Question 1

RKT Group Plc is a British multinational consumer goods company headquartered in England. It manufactures and markets branded products in the health, hygiene, and home sectors. It sells a comprehensive range of products through over 60 operating companies into nearly 200 countries. The companys brands include air fresheners, household cleaners, laundry products, furniture polishes and dishwashing detergents. It also makes over-the-counter pharmaceuticals such as analgesics, antiseptics, flu remedies, and gastrointestinal medications and offers products for hair removal, denture cleaning and pest control. The companys business is structured through a matrix of three geographical segments: Europe and North America; Latin America, North Asia, Southeast Asia and Australia and New Zealand; and Russia, Middle East, North Africa, Turkey, and Africa. These segments consist of a centralized category development, global sales, supply, and support functions such as finance, human resources, and information services. The group also has two non-core businesses: ABC Pharmaceuticals and Food. The central category development function is responsible for strategies, brand equity programs and best practices, and new product development, namely research and development and consumer and market research, for implementation by the geographical segments. The supply function is responsible for all procurement, production, and logistics globally, and is directly responsible for the operation of the companys production facilities worldwide. Information services function is responsible for the companys global systems infrastructure and global systems, including enterprise resource planning systems. In one of the multinational deals, RKT has a deal of credit sales to a customer in Australia amounting to AUD750,000, payable in 3-month time (December 2021). The treasurer of RKT suggests a few foreign exchange rate risks hedging methods. (1) Borrow AUD for three months, convert the loan into sterling and repay the loan out of eventual receipts. (2) Enter into a 3- month forward exchange contract with the company's bank. (3) Enter into an appropriate futures contract, and (4) Enter into an appropriate options contract.

Annual 3 months' interest rates

UK	6%
AUSTRALIA	3%
EUROPE	2.5%

Assume the company borrow and lend at the same rate.

The mid-market foreign exchange rates are as follow:

	SPOT	DECEMBER	MARCH
AUD TO 1	2.3834	2.3688	2.4000

The AUD to 1 Currency futures (Sterling 62,500 contracts)

	DECEMBER FUTURE	MARCH FUTURE
NOW	2.3500	2.4000
IN DECEMBER	2.3900	2.5000
IN MARCH	2.5555	2.6000

Foreign currency option (Sterling 31,250 contracts, in AUD per )

	CALL		PUT
Strike Price (AUD to 1)	December	March	December	March
2.40	0.07	0.08	0.06	0.04

Besides, the current Euro to 1 exchange rate is 1.667. RKT's finance director, Mr. Mayer, has some forecasts of Euro exchange rates in two years-time from three prominent banks.

Euro/ two-year forecasts

Cadbank	1.452
Dodgebank	1.514
Kogibank	1.782

A non-executive director of RKT, Mrs. Douglas, has suggested that to forecast future exchange rates, the interest rate differential between countries should be used. She expresses that based on the current short-term interest rates in the UK and in the Europe (the annual 3 months' interest rates given in the table above), the exchange rate in two years' time will be Euro 1.747/.

Required

(a) Analyse and review the four (4) factors RTK Plc need to consider before deciding whether to hedge the risk using the foreign currency markets.

(20 marks)