Sep 21, 2017 term paper 2

TRANSCORP HAS MADE A PURCHASE OF GOODS FROM A FOREIGN FIRM THAT WILL REQUIRE THE PAYMENT OF FC…

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Transcorp has made a purchase of goods from a foreign firm that will require the payment of FC 380,000 six months later. Transcorp wishes to make definite the amount of dollars it will need to pay the FC 380,000 on the due date. The foreign firm is domiciled in a country whose currency has been rising in relation to the dollar in recent years. The tax rate in both countries is 40%. Transcorp plans to borrow an amount in dollars from a U.S. bank to immediately exchange into FCs to buy securities in the foreign country, which, with interest, will equal FC 380,000 six months later. The interest rate that will be paid in the United States is 12%; the interest rate that will be earned on the foreign securities is 8%. When at the end of six months Transcorp is required to make the payment in FC, it will use the funds from the maturing foreign securities in FC to meet its obligation in FC. At the same time it will pay off the loan plus interest in the United States in dollars.

a) What is the net amount that Transcorp pays to meet the obligation of FC 380,000 in six months if the current spot rate is FC 2.00 to the dollar?

b) How much more is this than the amount Transcorp would have paid if payment had been made immediately instead of six months later?

c) At what forward rate of exchange would the amount paid by Transcorp have been the same as that it would have paid using the capital markets? Would Transcorp have taken the long position in the forward FC or have sold the FC forward short to hedge its position?

d) If a speculator took the opposite position from Transcorp in the forward market for FCs, would the speculator be long or short? If the speculator received a risk premium for holding this position, would this place the current forward rate in FC above or below the expected future spot rate in FC per dollar?


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