International Finance April, 2011 Question 1 (i) (ii) (iii) (iv) (v) (vi) Multinational Corporation with headquarters in United States of America is expecting cash flow of $5,000,000 from home business and N 200,000,000 from its Nigerian subsidiary at the end of period t, assuming that the Naira value is expected to be $/ N 153.0100 155.0120. What is the expected dollar cash flows? (a) US$6,290,222.69 (b) US$1,390,222.09 (c) US$5,130,000.29 (d) US$5,200,718.00 Tell quell rate can be defined as.. In a fixed Exchange Rate Market, if you are converting a quoted amount of home currency to that of a foreign currency, you will. the local currency amount by the rate given. Four types if international financial markets around the world are:.. One major advantage of Euro between participating countries is: (a) Complete elimination of exchange rate risk (b) Removal of trade barriers (c) Similarity in interest rate offered by government (d) Promotion of high level of employment among member countries. A practice by some banks where FOREX is employed for purposes other than originally declared is known as:.. (vii) Translation exposure can be defined as:....... 1
(viii) In a floating exchange rate market, to convert a set of cross rate to a direct rate, the formula to use is:. (ix) (x) Another name for law of one price is:... An option that can only be exercised on the options expiration date is:.... Comment This is the first time multiple-choice questions will be applied as a compulsory question. The aim is to cover a greater part of the syllabus. The questions were based on section A of the syllabus. One would have thought that this will improve the students performance but only a 34% pass rate was recorded. Answer (i) a (ii) An average calculated when buying a currency bill drawn on a foreign centre. (iii) Multiply (iv) (a) The foreign equity market (b) The Eurobond market (c) The Eurocurrency (d) The derivatives market. (v) a (vi) Round tripping (vii) Degree to which a firm s consolidated financial statements are exposed to fluctuations in exchange rate. (viii) CR = rhc rfc (ix) Purchasing Power Parity (x) European option. Question 2 As reported by one of the financial papers in Nigeria on April 1, 2010, crude oil price climbed on Tuesday 30 th March on blowing 2
of some oil installations by MEND in Nigeria and a tropical storm expected to erupt on a United States crude Merchant ship. The price of reference Brent North Sea crude oil June delivery climbed to $170 per barrel, thereby affecting forward market, the cost of which now stands at 13.52%. i. What is April 1, 2010 exchange rate? ii. Rationalise the relative forward margin per month for the period of the contract mentioned, assuming all economic indices remain constant throughout the period. iii. What are the implications of the market situation between April 1, 2010 and June 30 on crude oil merchant in Nigeria and the United States of America? Comment This is a past examination question of the Institute. As many as 139 candidates attempted it but only 39 succeeded in satisfying the examiners. Solution i. x 12 170 X 3 X 100 = 13.52 x 170 X 400 = 13.52 x X 400 = 13.52 X 170 400 x = 2298.4 x = 2298.4 400 (fm)x = 5.746 Spot rate on April 1, 2010 FR - FM - SR 170-5.746 = $ 164.254 ii. 3 Forward margin per month
5.746/3 = 1.9153 iii. Implications for crude oil merchants in Nigeria. The Nigerian crude oil merchants are mainly exporters and on a rising market situation where the home currency is gaining i.e. the currency is quoted at a discount (floating) premium (fixed). The implication is that Nigerian exporters will pay less for the imports. Implication on the USA merchant if US $ is quoted at a discount (fixed mkts). The exporter will receive less in future. Question 3 Abakaliki Steel Rolling Mills Limited is a manufacturer of high quality industrial steel and heavy iron rods. It has received an order for the exportation of iron rods to the Netherlands. Drawing were to be made by Abakaliki Steel Rolling Mills according to the terms of the inward documentary credit. Abakaliki Steel Rolling Mills Ltd had made 3 drawings under the credit and your bank, serving as the advisory/confirming bank, had credited your customer s account accordingly with the naira value of the export minus 