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[主观题]

Crag Co has sales of $200m per year and the gross profit margin is 40%. Finished goods inv

entory days vary throughout the year within the following range:

Crag Co has sales of 200m per year and the gross p

All purchases and sales are made on a cash basis and no inventory of raw materials or work in progress is carried. Crag Co intends to finance permanent current assets with equity and fluctuating current assets with its overdraft.

In relation to finished goods inventory and assuming a 360-day year, how much finance will be needed from the overdraft？

A.$10m

B.$17m

C.$30m

D.$40m

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更多“Crag Co has sales of $200m per…”相关的问题

第1题

ZXC Co currently has income of $30 million per year, of which 80% is from credit sales, an

d a net profit margin of 10%. Due to fierce competition, ZXC Co has lost market share and is looking for ways to win back former customers and to keep the loyalty of existing customers. The sales director has pointed out that a major competitor of ZXC Co currently offers an early settlement discount of 0·5% for settlement within 30 days, while ZXC Co itself does not offer an early settlement discount. He suggests that if ZXC Co could match this early settlement discount, annual income from credit sales would increase by 20%.

Credit customers of ZXC Co take an average of 51 days to settle invoices. Approximately 0·5% of the company’s credit sales have historically become bad debts each year and written off as irrecoverable. The finance director has been advised that offering an early settlement discount of 0·5% for payment within 30 days would increase administration costs by $35,000 per year, while 75% of credit customers would be likely to take the discount. The credit controller believes that bad debts would fall to 0·375% of credit sales if the early settlement discount were introduced.

ZXC Co has an average short-term cost of finance of 4% per year. Assume that there are 360 days in each year.

Required:

(a) Evaluate whether ZXC Co should introduce the early settlement discount. (6 marks)

(b) Discuss TWO ways in which a company could reduce the risk associated with foreign accounts receivable. (4 marks)

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第2题

Hummingbird Scents Co （Hummingbird) manufactures and sells luxury toiletries; they have be

Hummingbird Scents Co (Hummingbird) manufactures and sells luxury toiletries; they have been trading for over 20 years and the company’s year end is 30 September 2014. Hummingbird sells products to trade customers via its own website; this represents 60% of revenue. Remaining revenue is generated by contracts to supply toiletries to hotels. Below is a description of the sales system.

Hotel revenue

The hotel revenue is made up of four key customers. Hummingbird has one sales clerk, Brenda, who maintains all aspects of this revenue stream; Brenda receives customer orders, raises sales invoices and processes payments. In raising invoices, the sales system automatically inserts the online trade customer prices for products. However, each hotel customer has contracted prices which are lower than the online prices and hence Brenda manually edits the invoices prior to despatch.

Online revenue

New trade customers are set up in the sales ledger master file upon passing suitable credit checks, and a credit limit is set at this stage by the finance director. Customers place online orders up to their pre-set credit limit; they receive an email confirmation and the sales order interfaces into the despatch system. The order number is linked to the customer account number. Goods are despatched daily with a goods despatched note which is referenced to the sales order number but are not sequentially numbered. Hummingbird used to despatch goods via a reliable national courier company. However, to reduce costs they have changed to a cheaper local courier and some orders have been delivered to customers late.

Trade customers’ sales invoices are automatically generated by the system on the day the online order is placed. The prices are inserted in accordance with the website rates. Occasionally Hummingbird makes special offers or discounts sales; when this occurs the master file data has to be amended to ensure that the correct prices are used on invoices. This task is usually performed by a senior sales ledger clerk.

Revenue and receivables records

On a monthly basis statements are sent to the hotel customers; a number of trade customers have been requesting monthly statements and Hummingbird is considering this request. The company only reconciles the sales ledger control account at the end of September in order to verify the year-end balance.

Required:

(a) As the external auditor of Hummingbird Co, write a report to management in respect of the sales system described above which:

(i) Identifies and explains SEVEN deficiencies in the sales system; and

(ii) Provides a recommendation to address each of these deficiencies.

A covering letter IS required.

