Treasury and Risk Management

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Question one

I will recommend a forward market hedge. This involves paying the 8.5 million in the forward rate expected in a period of 180 days, where the spot rate will be yen 2.6/Rs. The result is 3,269,231 rupees, which is less costly compared to all other hedging strategies. This is because at that rate, Hindustan Lever will owe the Japanese company less in terms of the currency denomination. For instance if the Hindustan Lever Company decide to use the current spot rate to make the payment, the amount payable to the Japanese company will be 3,517,567 Indian rupees inclusive of the 4.58 percent currency agent fees. If Hindustan decides to invest the money and pay the money after 180 days, the amount payable to the Japanese company will be 3,269,230 Indian rupees at the expected sport rate of Yen 2.6/Rs after having input the investment rates and the cost of capital (Teall 2013).

Paying the payable using the forward exchange rate increases the amount payable to 3,541,667 Indian rupees. This hedging strategy also guarantees that the parties involved will not default. This is because the agreements put in place are binding on all the parties that are involved (Konrad 2009). The forward market hedge is tailored in such a way that it meets the requirements of that company that are suffering from the foreign exchange rate exposure (Teall 2013).Similarly, this type of hedging is used to trade instruments ranging from the currencies to the interest rate. In this instance, the Indian rupee is affected by the currency fluctuations. A forward rate favors the rupee over the Japanese Yen.

Question two

The following information pertains to the Clad Metal, a U.S multinational pursuing to propose a 5 year ore extraction project in Mexico. The initial investment cost was 500,000 dollars. The cost of capital given is 16%.the annual cash flows of the project from year one to year five are 100,000, 200,000, 250,000, 250,000, 250,000 dollars respectively

a)      What is the present value of the project given the following information

NPV = - 500,000 + 100,000 +200,000 + 250,000 + 250,000 + 250,000

                                 1.16         (1.16)2       (1.16)3         (1.16)4        (1.16)5

Year

Cash Flow

Present Values

0

- 500,000

- 500,000

1

  100,000

86,206

2

  200,000

148,632

3

  250,000

160,164

4

  250,000

138,075

 5                  

  250,000

119,028

                   NPV

 

152,105

 

The project should be taken. This is because the net present value is positive, indicating consistent gains from the project.

b)Any alterations to be done on the project require the approval of the committee of implementation, the senior management and the sponsors of the project. The sponsors could range from investors to creditors like bank institutions, government and the religious counterparts (Madura 2005). These parties are better informed in all factors that pertain to the political risk of a country. These factors are: government regulations and policies, currency strength of the country, the declarations of war by the country, the regulatory changes in the country, corruption levels, and the government composition changes. Others include expropriation history of the host country (Schmidt 2006). Christy (2013) states that unlike all other types of risks a company faces, quantifying political risk is quite hectic. John advocates information on the Economist’s Country Briefings as a way of estimating the political risk. These briefings contain information regarding the background of the country’s politics, government and the economy over the past years.

c)Assuming that the probability of nationalization of the project is between 5 to 7 percent, I would recommend approval of the project.

Assuming a 5% chance of expropriation

Year

Cash Flow

Present Values

PV * (0.95)t

0

- 500,000

- 500,000

 

1

  100,000

86,206

81,896

2

  200,000

148,632

134,140

3

  250,000

160,164

137,321

4

  250,000

138,075

112,461

5                  

  250,000

119,028

92,102

NPV

 

152,105

57,920

 

Assuming a 7% chance of expropriation

Year

Cash Flow

Present Values

PV * (0.93)t

0

- 500,000

- 500,000

 

1

  100,000

86,206

80,172

2

  200,000

148,632

128,552

3

  250,000

160,164

128,829

4

  250,000

138,075

103,286

5                  

  250,000

119,028

82,807

NPV

 

152,105

23,643

 

It is assumed there was no compensation. Both cases show that even after expropriation, the net present value is still positive, hence approval of the project (Stephen & Jones 2007).

d)I would not reconsider converting the expected cash flow from Mexican peso. Allowing the host government o fit into the project renders the project to depict the local image of the country. This is definitely likely to reduce the risk associated with the currency devaluation since the exports and imports of the project will not be restricted.

Question three

Advantages of debts instrument over the bank borrowing

Bank borrowing has been the form of financing that many companies and individuals in general have been using as a form of raising finances for projects. However as a result of increased competition among the banking sector, banks came up with new ways of financing that involved. The introduction of the debt instruments saw a number of borrowers migrate from bank borrowing as a result of added advantages. This segment will discuss various debt instruments and the benefits they offer in comparison to bank borrowing.

Syndicated Loans

Syndicated loans refer to loans given by a group of many lenders who are generally called a syndicate. The group of lenders joins forces to raise the funds foe a single borrower. The loans are administered to the borrower by a common agent using common documentation despite the different lenders. The terms and conditions are similar all through. These loans are advantageous over the bank loans in a number of ways. The lead lender here acts as the agent representing all other lenders in the loan administration as well as in the origination of documents. This helps in creating the environment that aids in consultation.ths also creates the flexibility in its administration. As a result, the mid sized companies have opted to go for the syndicated loans which were offered to the huge companies over the bank loans (Branson 2013).

