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FINC20023 International Financial Management - Central Queensland University

Question 1 Discuss the twin agency problem.What measures can reduce the problem?

Answer:-

Twin agency problem as the name suggests that problem arises on account of powers used for own benefit by agent while working for principal. The conflict has got its term from conflict between management and shareholders in company. Since company is owned by shareholders while managers are working as its agents.

Since managers are working on behalf of shareholders i.e.owners of company thus it is their prime duty to work for welfare of company however during day to day transactions and dealings, they start benefitting themselves which leads to loss to shareholders and overall loss to corporate sector including loss of trust. This problem is recent development in corporate sector.(James, 2017)

To curb these practices, many corporates have started using Carrot and stick approach implies that managers are paid some part of profitability also i.e. certain % of profits are paid to them in addition to their salary OR in lie of salary which keeps them motivated and leads to reduce the said problem.(Du, 2009)(Stulz, 2005)(Law Right, 2016)

Question 2: Discuss and differentiate between stakeholder capitalism model and shareholder wealth maximization model.

Answer:-

As the name implies, Shareholder wealth maximisation model means any model which increases the wealth of shareholders. Shareholders are persons who have invested in company and are allotted shares against their funds. Thus their wealth can be maximised by giving them dividend and increase their share pricing. It is purely financial model in which focus is on particular group/class of people i.e. shareholders. The target is to maximise their wealth only.(Peavler, 2018)

On other hand, Stakeholder capitalism model with name suggest "Stakeholder" it may include any person/class associates with company may be financially or non-financially such as employees, government etc. The target here is to make "satisfy" people who are associated with company directly or indirectly. In this case government will be satisfied if company is following all its guidelines, rules and regulations and paying taxes etci.e.both financial and non-financial factors. Its stake in company is safe.(Corning)(efinancemanagement)

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Question 3: Classify the following as a transaction reported in a sub-component of the current account, or the capital and financial accounts of the countries involved:

• An Australian company purchasesinsurancefroma UK based insurance company.
• An Australian resident purchases a laptop made in Japan from an Australian retailer.
• A USfirm acquires 100% shares of an Australian Telecom company.
• An Australian firm imports fruits from a Malaysiansupplier.
• A UK firm pays the salary of its executive working for a subsidiary in Australia.

Answer:-
Current account implies transactions relating to income and expenses while capital transactions include transactions relating to capital goods.(S, 2015)(educba)
(a) Insurance payment is current account transaction.
(b) Purchase of Laptop is a current account transaction.
(c) Purchase of 100% shares of a foreign company is a capital account transaction.
(d) Import of fruits is a current account transaction.
(e) Payment of salary (rendering of service) is a current account transaction.

Question 4:
Discuss ‘impossible trinity'. Provide and discuss relevant examples.

Trinity as name implies means "Three" fields and "Impossible" means can not be done.

Capital flow.jpg

As per this policy, trio cannot be achieved at same time. One has to forego in order to achieve others(The Hindu, 2017)(J.o'S., 2016)

Example:- If Country chooses to fix exchange rates with other countries and have a free flow of capital with others. then in that case independent monetary policy is not achievable because interest rate fluctuations will follow currency arbitrage and currency value will start declining.

If country chooses to have a free flow of capital and also have independent monetary policy. Due to mutual exclusiveness of fixed exchange rates and the free flow of capital, it is not possible to achieve this.

If a country chooses fixed exchange rates and independent monetary policy it cannot have a free flow of capital.
Thus this trio is given name "IMPOSSIBLE"

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Question 5:

An Australian company is planning to import a new machine and is making a choice between three international suppliers. The following information are available:

Supplier Location

Quoted Price

Shipping Cost

Japan

¥2,800,000

¥100,000

Canada

C$40,000

C$400

Germany

€25,000

€250

The following exchange rate information are available:
Spot exchangerate between Australian Dollar and US Dollar: $0.7100/A$
Spot exchange rate between US Dollar and Japanese Yen: ¥110/$
Spot exchange rate between Euro and US Dollar: $1.2500/€
Spot exchange rate between Canadian Dollar and US Dollar: $0.7400/C$
Which of these suppliers should the company choose? Assume that the choice is solely based on total Australian Dollar cash outlay required to cover the price of the machine and the shipping cost.

Answer:-

Part A

Firstly we need to calculate various rates as per Aus Dollar
1 yen equals 110$
Hence 1$ equals 1/110Yen
Further cost of equipment + shipping cost of japan model is Yen 2900000(2800000+100000)
Thus it implies it means its cost in terms of USD is Yen/110
Thus USD equals 2900000/110 = 26363.63 USD
Further 1 AUS$ equals 0.7100 USD
Thus 26363.63 USD equal 26363.63/.710 totalling to 37131.88Aus$

Part B
Spot exchange rate between Canadian Dollar and US Dollar: $0.7400/C$
It implies that 1 CD$ equals 0.7400 USD
Means cost of equipment is (40000+400)CD$ equals 29896 USD
1 AUS $ equals 0.7100 USD
i.e.29,896 USD means 42,107 Aus $

Part C
Total cost of equipment 25000+250 equals 25250{
Spot exchange rate between Euro and US Dollar: $1.2500/€
It implies that 25250 { equals 1.25*25250 USD total to 31562.50 USD
Further 1 AUS$ equals 0.7100 USD
i.e.31562.50 USD means 31562.5/0.7100 total to 44454.225 Aus $

Thus we can conclude that Japan is offering least rate in terms of Aus $ hence it is feasible to buy from it.

