P4 ACCA Workbook Q - MapitShareholder Wealth - Illustration 1 Year Share Price Dividend Paid 2007 3.30 40c 2008 3.56 42c 2009 3.47 44c 2010 3.75 46c 2011 3.99 48c There are 2 million

P4 ACCA Workbook Questions

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Lecture 1 Financial Strategy




Shareholder Wealth - Illustration 1

Year Share Price Dividend Paid

2007 3.30 40c

2008 3.56 42c

2009 3.47 44c

2010 3.75 46c

2011 3.99 48c

There are 2 million shares in issue.! ! ! ! ! ! ! ! ! ! ! ! Calculate the increase in shareholder wealth for each year:II. Per shareIII. As a percentageIV. For the business as a whole




EPS - Illustration 2

2010$‘000

2011$‘000

PBIT 2000 2100

Interest 200 300

Tax 300 400

Profit After Tax 1500 1400

Preference Dividend 300 400

Dividend 800 900

Retained Earnings 400 100

Share Capital (50c) 5000 5000

Reserves 3000 3100

Share Price $2.50 $2.80

Calculate the EPS for 2010 and 2011.




Lecture 2 Performance Measurement




Performance Analysis Illustration

X1 X2 X3

Non Current Assets 500 700 1000

Current Assets 150 200 300

650 900 1300

Ordinary Shares ($1) 300 300 300

Reserves 100 280 430

Loan Notes 150 200 300

Payables 100 120 270

650 900 1300

Revenue 3000 3500 4200

COS 2000 2400 3200

Gross Profit 1000 1100 1000

Admin Costs 300 350 400

Distribution Costs 200 250 300

PBIT 500 500 300

Interest 100 150 220

Tax 120 90 50

Profit After Tax 280 260 30

Dividends 100 110 30

Retained Earnings 180 150 0

Share Price $3.30 $4.00 $2.20

Using the information calculate and comment on the following Ratios:

I. Return on Capital EmployedII. Return on EquityIII. Gross MarginIV. Net MarginV. Operating MarginVI. Revenue GrowthVII. GearingVIII. Interest CoverIX. Dividend CoverX. Dividend YieldXI. P/E Ratio




Lecture 3Finance Sources




Rights Issue - Illustration 1

XYZ Ltd. intends to raise capital via a rights issue.

The current share price is $8.

They are offering a 1 for 4 issue at a price of $6.

Calculate the Theoretical Ex-rights Price.

Rights Issue - Illustration 2

ABC Ltd. has decided to raise capital via a rights issue.

The share price is currently $5.50 and ABC intends to raise $5m.

There are currently 6.25m shares in issue and ABC is offering a 1 for 5 rights issue.

Calculate the Theoretical Ex-Rights Price.




Lecture 5 Investment Appraisal I




ARR - Illustration 1

ABC Ltd are considering expanding their internet cafe business by buying a business which will cost $275,000 to buy and a further $175,000 to refurbish.

They expect the following cash to come in:

Year Net Cash Profits (£)

1 45,000

2 75,000

3 80,000

4 50,000

5 50,000

6 60,000

The equipment will be depreciated to a zero resale value over the same period and, after the sixth year, they can sell the business for $200,000

Calculate the ARR or ROCE of this investment




Relevant Cash Flow Criteria - Illustration 2

A business is considering investing in a new project. They have already spent $20,000 on a feasibility study which suggests that the project will be profitable.

The headquarters of the company has spare floor space which will be allocated to the project with $7,000 of the current monthly rent allocated to the project.

New equipment costing $2.5m will have to be bought and will be depreciated on a straight line basis over 10 years.

A manager who earns $30,000 per year and currently runs a similar project will also manage the new project taking up 25% of his time.

State whether each of the following items are relevant cash flows and explain your answer.

I. The cost of the feasibility study.

II. The rent charged to the project.

III. The new equipment.

IV. The depreciation on the new equipment.

V. The Managers salary.




Payback Period - Illustration 3

Initial Investment of $5.8m.

Annual Cash Flows of $400,000.

Calculate the Payback Period.

Payback Period - Illustration 4

Initial Investment of $6.2m.

