ExpertACCA · Question 02 · Treasury and Advanced Risk Management Techniques
SECTION B: ADVISORY REPORT
AeroTurbine Inc (AT) is a US-based developer of offshore wind farms. The company's base currency is the US Dollar ($). AT has recently signed a contract to purchase specialized turbine blades from a European manufacturer. The payment of €50 million is due in exactly six months.
AT's Treasury department is concerned about the volatility of the EUR/USD exchange rate and is considering hedging the exposure. The treasury is currently operated as a cost center, but the CFO is considering transitioning it to a profit center.
Foreign Exchange Data:
Current Spot Rate ($/€): 1.1520 - 1.1540
Six-month Forward Rate ($/€): 1.1610 - 1.1635
Currency Options (Over-the-Counter):
AT's bank has offered a six-month European call option to buy Euros at a strike price of $1.1600/€ for a premium of $0.025 per Euro. The premium is payable immediately.
Interest Rates (Annualized):
US Dollar: Borrowing 4.5%, Investing 2.5%
Euro: Borrowing 3.0%, Investing 1.0%
REQUIREMENTS:
(a) Calculate the expected US Dollar ($) cost of the €50 million payable in six months using:
(i) A Forward Exchange Contract.
(ii) A Money Market Hedge.
(iii) The Over-the-Counter (OTC) Currency Option (assume the option is exercised if the spot rate in six months is $1.1800/€, and calculate the total cost including the future value of the premium). (12 marks)
(b) Based on your calculations in part (a), recommend the most appropriate hedging strategy for AeroTurbine Inc, discussing the advantages and disadvantages of the currency option compared to the forward contract. (6 marks)
(c) Discuss the implications, benefits, and risks of transitioning AeroTurbine's treasury function from a cost center to a profit center. (7 marks)
SECTION B: ADVISORY REPORT
AeroTurbine Inc (AT) is a US-based developer of offshore wind farms. The company's base currency is the US Dollar ($). AT has recently signed a contract to purchase specialized turbine blades from a European manufacturer. The payment of €50 million is due in exactly six months.
AT's Treasury department is concerned about the volatility of the EUR/USD exchange rate and is considering hedging the exposure. The treasury is currently operated as a cost center, but the CFO is considering transitioning it to a profit center.
Foreign Exchange Data:
Current Spot Rate ($/€): 1.1520 - 1.1540
Six-month Forward Rate ($/€): 1.1610 - 1.1635
Currency Options (Over-the-Counter):
AT's bank has offered a six-month European call option to buy Euros at a strike price of $1.1600/€ for a premium of $0.025 per Euro. The premium is payable immediately.
Interest Rates (Annualized):
US Dollar: Borrowing 4.5%, Investing 2.5%
Euro: Borrowing 3.0%, Investing 1.0%
REQUIREMENTS:
(a) Calculate the expected US Dollar ($) cost of the €50 million payable in six months using:
(i) A Forward Exchange Contract.
(ii) A Money Market Hedge.
(iii) The Over-the-Counter (OTC) Currency Option (assume the option is exercised if the spot rate in six months is $1.1800/€, and calculate the total cost including the future value of the premium). (12 marks)
(b) Based on your calculations in part (a), recommend the most appropriate hedging strategy for AeroTurbine Inc, discussing the advantages and disadvantages of the currency option compared to the forward contract. (6 marks)
(c) Discuss the implications, benefits, and risks of transitioning AeroTurbine's treasury function from a cost center to a profit center. (7 marks)
How to approach this question
Full Answer
Common mistakes
Practice the full ACCA AFM — Advanced Financial Management Practice Exam 2
3 questions · hints · full answers · grading