This is designed to test students on Topic 1 (International Monetary System) and on Topic 4 and Topic 5 (Currency Risk Management).
 On topic 1, students are expected to research on a particular country’s unregulated financial system and the possible impact on the international financial landscape. The emphasis is on presenting the relevant arguments on the potency of an impending crisis if regulation is not imposed.
 On Topic 4 and topic 5, students are expected to devise a currency hedging strategy for a particular firm using derivatives. The emphasis is on quantitative skills and the mechanics of the different contracts.
Question 1 (20 marks)
Define China’s shadow banking system and the threats it poses to China’s domestic economy. Also present arguments why this may or may not trigger a worldwide crisis.
[4 + 8 + 8 = 20 marks]
Students are required to answer between 1000 and 1500 words. Please provide the word count. There should be a minimum of 5 references.
Question 2 (10 marks)
Ace plc produces drill bits for gold mining equipment. A German customer is contracted to pay Ace plc 8.5 million euros in six months’ time. The top management of the company is thinking whether or not to hedge this foreign currency receipt, and if so, which method would be optimal. Some executives believe the exchange rate will be GBP1= EUR 1.37 when payment is due from the customer. Other executives think the exchange rate will be GBP1= EUR 1.43. The alternatives available to Ace plc are as follows:
i. Forward contract hedge: Spot GBP/EUR Bid 1.4010 – Offer 1.4132 6 month forward points: 95/85
17
ii. Currency option hedge
Call option available: Strike GBP/EUR 1.4200 at premium GBP 1.20 per EUR100 Put option available: Strike GBP/EUR 1.4180 at premium GBP 1.00 per EUR100
iii. Money market hedge
Bid Offer Europe interest rates 2.75% 3.00% UK interest rates 6.20% 6.60%
The bank charges an administrative fee of 0.5% on the final receipt.
iv. To do nothing.
Required:
(a) Calculate the net receipt in GBP under each of the four alternatives assuming the exchange rate in six months are:
i. GBP1= EUR 1.37
ii. GBP1= EUR 1.43 [6 marks]
(b) Based on your answer in part a above, make a reasoned recommendation on which alternative is optimal. [4 marks]
There is no word count requirement for this question.