Cash Flows of:

Year 1: ! $1,200,000

Year 2:! $2,200,000

Year 3:! $2,500,000

Year 4:! $1,700,000

Calculate the Payback Period.




Discounted Cash-flows - Illustration 5

An investor wants a real return of 10%. Inflation is 5%

What is the MONEY/NOMINAL rate required?


A company undertakes a project with the following cash-flows:

Year Cash-Flows

1 5,000

2 7,000

3 8,000

4 10,000

5 11,000

6 9,000

The company has a cost of capital of 10%.

Calculate the present value of the cash flows for each of the six years and in total.





A company undertakes a project with the following cash-flows:

Year Cash-Flows

1 5,000

2 5,000

3 5,000

4 5,000

5 5,000

6 5,000

The company has a cost of capital of 10%.

Calculate the present value of the total cash flows for the six years


A company expects to receive $100,000 per year forever.

Their cost of capital is 10%.

Calculate the present value of the perpetuity.




Lecture 6 Investment Appraisal II




WDA - Illustration 1

A business buys a piece of equipment for $100.

Capital allowances are available at 25% reducing balance.

The tax rate is 30%

After the 4 year project the equipment can be sold for $25.

Working Capital - Illustration 2

A business requires the following working capital investment into a four year project:

Initial Investment:! ! 30,000

Year 1!! ! ! 35,000

Year 2!! ! ! 45,000

Year 3!! ! ! 32,000

Show the working capital line in the NPV calculation.




NPV - Illustration 3

A business is evaluating a project for which the following information is relevant:

I. Sales will be $100,000 in the first year and are expected to increase by 5% per year.

II. Costs will be $50,000 and are expected to increase by 7% per year.

III. Capital investment will be $200,000 and attracts tax allowable depreciation of the full value of the investment over the 5 year length of the project.

IV. The tax rate is 30% and tax is payable in the following year.

V. Working Capital invested will be 20% of projected sales for the following year.

VI. General inflation is expected to be 3% over the course of the project and the business uses a real discount rate of 9%.

Calculate the NPV for the project.




Lecture 7 - Investment

Appraisal III




Illustration 1

ABC has evaluated a project and come to the following conclusions.

At a discount rate of 10% the NPV will be $100,000

At a discount rate of 15% the NPV will be -$75,000

What is the IRR?




Illustration 2

Initial Investment (5,000)

Period Cash Flows

1 2,000

2 (1,000)

3 3,500

4 3,800

Cost of Capital 10%

NPV = 1,216

IRR = 19%

Calculate the MIRR.




Lecture 8 - Foreign NPV




Illustration 1

Item costs $1,000

€/$ 1 : 2

However inflation in US is 5% and Eurozone 3%

Calculate the exchange rate in one years time.

Illustration 2 (i)

US Interest rate = 10%

UK Interest rate = 8%

Exchange rate = €/$ 1 : 2

Predict the exchange rate in 1 year

Illustration 2 (ii)

Current spot rate $/£ 1 : 1

The dollar is expected to strengthen by 7% per anum

Forecast the $:£ rate for the next 4 years.




Illustration 3

ABC Ltd. is a UK company intending to undertake a project in Foreignland where the currency is the Franc (FR).

ABC uses a discount rate of 10% to evaluate projects in the UK and the current spot rate is £ / FR 2.000.

The risk free rate of interest in Foreignland is 5% with the UK rate being 7%.

The initial investment in the project will be FR 400,000 with net cash inflows over a 5 year project of FR 150,000 per year.

Ignore Tax.

Calculate the NPV of the project.

Illustration 4







Illustration 5



Sterling is expected to appreciate against the Franc by 10% per year.

Illustration 6




The initial investment in the project will be FR 400,000 with net cash inflows over a 5 year project of FR 150,000 per year.

Ignore Tax.

Calculate the NPV of the project by adjusting the discount rate.




Lecture 9 WACC I




Cost of Equity using DVM - Illustration 1

ABC Company has just paid a dividend of 35c.

The current share price is $3.25.

Calculate the Cost of Equity (Ke) using DVM.

