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Managing Economic and Transaction Exposure

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Managing Economic and Transaction Exposure Simulation
A summary in which you address the following:

1. For each major phase, describe the situation, your recommended solutions, and results.
2. Summarize different global finance concepts addressed in the simulation by answering the following questions:
3. What foreign exchange risk factors must be considered when making investments in another currency? What are appropriate techniques for mitigating these risks?
4. How may one take advantage of currency fluctuations when making long-term loan decisions?
5. Why is it important to evaluate political, social, and economic conditions of a country before investing in that country?
6. How does hedging help limit an organization's transactional exposure?
7. How does a currency swap help in limiting transactional exposure?

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Solution Preview

Simulation starts with the introduction of Rest Easy a chain of hotels based in Drenden. Rest Easy is planning to expand into its neighboring country Zenobia. As part of its expansion plan, Rest Easy has bought several properties in Arasia and Xandria, two main cities of Zenobia for D $ 50 million. This amount has to be paid back in four installments either in Drenden dollars or Zenobain pounds. Senior management does not want to pay all these installments in the same currency to limit its exposure to foreign exchange risk. In the first stage of the simulation, I have to determine whether the Zenobain pounds will fluctuate drastically in next one year and if so, how the payment should be divided between the two currencies.

Based on the trend given of the exchange rate of Zenobain pound and Drenden dollar, I projected that the Zenobian pound would devalue at the rate 1.75 %. Based on the CFO's advice and currency trend, I decided to pay the four quarterly installments 60 % in Drenden dollars and 40 % in Zenobian pound. I took this decision to limit the Rest Easy's exposure to foreign exchange risk. If Zenobian pound appreciates during this period, Rest Easy may have to face significant loss. That is the reason why I decided to limit Rest Easy's payable amount in Zenobian pounds.

In the second stage of the simulation, a situation is presented in Xandria city of Zenobia. There is an outbreak of new virus with flu symptoms in Xandria. Zenobian economy has been badly affected. This has led to devaluation of Zenobian pound that has forced the Zenobian government to increase key interest rates by 1 %. In this situation, senior management has advised that I should hedge 50 % the amount payable in ...

Solution Summary

The solution examines managing economic and transaction exposure simulations. For each major phase the situation is described and a solution is recommended.