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WaFlo Co is a -based company which has the following expected transactions.. One month: Expected receipt...

WaFlo Co is a -based company which has the following expected transactions..

One month: Expected receipt of 240,000

One month: Expected payment of 140,000

Three months: Expected receipts of 300,000

As the Corporate Finance Manager for WaFlo CO. you collect the following information:

Spot rate (K per K): 1.7820 ± 0.0002

One month forward rate (K per K): 1.7829 ± 0.0003

Three months forward rate (K per K): 1.7846 ± 0.0004

Money market rates for WaFlo Co:

Borrowing Deposit

One year Kwacha interest rate: 4.9% 4.6

One year dollar interest rate: 5.4% 5.1

Assume that it is now 1 April.

Required:

(a) Discuss the differences between transaction risk, translation risk and economic risk.

(b) Explain how inflation rates can be used to forecast exchange rates.

(c) Calculate the expected Kwacha receipts in one month and in three months using the forward market.

(d) Calculate the expected Kwacha receipts in three months using a money-market hedge and recommend whether a forward market hedge or a money market hedge should be used.

(e) Discuss how Kwacha currency futures contracts could be used to hedge the three-month dollar receipt.

Zambian based company

Expert Solution

Answer.

a). Transaction Risk- the risk associated with adverse effect of foreign exchange rate fluctuations on completed foreign exchange contract prior to its settlement. whereas,

Translation Risk- The risk of change in value of assets, liabilities and equities due to hanges in foriegn exchange rates or currency rate changes. This risk occurs when Companies denominate a portion of their accounts, assets and liabilities in foreign currency. Its also called acconting exposure. However,

Economic risks- When a country's macro economic conditions such as government regulations, political conditions, foreign exchange etc. effects the investments specially one in foreign country.

All the types of risk are rlated to forien exchange rates and investments in foreign countries.

b) Inflation rates act as a major contributing factor towards change in foreign exchange rates of a country and its currency against other currencies of the nations. Inflation rate is more likely to have an inverse relationship with country's curreny value and foreign exchange rates. A very high rate of inflation will have a negative effect on its currency value against other nations currencies. However, low inflation rates will not likely to have a positive effect on currency's exchange rate in proportion.

c). %

spot rate	1.782
one month forward rates	1.7829
3 month forward rates	1.7846
spot rate for 1 months	3.64094
spot rate for 3 months	1.783733

jeff jeffy answered 7 months ago

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