1% exchange commission and charges as the maximum permissible by the exchange control regulations in Nigeria. The third drawing was made 2 days ago. You have instructed your Head of Department to credit the customer s account and seek reimbursement from the issuing bank in consonance with the credit terms using voucher identification number (VIC/FTB/OC/IDC/ 0062). Mr. Solley, the newly recruited banking officer who brought the voucher for your signature, sought your explanation on how the exchange rates and the naira values have been arrived at and, while going through the customer s records, you extracted the following pieces of information. 4
(i) 5
Narration Date of Forward Contract Delivery Period of Forward Value Contract 1 st shipment, April 1, 2010 June $ 850,000 2 nd shipment Between July 2 and $850,000 Sept. 2010 3 rd shipment April 1, 2010 Sept. 2010 $ 850,000 4 th shipment April 1, 2010 Between Sept and Oct 2010 $ 850,000 (ii) The last contract could not be performed in whole and a10% reduction variation was allowed while the Letter of Credit was amended accordingly. The relevant entries for this transaction were yet to be effected in other records of the customer but the spot exchange rates as at this period under consideration were (i.e. for contract variation only). $/N 135,8320 N 138,4345. (iii) Rates for 90 days inter-bank and commercial paper only. (These are different terms, the letter of credit exchange commission, please). Centre Nominal Foreign Commission Margin rate stamp duty Lagos 18.5% 2.00 per mille 1 / 8 % 4% p.a New York 5.25% 1.75 per mille 1 / 5 % 2% p.a London 4.25% 1.73 per mille ¼% 2% p.a Amsterda m 6.7% 1.85 per mille ¼% 2.5% p.a (iv) You could not immediately ascertain the amount credited to the customer s account on each of the first 3 shipments but the entries before you indicate that N 102,916.04 was to be credited exclusive of the variations in (ii) above. You are required to explain to Mr. Solley the following, including how you arrived at them: (a) The spot rate for the forward contract on April 1, 2010 taking into consideration the 1% maximum spread rule of the Nigerian Foreign Exchange Market System. 6
(b) (c) (d) The forward rates of the transactions. The analysis of the effects of the variation on the customer s account. The definition of forward (overlapping option) contract. Comment This is a question on forward contract and also a past question, but only 56 candidates attempted it with only a 25% pass rate. Solution (a) Contract Amount Less 10% $ 850,000 (850,000-10%) $ 765,000 Naira amount collected N 103,956,545.50 (b) 103,956,545 = 135.8909 765,000 (c) Effects of variation April /Sept 126.583 Sept/Oct Forward 9.3097 135.89 or 135.8909 Naira credit $850,000 x 135.890 = 115,507,265.00CR $850,000 x135.890 = ( -01= 116,662,337.70 DR) 1,155,072.70DR 76500x135.8320 = 103,911,480 CR 103,796,407.30 Amount already credited 103,956,545.50 160,138.20DR (d) 7 Overlapping option forward contract is a hedging instrument which allows a hedger to hedge the risk of exchange rate, particularly when the date of performance is not certain but lies between more than 3 market rates.
All the rates are determined and the bank applies the principle of buy low sell high. Question 4 (i) (ii) (iii) (iv) (v) 8 Collection of financial documents not accompanied by commercial documents is (a) Documentary Collection (b) Documentary Acceptance Credit (c) Clean Collection. Clean report of finding means: (a) Inspection Report containing remarks that are written on white paper to make it more legible. (b) Inspection Report containing some clean clauses. (c) Inspection Report remarking that goods are in good order. (d) Inspection Report remaking that goods are neatly packed. The order of safety from the point of view of an exporter is: (a) Open Account, Payment in Advance, Bills for Collection, Open Account. (b) Advance payment. Documentary letters of credit, Bills for Collection, Open Account. (c) Documentary letters of credit, Open Account, Advance Payment. (d) Open Account, Payment in Advance, Documentary letters of credit, Bills for collection. The following are non-conventional incoterms except: (a) DDP (b) DAF (c) DES (d) CIF Form M is used by merchants in Nigeria to: (a) Process Personal Travel Allowance.