Cost of Equity using DVM - Illustration 2

ABC Company has just paid a dividend of 35c.

The dividend paid has grown by 4% per year for the past 5 years.


Calculate the Cost of Equity (Ke) using DVM.

Cost of Equity using CAPM - Illustration 3

Company A has a Beta of 1.2.

Government bonds are currently trading at 4%.

The average return than investors in the market can expect is 15%.

Calculate the Cost of Equity using CAPM.




Cost of Equity using CAPM - Illustration 4


Company B has a Beta of 1.


The average return than investors in the market can expect is 12%.

Calculate the Cost of Equity using CAPM for each company.

Cost of Equity using CAPM Illustration 5


Company B has a Beta of 1.2.


The average market risk premium is 6%.

Calculate the Cost of Equity using CAPM for each company.




Lecture 10WACC II




Irredeemable Debt - Illustration 1

A company has issued 10% irredeemable debt.

The market value of the debt is $90.

The tax rate is 30%

Calculate the cost of debt (Kd).

Redeemable Debt - Illustration 2

A Company has issued debt which is redeemable in 5 years time.

Interest is payable at 8%.

The current market value of the debt is $102.

Ignore taxation.

Calculate the Cost of Debt (Kd).

Redeemable Debt - Illustration 3

A Company has issued debt which is redeemable in 5 years time.



Tax is payable at 30%.





Convertible Debt - Illustration 4

A Company has issued debt which is convertible in 5 years time.



On conversion, investors will have a choice of either:

I. Cash at a 15% premium; or

II. 18 shares per loan note.

The current share price is $6 and it is expected to grow in value by 4% per year.

Tax is payable at 30%.


Preference Shares - Illustration 5

A company has issued 8% preference shares with a nominal value of $1.

The market value of the shares is 80c.

The tax rate is 30%.

Calculate the cost of the preference shares (Kd).




Bank Debt - Illustration 6

A company has a bank loan of $2m at an interest rate of 10%.


Calculate the cost of debt (Kd).

WACC - Illustration 7

Company A is funded as follows:

Item Capital Structure Cost

Equity 85% 15%

Debt 15% 7%

Calculate the Weighted Average Cost of Capital.






Balance Sheet Extract

Ordinary Shares (50c) 3000

Loan Notes 2000

Bank Loan 1000

The cost to the company of each of the above items has been calculated as:

Ordinary Shares 13%

Loan Notes 8%

Bank Loan 5%

The Loan notes are currently trading at $94.

The current share price is $1.50







Balance Sheet Extract

Ordinary Shares (50c) 2000

12% Loan Notes 1500

8% Preference Shares ($1) 500

Bank Loan 750

Details on these are as follows.

The company has an equity beta of 1.2. Government bonds are currently trading at 6% and the average market risk premium is 7%.

The Loan notes are currently trading at $106 and are redeemable at par in 5 years time.

The preference shares are trading at 92c.

The bank loan has an interest rate of 10%.







Lecture 11 Capital Structure




Capital Structure - Illustration 1

A company has total capital of $1,000 with debt making up $300 and equity making up $700 of the total. The company’s cost of debt is 5% and cost of equity is 14%.

I. Calculate the company’s current WACC.II. Calculate the WACC if the company substitutes $200 of equity for $200 of debt

causing their cost of equity to rise to 16%.III. Calculate the WACC if the company substitutes $300 of equity for $300 of debt

causing their cost of equity to rise to 25%.




Lecture 12 M & M Formulae




Illustration 1 ABC Ltd has a share price of 350c and 1m shares in issue. It currently has no debt. Current cost of capital is 13%. The directors have decided to replace $2m of equity with 10% debt. The tax rate is 30%. Required

(i) Calculate the new value of the geared firm.

(ii)Calculate the value of the Equity in the geared firm.

Illustration 2

ABC Co. and CD Co. operate in the same industry and are identical in their ability to generate cash flows.

ABC Co. is financed by Equity only of 3m shares with current value of $1 and has a cost of equity calculated at 15%.

CD Co. has the same total capital but within it has irredeemable debt with a market value of $0.9m.


