International Financial Management - Assignment Example

Topic: Name: Lecturer: Course name: Course code: Date Q1). The geographical arbitrage profit with the two exchange rates The existing exchanged rates as depicted in stock market of different states between Westpac bank in Sydney and the Barclays bank in London as at the transaction date is as follows Westpac Sydney        Barclays London A$ 1.1840-60/€                A$ 1.1830-50/€ The exchange ratio therefore is as follows In Sydney (west pack bank) ($1.184/60) = 0.0197 In Barclays (Barclays bank) (1.185/60) = 0.0198 As of the above exchange ratio examination, it can be observed that the Euros is overvalued in Westpac bank in Sydney and undervalued in Barclays bank in London. This is only an effective comparison holding other factors constant, that there was free flow of capital among the two financial institutions. Consequently, an arbitrageur’s determination is to take benefit of the undervalued exchange by disposing the dollars in London and re-selling them it in Westpac bank so as to take home the yields arising from taking advantage of the currency weakness. For that reason if $ 1 million is sold in London, arbitrageurs will obtain a return corresponding to ($1 million * 0.0198 = €98,000 Where $ 1 million is sold again in Sydney at the same time, an arbitrageur’s will have a yield on return of (60/€ *€98,000/ $ 1.1840 = € 3, 195,652.17 For this reason, total arbitrage profit that will be earned by an investor in Sydney would be (3, 195,652.17 – 1098, 000) = €2,097,652.17. When an investor changes this amount from Euros to US dollars, it will give him an arbitrage profit of (€2,097,652.178 1.181}/60} =- $ 41,393.67 In conclusion, arbitrage process is considered vital because an investor would earn profit out of the weaker currency and thus to take full advantage of arbitrage process, an arbitrageur’s need to have full knowledge of how the stock market of different shares are trading. Consequently, to take advantage of the weak performing currency in the security market, an arbitrageur’s must consider disposing the undervalued currency and buying the overvalued currency in west pack bank in order to earn an arbitrage profit. Q2).The diagram and the relevant procedure Toshi Numata must take to make a covered interest arbitrage profit Initial capital investment $ 2 million 6 month forward exchange rate 109.8 Japanese yen deposit rate 1.8% Existing Spot rate 110.2 Dollar deposit interest rate 3% If Toshi Numata will invest the $ 2 million in the country, it will yield him a return of ($ 2 million * 1.8 %} + $ 2 million) = $ 20036,000 If Toshi Numata will ignore the compounding and hence exchange the future worth of Japanese yen for dollars at the future forward exchange rate for 180 days, he will earn a yield of Investing today ($ 2 million/ 110.2 Spot rate) = $18,148.62 180 days forward exchange rate ($18.148.62* 3%)* 109.8 forward exchange rate} = $ 18,693.28 Exchange to US dollars. ($ 18,693.28/110.2} = $ 2,052,522.65 Therefore, covered arbitrage returns would be ($ 2 million - $2,052,522.65) = $52,522.65 Diagrammatic representation of covered interest arbitrage start end $20,036,000 2 million 1.8% $2,052,522.65 spot rate 110.2 forward premium 109.8 $18,148.82 growth rate 3% 18,693.28 From the above presentation, a profit from the covered interest arbitrage is envisaged and thus an investor should consider investing in West Pac bank. The above diagram gives a detail procedure which a potential investor would follow in order to realize profit out of the covered arbitrage interest process. The process starts systematically from the beginning to the end. (Madura, 2011) Q3). Expected US dollar in relation to this analysis Anticipated U.S inflation 1% Spot rate 3.76% Malaysian ringgit inflation 4% Hence the projected one year spot rate Spot rate*{1+Rm inflation)/ (US dollar inflation+1) Therefore, one year anticipated spot rate 3.75*(1+4%)/ (1+1%) = 3.861 The hotel projected charges (30day) RM ((1050*31.2%) = 32,760 The expected US dollar in relation to this analysis (32760/3.861) = $ 8,484.85 Q3b).the Percentage dollar Cost New cost of dollar 8484.85 Existing dollar cost 8400 Change in dollar cost 84.85 Hence the percentage change in dollar cost (84.85/8484.85)*100% =1% Q4a) hypothesis charge existing spot rate 120 in US $/yen 0. 