Note: Up to two marks will be awarded within this requirement for presentation and the remaining marks will be split equally between each part. (16 marks)

(b) Describe substantive procedures the auditor should perform. to confirm Hummingbird Co’s revenue. (4 marks)

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第3题

The following scenario relates to questions 6–10.Corfe Co is a business which manufactures

The following scenario relates to questions 6–10.

Corfe Co is a business which manufactures computer laptop batteries and it has developed a new battery which has a longer usage time than batteries currently available in laptops. The selling price of the battery is forecast to be $45.

The maximum production capacity of Corfe Co is 262,500 units. The company’s management accountant is currently preparing an annual flexible budget and has collected the following information so far:

The following scenario relates to questions 6–10.C

In addition to the above costs, the management accountant estimates that for each increment of 50,000 units produced, one supervisor will need to be employed. A supervisor’s annual salary is $35,000.

The production manager does not understand why the flexible budgets have been produced as he has always used a fixed budget previously

Assuming the budgeted figures are correct, what would the flexed total production cost be if production is 80% of maximum capacity？

A.$2,735,000

B.$2,770,000

C.$2,885,000

D.$2,920,000

In the first month of production of the new battery, actual sales were 18,000 units and the sales revenue achieved was $702,000. The budgeted sales units were 17,300.

Based on this information, which of the following statements is true？

A.When the budget is flexed, the sales variance will include both the sales volume and sales price variances

B.When the budget is flexed, the sales variance will only include the sales volume variance

C.When the budget is flexed, the sales variance will only include the sales price variance

D.When the budget is flexed, the sales variance will include the sales mix and quantity variances and the sales price variance

Which of the following statements relating to the preparation of a flexible budget for the new battery are true？

(1) The budget could be time-consuming to produce as splitting out semi-variable costs may not be straightforward

(2) The range of output over which assumptions about how costs will behave could be difficult to determine

(3) The flexible budget will give managers more opportunity to include budgetary slack than a fixed budget

(4) The budget will encourage all activities and their value to the organisation to be reviewed and assessed

A.1 and 2 only

B.1, 2 and 3

C.1 and 4

D.2, 3 and 4

The management accountant intends to use a spreadsheet for the flexible budget in order to analyse performance of the new battery.

Which of the following statements are benefits regarding the use of spreadsheets for budgeting？

(1) The user can change input variables and a new version of the budget can be quickly produced

(2) Errors in a formula can be easily traced and data can be difficult to corrupt in a spreadsheet

(3) A spreadsheet can take account of qualitative factors to allow decisions to be fully evaluated

(4) Managers can carry out sensitivity analysis more easily on a budget model which is held in a spreadsheet

A.1, 3 and 4

B.1, 2 and 4

C.1 and 4 only

D.2 and 3

The management accountant has said that a machine maintenance cost was not included in the flexible budget but needs to be taken into account.

The new battery will be manufactured on a machine currently owned by Corfe Co which was previously used for a product which has now been discontinued. The management accountant estimates that every 1,000 units will take 14 hours to produce. The annual machine hours and maintenance costs for the machine for the last four years have been as follows:

The following scenario relates to questions 6–10.C

What is the estimated maintenance cost if production of the battery is 80% of maximum capacity (to the nearest $’000)？

A.$575,000

B.$593,000

C.$500,000

D.$735,000

请帮忙给出每个问题的正确答案和分析，谢谢！

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第4题

Heraklion Co is a manufacturer of footballs and is a new audit client for your firm. You a

re an audit supervisor of Spinalonga & Co and are currently preparing for the forthcoming interim and final audit for the year ending 31 October 20X6. You are required to document and assess the sales system, recommend control improvements to deal with a specific fraud issue as well as undertake substantive testing of revenue.

Sales ordering, goods despatched and invoicing

Heraklion Co sells footballs to a range of large and small sports equipment retailers in several countries. Sales are made through a network of sales staff employed by Heraklion Co, but new customer leads are generated through a third party company. Sales staff are responsible for assessing new customers’ creditworthiness and proposing a credit limit which is then authorised by the sales director. The sales staff have monthly sales targets and are able to use their discretion in granting sales discounts up to a maximum of 10%. They then record any discount granted in the customer master data file.

