Question

Question 1
 
(a) Assume that the spot exchange rate of the South African Rand is 1.73. 
 
How will this spot rate adjust according to Purchasing Power Parity (PPP) if South Africa experiences an inflation rate of 7 percent while Zambia experiences an inflation rate of 2 percent?                                                                      
 
(10 Marks)
 
(b) With the aid of a practical example, explain how a Zambian corporation could hedge net receivables in rands with futures contracts.                           
 
(10 Marks)      
 
(c) Tom Sakala is looking to make and investment in either Namibia or Eswatini, but is uncertain about how the exchange rate will be in a years’ time. He has found the following data on the future interest rates for both countries:
 
Namibia  Eswatini 
One year interest rates       6%       9%
 
Using appropriate exchange rate forecasting theory, explain which country will have the stronger currency exchange in one years’ time?                       (10 Marks)

Answer 1

The following calculations are done based on PPP consideration -

.

Spor exclange Geake Bout. Africa Randel = 1073 1 Kunen Purchasing SA Rand : 173. Pomen Paring (PPp) holds than Exbecked Heate SA Rand It intereste), in SA Spor rate & Mwan itim to in Zambia inflation at but Interess cate, it Enflation I'm Zambia Expected exchange reales reates Spar reare South Afria /Zambia South Africa 1 + 0.0% Elr) Rate s 1.73 x. 1+0.07 itlolation Ying ! 1 1 So the doop. 1.651 future expected exchange reate is expected to South Africa » Curseny Deppiciats → Curreny Approcciates. Zambia

So For a Zambian corporation,

Let us take the following example-

Ac Payable = 50 Rand

Ac Receivable =100Rands.

---------------------------

Net position = +50Rand in receivable.

So the corporation has a net position in receivables, by looking into the inflation rates and PPP theory as per the above solution, the Risk management team expects the home currency to rise and the Receivable currency to fall.

So they will enter into a long position in futures contract with the Net Receivables amount as calculated.