Required

(i) Calculate the value of CD Co.

(ii)Calculate the value of the Equity in CD Co.




Illustration 3



CD Co. has the same total capital but within it has irredeemable debt with a market value of $0.9m and cost of debt of 8%.


Required

(i) Calculate the Cost of Equity for CD Co.

Illustration 4



CD Co. has the same total capital but within it has irredeemable debt with a market value of $0.9m and cost of debt of 8%.


Required

(i) Calculate the WACC for CD Co.




Lecture 14Risk Adjusted WACC




Risk Adjusted WACC - Illustration 1

Company A intends to undertake a project in an unrelated industry.

The following details are relevant:

Item Company A Proxy Company

Equity Beta (βe) 1.2 1.4

Value of Equity 1000 800

Value of Debt 400 500

The risk free rate is 4%.

The average return on the market is 12%.

The post tax cost of debt is 7%.

Calculate the risk adjusted WACC to be used in evaluating the project.

Ignore Tax




Risk Adjusted WACC - Illustration 2

Company A intends to undertake a project in an unrelated industry.

The following details are relevant:

Item Company A Proxy Company

Equity Beta (βe) 1.1 1.3

Value of Equity 1200 900

Value of Debt 500 450


The average return on the market is 12%.


The post tax cost of debt is 8%.

Calculate the risk adjusted WACC to be used in evaluating the project.




Illustration 3

Company A Company B

Debt/Equity 1/3 1/4

Equity Beta 1.2

Debt Beta 0.3

Assume that the Asset Beta and the Debt Beta of each firm is the same.

Calculate the Equity Beta for Company B.




Lecture 15 APV




Illustration 1

Cost of Equity in Geared Firm = 12%

Cost of Debt = 8%

Debt/Equity ratio = 1/2

Tax rate = 30%

Calculate the cost of equity in an ungeared firm.

Illustration 2

Company AB has used $5m of 10% debentures to finance a project lasting for 4 years. The tax rate is 35%.

Issue costs are 3% and are tax deductible.

What is the PV of the issue costs for APV purposes?

Illustration 3


Issue costs are 3% and are tax deductible. These are to be raised along with the finance.

What is the PV of the issue costs for APV purposes?




Illustration 4


What is the PV of the tax relief available for APV purposes?

Illustration 5

Company AC needs to raise $10m in debt finance for 4 years.

Company AB has raised $7m of 10% debentures and the rest is provided by a subsidised government loan of $3m at 5%.


Calculate the financing effects of the debt for APV purposes.

Illustration 6

ABC Co. is considering a project which is expected to generate cash inflows of $500,000 per year for 5 years and cost $500,000 of initial investment.

Costs have been estimated at $350,000 per year.

ABC has a current cost of equity of 14% and a cost of debt of 7% and a current debt to equity ratio of 1/3.

To undertake the the project the $500,000 will be raised through a bond issue of 8% with issue costs of 4% to be raised in addition to the finance.





Lecture 16 More Risk




Illustration 1 ABC Ltd is undertaking a project costing $900m with expected net cash flows of $400m in years 1 & 2 then $600m in year 3.

The FD considers that these cash flows may be overestimated by as much as 10% in year 1, 15% in year 2 and 20% in year 3.

The risk free rate is 5% Required

Using certainty equivalents calculate the expected NPV of the project.




Lecture 17 Options Pricing I




Illustration 1

Current Share Price:! ! $120Exercise Price:! ! ! $100Risk Free Interest Rate:! ! 10%Variance of Shares:!! ! 25%Time to Expiry:! ! ! 3 months

Calculate the value of the call option.

Illustration 2

Current Share Price:! ! $110Exercise Price:! ! ! $97Risk Free Interest Rate:! ! 8%Standard Deviation Shares:! 30%Time to Expiry:! ! ! 3 months




Lecture 18 Options Pricing II




Illustration 1

Current Share Price:! ! $120Exercise Price:! ! ! $100Risk Free Interest Rate:! ! 10%Variance of Shares:!! ! 25%Time to Expiry:! ! ! 3 months

We already calculated in the last lecture that the call option value is $25.53.

