International Financial Markets: Exchange Rates and Inflation

You graduated with your Master’s three years ago and are now employed as a manager at a well-known UK company. The main Board of the company is considering setting up a subsidiary company in continental Europe. The exact location has not yet been decided, but the overwhelming likelihood is that it will be within an EU country. The Board propose to operate a pilot project, as follows: The project would require an initial investment of €10m (in year 0). The expected revenues are €3m at the end of year 1, €5m at the end of year 2, and €10m at the end of both years 3 and 4. Take the sterling/euro direct exchange rate as 1.05. The company’s money cost of capital is estimated as 8% p.a. For the foreseeable future, the rate of inflation in the UK is estimated to be 3% p.a., and in the euro economies as 1% p.a.

In addition to the provision of goods and services by the subsidiary to the UK and Eurocurrency markets, it is anticipated that the subsidiary will trade with companies in the Far East. Arising from these proposals and intentions, the Board seek information on international financial markets to help with their decision-making; consequently, they have instructed you to write a paper, containing illustrative examples where appropriate, addressing this need. The Chief Executive Officer has said that she wishes to read an academically sound paper entitled ‘International Financial Markets: Exchange Rates and Inflation’, presented in accordance with the Submission Notes given below. The matters that should be covered by your paper include, but are by no means to be restricted to, the following:

1 Foreign currency translation using direct and indirect rates of exchange and the calculation of cross rates between pairs of currencies;
2 The feasibility of estimating spot and forward rates of exchange;
3 Internal and external hedging techniques;
4 As an illustrative Appendix, an estimate of the net present value of the proposed pilot project. The Board require NPV (expressed in pounds sterling) to be calculated using four methods: firstly, using real Euro denominated cash flows discounted at the Euro base real rate; secondly, real Sterling denominated cash flows discounted at the domestic real rate; thirdly, using Euro denominated money cash flows discounted at the Euro base money rate; and, fourthly, using Sterling money cash flows discounted at the Sterling money rate.

You graduated with your Master’s three years ago and are now employed as a manager at a well-known UK company.  The main Board of the company is considering setting up a subsidiary company in continental Europe.  The exact location has not yet been decided, but the overwhelming likelihood is that it will be within an EU country.  The Board propose to operate a pilot project, as follows:  The project would require an initial investment of €10m (in year 0).  The expected revenues are €3m at the end of year 1, €5m at the end of year 2, and €10m at the end of both years 3 and 4.  Take the sterling/euro direct exchange rate as 1.05.  The company’s money cost of capital is estimated as 8% p.a.  For the foreseeable future,the rate of inflation in the UK is estimated to be 3% p.a., and in the euro economies as 1% p.a.

In addition to the provision of goods and services by the subsidiary to the UK and Eurocurrency markets, it is anticipated that the subsidiary will trade with companies in the Far East.  Arising from these proposals and intentions, the Board seek information on international financial markets to help with their decision-making; consequently, they have instructed you to write a paper, containing illustrative examples where appropriate, addressing this need.  The Chief Executive Officer has said that she wishes to read an academically sound paper entitled ‘International Financial Markets: Exchange Rates and Inflation’, presented in accordance with the Submission Notes given below.  The matters that should be covered by your paper include, but are by no means to be restricted to, the following:

1    Foreign currency translation using direct and indirect rates of exchange and the calculation of cross rates between pairs of currencies;
2    The feasibility of estimating spot and forward rates of exchange;
3    Internal and external hedging techniques;
4    As an illustrative Appendix, an estimate of the net present value of the proposed pilot project.  The Board require NPV (expressed in pounds sterling) to be calculated using four methods: firstly, using real Euro denominated cash flows discounted at the Euro base real rate; secondly, real Sterling denominated cash flows discounted at the domestic real rate; thirdly, using Euro denominated money cash flows discounted at the Euro base money rate; and, fourthly, using Sterling money cash flows discounted at the Sterling money rate.

Required:

Prepare the paper that the Board wish to consider.
[Total 100%]

One of the common characteristics of those EM4001Continuous Assessment submissions that received unsatisfactory grades in previous years was a failure to comply with the submission requirements.  Many failing candidates seemed to think that it didn’t matter if they ignored these detailed requirements: consequently, many candidates who had worked diligently (and whose submissions contained good work) nevertheless scored poorly, simply because of non-compliance with the Submission Notes or other requirements.  If you are unsure of the appropriate format to use for your submission, part of your task is to find out, because significant marks will be deducted if an inappropriate format is used.  As part of ensuring that your submission is in the correct style, you need to take the Submission Notes below seriously: they are not optional, and marks will be specifically allocated for compliance with them.  To reiterate, compliance, in every particular, with the GeneralSubmission Notesbelow and the Continuous Assessment Requirements is mandatory.

In addition, you are warned that citation from the Wikipedia website will result in a mark of zero.
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