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Question 6:
A Japanesecar now costs ¥2,200,000, while an identical German car costs €35,000. Suppose, the relevant spot exchange ratesare now¥88.04/A$ and €0.6404/A$ and the expected inflation rates in Australia, Japan and Germany are respectively 2.5%, 0% and 1.4%.What will be the Australian Dollar price of these cars 1 year from nowfor 100% exchange rate pass through?

Japanese Car

German Car

Cost Yen 2200000

35000 Euro

Forward rate = S (1+iD)/(1+iF)
Here iD = Domestic inflation rate and iF inflation rate in foreign currency
hence

(i) Forward rate = Spot rate x 1+ (1.4%)/1+(2.5%)
i.e. 0.6404 x 1.014/1.025
i.e 1 Aus $ = 0.6335 Euro
German car cost (after 1 year) = Euro 35000/0.6335 = 55248.61 Aus $

(ii) FR= 88.04 x1.00/1.025
1 Aus $ = 85.89Yen
Japanese car cost Yen(after 1 year) 2200000/85.89 = 25614 Aus $

Question 7:

John is a US based Forex trader. He focuses principally on the Japanese Yen/USDollar (¥/$) rate. The current spot rate is ¥110/$. Afterconsiderable study, he concludes that the exchange rate, in the coming 60 days, will probably be about ¥125/$. He has the following options on the Japanese Yen to choose from:

Option

Strike Price

Premium

Put on ¥

¥115/$

$0.000032/¥

Call on ¥

¥115/$

$0.000041/¥

Discuss whether he should buy a Put on ¥ or Call on ¥ and determine his net profitif the spot rate at the end of the 60 days is ¥122/$.(Milton, 2019)

Answer: If John expects the rate after 60 days for $1 would be ¥125, he shall buy a call option with a strike price of ¥115 (Put option with a strike price of ¥115 would lapse if the final price is ¥125).
Premium/ call option: $0.000032*115 = $0.00368
Therefore, profit after 60 days (in case call options are purchased): ¥(122-115) = ¥7.
Net profit (in $) per call option = $(7/122) - $0.00368 = $(0.057-0.00368) = $0.053

Question 8:
Discuss how intervention may occur in the foreign exchange market. In your discussion, also indicate the pros and cons of such intervention.

Answer:-
As the name suggests that forging exchange intervention implies is an operations done by country's central bank to control fluctuations in currency and to control inflation and make currency stable. This is usually exercised in developing countries more to prevent themselves from exchange fluctuations side by side encouraging developed economies to attract in their country.(Kuepper, 2018)

Here "control" means rate fluctuations change control which say if some currency fell by 10% that will trigger all the stakeholders to act and need to go for higher value to minimize risks thus to check this, central bank may go for maximum 1-2% reduce per week. It will slow down the downfall for some time and panic will be reduced.(Trading Point)

Similarly substantial increase in rate is also not good specially economies which are relying more on exports and has competitive prices with other countries.(Evrensel)

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Question 9:

On a particular date, the exchange rate between the Great Britain Pound (GBP) and the Australian Dollar and the exchange rate between the Australian Dollar and Euro were respectively £0.6221/A$ and A$1.64/€. On a later date, the exchange rates were respectively £0.6505/A$ and A$1.58/€. What were the percentage change in the values of the GBP and Euro against the Australian Dollar between these two dates? Were the changes devaluation or revaluation or appreciation or depreciation of these currencies? Assume that Australian Dollar is the home currency.

Forward rate = S (1+iD)/(1+iF)
Here iD = Domestic inflation rate and iF inflation rate in foreign currency
hence

Spot rate
1 Aus $ = 0.6221 PD i.e.1 PD = 1.64 Aus $
Forward rate
1 Aus $ = 0.6505 PD i.e 1 PD = 1.58 Aus $

% change= (FR-SR) x 100 x 360/60
SR
=0.6505-0.6221 x 100 x 360/60

0.6221

= 27.39%

(b) % change = 1.58-1.64 x 100 x 360/60
1.64
= -21.95%


Question 10:

An Australian organization has a €2,000,000 account receivable from a Spanish customer in 2 months. The current spot exchange rate between Australian Dollar (A$) and Euro (€) is €0.7070/A$. The Australian organization expects that the spot rate in 2 months will be €0.7570/A$. The 2-month forward exchange rate is €0.7250/A$. The Australian Dollar (A$) 2-month borrowing rate is 5.00% per annum and the Australian Dollar (A$) 2-month investment rate is 2.50% per annum. The Euro (€) 2-month borrowing rate is 4.55% per annum and the Euro (€) 2-month investment rate is 2.00% per annum. The organization's weighted average cost of capital is 8% per annum. The organization is considering three hedge positions: remaining unhedged, forward market hedge and money market hedge. Which one of these three hedge positions should the organization adopt?

Receivables 2000000 PD in 2 months
SR Aus $= 0.7070 PD and expected SR after 2 months 0.7570
FR = 0.7250
Hedge= Amount/ Expected Spot rate
2000000/0.7570 Aus $ =2642008 Aus $
Forward market rate hedge rate = Amount/FR i.e. 2000000/0.7250 = 2758620 Aus $

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