Calculate the value of the corresponding put option.

Illustration 2

ABC Ltd. has an option in CD Ltd. which is due to expire in 6 months.

A dividend of 55 cents is due to be paid in 3 months time and the current share price is $15.


Calculate the dividend-adjusted share price.




Illustration 3

ABC Co. is planning to expand into Foreignland by opening a new distribution centre there.

The project would cost $20m and the present value of the cash flows are forecasted to be $17m leading to a negative NPV of $3m.

However, by undertaking the investment they could expand further into Foreignland with a second distribution centre.

The second centre is expected to have the following details:

Estimated Cost (Pe):! ! ! $30m

PV Expected Net Receipts (Pa):! ! $23m

Timing (t):! ! ! ! ! 5 years

Risk Free Rate (r):! ! ! ! 8%

Volatility (s):! ! ! ! ! 30%

Calculate the value of the call option on the second distribution centre (this is an option to expand).




Lecture19 More on Cost of Debt




Illustration 1

ABC Co. has 5 year bonds in issue with a BBB credit rating which have a credit spread of 115.

5 year treasury bonds have a current return of 3.4%

What is the expected yield on ABC’s bonds?

Illustration 2

A government has three bonds in issue that all have a face or par value of $100 and are redeemable in one year, two years and three years respectively. Since the bonds are all government bonds, let’s assume that they are of the same risk class. Let’s also assume that coupons are payable on an annual basis. Bond A, which is redeemable in a year’s time, has a coupon rate of 7% and is trading at $103. Bond B, which is redeemable in two years, has a coupon rate of 6% and is trading at $102. Bond C, which is redeemable in three years, has a coupon rate of 5% and is trading at $98.

Illustration 3

ABC Co. has 3 yr 8% bonds in issue which are redeemable at par after the 3 year term. The yield to maturity is 10% and they are trading at $95.

Calculate the Macauley Distribution.




Lecture 20 Corporate Failure I




No Illustrations




Lecture 21 Corporate Failure II




Illustration 1

$‘000

Assets 500

500

Equity & Liabilities

Issued Equity Shares @ $1 each 600

Share Premium 100

Retained Earnings -300

Liabilities 100

500

Dividends cannot be paid while accumulated losses exist.

Equity of $600,000 is only backed by assets of $500,000.

Loan finance cannot be raised due to the current financial position.

Required

Apply a capital reduction and restate the statement of financial position.




Illustration 2

$‘000

Intangible Asset (Brand) 50,000

Non Current Assets 220,000

270,000

Inventory 20,000

Receivables 30,000

320,000

Equity & Liabilities

Issued Equity Shares @ $1 each 100,000

Share Premium 75,000

Retained Earnings -100,000

75,000

Debenture Loan 125,000

Overdraft 20,000

Payables 100,000

320,000

A reconstruction scheme is to take place under the following conditions:

(i) The equity shares of $1 nominal currently in issue will be written off and will be replaced on a one-for-one basis by new equity shares with nominal value of $0.25.

(ii)The debenture loan will be replaced by the issue of new equity shares - four new shares with nominal value of $0.25 each for every $1 debenture loan converted.

(iii)New shares with a nominal value of $0.25 will be offered to the existing equity holders in the ratio of three new shares for every one currently held. All current equity holders are expected to take this up.

(iv)Share premium account to be eliminated.(v)Brand to be written off as it is impaired.(vi)Deficit on the retained earnings to be eliminated.

Prepare the revised SFP and show any workings undertaken to achieve this.




Lecture 22 Business Valuations

I




Net Assets Valuation Method Illustration 1

Non Current Assets 550,000

Current Assets 170,000

Current Liabilities -80,000

Share Capital 300,000

Reserves 200,000

10% Loan Notes 150,000

The Market Value of property in the Non Current Assets is $50,000 more than the book value.The Market Value of property in the Non Current Assets is $50,000 more than the book value.

The Loan Notes are redeemable at a 5% premium.The Loan Notes are redeemable at a 5% premium.

What is the value of a 70% holding using the net assets valuation basis?




DVM - Illustration 2

ABC pays a constant dividend of 45c. It has 3m ordinary shares.

