Question 1: (10 marks)

Part A

Suppose you are a China-based investor who just sold Australian Commonwealth Bank (CBA) shares that you had bought six months ago. You had invested Yuan 446,000 to buy CBA shares for $70 per share. The exchange rate was 4.46Yuan/$. You sold the stock for $65  per  share  and  converted  the  dollar  proceeds  into  Yuan  at  the  exchange  rate  of 5.46Yuan/$.

a) Determine the percentage return from this investment in Australian dollars. Show all workings. (2 marks)

b) Compute the rate of return on your investment in Yuan terms. Show all workings. (2 marks)

Part B

c) With regard to international diversification, what is home bias? Give two possible explanations for why it occurs. (3 marks)

d) Var (Ri$) = Var(Ri) + Var(si) + 2Cov(Ri,si)

This equation demonstrates that exchange rate fluctuations contribute to the risk of foreign investment through two channels.

What are they? (2 marks)

e) What are the two missing words in the sentence below?

As the number of assets in a portfolio increases, the portfolio variance becomes more dependent on the                                and less dependent on the                           .

(1 mark)

Question 2: (10 marks)

Billy Samuels of Brisbane just purchased a Korean company that produces plastic nuts

and bolts for car manufacturers. The purchase price was KRW 7030 million. KRW 1000   million has already being paid and the remaining KRW 6030 million is due in six months. The current spot rate is KRW 1200 / AUD and the 6-month forward rate is KRW 1260 /    AUD.

Additional Data:

6-month Korean interest rate                                           16% pa

6-month Australian interest rate                                       4% pa

6-month call option on KRW at KRW 1200/AUD                  3%

6-month put option on KRW at KRW 1200/AUD                  2.4%

Billy Samuels can invest at the given rates above, or borrow at 2% pa above these rates. Billy Samuel’s WACC is 25% pa.

a) Calculate the cost of a money market hedge at the time the payment is due. (4 marks)

b) Calculate the cost of an option hedge at the time the payment is due assuming you exercise the option (4 marks)

c) With regards to futures contracts, what is the difference between a maintenance margin and a variation margin? (2 marks)

Question 3: (10 marks)

During the semester you studied the “Porsche Exposed” case study. In relation to this study:

“Porsche has the heaviest U.S. exposure (and this is increasing), yet it has the lowest level of natural hedging in the sector. ”

Porsche, Citigroup Smith Barney, September 24, 2003,p.5.

With regards to natural hedging: 

a) What was the financial (natural) hedge proposed to Porsche? How would this have worked? (2 marks)

b) What was the operation (natural) hedge proposed to Porsche? How would this have worked? (2 marks)

c) Why did Porsche not want to use the operation hedge proposed? What are the arguments for and against this position? (3 marks)

d) Which of the financial hedge or the operation hedge would you recommend to Porsche? Why?           (3 marks)

Question 4: (10 marks)

Red Baron Company, a U.S. MNC, is contemplating making a foreign capital expenditure in New Zealand.   The initial cost of the project is NZD12,000.   The annual cash flows over the five year economic life of the project in NZD are estimated to be 2,000, 3,000, 4,000, 5,000, and 8,000.  The parent firm’s cost of capital in USD is 10 percent.  Long- run inflation is forecasted to be 4 percent per annum in the U.S. and 8 percent in New Zealand.   The  current spot foreign exchange rate is NZD/USD = 4.20.   Determine the

NPV for the project in USD by:

a) Calculating the NPV in NZD using the NZD equivalent cost of capital according to the Fisher  Effect  and  then  converting  to  USD  at  the  current  spot  rate.  (Must  show  all

workings) (4 marks)

b) Converting all cash flows from NZD to USD at Purchasing Power Parity forecasted exchange rates and then calculating the NPV at the USD cost of capital. (Must show all

workings) (6 marks)