells coffee beans to European buyers, invoicing in Euros (EUR). GlobalBean expects to receive EUR 500,000 in three months. The company is concerned about foreign exchange risk and interest rate risk on a floating rate loan it holds. To hedge the EUR 500,000 receipt using a money market hedge, what is the correct sequence of actions GlobalBean should take today?

CASE 3: GLOBALBEAN CO GlobalBean Co is a coffee exporter based in the US (reporting in USD). The company frequently sells coffee beans to European buyers, invoicing in Euros (EUR). GlobalBean expects to receive EUR 500,000 in three months. The company is concerned about foreign exchange risk and interest rate risk on a floating rate loan it holds. GlobalBean decides to look at currency futures. The standard contract size for EUR futures is EUR 125,000. The tick size is 0.0001 USD/EUR. Calculate the value of one tick per futures contract in USD. (Enter your answer as a number to two decimal places, e.g., 10.50)

CASE 3: GLOBALBEAN CO GlobalBean Co is a coffee exporter based in the US (reporting in USD). The company frequently sells coffee beans to European buyers, invoicing in Euros (EUR). GlobalBean expects to receive EUR 500,000 in three months. The company is concerned about foreign exchange risk and interest rate risk on a floating rate loan it holds. GlobalBean has a $2 million floating rate loan linked to SOFR. The company fears interest rates will rise and wishes to use an Interest Rate Swap to fix its borrowing costs. How should GlobalBean structure the swap with a bank?

CASE 3: GLOBALBEAN CO GlobalBean Co is a coffee exporter based in the US (reporting in USD). The company frequently sells coffee beans to European buyers, invoicing in Euros (EUR). GlobalBean expects to receive EUR 500,000 in three months. The company is concerned about foreign exchange risk and interest rate risk on a floating rate loan it holds. GlobalBean is forecasting exchange rates for next year. The current spot rate is 1.2000 USD/EUR. Annual inflation is expected to be 3% in the US and 1.5% in the Eurozone. Using Purchasing Power Parity (PPP), calculate the expected spot rate in one year (USD/EUR). (Enter your answer to four decimal places, e.g., 1.2345)

**Section A** Horizon Builders expects to borrow $10 million in 3 months' time for a period of 6 months. To hedge against rising interest rates, they enter into a 3-9 Forward Rate Agreement (FRA) at 5.0%. When the borrowing date arrives, the reference market interest rate (LIBOR) is 6.5%. Which of the following statements correctly describes the outcome of the FRA?

**Section A** Which of the following is a primary disadvantage of using currency futures contracts compared to over-the-counter (OTC) forward contracts for hedging foreign exchange risk?

**Section B - Case 3: GlobalLogix** *Scenario:* GlobalLogix is a cross-border logistics firm based in the Eurozone (€). The company expects to receive $2,000,000 from a US client in 3 months' time. Current spot rate ($/€): 1.1500 - 1.1550 3-month forward rate ($/€): 1.1600 - 1.1660 Eurozone interest rates: Borrow 2.0% per year, Deposit 1.0% per year. US interest rates: Borrow 4.0% per year, Deposit 3.0% per year. If GlobalLogix uses a forward contract to hedge this receipt, how many Euros (€) will they receive in 3 months?

**Section B - Case 3: GlobalLogix** *Scenario:* GlobalLogix is a cross-border logistics firm based in the Eurozone (€). The company expects to receive $2,000,000 from a US client in 3 months' time. Current spot rate ($/€): 1.1500 - 1.1550 3-month forward rate ($/€): 1.1600 - 1.1660 Eurozone interest rates: Borrow 2.0% per year, Deposit 1.0% per year. US interest rates: Borrow 4.0% per year, Deposit 3.0% per year. GlobalLogix is considering a money market hedge instead of a forward contract. What is the correct sequence of steps to set up this hedge today?