0.0833 Time to Maturity 90 90 Day estimated closing spot rate 140 in US $/yen $ 0.00714 A Call on yen A Put on yen Yen/US$ exercise price 125 125 in US$ /yen $ 0.00800 $ 0.00800 US$/yen Premium $ 0.00046 $ 0.00003 From the above data examination, Katya ought to buy a put on yen because he is able to gain from the rising profit on dollars owing to the turn down in the price of Yen. Q4b). Break even point Since Katya buys a put on yen, he will pay the premium at the moment so that he can get hold of the US dollars subsequent to exercising the put in 90 days. $ in Yen $ Exercise price 0.008 125 less : premium: -0.0003 0 the Break even 0.00797 125.47 From the above data analysis, it can be depicted that katya is going to break even at 125.47 Japanese yen when he invest in the local currency and 0.00797 $ when katya does his investment abroad. It is advisable that he invest abroad because there will be a lower risk of return due to lower amount of $ 0.00797 to be tolerated before he earns no profits from investment, Q4C) given a spot rate of 140 Yen/$ at the end of the 90 day, the gross and net profit of katya would receive amount to The gross profit the Net profit strike price 0.008 0.008 less: spot rate -0.00714 -0.00714 premium 0 -0.0003 0.00086 0.00083 Q5 A) exchange rate following devaluation The spot exchange rate TL68, 000/USD      The Malaysian currency is devalued by -20%, To incorporate the effect of inflation, we include the standard error rate of +5% in the existing rate of devaluation and thus we derive an adjusted devalued rate   of 25% Therefore, the currency the exchange rate after devaluation would be (25%* TL 68,000) = $ 85,000, An improvement in exchange rate as observed from the above examination is brought about by Presence of currency devaluation in the country. This will therefore lead to decline in the effect of inflation. This decrease in the rate of inflation will cause stabilization of countries currency and thus lead to enhanced economic growth amid worldwide rising inflation.   (Sercu, 2009) 5B). the Percentage change after declining to TL100, 000/USD      Previous value Percentage change (100.000-68.000/100,000}*100% = -32%    The percentage change from the devalued value (100.000-85.000/100,000}*100% = -15 % An increase in percentage rate from -32% to -15% is envisaged when there is a reduction in spot rate to TL100, 000/USD .this shows a positive consequence of the currency trading in the security market and hence will lead to stable countries economy as well as the standard of living because of superior currency exchange in the security market. Q6). The weighted average cost of capital for company A and B Market risk premium 5.5%, Risk free rate 2.5 %, Tax rate 40% WACC = risk free rate +beta (premuim) * net of tax. Hence Company (A) Weighted average cost of capital = Ks (S/T) + KD (D/T) (1-T) Where KD is the cost of debt 1-t is net of tax Ks is the cost of Equity T is the total value of the capital Company A Cost of equity (KS) = 2.5% + 0.86(5.5%) = 7.23% Hence WACC = (7.23%+6.885{0.6) = 11.36% Company B Cost of equity (KS) = 2.5% + 0.78((5.5%) = 6.79% Therefore, WACC = (6.79%+7.125{0.6) = 11.07% In ascertaining the beta of Cargill Company, the Hamada model will be deemed relevant. This model is considered useful where two company of levered and unlevered capital structure exist in the market. The model is derived as follows. Beta (L) = Beta (Ul) {1+ (D/T) (net of tax) UL is the unlevered firm L is the levered firm UL is the unlevered firm, D is the total debt and T is the total capital of the company. Beta (L) = 0.82(1+6.82/11.73) (0.6) = 4.48 % The weighted average cost of capital (WACC) for Cargill therefore is going to be WACC = 2.5%+ 4.48(5.5) = 27.14% It can be observed from the above extermination that Cargill has a capital structure which is quite higher as compared to those for company A and B. this is due to the fact that Cargill has a superior weighted average cost of capital. This is why the company is having an exemplary performance in the challenging market though the company is managed and financed by a private individual. In summary, capital structure of a firm is deemed releavnt in decision theory because a company with an optimall capitall structure will have minimal risk as well as strong capitall base. A levered firm commands a higher value and lower cost of capital unlike unlevered firm. This is because a levered firm will have lower risk on the returns. (Madura, 2011) Reference Sercu, P. (2009). In International Finance: Theory Into Practice . Madura, J. (2011). In International Financial Management, 11th ed (p. ppg 153). -, J. M. In International Financial Management, Abridged Edition (p. ppg 147). Clark, E. (2002). In International Finance. . Read More