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 GreenDigital 3 years to pay for the equipment that will be shipped to GreenDigital, but the payments must be conducted with quarterly instalments of 5,250,000 Yen by the U.K. subsidiary. Therefore, 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:
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Provide your answers in the cells below |
Marks |
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Payments to be conducted by GreenDigital subsidiary in the U.K. |
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0.5 mark |
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How often? Monthly = 12/ Quarterly = 4/Semi-annual = 2 |
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0.5 mark |
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Swap bank Yen bid rate |
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0.5 mark |
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Therefore, notional Yen principal calculated with information above |
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0.5 mark |
Calculation of the notional principal of the hedge in British pounds:
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Provide your answers in the cells below |
Marks |
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Spot exchange rate $/Yen ask rate |
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0.5 mark |
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Spot exchange rate $/GBP bid rate |
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0.5 mark |
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Therefore, British pound notional principal calculated with information above. |
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0.5 mark |
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Swap bank GBP ask rate |
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0.5 mark |
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U.K. subsidiary pays quarterly: |
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0.5 mark |
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GBP/Yen Exchange rate locked in for three years: |
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0.5 mark |
Complete the diagram below to show the swap transaction graphically by inserting the correct interest rate or currency values below: (6 marks)
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UK subsidiary |
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GBP notional principal =
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Notional GBP swap principal |
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Japanese exporter |
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Yen notional principal =
notional principal = ¥3,925,233,644.86
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Notional Yen swap principal |
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b. Explain to the CEO what forfaiting is, why it is possible that forfaiting of the transaction can occur and the implication that it will have on the swap transaction.
Provide your answers in space provided below:
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Question |
Your answer |
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What is forfaiting? (Give an explanation). (3 marks) |
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Why can forfaiting occur? (1 mark) |
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Implication on the swap transaction (State whether it impacts the swap or not and the reason for it). (1 mark) |
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