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I had a small query from the Dec 2010 F9 exam regarding question question 3 part (c) of WQZ Co. I know get the first part of the requirement regarding the receivables policy but this second part requirement of “what is the maximum early settlement discount that could be offered?”
I get the arithmetic calculation and fully understand it of “Comparing the total benefits of $1,050,000 with 25% of annual credit sales of $87,600,000, which is $21,900,000, the maximum early settlement discount that could be offered is 4·8% (100 x (1·050/21·9)).”
But what is the logic and understanding behind this calculation? I don’t get it! Is there an alternative way of calculating the maximum settlement discount in a more “clear” way?
Also regarding a separate question, June 2011 question 4 (a) (ii) regarding the money market hedge or forward market hedge. Now this question is a little tricky because he has given a range of exchange rate, not just one exchange rate! I understand why $12.50 has been used for the money market hedge but I don’t get why pesos 12·805 has been used for the forward rate. You see the bank buys high and the bank sells low. With the forward market the bank is buying the pesos (the pesos we earned from the export) so the bank buys high, the bank should buy at – pesos 12·889 but the examiner has used 12.805? So why is there this discrepancy? Bank buys high, bank sells low so looking at them selling dollars they should sell at 12.805 so that way the examiner is right but looking at what they buy, then they should buy at 12.889. So should we always look at it the way that the bank is selling what rather than what they are buying what? Selling dollars (low) at 12.805? It’s so confusing! Please explain.
Thanks,
Gabriel
With regard to your first question, the savings will only be made if the discount is offered. The more the discount, then the less the net saving will be. The maximum discount that they can afford to offer is when the net saving is zero – a lower discount will be worth offering, but a higher discount will not be worth offering.
With regard to your second question, you clearly have not watched my lecture on foreign exchange – you should, because then you would not have a problem.
The bank is not buying pesos! It is the company that is buying pesos because the company works in $’s and need to buy pesos in order to pay interest. There is no confusion in the question (or answer 🙂 )Yes you got it correct! I’ve haven’t watched the videos. The reason being I live in a third world country whereby I don’t have fast enough internet speeds to watch the videos and the videos aren’t downloadable so my only sources of knowledge is “ask the tutor” and the F9 OT course notes.
Yes I get your logic of the company buying the pesos due to it’s loan. However, the company is selling $ in exchange for pesos. So if the company is selling $, then the bank (the opposite party) is buying the $ and the bank should buy high so it will buy at pesos 12·889 (the higher FORWARD rate in six month’s time)
The other way to think of it, the right way I guess, is that the company is buying pesos so the bank is selling pesos so the bank sells low at pesos 12·805 and this is the correct rate to be used.
So should we always look at it from the angle of what the bank is selling rather than what the bank is buying in a forward exchange rate scenario?
Because using the two different directions, as above, gives two differing answers so in the exam how do we know which angle to look at? The bank buying or the bank selling?
Thanks a lot.
Have you tried watching the videos recently? The new software should adapt the video to the speed of the internet connection.
I don’t know why you have written two ways of thinking about the exchange.
If anyone is buying anything from someone then they will pay the lowest price they can. If they are selling something to someone then they will charge the highest price they can.
Here, the bank is buying $’s from the company so they will pay them the lowest number of pesos.
No – you do not always look at what the bank is selling. Here, the bank is buying $’s from the company for pesos. If the company had received income in pesos and wanted to change them to $’s, then the bank would be selling $’s to the company and would apply the higher exchange rate.
I actually find it easier to look at it from the company’s point of you and then learn it as a rule. In the exam you have not got the time to think it through – it has to become automatic. You will have seen on page 122 of the Course Notes how I choose to remember it.
I got confused because for a day or two one of my friends handed me the Kaplan F9’study text whereby I was reading a chapter on hedging and it stated, as I quote from my hand written notes, if in confusion then always think in terms of what favors the bank, then a diagram of 2 arrows were drawn, whereby it was written in an arrow pointing upwards ‘the bank buys high’ and the in an arrow pointing downwards it was written ‘the bank sells low’. I even have a picture of these two arrows in my phone. But it’s now clear that explanation is false and invalid. I wonder why didn’t Kaplan proof read their study text before producing such wrong information?
Thanks,
I will always look at it in terms of what favors the company.
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