Important

Question 1

Money market hedge - Payment to FX supplier

Answer 1

1. Deposit payment amount in FX - Payment / (1+(FX dep interest x months/12))
2. Buy FX at spot rate - Above / spot rate (left)
3. Borrow £ for total payment - Above amount x (1+(£ borrowing rate x months/12))

Question 2

Money market hedge - Receipt from FX customer

Answer 2

1. Borrow receipt in FX - Receipt / (1+(FX borrowing interest x months/12))
2. Sell FX at spot rate - Above / spot rate (right)
3. Deposit £ for total receipt - Above amount x (1+(£ deposit rate x months/12))

Question 3

Forward contract exchange rate

Answer 3

Spot rate + discounts - premiums
- receipts use spot rate on right

Question 4

Exchange rate futures

Answer 4

1. Buy/sell? FX payment = buy FX and Sell £
2. When?
3. How many? FX payment / current futures price
4. Above / contract size
5. Gain/Loss - Sell at current futures price - buy at what futures price will be
6. Gain/Loss x contract size x no. contracts
7. Net amount = (Original payment - gain) / spot rate

Question 5

Exchange rate OTC currency options

Answer 5

1. Buy/sell? FX payment – Buy FX – call option
2. When?
3. Exercise? If option to exercise price higher than spot rate, then exercise
4. Calculate premium, plus interest (£ deposit)
5. Payment amount / exercise spot rate + premium

Question 6

What is Interest Rate Parity and how is it calculated?

Answer 6

Predicts the forward rate based on interest rates
Spot rate x (1+FX interest rate) / (1 + £ interest rate)

Question 7

What is an economic risk?

Answer 7

Loss of international competitiveness due to exchange rates moving unfavourably
Can hedge risk through diversification

Question 8

What is translation risk?

Answer 8

International operations lose value when revenue and assets translated back to company’s reporting currency for financial statements

Question 9

Interest rate - no hedge

Answer 9

Loan amount x bank rate

Question 10

Interest rate - Options

Answer 10

1. If option rate is higher than bank rate for borrow – do not exercise.
   - Loan amount x bank rate + premium
2. If option rate is lower than bank rate for borrow – exercise
   - Loan amount x option rate + premium

Question 11

Interest rate - forwards

Answer 11

1. Calculate the loan interest from the bank
2. Add gain/loss (Forward rate – bank rate) x Amount borrowed x months/12
3. Check – Amount borrowed x forward rate x months/12

Question 12

Interest rates - futures

Answer 12

1. Buy/sell? Borrow = sell
2. When?
3. How many? Loan amount / contract size x loan months/3 months
4. Gain/Loss - Strike price (sell) vs futures price (buy)
5. Gain/Loss on futures - Gain/loss x contract size x no. contracts x months/12
6. Interest on loan - Amount borrowed x interest rate x months/12
7. Premium
8. Interest cost = Interest paid on loan +gain/loss + premium

Question 13

What does linear regression identify?

Answer 13

Independent variables associated with a change in a dependant variable

Question 14

List some statistical bias

Answer 14

Selection bias: not representative of whole population
Observer bias: Researcher bias
Survivorship bias: some data already removed

Question 15

What does standard deviation measure?

Answer 15

The variation in a data set (=STDEV funtion)
Higher = higher risk

Question 16

What is the co-efficient variation?

Answer 16

Standard deviation / mean
Shows the significance of the variation.

Question 17

What does correlation show?

Answer 17

How strong the relationship is between two variables (=CORREL function)
Positive: both increase (1 prefect)

Question 18

What are real options?

Answer 18

NPV only considers identifiable cash flows. There could be other benefits in the future if certain courses of action are taken

Question 19

Give examples of real options

Answer 19

Follow on: Opportunity to launch newer versions
Timing: Can decide when to commence
Abandonment: Opportunity to reduce capacity

Question 20

List some risks of domestic trading

Answer 20

Physical: damage/stolen
Credit: customer default

Question 21

List some risks of international trading

Answer 21

Political
Cultural
FX

Question 22

List 7 things that can increase the PV of future cash flows

Answer 22

Sales (max)
Life of cash flows (max)
Operating margin (max)
Working capital (min)
Cost of capital (min)
Assets (min)
Tax (min)

Question 23

List environmental costs

Answer 23

Conventional (raw mat etc)
Potentially hidden (general overheads)
Contingent (future)
Image & relationship (intangibles)

Question 24

How do you calculate replacement analysis?

Answer 24

1 year replacement: PV of cash flows / annuity factor for 1 year

Question 25

What is hard capital rationing?

Answer 25

When a company is forced to limit its capital due to external factors, while soft capital rationing is when a company chooses to limit its capital due to internal factors

Question 26

Disadvantages of CAPM

Answer 26

Hard to identify risk-free rate, average market return and beta factors
Assumes all investors are diversified

Question 27

Disadvantages of DVM?

Answer 27

Estimating g is difficult
Historic inputs: not indicator of future
Assumes perpetual dividend growth

Question 28

How do you calculate cost of preference shares?

Answer 28

Kp = D / P

Question 29

How do you calculate cost of Irredeemable debt?

Answer 29

Kd = I x (1-T) / P

Question 30

How do you calculate interest cover?

Answer 30

Profit before interest / Interest