The sales staff visit customer sites personally and orders are completed using a two-part pre-printed order form. One copy is left with the customer and the other copy is retained by the sales person. The sales order number is based on the sales person’s own identification (ID) number.

The company markets itself on being able to despatch all orders within three working days. Once the order is taken, the sales person emails the finance department and warehouse despatch team with the customer ID and the sales order details and from this a pick list is generated. Sequentially numbered goods despatched notes are completed and filed in the warehouse.

Sequentially numbered invoices are generated using the pick lists for quantities and the customer master data file for prices. Standard credit terms for customers are 30 days and on a monthly basis sales invoices which are over 90 days outstanding are notified to the relevant sales person to chase payment directly with the customer.

Payroll fraud

The finance director, Montse Mirabelle, has informed you that a significant fraud took place during the year in the payroll department. A number of fictitious employees were set up on the payroll and wages were paid into one bank account. This bank account belonged to two supervisors, who were married, and were employed by Heraklion Co. One had sole responsibility for setting up new joiners in the payroll system and the other processed and authorised bank transfer requests for wages and supplier payments. These employees no longer work for the company and Montse has asked the audit firm for recommendations on how to improve controls in this area to prevent this type of fraud occurring again. Heraklion Co operates a Human Resources department.

Required:

(a) Describe TWO methods for documenting the sales system, and for each explain ONE advantage and ONE disadvantage of using this method. (6 marks)

(b) Identify and explain SEVEN deficiencies in the sales system of Heraklion Co and provide a recommendation to address each of these deficiencies. Note: Prepare your answer using two columns headed Control deficiency and Control recommendation respectively. (14 marks)

(c) In relation to the payroll fraud, identify and explain THREE controls Heraklion Co should implement to reduce the risk of this type of fraud occurring again and, for each control, describe how it would mitigate the risk. (6 marks)

(d) Describe substantive procedures the auditor should perform. to obtain sufficient and appropriate audit evidence in relation to Heraklion Co’s revenue. (4 marks)

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第5题

Extracts from the recent financial statements of Bold Co are given below.A factor has offe

Extracts from the recent financial statements of Bold Co are given below.

Extracts from the recent financial statements of B

A factor has offered to manage the trade receivables of Bold Co in a servicing and factor-financing agreement. The factor expects to reduce the average trade receivables period of Bold Co from its current level to 35 days; to reduce bad debts from 0·9% of turnover to 0·6% of turnover; and to save Bold Co $40,000 per year in administration costs. The factor would also make an advance to Bold Co of 80% of the revised book value of trade receivables. The interest rate on the advance would be 2% higher than the 7% that Bold Co currently pays on its overdraft. The factor would charge a fee of 0·75% of turnover on a with-recourse basis, or a fee of 1·25% of turnover on a non-recourse basis. Assume that there are 365 working days in each year and that all sales and supplies are on credit.

Required:

(a) Explain the meaning of the term ‘cash operating cycle’ and discuss the relationship between the cash operating cycle and the level of investment in working capital. Your answer should include a discussion of relevant working capital policy and the nature of business operations. (7 marks)

(b) Calculate the cash operating cycle of Bold Co. (Ignore the factor’s offer in this part of the question). (4 marks)

(i) on a with-recourse basis;

(ii) on a non-recourse basis. (7 marks)

(d) Comment on the financial acceptability of the factor’s offer and discuss the possible benefits to Bold Co of factoring its trade receivables. (7 marks)

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第6题

Saxophone Enterprises Co （Saxophone) has been trading for 15 years selling insurance and h

Saxophone Enterprises Co (Saxophone) has been trading for 15 years selling insurance and has recently become a listed company. In accordance with corporate governance principles Saxophone maintains a small internal audit department. The directors feel that the team needs to increase in size and specialist skills are required, but they are unsure whether to recruit more internal auditors, or to outsource the whole function to their external auditors, Cello & Co.