The shareholders require a return of 15%.

What is the Value of the business?

DVM - Illustration 3

A business has Share Capital made up of 50c shares of $3 millionDividend per share (just paid) 30cDividend paid four years ago 22cRequired Return = 12%

Calculate the Value of the business using the dividend valuation method.




P/E Ratio Method - Illustration 4

X1 X2 X3

$‘000 $‘000 $‘000

Revenue 3000 3500 4200

COS 2000 2400 3200




PBIT 500 500 300


Tax 120 90 50




Industry P/E Average 13 12 14

Calculate the Value of the Company for each of the 3 years using the P/E Ratio method.




P/E Ratio Method - Illustration 5

X1 X2 X3

$‘000 $‘000 $‘000

Revenue 3200 3800 4800

COS 2000 2400 3200




PBIT 700 800 900


Tax 120 90 50




Industry P/E Average 17 15 18

Number of Shares 3m 3m 3m

Calculate the Earnings Per Share for each of the 3 years

Calculate the Value of the Company for each of the 3 years using the EPS you calculate.




Earnings Yield - Illustration 6

X1 X2 X3

$‘000 $‘000 $‘000

Revenue 3100 3700 4600

COS 2000 2400 3200




PBIT 600 700 700


Tax 120 90 50




Earnings Yield 0.15 0.18 0.17

Number of Shares 4m 4m 4m

Calculate the Earnings Per Share for each of the 3 years and the share price using the earnings yield.




Present Value of Future Cash Flows - Illustration 7

ABC Company earned $100,000 in cash inflows this year.

They expect this to increase in each of the next 5 years by 5% and after that to increase by 2% forever.

The company uses a cost of capital of 10%.

Calculate the value of the company using the present value of future cash flows method.




Lecture 23Business Valuations

II




Illustration 1

Company A has 100m shares at £3 each. Company B has 50m shares of £1 each.

Company A makes an offer of 1 new shares for every 5 held in B and has worked out

that the synergies available are valued at £20m

Calculate the expected value of a share in the combined company.

Illustration 2

Post Tax Profit P/E Ratio Pre Aq. ValueCompany A £150m 10 £1500mCompany B £10m 7 £70m Estimating the post acquisition value of the combined business is done by applying the P/E ratio of Company A to the combined earnings of the new combination.




Lecture 24Advanced Business

Valuations




Illustration 1

ABC Ltd. uses a time horizon of 12 years to forecast free cash flows.

They use a planning horizon of 3 years after which they expect cash flows to remain at a steady level.

The cash flows projected are as follows:

Year $

1 3m

2 5m

3 7m

The stock market value of debt is $6m and the cost of capital is 10%.

Calculate the value of the firm and the value of the equity.




Illustration 2

The following figures are relevant:

$m

Operating Profit 400

Depreciation 150

Increase in Working Capital 40

Capital Expenditure to replace assets 8

New Capital expenditure 18

Interest Paid 7

Loans Repaid 30

Tax Paid 120

Calculate the free cash flows before interest and dividends and then the free cash flows to equity.

Illustration 3

A company has NOPAT which has been adjusted for EVA purposes of $700m. It’s capital employed is $5,000m and it’s WACC is 8%. The total debt of the company is $1,000m.

Calculate the EVA for the company and use it to value the firm and the firm’s equity.




Illustration 4

ABC Co. wants to value their company in order to raise more capital. They have a lot of intangible assets so wish to use the CIV method to put a value to these.

ABC has operating profit of $250m and has a WACC of 9% and an asset base of $700m.

CD Co. is a larger but similar firm which made an operating profit of $1,000m on an asset base of $5,500m.

Calculate the value of ABC Co. incorporating the CIV.




Lecture 25Multinational

Companies




Illustration 1

Figures from the cash flow statement of ABC Ltd. are as follows:

20X1$m

20X0$m

Operating Cash Inflows 1,500 1,000

Capital Expenditure 250 200

Dividends from Joint Venture 130 100

Taxation Paid 200 170

Interest Paid 75 60

Disposal of Subsidiary 500 -

New Shares Issued 300 -

Calculate the free cash flows to equity or dividend capacity of ABC Ltd. for the year ended 20X1.