(b) (c) (d) Process Visible Imports Process Invisible Exports Process Visible Exports. (vi) Money laundering means: (a) The system of cleaning dirty money by apparently legitimate transaction. (b) The process of round tripping (c) Illegal dealings in currencies (d) The practice of concealing the source of financial transactions. (vii) Which article in UCP 600 covers Transferable credits?..... (viii) Under discounting of book debts, the factor is under obligation to perform the following financial functions except: (a) Provision of funds (b) Capital management (c) Credit management (d) Risk bearing. (ix) (x) A special loan given to the importer which is secured by a charge over the goods for which the loan is granted is known as:..... In URC 522, articles 7 and 9 cover and. respectively. Comment This is a multiple-choice question, the aim of which is to cover a greater part of section B of the syllabus. A compulsory question, 82% passes were recorded. Answer 9
(i) d (ii) c (iii) b (iv) d (v) b (vi) a (vii) Articles 38 (viii) b (ix) Merchandise /Produce loan (x) Partial payment. Question 5 Your customers, DARBOL Plc, who have only naira account with you, have to pay E150,000 to a Spanish Transport Company in Madrid. The Managing Director, Mr. Dare Bolaji, is seeking your assistance on how to make the payment. Required: Brief notes describing: (a) Instructions you will need to receive from the customer. (b) The methods by which a remittance may be made and also the accounting procedures necessary for each method described. Comment This is a straightforward question on means of international settlements with correspondence accounting entries. Only 21% passes were recorded out of 100 candidates that attempted the question. Answer (a) Customer to give written instruction to the bank to debit his account with the equivalent in naira of E150,000. This written instruction should be on an appropriate form with the bank, depending on the required method of remittance (i.e. a draft, EMT), mail transfer, telegraphic transfer or other appropriate means. 10
(b) The method by which a remittance may be made are draft, mail transfer, telegraphic transfer or SWIFT. Draft - A banker s draft for E150,000 should be drawn by the bank on its correspondent bank in Spain in which it has an account. Draft to be handed to Darbol which should send it to the Spanish Transport Company in Madrid, as the payee. Bank sells E150,000 to Darbol Plc and debits Darbol Plc account with naira equivalent, upon customer s valid written instruction. When draft is presented to the Spanish correspondent bank for payment, the Spanish bank will debit the Nigerian bank, i.e. the account, while the Spanish bank will also pay E150,000 to the bank acting on behalf of the Spanish Transport Company. i. In the account of the Nigerian bank, DEBIT Darbol Plc account the equivalent of E150,000, and CREDIT Nostro A/c with Spanish correspondent E150,000. b) In the accounts of Spanish Correspondent, DEBIT Vostro A/C of the Nigerian bank E150,000, credit Remitting bank account on behalf of the Spanish payee E150,000. ii. Mail Transfer: This is a payment order in writing by the Nigerian bank to its correspondent, instructing the Spanish bank to pay E150,000. Debit : Darbol account E 150,000 Credit: Nostro A/c with Spanish Correspondent bank E150,000 11 iii. SWIFT: Payment by SWIFT is the same for payment by Telegraphic Transfer (TT), with the exception that the instructions are sent by the ( on line computerized) SWIFT system rather than by air mail, telex or cable.