Saxophone is required to comply with corporate governance principles in order to maintain its listed status; hence the finance director has undertaken a review of whether or not the company complies.

Bill Bassoon is the chairman of Saxophone, until last year he was the chief executive. Bill is unsure if Saxophone needs more non-executive directors as there are currently three non-executive directors out of the eight board members. He is considering appointing one of his close friends, who is a retired chief executive of a manufacturing company, as a non-executive director.

The finance director, Jessie Oboe, decides on the amount of remuneration each director is paid. Currently all remuneration is in the form. of an annual bonus based on profits. Jessie is considering setting up an audit committee, but has not undertaken this task yet as she is very busy. A new sales director was appointed nine months ago. He has yet to undertake his board training as this is normally provided by the chief executive and this role is currently vacant.

There are a large number of shareholders and therefore the directors believe that it is impractical and too costly to hold an annual general meeting of shareholders. Instead, the board has suggested sending out the financial statements and any voting resolutions by email; shareholders can then vote on the resolutions via email.

Required:

(a) Explain the advantages and disadvantages for each of Saxophone Enterprises Co AND Cello & Co of outsourcing the internal audit department.

Note: The total marks will be split as follows:

Saxophone Enterprises Co (8 marks)

Cello & Co (2 marks) (10 marks)

(b) In respect of the corporate governance of Saxophone Enterprises Co:

(i) Identify and explain FIVE corporate governance weaknesses; and

(ii) Provide a recommendation to address each weakness.

Note: The total marks will be split equally between each part. (10 marks)

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第7题

You are the audit supervisor of Seagull & Co and are currently planning the audit of y

our existing client, Eagle Heating Co (Eagle), for the year ending 31 December 2014. Eagle manufactures and sells heating and plumbing equipment to a number of home improvement stores across the country.

Eagle has experienced increased competition and as a result, in order to maintain its current levels of sales, it has decreased the selling price of its products significantly since September 2014. The finance director has informed your audit manager that he expects increased inventory levels at the year end. He also notified your manager that one of Eagle’s key customers has been experiencing financial difficulties. Therefore, Eagle has agreed that the customer can take a six-month payment break, after which payments will continue as normal. The finance director does not believe that any allowance is required against this receivable.

In October 2014 the financial controller of Eagle was dismissed. He had been employed by the company for over 20 years, and he has threatened to sue the company for unfair dismissal. The role of financial controller has not yet been filled and so his tasks have been shared between the existing finance department team. In addition, the purchase ledger supervisor left in August and a replacement has been appointed in the last week. However, for this period no supplier statement reconciliations or purchase ledger control account reconciliations were performed.

You have undertaken a preliminary analytical review of the draft year to date statement of profit or loss, and you are surprised to see a significant fall in administration expenses.

Required:

Explain FIVE audit risks, and the auditor’s response to each risk, in planning the audit of Eagle Heating Co.

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第8题

You are the audit supervisor of Maple & Co and are currently planning the audit of an

existing client, Sycamore Science Co (Sycamore), whose year end was 30 April 2015. Sycamore is a pharmaceutical company, which manufactures and supplies a wide range of medical supplies. The draft financial statements show revenue of $35·6 million and profit before tax of $5·9 million.

Sycamore’s previous finance director left the company in December 2014 after it was discovered that he had been claiming fraudulent expenses from the company for a significant period of time. A new finance director was appointed in January 2015 who was previously a financial controller of a bank, and she has expressed surprise that Maple & Co had not uncovered the fraud during last year’s audit.

During the year Sycamore has spent $1·8 million on developing several new products. These projects are at different stages of development and the draft financial statements show the full amount of $1·8 million within intangible assets. In order to fund this development, $2·0 million was borrowed from the bank and is due for repayment over a ten-year period. The bank has attached minimum profit targets as part of the loan covenants.

The new finance director has informed the audit partner that since the year end there has been an increased number of sales returns and that in the month of May over $0·5 million of goods sold in April were returned.

