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A US company has agreed to buy goods from a company in the UK. Payment is against delivery and the invoices will be in Sterling (GBP).
The first delivery of goods will be on 31st March 2017 for the sum of GBP 15 million. Under the same contract, the US company has the option of buying a second consignment of the same goods, at the same price, for delivery on 30th June 2017. The US company has until 15th April 2017 to decide whether to take up the second consignment.
As at 6th January 2017 the following information is available:
Spot FX rate 1 GBP = USD 1.2280 – 1.2285
1 month forward rate 1 GBP = USD 1.2285 – 1.2291
3 month forward rate 1 GBP = USD 1.2298 – 1.2305
6 month forward rate 1 GBP = USD 1.2330 – 1.2337
USD rates 1 month 0.7656 – 0.8250% pa
3 month 1.0093 – 1.0690% pa
6 month 1.3210 – 1.3800% pa
GBP rates 1 month 0.2579 – 0.3180% pa
3 month 0.3728 – 0.4330% pa
6 month 0.5355 – 0.5950% pa
GBP/USD Currency Futures (CME)
March 2017 1.2293
June 2017 1.2325
September 2017 1.2358
(a) It is the first time that the US company has imported goods from the UK having previously imported similar goods from Germany. With reference to currency movements since the Brexit referendum (June 2016) suggest reasons for this. (10 marks)
(b) Explain the nature of the currency risk that the US company is exposed to and discuss the factors that might influence the company’s decision as to whether to hedge this risk. (10 marks)
(c) For the first delivery on 31st March 2017 suggest 3 alternative ways of hedging the currency risk. Your answer should include appropriate calculations and should make a recommendation as to the preferred hedging strategy. (10 marks)
(d) For the first delivery on 31st March 2017, determine the effectiveness of the 3 hedging strategies suggested in (c) above relative to remaining unhedged. (8 marks)
(e) Given that the second consignment is not necessarily going to be ordered discuss why using currency options is a suitable hedging strategy. Additionally, use the Black-Scholes option pricing model to determine the likely cost of this option, using the data presented as at 6th January 2017, and justifying any assumptions made. (The implied volatility of GBP/USD at-the-money options was about 10% on 6th January 2017, but has been as high as 18% over the last 6 months.) (12 marks)
Question 2 – Global Stock Markets
Many international stock markets performed well in 2016, with many markets in the US and Europe reaching all-time highs. Contributing factors might include an improvement in the US economy and a rally in commodity prices including oil. However, the past year also witnessed a series of political shocks and the markets’ response was not what many investors expected.
(a) Research and report on the extent to which the performance of stock markets around the world have become integrated. For this report I expect consideration of data from 1st January 2015 until 31st March 2017, with extra marks awarded for good geographical coverage and any quantitative analysis provided. (15 marks)
(b) Choose a FTSE-100 company with international operations. For your selected company collect, present and analyse data that enables you to fully discuss the impact of recent and relevant political and economic events on the company’s share price performance. A good analysis will include relative share price performance against the sector as well as against the FTSE-100. For your selected company please also detail any recent capital fund raising and capital restructuring, as appropriate. For this report and analysis I expect you to consider data from 1st January 2016 to 31st March 2017. (25 marks)
(c) Forecasts are very difficult to make. In early January 2017 Andy Haldane (Chief Economist at the Bank of England) described the failure of economists to predict the financial crisis of 2007/2008 as a ‘Michael Fish’ moment. In the same speech, Andy Haldane also spoke about the performance of the UK economy post the Brexit vote. For your chosen FTSE-100 company, identify and discuss relevant issues likely to affect their share price performance in 2017. (10 marks)
(Total = 50 marks)