INSTITUTE OF ACCOUNTANCY ARUSHA
IN COLLABORATION WITH
COVENTRY UNIVERSITY (UK)
Master of Science in Finance and Investment
2016/17
FINANCIAL RISK MANAGEMENT (ARUM23 EFA)
REVIEW QUESTIONS
SET ONE REVIEW QUESTIONS
QUESTION ONE [HEDGING FOREIGN PAYABLES]
1
, Pink Ink Company is a U.K. based exporter. It has invoiced a customer for US$350,000 payable on 1 st
September. The current US$/£ spot is: 1.5190 – 1.5230. It wishes to hedge its FX risk exposure using
traded currency options. The £ September calls with an exercise price of US$1.50 have a premium of
8c. The £ call option contracts are in respect of £25,000. Option premiums are quoted in cents/£
REQUIRED:
a) Set up the option hedge and compute the option premium payable
a) If on 1st September, the US$/£ spot is 1.6470 – 1.6500 advise Pink Ink on whether it should allow its
option to lapse or exercise them
QUESTION TWO
Premier company, a Tanzanian Company, imports goods from UK and is invoiced for £216,500 payable
on the 15th January. The Company wishes to hedge using current options at an exercise price of
TZS1,750. Data is as follows:
Exchange Rates: TZS/£ 1,712 – 1,715
£ Options Contract Size is £12,500 March Contracts
Exercise Price £Calls £Puts
1,650 90.25 40.30
1,700 80.45 90.80
1,750 62.50 95.80
Contract prices are in cents/£.
REQUIRED:
i) Show the hedge position and compute its cost.
ii) Illustrate the action the company will take on the 15 th January if the TZS/£ spot rate at that
time is TZS1, 842 – 1,845.
iii) Calculate the Net Saving that the company makes as a result of its option hedge.
QUESTION THREE (HEDGING FOREIGN RECEIVABLES)
Opportunity Company is a Great Britain based exporter. It has invoiced a customer in the United States
of America for US$ 1,1058,000 payable of 30 th June. The current US$/£ spot is 1.7296 – 1,7330
The company wishes to hedge its foreign exchange risk exposure using traded currency options. The £
June calls with an exercise price of 1.70 have a premium of 9c. the £ call option contracts are in respect
of £25,000. Option premiums are quoted in cents/£.
REQUIRED:
i) Set up the option hedge and calculate the option cost. (Hint: Round up the required number
of calls to the nearest whole number)
ii) If on 1st June, the US$/£ spot is 1.8460 – 1.8550, advise Opportunity Company on whether
it should allow the options to expire or exercise them.
2
IN COLLABORATION WITH
COVENTRY UNIVERSITY (UK)
Master of Science in Finance and Investment
2016/17
FINANCIAL RISK MANAGEMENT (ARUM23 EFA)
REVIEW QUESTIONS
SET ONE REVIEW QUESTIONS
QUESTION ONE [HEDGING FOREIGN PAYABLES]
1
, Pink Ink Company is a U.K. based exporter. It has invoiced a customer for US$350,000 payable on 1 st
September. The current US$/£ spot is: 1.5190 – 1.5230. It wishes to hedge its FX risk exposure using
traded currency options. The £ September calls with an exercise price of US$1.50 have a premium of
8c. The £ call option contracts are in respect of £25,000. Option premiums are quoted in cents/£
REQUIRED:
a) Set up the option hedge and compute the option premium payable
a) If on 1st September, the US$/£ spot is 1.6470 – 1.6500 advise Pink Ink on whether it should allow its
option to lapse or exercise them
QUESTION TWO
Premier company, a Tanzanian Company, imports goods from UK and is invoiced for £216,500 payable
on the 15th January. The Company wishes to hedge using current options at an exercise price of
TZS1,750. Data is as follows:
Exchange Rates: TZS/£ 1,712 – 1,715
£ Options Contract Size is £12,500 March Contracts
Exercise Price £Calls £Puts
1,650 90.25 40.30
1,700 80.45 90.80
1,750 62.50 95.80
Contract prices are in cents/£.
REQUIRED:
i) Show the hedge position and compute its cost.
ii) Illustrate the action the company will take on the 15 th January if the TZS/£ spot rate at that
time is TZS1, 842 – 1,845.
iii) Calculate the Net Saving that the company makes as a result of its option hedge.
QUESTION THREE (HEDGING FOREIGN RECEIVABLES)
Opportunity Company is a Great Britain based exporter. It has invoiced a customer in the United States
of America for US$ 1,1058,000 payable of 30 th June. The current US$/£ spot is 1.7296 – 1,7330
The company wishes to hedge its foreign exchange risk exposure using traded currency options. The £
June calls with an exercise price of 1.70 have a premium of 9c. the £ call option contracts are in respect
of £25,000. Option premiums are quoted in cents/£.
REQUIRED:
i) Set up the option hedge and calculate the option cost. (Hint: Round up the required number
of calls to the nearest whole number)
ii) If on 1st June, the US$/£ spot is 1.8460 – 1.8550, advise Opportunity Company on whether
it should allow the options to expire or exercise them.
2
