FNCE3004 International Finance - Open Book Examination

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XYZ is a multinational company headquartered in Singapore that engages in diverse activities, including the production of electronic tools such as handheld digital electronic microscopes, digital multimeters, voltage testers, and more. To support its manufacturing operations, the company imports electronic components from countries like Japan and South Korea.

The company sells its products in markets such as Australia, Canada, and the United Kingdom, with the majority of sales occurring in Australia. As a result, XYZ has established a subsidiary in Australia to facilitate the resale and distribution of its products to various businesses. The quarterly net profit after tax generated by the subsidiary is AUD500,000. In addition to the Australian market, XYZ exports its products to Canada and the United Kingdom through independent distributing companies, which purchase the tools at wholesale prices from XYZ.

To further streamline its operations and mitigate risks and costs, XYZ is actively exploring the possibility of constructing an electronic component manufacturing plant in Singapore. By establishing a local manufacturing facility, XYZ aims to eliminate the need for importing electronic components from countries like Japan and South Korea. This strategic move would enhance supply chain efficiency and bolster the company's competitive advantage in the market. XYZ already possesses ample manufacturing space and is well-prepared to embark on its expansion plans. To facilitate this, the company intends to import manufacturing equipment worth 740,000,000 WON from South Korea. The installation of the machinery will be undertaken by local Singaporean companies, incurring a cost of SGD2,000,000.

With the necessary manufacturing space already in place, XYZ's focus is now on acquiring the essential equipment and partnering with local experts for the installation process. This approach ensures a seamless transition and allows XYZ to efficiently leverage its existing infrastructure for the establishment of the electronic component manufacturing plant. The Chief Executive Officer (CEO) of XYZ, requests the following information to assist him with determining the extent of exchange rate risk and the availability of funds to conduct the multinational transactions:

  1. The CEO has requested a forecast of the SGD/AUD exchange rates for both a two-year and four-year time frame. These projections will be calculated based on two commonly used economic indicators: Purchasing Power Parity (PPP) and the International Fisher Effect (IFE). To perform this analysis, the following existing information will be utilized:
Current SGD/AUD spot exchange rate SGD$0.95/AUD
Expected annual Singapore inflation 1.23%
Expected annual Australia inflation 0.85%
Expected Singapore one-year interest rate 0.258%
Expected Australia one-year interest rate 0.106%
  1. The CEO is concerned about the potential increase in interest rates by 0.85% in Australia. The Australian subsidiary currently holds a short-term loan of AUD2,200,000 that will mature in 60 days. After the loan expires, the subsidiary will need to borrow the same amount again to cover operational expenses. To mitigate the risk of rising interest rates, the CEO is considering a 60-day forward rate agreement in Australia. The agreed rate for the calculation will be based on the current risk-free Australia rate, and the settlement rate will be the current risk-free rate plus 0.85%.

To advise the CEO on whether XYZ should take a long or short position to hedge against the risk of increasing interest rates, the information from the provided table can be utilized for the necessary calculations.

Annual risk-free interest rates:
Singapore 0.258%
Japan 0.025%
South Korea 0.664%
Canada 0.166%
UK 0.106%
Australia 0.112%
South Africa 4.545%