Lecture 26F9 FX Risk Revision




Buy or Sell Currency - Illustration 1

You have an invoice to pay to a US business of $1250 and you are a UK business.

The rate offered by the bank is $:£ 1.2500 - 1.3500

How many £ will it take to pay the $125?

Buy or Sell Currency - Illustration 2

You have issued an invoice to a US customer of $2000 and you are a UK business.

The rate offered by the bank is $:£ 1.4500 - 1.5500

How many £ will you receive for the $2000?




Purchasing Power Parity Theory - Illustration 3

The current exchange rate is 2$ per £.

Inflation in the US is 6%.

Inflation in the UK is 8%.

What will the FX rate be in 1 years time?

Interest Rate Parity Theory - Illustration 4

The current exchange rate is 2$ per £.

The interest rate in the US is 3%.

The interest rate in the UK is 2%.

What will the FX rate be in 1 years time?

Forward Rate - Illustration 5

ABC Company has entered into a contract whereby they will receive $500,000 from a US customer in 3 months.

ABC is a UK company.

A 3 month forward rate is available at $:£ 1.6000 +/- 0.0500.

Calculate the amount of £ ABC would receive under the forward contract.




Money Market Hedge - Illustration 6

A UK business needs to pay $350,000 to a US supplier in 3 months time.

Exchange rate now: $:£ 1.6500 - 1.7000

Deposit rates UK 4% annual US 6% annual

Borrowing rates UK 5% annual US 6.5% annual

How much £ will the transaction cost using a money market hedge?

Money Market Hedge Illustration 7

A UK business will receive $350,000 from a US supplier in 3 months time.

Exchange rate now: $:£ 1.6500 - 1.7000

Deposit rates UK 4% annual US 6% annual

Borrowing rates UK 5% annual US 6.5% annual

How much £ will the business receive using a money market hedge?




Lecture 27FX Risk: Futures




Illustration 1

A UK company will receive $2.5m from an american customer in 3 months time in February.

The following information is relevant:

Futures: (contract size £62,500)

December 1.5830 $/£

March 1.5796 $/£

Forward Rates: Spot 1.5842 - 1.5851

1 month 0.0056 - 0.0053 pm

3 month 0.0172 - 0.0164 pm

28 February:

Assume that the spot rate moves to 1.6490 - 1.6510

March futures have a price of 1.6513

Required

Assess whether a future or forward currency hedge would have been better with hindsight.




Illustration 2

MNO is a UK based company that has delivered goods, invoiced at $1,800,000 US dollars to a customer in Singapore. Payment is due in three months’ time, that is, in February 2007. The finance director of MNO is concerned about the potential exchange risk resulting from the transaction and wishes to hedge the risk in either the futures or the options market.

The current spot rate is $1·695/£. A three month futures contract is quoted at $1·690/£, and the contract size for $/£ futures contracts is £62,500.

Assuming that the spot rate and the futures rate turn out to be the same in February 2007, indicating that there is no basis risk, identify the cost of hedging the exchange rate risk using futures where the exchange rate at the time of payment is:

(i) $1·665/£

(ii) $1·720/£

Illustration 3

ABC Co. is a sterling based company that expects to receive $250m in 4 months time.

The spot rate is £/$ 0.6690

Futures are available in $250,000 contracts as follows:

2 month expiry 0.6666

5 month expiry 0.6645

Estimate the result of the hedging transaction given that the spot rate is predicted to be 0.6674 in 4 months time and that basis risk reduces in a linear manner.




Illustration 4

Using the information in illustration 3 calculate the total receipt using the ‘lock-in rate’.