Maple & Co attended the year-end inventory count at Sycamore’s warehouse. The auditor present raised concerns that during the count there were movements of goods in and out the warehouse and this process did not seem well controlled.

During the year, a review of plant and equipment in the factory was undertaken and surplus plant was sold, resulting in a profit on disposal of $210,000.

Required:

(a) State Maples & Co’s responsibilities in relation to the prevention and detection of fraud and error. (4 marks)

(b) Describe SIX audit risks, and explain the auditor’s response to each risk, in planning the audit of Sycamore Science Co. (12 marks)

(c) Sycamore’s new finance director has read about review engagements and is interested in the possibility of Maple & Co undertaking these in the future. However, she is unsure how these engagements differ from an external audit and how much assurance would be gained from this type of engagement.

Required:

(i) Explain the purpose of review engagements and how these differ from external audits; and (2 marks)

(ii) Describe the level of assurance provided by external audits and review engagements. (2 marks)

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第9题

Section B – TWO questions ONLY to be attemptedLouieed Co Louieed Co, a listed company, is

Section B – TWO questions ONLY to be attempted

Louieed Co

Louieed Co, a listed company, is a major supplier of educational material, selling its products in many countries. It supplies schools and colleges and also produces learning material for business and professional exams. Louieed Co has exclusive contracts to produce material for some examining bodies. Louieed Co has a well-defined management structure with formal processes for making major decisions.

Although Louieed Co produces online learning material, most of its profits are still derived from sales of traditional textbooks. Louieed Co’s growth in profits over the last few years has been slow and its directors are currently reviewing its long-term strategy. One area in which they feel that Louieed Co must become much more involved is the production of online testing materials for exams and to validate course and textbook learning.

Bid for Tidded Co

Louieed Co has recently made a bid for Tidded Co, a smaller listed company. Tidded Co also supplies a range of educational material, but has been one of the leaders in the development of online testing and has shown strong profit growth over recent years. All of Tidded Co’s initial five founders remain on its board and still hold 45% of its issued share capital between them. From the start, Tidded Co’s directors have been used to making quick decisions in their areas of responsibility. Although listing has imposed some formalities, Tidded Co has remained focused on acting quickly to gain competitive advantage, with the five founders continuing to give strong leadership.

Louieed Co’s initial bid of five shares in Louieed Co for three shares in Tidded Co was rejected by Tidded Co’s board. There has been further discussion between the two boards since the initial offer was rejected and Louieed Co’s board is now considering a proposal to offer Tidded Co’s shareholders two shares in Louieed Co for one share in Tidded Co or a cash alternative of $22·75 per Tidded Co share. It is expected that Tidded Co&39;s shareholders will choose one of the following options:

(i) To accept the two-shares-for-one-share offer for all the Tidded Co shares; or,

(ii) To accept the cash offer for all the Tidded Co shares; or,

(iii) 60% of the shareholders will take up the two-shares-for-one-share offer and the remaining 40% will take the cash offer.

In case of the third option being accepted, it is thought that three of the company&39;s founders, holding 20% of the share capital in total, will take the cash offer and not join the combined company. The remaining two founders will probably continue to be involved in the business and be members of the combined company&39;s board.

Louieed Co’s finance director has estimated that the merger will produce annual post-tax synergies of $20 million. He expects Louieed Co’s current price-earnings (P/E) ratio to remain unchanged after the acquisition.

Extracts from the two companies’ most recent accounts are shown below:

Section B – TWO questions ONLY to be attemptedLoui

The tax rate applicable to both companies is 20%.

Assume that Louieed Co can obtain further debt funding at a pre-tax cost of 7·5% and that the return on cash surpluses is 5% pre-tax.

Assume also that any debt funding needed to complete the acquisition will be reduced instantly by the balances of cash and cash equivalents held by Louieed Co and Tidded Co.

