Answer to Question #212847 in Management for Zizah

Question

You are the Chief Investment Officer of the Kaufland Hypermarket Chain and has identified Malaysia as the next country to investment.

Answer the following with specific reference to your business plan.

6) Assuming the investment in Malaysia in fully funded by equity, provide an estimation for the investment’s discount rate. Show the calculation by taking appropriate assumptions.

 

7) Based on the exchange rate of home currency and Ringgit

Malaysia for 2016-2020, explain the risk of transaction exposure and

translation exposure.

 

8) Assuming your business operation commences in June 2021 and

Ringgit Malaysia is softening against the home currency throughout the year.

Examine the impact and propose a hedging strategy using:

i. currency option.

ii. currency futures.

Answer 1

6. Investment discount rate = post discount price - pre-discount prices then divide the new number by the pre-discount price and multiple the results by 100.

For example, the estimated post discount price for Malaysia is 2.5

Pre discount price is 1.75

Then the discount rate will be; 2.5- 1.75= 0.25 then divide it by the pre-discount price 0.25÷ 1.75 × 100= 14.3%

The estimated investment discount is 14.3%.

7. The translation exposure risk for Malaysia will be the uncertainty of its future dollar sales revenue. This means that future sales will not materialize and the price will be at risk.

The transaction exposure risk that will affect Malaysia is the risk of fluctuations rate between the transaction date and the subsequent settlement date, therefore the country may risk losing a huge amount of money and thus affecting the cash flow conversion of the country.

8. When the ringgit soften against home currency mean the country is at risk of losing conversion in the future therefore the currency option and currency future can be applied to fix the exchange rate

Currency option- will be used to give the country the right to purchase the underlying currency at the exercise price on future dates to take the advantage of the favorable movement

Currency future- it's a standard hedging instrument that will help in fixing the exchange rate at some future date, this can be done by buying the future to set up the hedge.