**Section B - Case 3: GlobalLogix** *Scenario:* GlobalLogix is a cross-border logistics firm based in the Eurozone (€). The company expects to receive $2,000,000 from a US client in 3 months' time. Current spot rate ($/€): 1.1500 - 1.1550 3-month forward rate ($/€): 1.1600 - 1.1660 Eurozone interest rates: Borrow 2.0% per year, Deposit 1.0% per year. US interest rates: Borrow 4.0% per year, Deposit 3.0% per year. The risk that the $2,000,000 receipt will be worth fewer Euros than expected when it is actually converted in 3 months is an example of which type of foreign exchange risk?

**Section B - Case 3: GlobalLogix** *Scenario:* GlobalLogix is a cross-border logistics firm based in the Eurozone (€). The company expects to receive $2,000,000 from a US client in 3 months' time. Current spot rate ($/€): 1.1500 - 1.1550 3-month forward rate ($/€): 1.1600 - 1.1660 Eurozone interest rates: Borrow 2.0% per year, Deposit 1.0% per year. US interest rates: Borrow 4.0% per year, Deposit 3.0% per year. Assume the annual inflation rate is expected to be 3.0% in the US and 1.5% in the Eurozone. Using Purchasing Power Parity (PPP), forecast the expected spot rate ($/€) in exactly one year's time. Use the spot rate of 1.1550 as your base. (Provide your answer to four decimal places, e.g., 1.1234).

**Section B - Case 3: GlobalLogix** *Scenario:* GlobalLogix is a cross-border logistics firm based in the Eurozone (€). The company expects to receive $2,000,000 from a US client in 3 months' time. Current spot rate ($/€): 1.1500 - 1.1550 3-month forward rate ($/€): 1.1600 - 1.1660 Eurozone interest rates: Borrow 2.0% per year, Deposit 1.0% per year. US interest rates: Borrow 4.0% per year, Deposit 3.0% per year. GlobalLogix is also considering using currency options to hedge the receipt. Which TWO of the following statements regarding currency options are correct?

**Section A** EuroRail Freight wishes to hedge against rising interest rates on a planned borrowing. The treasurer enters into a '4-v-7' Forward Rate Agreement (FRA). What does the term '4-v-7' indicate regarding the timing of the FRA?

**Section A** Andean Copper, based in Chile, exports to the USA. The current spot exchange rate is 800 CLP/USD (Chilean Pesos per US Dollar). Annual inflation is expected to be 5% in Chile and 2% in the USA. According to Purchasing Power Parity (PPP), what is the expected spot exchange rate in one year's time? (Round to two decimal places)

**Section B - Case 1: Verdant Yields Co** *Scenario:* Verdant Yields Co is an organic avocado exporter. The business is highly seasonal. Annual credit sales are $18,250,000. The current trade receivables balance is $3,000,000. Assume a 365-day year. **Question 5:** Verdant Yields expects to receive a large payment in Euros in three months. The treasury team believes the Euro will depreciate against their home currency over this period. Which internal hedging technique should Verdant Yields attempt to negotiate with the customer?

**Section B - Case 3: AeroFreight Logistics** *Scenario:* AeroFreight Logistics operates drone deliveries across Europe and Asia. The company is based in the UK (GBP). It owes a supplier €500,000 payable in 6 months. Spot rate: €1.1500 - €1.1550 / £1 6-month forward rate: €1.1400 - €1.1460 / £1 UK 6-month borrowing rate: 4% (annual) Euro 6-month deposit rate: 2% (annual) **Question 1:** If AeroFreight uses a forward market hedge, what will be the exact GBP cost of the €500,000 payment in 6 months?

**Section B - Case 3: AeroFreight Logistics** *Scenario:* AeroFreight Logistics operates drone deliveries across Europe and Asia. The company is based in the UK (GBP). It owes a supplier €500,000 payable in 6 months. Spot rate: €1.1500 - €1.1550 / £1 6-month forward rate: €1.1400 - €1.1460 / £1 UK 6-month borrowing rate: 4% (annual) Euro 6-month deposit rate: 2% (annual) **Question 2:** According to Interest Rate Parity (IRR), why is the Euro trading at a forward premium against the GBP?

