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Question 3: (16 marks)

a. The profit generated by the subsidiary in the U.K. is considered as a good source of money to be used to pay for the import of manufacturing equipment from Japan for the electronic component plant in the U.S.A. The CEO has already entered into negotiations with the Japan supplier of the equipment.The supplier is willing to provide HighTech3 years to pay for the equipment that will be shipped to HighTech, but the payments must be conducted with quarterly instalments of 5,250,000 Yen by the U.K. subsidiary. This is why the CEO wants you to construct a currency swap arrangement where the profits of the U.K. subsidiary can be used to pay for the equipment. You have to apply the swap bank quotes to conduct this three year swap and also depict the swap graphically for the CEO to see how the swap will work.

Workings:

Calculation of the notional principal of the hedge in Japanese yen:

Provide your answers in the cells below

Marks

Payments to be conducted by HighTech subsidiary in the U.K.

0.5 mark

How often? Monthly = 12/ Quarterly = 4/Semi-annual = 2

0.5 mark

Swap bank Yen bid rate

0.5 mark

Therefore, notional Yen principal calculated with information above

0.5 mark

Calculation of the notional principal of the hedge in British pounds:

Provide your answers in the cells below

Marks

Spot exchange rate $/Yen ask rate

0.5 mark

Spot exchange rate $/GBP bid rate

0.5 mark

Therefore, British pound notional principal calculated with information above.

0.5 mark

Swap bank 3 year GBP ask rate

0.5 mark

U.K. subsidiary pays quarterly:

0.5 mark

GBP/Yen Exchange rate locked in for three years:

0.5 mark

Question 3 continued:

Complete the diagram below to show the swap transaction graphically by inserting the correct interest rate or currency values below: (6 marks)

Swap bank

b. Explain to the CEO what forfaiting is, why it is possible that forfaiting of the transaction can occur andthe implication that it will have on the swap transaction. (4 marks)

Provide your answers in space provided below:

Question

Your answer

What is forfaiting? (Give an explanation). (3 marks)

Why can forfaiting occur? (1 mark)

Implication on the swap transaction (State whether it impacts the swap or not and the reason for it). (1 mark)