Lecture 28FX Risk: Options &

Swaps




Illustration 1 A German company expects to receive $15m from a US company in December. The spot rate is $1.4850 – $1.4860. The premiums for $/€ Options of €32,500 are: Strike CALLS PUTS Price Oct Nov Dec Oct Nov Dec 1.4860 0.71 1.35 2.40 0.86 1.90 2.201.4870 0.71 1.35 2.30 0.86 1.90 2.25 The company is concerned that the $ may weaken. (i) Show how traded $/€ options may be used to hedge this risk. (ii) Assume the spot rate moves to either 1.600 or 1.400

Illustration 2

Evans Co. is an Australian firm looking to expand in France and is thus looking to raise €24m it can borrow at the following fixed rates:

A$ 7.0%€5.6%

Portmoth is a Spanish Co. looking to acquire an Australian firm and wants to borrow A$40m. It can borrow at the following rates:

A$7.2%€5.5%

The current spot rate is A$1 = €0.60

Show how a currency swap for 1 yr with interest paid at the end of the year would work.




Illustration 3

ABC Co. is a German company considering a project in Zancar, a foreign country where the currency is the Franc (Fr). The investment in the project would be Fr250m and they expect to sell out of the project after 1 year for Fr350m.

The current exchange rate is 25Fr/£ and the government in Zancar has offered a forex swap at this rate. The borrowing rate in the Eurozone is 5% and it is expected that the FX rate in one year will be 40Fr/£.

Show the effect if ABC Co.

i. Undertakes the forex swap.

ii.Does not undertake the forex swap

Illustration 4

Companies A, B and C are within the same group whereas company D is an external company. The following liabilities have been identified between the 4 companies:

Owed Form Owed to Amount(Millions)

A B £20

B C €30

C D $45

C A ¥100

C B £35

D B €20

D C $30

Mid-market spot rates are:

£1 = $1.45£1 = €1.20£1 = ¥200

Establish the net indebtedness that would require external hedging.




Lecture 29Interest Rate Risk I




Illustration 1

ABC Ltd. has entered into a commitment to borrow $10m in 3 months time for a period of 3 months.

The bank has offered a 3v6 FRA at 6.00% - 5.65%.

Calculate the effect if the market rate in 3 months is

i. 7%ii.4%

Illustration 2

ABC Ltd. has entered into a commitment to borrow $10m in 3 months time for a period of 3 months.

The bank has offered an IRG at 6% for a premium of 0.075% of the loan capital.

Calculate the effect if the market rate in 3 months is

i. 7%ii.4%

Illustration 3

Company A is considering an interest rate swap with Company B. They can borrow at the following rates:

! ! Fixed FloatingA 10% LIBOR +1%B 12% LIBOR +1.5%

Show the effect of using an interest rate swap.




Lecture 30Interest Rate Risk II




Illustration 1

ABC Ltd. wants to borrow $100m for 2 months with the current interest rate being 3%. It is currently January 31st.

They decide to hedge their risk by using interest rate futures which are currently quoted at:

March Price = 94.50

June Price = 94.85

The contract size is $500,000.

By the date of the transaction the futures price has moved to 94.25 and the base rate of interest has risen to 3.25%

Illustration 2

LTG Co. decides on the 1st January to hedge $30m of borrowings that will start on 30th April and last for 3 months. The rate on the loan will be fixed at the LIBOR rate on that date.

A $500,000 futures contract is available for June at 94.80 with the LIBOR rate being 5.5%.

i. Assuming that the basis reduces in a linear manner and that LIBOR is 4.5% on 30 April calculate the financial result of the hedge.

ii.Calculate the lock-in rate for the transaction and the effect of using that rate.




Illustration 3

ABC Co. is borrowing $20m for 6 months with current market rate of 4%. They need the loan for 6 months beginning in 1 month’s time.

Interest rate options are available in $500,000 contracts for 3 month December interest rate futures. Today is the 30th September.

The following premiums are offered (quoted in %):

Exercise Price Call Put

95.50 1.35 -

95.75 1.06 0.16

96.00 0.56 0.56

96.25 0.17 1.07

Calculate the effect of an options hedge if the interest rate moves to 6% and if the December futures price moves to 95.00 in one month’s time.




Documents

P4 ACCA Workbook Q - MapitShareholder Wealth - Illustration 1 Year Share Price Dividend Paid 2007 3.30 40c 2008 3.56 42c 2009 3.47 44c 2010 3.75 46c 2011 3.99 48c There are 2 million