SWIFTT is an acronym for Society for Worldwide lnterbank Financial Telecommunications. iv. Telegraphic Transfer: Telegraphic Transfer (TT) is the same as Mail Transfer, with the exception that the Nigerian bank will send its instruction to the Spanish banks by telex or cable rather than by air mail. Question 6 (a) (b) State the advantages of borrowing in the Euro-currency market. What are the advantages of investing in Eurobonds? Comment This is a textbook question that one would have expected most candidates to attempt and perform very well in but only 95 candidates attempted it with about 55% passes. Answer a) i. It is the best way for multinational companies to raise additional loans for development. This is facilitated through loan syndication. ii. Although interest rates are competitive, lowest rate than conventional loans could be negotiated. iii. It is a faster and possibly more easily managed loan for blue-chip companies and countries noted for previous loan repayment without straw. iv. In times of credit squeeze in some countries, Eurocurrency loan can be arranged because there is no strict regulation on the operation. v. Long-term repayment tenor of up longest can be negotiated for the loans. b. Advantages of investing in Eurobonds. i. The prices of the loan syndication offer the borrower a great deal of anonymity through the issue of bearer bonds. 12
ii. Long volumes of loan can be arranged through the syndication. iii. The interest element is not liable to public withholding tax. iv. The loan normally has long-term repayment terms, i.e. currencies. v. Eurobond is determined in convertible currency and swapped to another currency to meet the agreement of the borrower. Question 7 Financial Institutions offer a variety of services to their customers who engage in international business. They offer these services to both exporter and importer customers depending on the need of the customer per time. Required: (a) (b) Identify and discuss some of these services to both importer and exporter customers. List and discuss four (4) principal types of performance bond. Comment This is also a simple and straightforward question which is intended to boost candidates performance, but only 52% passes were recorded out of the 91 candidates that attempted it. Answer a. Services to both importer and exporter customers i. Business advisory services in the areas of: Business objectives, Budgeting, Costing, 13
Book-keeping and financial accounting, and Capital investment approval. ii. iii. iv. Money transaction. Finance: Overdraft loan, Accommodation finance, Advance against collection, Negotiation of bill of exchange, Bill discounting, and Hypothecation letter or produce letter. Medium-term finance in area of; Factoring, Hire purchase, Leasing, Forfeiting, Matching foreign currency with borrowing, and Avalising. b. Principal types of Performance Bond. i. Bid Bond: Bid or tender bond is usually provided by means of bank guarantee. It enables the overseas buyer to claim some compensation in case the contractor backs out of the contract after it has been awarded to him. 14 ii. iii. Advance Payment or Progress Payment Bonds: This guarantees that any advance or money paid by the buyer for the purchase of goods would be refunded if the contract is not completed. Performance Bond: This is usually issued when a tender bond is cancelled at the guarantee that the terms of the contract will be carried out and that the contract will be completed to the satisfaction of the buyers. It attests to the technical and financial capability of the contractor to successfully complete the contract.
iv. Warranty or Retention Bond: Here, the person issued the contract; the buyer might retain about 10% of the values of the contract and only pay about 90% currently supplied. When the contract is completed, the contractor or exporter will expect to retain the 10% balance but the buyer might be worried that the exporter will fail to provide maintenance support for the contract work with the terms of the contract if paid in full in the buyer s right. Hence, a request for retention bond before releasing the balance. Question 8 (a) (b) Write short notes on the following international units of account. (i) West African Unit Account (WAUA) (ii) European Currency (EURO) (iii) Special Drawing Rights (SDR) List 10 ways by which Nigeria can reduce its external debts. Comment This is also a textbook question that candidates do not require any special skill to answer. The pass rate was actually high. Out of 113 candidates that attempted the question, the total number of passes recorded was 88, which is quite high. Answer i. West African Unit Accountant It is the operative mechanism for denominating intra-west African trade and is the currency for clearing settlement. It serves all functions of money and is fixed at par with one Special Drawing Right of IMF. 15
ii. iii. It is quite helpful to members of ECOWAS whose individual currencies are not convertible. It is not at optimal use because of features and problems of trading within the ECOWAS. European Currency Euro is the common currency of the countries belonging to the Europeans Monetary System. Euro helps to break down the structures of border demarcation thereby promoting economic integration. Euro promotes trade between members of the European Union. Euro removes exchange risk between member countries. Euro is regulated by the European Central Bank. Euro is an International Reserve. Special Drawing Rights (SDR) In 1970, the first set of paper gold called SDR was issued in proportion to members quotas. SDRs is IMF s unit of account. The value of SDR is determined from a basket of currencies. It is used to settle financial commitments between members. It can be swapped for another currency other than gold. It is an international reserve asset. It enhances international liquidity. 8b. 10 ways by which Nigerian debts can be reduced: Debt Equity Swaps; Debt buyback; Debt conversion; Debt-for-Debt Swap; Debt Cancellation; Debt rescheduling; Relending; 16
17 Exit bond; On-lending; Co-financing.