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Hello John,
In part c of casasophia we would receive an npv of 1.33m euros, using swaps. However without swaps we’ll have to convert MShs 1500m at the actual spot rates which can be estimated using purchasing power parity, given that inflation in mazabia can range from 5%-15% & euro inflation is expected to be stable at 1.2%. Estimating the actual rates, in both, best and worst case scenario i.e (5% & 15%), we’re getting an npv higher than the swap i.e. 1.33. At 15% I’m getting an npv of 1.59m which is still higher.
I don’t get the examiner’s explanation that: swap agreement would be beneficial for casasophia, preventing it from any loss, if mazabian inflation rate is higher than 9.7%.
How’s it possible, if even at 15% we’re getting a higher npv?
This is how I have calculated rates without swap:-
MShs(120.9*1.15)/(1*1.012)= MShs 137.388/euro.
Many Thanks 🙂You are reading too much into the examiners comment (although he could have worded it better!).
He only says that it would probably be beneficial to enter into the swap, simply because it fixes the future exchange rates and therefore eliminates any risk of changes in the income.
Also, whereas forward rates are always determined using interest rate parity, future spot rates are affected by all sorts of factors – we use purchasing power parity in the exam to estimate future spot rates, but they are only an estimate and the actual future spot rates could be completely different.
So the conclusion I reached, that entering into swap may not be beneficial for Casasophia, considering the current inflation rate estimates, would also be correct?
Yes, provided that you didn’t just state this as a ‘fact’ but stated the reasoning for your advice 🙂
Thankyou so much John, with your help, I’m able to get things which I never understood previously. God bless you 🙂
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