This examination contains five questions
Please answer any three
All questions carry equal marks
Sub-questions equally valued except where indicated
Final exam worth 50% of total course assessment
Complete answers must be written in the examination scripts provided
Please write legibly in blue or black ink
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1. (a) If the Euro is trading at USD/EUR = 0.751131 on the spot market and current annualized money market rates in the U.S. and the Eurozone are 0.06% and 1.197% respectively, what will be the 180-day and 90-day forward rates under interest rate parity conditions? What exactly would happen if the forward rates in practice are below those given using IRP? (50%)
(b) Critically examine the proposition that the forward exchange rate is an unbiased predictor of the future spot rate. (50%)
2. Gastronome® is a well-known manufacturer of frozen foods in the United States. They are considering a proposal to manufacture their Gourmet™ brand of high quality frozen foods in the United Kingdom. One inducement to make the investment is subsidised financing in the form of a six-year loan of $20 million at 4% per annum. This loan would be repayable in six equal end-year payments. Additional information includes:
Gastronome® cost of equity 24 %
Market cost of debt (unsubsidised) 10 %
Optimal capital structure 40% debt, 60% equity
UK T-Bill rate 8 %
Corporate tax rate, USA and UK 34 %
(a) What discount rate should Gastronome® use to evaluate the proposed project? (33%)
(b) Would you recommend that Gastronome® undertake this investment? Explain fully. (33%)
(c) What is the value of the subsidised loan? How would such a loan affect Gastronome®’s capital budgeting analysis? What (if any) are the controversial aspects? (33%)
3. Following Brexit—the UK’s departure from the European Union (EU)—in Spring 2019 it is anticipated that European capital markets will become more segmented. This is likely to be made worse if there is a ‘no deal’ Brexit. Analyse fully the likely impact of this segmentation on the Cost of Capital (WACC) for UK-based international companies.
4. Outlandish plc is a UK importer with a euro-denominated payable of €100 million due in 3 months’ time. Outlandish wants to hedge this payment, and has identified four key methods:
(a) Money market instruments (b) fx futures
(c) fx forwards (d) buying a call option on the euro
The spot rate is currently 0.66 GBP/EUR, and the three-month forward rate is 0.6616 GBP/EUR. Money market interest rates are 4% per annum for sterling and 3% per annum for euros. Compare and contrast each of the four strategies, and make a full recommendation to Outlandish.
5. Bibbity Bobbity Boo (BBB) manufactures and sells specialist sportswear for women and girls. The company began operating in in the 1990s, initially specialising in swimwear. Increased demand has seen its range of products and markets become increasingly pan-European. BBB has serious concerns about the impact of the UK leaving the EU (Brexit) in Summer 2019. BBB is seriously considering moving a significant portion of its European operations to Lille, France, where it will operate under the umbrella of BBB (EU). BBB believes such a move will enable it to continue to participate seamlessly in the EU markets, despite being segmented from the UK. Additionally, BBB believes the cost of operations in Lille will be lower, both for labour and overheads.
(a) What are the key exposures (risks) of such a move? (50%)
(b) What can Bibbity Bobbity Boo do to mitigate each of these exposures? (50%)
NO PLAGIARISM!!!!!!!