Honey plc is a UK company which has two forthcoming US dollar transactions, a $3,500,000 receipt from a US customer and a payment of $5,019,400 to a US supplier.  These transactions are expected to happen in 4 months.  It is now 1^st February.

Honey plc wishes to evaluate alternative approaches to hedging its risk.

Exchange rates are as follows:

	$/£1
Spot	1.3559  -1.3569
4 months forward	1.3513 - 1.3520

 

$/£1 currency futures: £125,000

March	1.3524
June	1.3506
September	1.3497

 

Honey plc estimates that the futures price on the settlement date will be 1.3511 and the spot rate on settlement date 1.3522.

 

Annual Interest Rates:

	Borrowing (%)	Investing (%)
UK	4.50	1.70
US	4.75	1.50

 

Required :  Calculations you MUST show workings details):

1. Using the futures market, forward market and the money market, recommend which foreign exchange hedging strategy should be utilised.   The calculations are worth 12 marks and the discussion justifying the recommendation is worth 8 marks.                                                                                            

 

1. What are the main types of risk facing a multi-national organisation relating to foreign exchange and how can these risks be mitigated? Advise on whether or not companies should hedge risks at all times?

 

Part (b)

You are to set out a potential portfolio strategy for an investor who has £1m to invest.  The funds can be invested in one or more of three specified projects.

 

Details of the possible investments are:

 

	Return (%) E(R )	Expected standard deviation of returns (%)  SD( R)
Project 1	18	8
Project 2	21	11
Project 3	29	19

 

 

 

Correlation coefficients of returns are as follows:

Between projects	Correlation
1 and 2	0.80
1 and 3	0.40
2 and 3	-0.65

 

Required (to be attributed full marks for calculations you MUST show workings details): 

1. Calculate the expected risk and return if 30% is invested in each of projects 1 and 2 and 40% in 3. 

1. Considering Markowitz's contribution to portfolio diversification, choose two projects to invest in and illustrate how the investor might be able to minimise risk when investing in two projects only.                                             

Discuss the results from parts i) and ii) above and justify which investment strategy would provide the best utility for the investor.     

Answer rating: 100% (QA)

Part a Honey plc Foreign Exchange Hedging Strategy Using the futures market Sell 35m futures at 1350... View the full answer