Risk Management and Derivatives 723g33 There are altogether 4 questions. 50 points in total. At least 60% is needed to pass the exam. Start each question on a new answering sheet. Handwriting should be as clear as possible. English/Home language Dictionary is allowed together with a financial calculator. Best of Luck! 1. International Parity Conditions are the basic guiding blocks in the exchange rate determination. 1a). State the International Parity Conditions (5p). 1b). Using an example to illustrate how Interest Rate Parity, Purchasing Power Parity, International Fisher Effect, and Expectations Theory link forward exchange rate, inflation differential, Interest Rate differential and Spot exchange rate, future spot rate between two countries. (10p) 2. A) State the benefit and the cost of hedging. (5p) B) Porsche sales dropped 38% in 1992-1993 due to combined recession and weak dollar and strong Euro. This has prompt Porsche to hedge against currency risks. The net exposure after deducting the dollar expenses was 1,2852 billion dollars in 2003, up from 1,225 billion dollars. As the Financial Officer in Porsche, what are you going to do to minimize the exposure? (5p) 3. Exchange Rate Exposure management 3a) What are transaction exposure and operating exposure? State some of the measures that MNEs do to hedge against their operating exposure. (5p) 3b) Trident US has made a deal with Telecom France to export machine parts to the French Multinational company, the total payment is denominated in US dollars 50 M $. Due in 3 months. The manager in Telecom France asks you to help manage the exchange rate exposure. What is your plan? (Suppose the spot rate is 1,4750$/€, the forward rate is quoted at +50 basis points. (i.e. the forward rate is 1,4800$/€), You know you need to form an opinion about the future exchange rate of Euro against dollar in order to make a decision. ) 10p 4. Country A has experienced a severe Budget deficit and Trade Imbalance, The interest rate has been kept artificially low by the Central Bank, but there is a growing concern that the government might default on its international debt payment. The creditors want risk adjusted interest rate on the renewed debt which is deemed too high by Country A. What would you suggest for Country A to do in order to get out of this crisis and get back on track? (10p)