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sir in the comments about the hedging strategies(part a), I found this ,one pertaining to money-market hedge, (adverane is a swiss co. which is going to receive 6.45million USD)
“Adverane Co should also consider, as regards money market hedging, that CHF receipts could be used to pay off any existing CHF loans, or for other investment purposes, in which case the benefit to Adverane Co could be greater than hedging using futures”
By this line are they trying to hint at the fact that instead of keeping it for investment purposes for 4months (once it has been borrowed from US immediately) we should use it to pay off any outstanding loans(on the presumption that borrowing rate is going to be more than investing rate, so use receipts for that purpose for greater savings)??
Question 2)
In the part c) of the same question:
“If it is decided that an allowance should be made for costs of internal transfer being lower, central treasury may have to determine what this should be as it may vary significantly between products and divisions.”
Sir I don’t remember studying about any allowance to be made for costs of internal transfer being lower in F5. What are they really trying to say, and what is its purpose?
Your first question:
The calculations for the futures assumes (as we always do) that there is no basis risk i.e. that the basis falls linearly to zero over the life of the future. In practice this will not be the case and there is therefore the risk that the fall in the basis might be higher or lower than what we assume which would affect the end result. All the examiner is saying is that as a result it might be that futures do not give the best outcome – it depends on whether the basis risk is likely to be significant.
Your second question:
Costs of internal transfers were certainly relevant in Paper F5 (now PM). Although it makes sense to base transfer prices on external market prices, we do need to take into account things like delivery costs which are likely to be lower when transferring internally than they will be when buying or selling externally.
replying to my second doubt: what has that got to do with making internal allowance? i still don’t understand why is there a need to make an allowance.
If the transferring division can sell externally for (say) $15, then this would normally be the transfer price.
However, if selling externally for $15 involved paying delivery costs of $1, but these delivery costs would not be payable if transferring to the other division, then they would be happy with a transfer price of only $14.
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