Required:

(a) Discuss the advantages and disadvantages of the acquisition of Tidded Co from the viewpoint of Louieed Co. (6 marks)

(b) Calculate the P/E ratios of Tidded Co implied by the terms of Louieed Co’s initial and proposed offers, for all three of the above options. (5 marks)

(c) Calculate, and comment on, the funding required for the acquisition of Tidded Co and the impact on Louieed Co’s earnings per share and gearing, for each of the three options given above.

Note: Up to 10 marks are available for the calculations. (14 marks)

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第10题

Robber Co manufactures control panels for burglar alarms, a very profitable product. Every

product comes with a one year warranty offering free repairs if any faults arise in this period.

It currently produces and sells 80,000 units per annum, with production of them being restricted by the short supply of labour. Each control panel includes two main components – one key pad and one display screen. At present, Robber Co manufactures both of these components in-house. However, the company is currently considering outsourcing the production of keypads and/or display screens. A newly established company based in Burgistan is keen to secure a place in the market, and has offered to supply the keypads for the equivalent of $4·10 per unit and the display screens for the equivalent of $4·30 per unit. This price has been guaranteed for two years.

The current total annual costs of producing the keypads and the display screens are:

Robber Co manufactures control panels for burglar

Notes:

1. Materials costs for keypads are expected to increase by 5% in six months’ time; materials costs for display screens are only expected to increase by 2%, but with immediate effect.

2. Direct labour costs are purely variable and not expected to change over the next year.

3. Heat and power costs include an apportionment of the general factory overhead for heat and power as well as the costs of heat and power directly used for the production of keypads and display screens. The general apportionment included is calculated using 50% of the direct labour cost for each component and would be incurred irrespective of whether the components are manufactured in-house or not.

4. Machine costs are semi-variable; the variable element relates to set up costs, which are based upon the number of batches made. The keypads’ machine has fixed costs of $4,000 per annum and the display screens’ machine has fixed costs of $6,000 per annum. Whilst both components are currently made in batches of 500, this would need to change, with immediate effect, to batches of 400.

5. 60% of depreciation and insurance costs relate to an apportionment of the general factory depreciation and insurance costs; the remaining 40% is specific to the manufacture of keypads and display screens.

Required:

(a) Advise Robber Co whether it should continue to manufacture the keypads and display screens in-house or whether it should outsource their manufacture to the supplier in Burgistan, assuming it continues to adopt a policy to limit manufacture and sales to 80,000 control panels in the coming year. (8 marks)

(b) Robber Co takes 0·5 labour hours to produce a keypad and 0·75 labour hours to produce a display screen. Labour hours are restricted to 100,000 hours and labour is paid at $1 per hour. Robber Co wishes to increase its supply to 100,000 control panels (i.e. 100,000 each of keypads and display screens). Advise Robber Co as to how many units of keypads and display panels they should either manufacture and/or outsource in order to minimise their costs. (7 marks)

(c) Discuss the non-financial factors that Robber Co should consider when making a decision about outsourcing the manufacture of keypads and display screens. (5 marks)

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第11题

Section A – This ONE question is compulsory and MUST be attemptedCocoa－Mocha－Chai （CMC) Co

Section A – This ONE question is compulsory and MUST be attempted

Cocoa-Mocha-Chai (CMC) Co is a large listed company based in Switzerland and uses Swiss Francs as its currency. It imports tea, coffee and cocoa from countries around the world, and sells its blended products to supermarkets and large retailers worldwide. The company has production facilities located in two European ports where raw materials are brought for processing, and from where finished products are shipped out. All raw material purchases are paid for in US dollars (US$), while all sales are invoiced in Swiss Francs (CHF).

Until recently CMC Co had no intention of hedging its foreign currency exposures, interest rate exposures or commodity price fluctuations, and stated this intent in its annual report. However, after consultations with senior and middle managers, the company’s new Board of Directors (BoD) has been reviewing its risk management and operations strategies.