  1. The subsidiary in Australia generates a significant amount of profit, which can be utilized to fund the import of manufacturing equipment from South Korea for the electronic component plant in Singapore. The CEO has initiated negotiations with the South Korean equipment supplier, who is willing to offer XYZ a payment period of 3 years. However, the payments must be made through quarterly installments of 62,000,000 WON by the Australia subsidiary. To facilitate this arrangement, the CEO has requested the construction of a currency swap that enables the utilization of the Australia subsidiary's profits to cover the equipment costs. To proceed with the three-year currency swap, you will apply the swap bank quotes. Additionally, a graphical representation of the swap will be provided to help the CEO visualize how the swap arrangement will function. Relevant information required for these calculations and the graphical representation is provided below:
Exchange rates: Spot
Bid Ask
SGD/JPY 0.0094 0.0095
SGD/Won 0.0006 0.0008
SGD/CAD 0.7614 0.7616
SGD/GBP 1.3034 1.3038
SGD/AUD 0.7225 0.7226
SGD/ZAR 0.0606 0.0607
Current borrowing interest rates on loans: Fixed Libor
Singapore 0.640% 0.130%
Japan 0.525% 0.015%
South Korea 1.164% 0.654%
Canada 0.666% 0.156%
UK 0.577% 0.067%
Australia 0.612% 0.102%
South Africa 5.045% 4.535%
Years Bid% Ask% Bid% Ask% Bid% Ask% Bid% Ask% Bid% Ask% Bid% Ask% Bid% Ask%
1 0.630 0.650 0.515 0.535 1.154 1.174 0.656 0.676 0.567 0.587 0.602 0.622 5.035 5.055
2 0.640 0.660 0.525 0.545 1.164 1.184 0.666 0.686 0.577 0.597 0.612 0.632 5.045 5.065
3 0.650 0.670 0.535 0.555 1.174 1.194 0.676 0.696 0.587 0.607 0.622 0.642 5.055 5.075
4 0.660 0.680 0.545 0.565 1.184 1.204 0.686 0.706 0.597 0.617 0.632 0.652 5.065 5.085
5 0.670 0.690 0.555 0.575 1.194 1.214 0.696 0.716 0.607 0.627 0.642 0.662 5.075 5.095
6 0.680 0.700 0.565 0.585 1.204 1.224 0.706 0.726 0.617 0.637 0.652 0.672 5.085 5.105
7 0.690 0.710 0.575 0.595 1.214 1.234 0.716 0.736 0.627 0.647 0.662 0.682 5.095 5.115
8 0.700 0.720 0.585 0.605 1.224 1.244 0.726 0.746 0.637 0.657 0.672 0.692 5.105 5.125
9 0.710 0.730 0.595 0.615 1.234 1.254 0.736 0.756 0.647 0.667 0.682 0.702 5.115 5.135
10 0.720 0.740 0.605 0.625 1.244 1.264 0.746 0.766 0.657 0.677 0.692 0.712 5.125 5.145
Other summarised information:
Australia subsidiary profits generated quarterly: AUD500,000
Import cost of equipment/machinery for the manufacturing of electronic components in Singapore: WON74,000,000


  1. Question 4:

Let's consider the following example of an interest rate swap involving two firms, Firm A and Firm B. Firm A prefers a variable interest rate loan, while Firm B prefers a fixed interest rate loan. The banks offer the following lending rates:

Firm A can obtain either a fixed rate loan at 7% or a variable rate loan tied to LIBOR.

Firm B can obtain either a fixed rate loan at 10% or a variable rate loan tied to LIBOR + 1%.

In this scenario, a swap bank has engaged in negotiations with Firm A and Firm B for separate transactions:

Firm A enters into an agreement with the swap bank, whereby Firm A pays the swap bank the variable interest rate LIBOR on the loan, and the swap bank pays Firm A a fixed interest rate of 8% on the loan.

Similarly, the swap bank negotiates an agreement with Firm B, where Firm B pays the swap bank a fixed interest rate of 8.5% on the loan, and the swap bank pays Firm B the variable interest rate LIBOR on the loan.

4.1. Calculate the quality spread differential of this swap.

4.2. Assuming the principal value of this loan is 5 million USD. How much profit the swap bank could earn? How much interest cost saving from firm A and firm B respectively?

4.3. Using one sentence or one calculation result to summarize the connection between your answers in 4.2 and 4.1.

  1. Question 5:

A 3-year currency swap has a remaining life of 26 months.

It involves exchanging interest at 10% on £25 million for interest at 8% on $35 million once a year.

The term structure of interest rates is currently flat in both the U.S. and the U.K. If the swap were negotiated today, the interest rates exchanged would be $7% and £10%. All rates were quoted with annual compounding. The current exchange rate is $2 = £1.

What is the value of the swap (in USD) to the party paying dollars?


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