It is difficult to manage many bank relationships, therefore borrower seek to get syndicated loans. This is because bank loans require some levels of comfort to be established between the two sides, and this will take time and a lot of effort. Sequence, it takes time to negotiate a document with a bank and more time if we are talking of more that three banks, it becomes hectic and inefficient. With this knowledge, borrowers ranging from companies to individuals opt to borrow syndicated loans which involve effort that is consolidated and new banking contacts made (Branson 2013).

Lenders are more supportive of these loans because syndications allow them to offer more loans and diversify the risk within the portfolios in a wide range (Branson 2013). Diversifying the lenders who offer the credit facility allows the banks that are participating to commit their funds to a specific desired asset. Their commitment is therefore less directed to the exposure or risk involved with the commitment of such an amount of money. The presence of an agent to facilitate the administering of the funds gives the banks the flexibility to negotiate and operate the credit facility, since the dealer is one bank that is representing all the other banks.

Due t the joined efforts, the syndicated loans are able to meet the various credit needs and the preferences of the customer. The agent, in agreement with the borrower settles down the agreement through assembling the groups of lenders who are the other banks. The borrower is given the access to the money after six to eight weeks. The terms of loan here can be dictated by both the parties, that is the borrower and the lenders through the agent (Branson 2013).

Euro Notes

The foreign exchange risk of the euro is less compared to the bank loans. This means one can access the money from all the countries issued with the euro notes without necessarily worrying about the exchange rate fluctuations. This is because euro helped in enhancing the stability of the exchange rates and exploitation of the integrated capital markets. The euro notes also come with reduced interest rates as compared to the bank loans. This is because of the reduced risks involved with the inflation and the exchange rates. Euro notes also enhance profitability of the institution borrowing. The euro notes require minimal infrastructure for securing the loan. The issue of analyzing the borrower’s character and the history of the customer is not an option. This saves the time involved in acquiring the loan and enhances efficiency as compared to the bank loans.

E-Commercial Papers

These papers do not require collateral as is a requirement from the banks. This also means that no lien is required on the assets of a company in case the company is the borrower. As compared to the bank loans, the e-commercial papers mature faster hence save the cost of wasting time. Fast maturity also enhances flexibility in handling the money. Due to the high credit ratings that the e-commercial papers are given, the risk of acquiring the papers are low hence the cost of capital attaches to granting them is equally as low (Sharma 2010).

Low cost of capital translates into other benefits to the borrower among them profitability and security. Another advantage is the flexibility to transfer the obligation to another party. Commercial papers allow trading hence giving the investors the opportunity to transfer the obligation, something not possible in bank loans unless it’s a guarantor or a security being sold. The commercial papers are cheaper compared to the bank loans. Raising the capital is less costly and faster. This is because they give the companies a fast way to take the advantage of the fluctuations of the interest rates in the market (Sharma 2010).

Euro Medium Term Notes

These offer flexibility to the borrowers in terms of the documentation that is required. They are referred to as the unsecured loans therefore don’t require securities. The notes are issued by a company to the investors through the agents. This gives the borrowers the flexibility to engage in any form of interaction with the investors. Their maturity is usually between 5 to 10 years but can also extend to 50 years. This gives the borrower the time to repay the debt. Bank loans normally limit the borrower to less those five years to finish repayment of a loan. The papers also provide the investors with the flexibility to choose the types of the notes that they desire, the period of maturity they are comfortable with and the coupon rate that suits them. This is contrary to the bank loans which have specific guidelines. These notes also provide the borrower with a continuous flow of cash and not a one time inflow from the banks (Medium-Term Note 2013).

International Bonds

These are bonds that are offered in various currencies throughout out the world. According to Fedorov (2013) most of loans from the bank come with conditions and restrictions since the banks are governed by the bank loan covenants. No such restrictions however are imposed for bond holders. The only requirement they are supposed to fulfill is paying the interest and the principal amount at maturity of the bond. International bonds also provide the transparency of investment compared to the loan. In bank loans, the bank has the power to increase the interest rates but the international provide the information on all the details of the bind before committing the money.

Borrowing using the international bond also diversifies the portfolio of the investment as well as providing steady consistent income at a very low risk. The variety of the international bonds also gives the investors the choice of ganging and choosing the most favorable, for instance whether to go with the short term or long term. More of the money belonging to the investors who are the creditors goes towards purchasing the bond and not other expenses hence terming them more cost efficient compared to the bank loans. These bonds are also more secured compared to the traditional bank loans. The transparency of the share prices also helps to understand the environment you are committing the funds into, hence reduced risks (Stephen & Jones 2007).

Conclusion

Having studied the five debt instruments, the common factors that emerge are flexibility and cost effectiveness. Contrary to bank borrowing, these debt instruments are designed to suit the various customer needs and also give the customers the opportunity to choose from a variety if choices offered. The interest rate for the debt instruments are also higher compared to that of bank loans. Borrowers need to understand the advantages they stand to gain in choosing one over the other.

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