The following two proposals have been put forward by the BoD for further consideration:

Proposal one

Setting up a treasury function to manage the foreign currency and interest rate exposures (but not commodity price fluctuations) using derivative products. The treasury function would be headed by the finance director. The purchasing director, who initiated the idea of having a treasury function, was of the opinion that this would enable her management team to make better decisions. The finance director also supported the idea as he felt this would increase his influence on the BoD and strengthen his case for an increase in his remuneration.

In order to assist in the further consideration of this proposal, the BoD wants you to use the following upcoming foreign currency and interest rate exposures to demonstrate how they would be managed by the treasury function:

(i) a payment of US$5,060,000 which is due in four months’ time; and

(ii) a four-year CHF60,000,000 loan taken out to part-fund the setting up of four branches (see proposal two below). Interest will be payable on the loan at a fixed annual rate of 2·2% or a floating annual rate based on the yield curve rate plus 0·40%. The loan’s principal amount will be repayable in full at the end of the fourth year.

Proposal two

This proposal suggested setting up four new branches in four different countries. Each branch would have its own production facilities and sales teams. As a consequence of this, one of the two European-based production facilities will be closed. Initial cost-benefit analysis indicated that this would reduce costs related to production, distribution and logistics, as these branches would be closer to the sources of raw materials and also to the customers. The operations and sales directors supported the proposal, as in addition to above, this would enable sales and marketing teams in the branches to respond to any changes in nearby markets more quickly. The branches would be controlled and staffed by the local population in those countries. However, some members of the BoD expressed concern that such a move would create agency issues between CMC Co’s central management and the management controlling the branches. They suggested mitigation strategies would need to be established to minimise these issues.

Response from the non-executive directors

When the proposals were put to the non-executive directors, they indicated that they were broadly supportive of the second proposal if the financial benefits outweigh the costs of setting up and running the four branches. However, they felt that they could not support the first proposal, as this would reduce shareholder value because the costs related to undertaking the proposal are likely to outweigh the benefits.

Additional information relating to proposal one

The current spot rate is US$1·0635 per CHF1. The current annual inflation rate in the USA is three times higher than Switzerland.

The following derivative products are available to CMC Co to manage the exposures of the US$ payment and the interest on the loan:

Exchange-traded currency futures

Contract size CHF125,000 price quotation: US$ per CHF1

Section A – This ONE question is compulsory and MU

It can be assumed that futures and option contracts expire at the end of the month and transaction costs related to these can be ignored.

Over-the-counter products

In addition to the exchange-traded products, Pecunia Bank is willing to offer the following over-the-counter derivative products to CMC Co:

(i) A forward rate between the US$ and the CHF of US$ 1·0677 per CHF1.

(ii) An interest rate swap contract with a counterparty, where the counterparty can borrow at an annual floating rate based on the yield curve rate plus 0·8% or an annual fixed rate of 3·8%. Pecunia Bank would charge a fee of 20 basis points each to act as the intermediary of the swap. Both parties will benefit equally from the swap contract.

Required:

(a) Advise CMC Co on an appropriate hedging strategy to manage the foreign exchange exposure of the US$ payment in four months’ time. Show all relevant calculations, including the number of contracts bought or sold in the exchange-traded derivative markets. (15 marks)

(b) Demonstrate how CMC Co could benefit from the swap offered by Pecunia Bank. (6 marks)

(c) As an alternative to paying the principal on the loan as one lump sum at the end of the fourth year, CMC Co could pay off the loan in equal annual amounts over the four years similar to an annuity. In this case, an annual interest rate of 2% would be payable, which is the same as the loan’s gross redemption yield (yield to maturity).

Required: Calculate the modified duration of the loan if it is repaid in equal amounts and explain how duration can be used to measure the sensitivity of the loan to changes in interest rates. (7 marks)

(d) Prepare a memorandum for the Board of Directors (BoD) of CMC Co which:

(i) Discusses proposal one in light of the concerns raised by the non-executive directors; and (9 marks)

(ii) Discusses the agency issues related to proposal two and how these can be mitigated. (9 marks)

Professional marks will be awarded in part (d) for the presentation, structure, logical flow and clarity of the memorandum. (4 marks)

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