**Section B - Case 3: AeroFreight Logistics** *Scenario:* AeroFreight Logistics operates drone deliveries across Europe and Asia. The company is based in the UK (GBP). It owes a supplier €500,000 payable in 6 months. Spot rate: €1.1500 - €1.1550 / £1 6-month forward rate: €1.1400 - €1.1460 / £1 UK 6-month borrowing rate: 4% (annual) Euro 6-month deposit rate: 2% (annual) **Question 5:** AeroFreight's operations are subject to various risks. According to portfolio theory, which TWO of the following represent systematic risk for AeroFreight?

Section A CryptoVault Exchange is concerned that interest rates on its fiat currency borrowings will rise over the next six months. The treasury team is deciding between a Forward Rate Agreement (FRA) and an Interest Rate Guarantee (IRG). Which of the following statements is true regarding these hedging instruments?

Section A A multinational firm is evaluating cash flows from a fictional emerging market, 'Zandia'. The current spot exchange rate is 15.00 Zandian Dollars (ZD) to 1 US Dollar ($). Annual inflation in Zandia is expected to be 12%, while US inflation is expected to be 3%. According to Purchasing Power Parity (PPP), what is the expected exchange rate (ZD per $) in exactly one year? (Round to two decimal places)

Section B - Case 3: LithiumX Scenario: LithiumX is a cross-border mining company based in the US. It expects to receive €2,000,000 in exactly 3 months from a European client. Spot exchange rate: €1.1500 - €1.1550 / $1 3-month forward rate: €1.1600 - €1.1640 / $1 US interest rates: 4% borrow, 2% deposit (annual) Euro interest rates: 5% borrow, 3% deposit (annual) Question: If LithiumX uses a forward market hedge, what will be the guaranteed US Dollar ($) receipt in 3 months?

Section B - Case 3: LithiumX Scenario: LithiumX is a cross-border mining company based in the US. It expects to receive €2,000,000 in exactly 3 months from a European client. Spot exchange rate: €1.1500 - €1.1550 / $1 3-month forward rate: €1.1600 - €1.1640 / $1 US interest rates: 4% borrow, 2% deposit (annual) Euro interest rates: 5% borrow, 3% deposit (annual) Question: What is the first step LithiumX must take to set up a money market hedge for this €2,000,000 receipt?

Section B - Case 3: LithiumX Scenario: LithiumX is a cross-border mining company based in the US. It expects to receive €2,000,000 in exactly 3 months from a European client. Spot exchange rate: €1.1500 - €1.1550 / $1 3-month forward rate: €1.1600 - €1.1640 / $1 US interest rates: 4% borrow, 2% deposit (annual) Euro interest rates: 5% borrow, 3% deposit (annual) LithiumX is also bidding on a new contract in Japan. If they win the contract, they will receive ¥500 million in 6 months. If they lose, they receive nothing. The contract award date is in 1 month. Question: Which hedging instrument is most appropriate for the potential Japanese Yen receipt?

Section B - Case 3: LithiumX Scenario: LithiumX is a cross-border mining company based in the US. It expects to receive €2,000,000 in exactly 3 months from a European client. Spot exchange rate: €1.1500 - €1.1550 / $1 3-month forward rate: €1.1600 - €1.1640 / $1 US interest rates: 4% borrow, 2% deposit (annual) Euro interest rates: 5% borrow, 3% deposit (annual) LithiumX has a subsidiary in Europe. At year-end, the subsidiary's financial statements, denominated in Euros, must be consolidated into LithiumX's US Dollar financial statements. Question: What type of foreign exchange risk does this consolidation process represent?

Section B - Case 3: LithiumX Scenario: LithiumX is a cross-border mining company based in the US. It expects to receive €2,000,000 in exactly 3 months from a European client. Spot exchange rate: €1.1500 - €1.1550 / $1 3-month forward rate: €1.1600 - €1.1640 / $1 US interest rates: 4% borrow, 2% deposit (annual) Euro interest rates: 5% borrow, 3% deposit (annual) Question: According to Interest Rate Parity (IRP), why is the 3-month forward rate higher (more Euros per Dollar) than the spot rate?