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Answer & Explanation
Solved by verified expert| a) Assume Blur chooses to enter into a forward exchange contract for the maximum possible payment of A$4.9m. What actions will the firm take and what will be the value of its net payments in £, if in one year: | |||
| (i) the new deal is agreed? | |||
| Payment to be made in 1 year - A$ | 4900000 | ||
| One year forward rate (£/A$) | 0.59 | ||
| Blur would have to enter into a 1 year Forward contract at t=0, for conversion of £ 4.9M to A $ at rate of 0.59 | |||
| Net Payments in £ | 2891000 | ||
| (ii) the new deal is not agreed? | |||
| Net payment to be made - A$ | 1800000 | ||
| What will be the expected value of Blur's net payment in £? (5 marks) | |||
| Net Payments in £ @0.59 | 1062000 | ||
| Blur would have to enter into a 1 year Forward contract at t=0, for conversion of £1.8M to A $ at rate of 0.59 | |||
| b) Assume now that Blur chooses to hedge the certain payment of A$1.8m using a forward exchange contract, and the uncertain payment of A$3.1m using a call option with an exercise price of £0.57 and a premium of £0.015 per A$. | |||
| What will be the value of its net payments in £ from this strategy, if in one year: | |||
| (i) the new deal is agreed? | |||
| Certain payment - A$ | 1800000 | ||
| Forward contract rate | 0.59 | ||
| Payment to be made on certain contract | 1062000 | ||
| Uncertain payment (N) | 3100000 | ||
| Call Option | |||
| Strike Price (X) | 0.57 | ||
| Premium (p) | 0.015 | ||
| Spot rate in 1 year (S1) | 0.58 | ||
| P&L on Option ={MAX(S1-X,0) - p} | -0.005 | ||
| Effective exch rate | 0.585 | S1- P&L | |
| Payment to be made after 1 year | 1813500 | ||
| Total payment | 2875500 | ||
Step-by-step explanation
| (ii) the new deal is not agreed? | |||
| What will be the expected value of Blur's net payment in £? (7 marks) | |||
| Assume that Blur enters into the Option contract for the uncertain payment initially | |||
| P&L on Option at expiry ={MAX(S1-X,0) - p} | -0.005 | from b(i) above | |
| P&L on Option contract | -15500 | N*P&L | |
| Payment on certain contract | 1062000 | ||
| Net payment to be made in 1 year | 1046500 | ||
| c) Suppose now that the spot exchange rate in one year is A$=£0.62. What will be the new expected values in £ of the strategies in parts (a) and (b)? Have they changed? Explain why/why not. (7 marks) | |||
| (a) With forward contract for both certain and uncertain payments the expected £ payment would not change since the rate is fixed as per forward contract | |||
| (b) For part (b) only the part related with the Call option would get impacted with the new spot rate | |||
| Certain payment - A$ | 1800000 | ||
| Forward contract rate | 0.59 | ||
| Payment to be made on certain contract | 1062000 | ||
| Uncertain payment (N) | 3100000 | ||
| Call Option | |||
| Strike Price (X) | 0.57 | ||
| Premium (p) | 0.015 | ||
| Spot rate in 1 year (S1) | 0.62 | ||
| P&L on Option ={MAX(S1-X,0) - p} | 0.035 | ||
| Effective exch rate | 0.585 | S1- P&L | |
| Payment to be made after 1 year | 1813500 | ||
| Total payment | 2875500 | ||
| When uncertain payment is not required to be made | |||
| Payment on certain contract | 1062000 | ||
| P&L on Option at expiry ={MAX(S1-X,0) - p} | 0.035 | from b(i) above | |
| P&L on Option contract at expiry | 108500 | N*P&L | |
| Net payment to be made in 1 year | 953500 |
| Part -2 | |||
| 1. Financing Mix refers to the sources of capital deployed by a company | |||
| There are two common sources of funds | |||
| Equity Financing - where stakeholders (individuals, mutual funds, financial institutions) deploy their own funds in purchasing shares of a company | |||
| Debt Financing - where the company issued fixed income instruments to investors which pay a fixed coupon interest at regular intervals | |||
| Debt is considered cheaper than equity since the interest payments on coupons are considered tax deductible and reduce the effective tax paid by company. However high levels of debt which are not commensurate with EBIT could cause a debt trap for company | |||
| Equity Financing comes at a price since investors expect regular dividend payments on their shares which are paid from net income earned. Equity investors earn from dividend income and also capital appreciation of stock held by them. | |||
| 2. Equity capital can be sourced from individual investors, mutual funds, financial institutions, PE funds, VC funds | |||
| The rate of return expected by PE and VC funds are generally much higher than individuals and MFs | |||
| 3. Factoring is a financial transaction between a business owner and a third party that provides instant cash to the former in exchange for the account receivables of the business. | |||
| Leasing is a commonly used source of medium term finance for investment. Leasing and hire purchase are financial facilities which allow a business to use an asset over a fixed period, in return for periodic payments. The business customer chooses the equipment it requires and the finance company buys it on behalf of the business. | |||
| Credit cards are sometimes used to purchase assets, when other sources of funding are unavailable. This is not a preferred route of funding since the interest charges on card payments are very high | |||
| Sales and operations planning is an integrated business management process through which the executive/leadership team continually achieves focus, alignment and synchronization among all functions of the organization. The S&OP process includes an updated forecast that leads to a sales plan, production plan, inventory plan, customer lead time (backlog) plan, new product development plan, strategic initiative plan and resulting financial plan |
| Hence it involves Sales, engg, finance, mftg, operations and HR |
