W1-2-60-1-6

JOMO KENYATTA UNIVERSITY

OF
AGRICULTURE AND TECHNOLOGY
UNIVERSITY EXAMINATIONS 2016/2017
YEAR 4 SEMESTER II EXAMINATION FOR THE DEGREE OF BACHELOR OF
COMMERCE
HBB 2403: FINANCIAL RISK MANAGEMENT
DATE: December 2016 TIME: 2 HOURS

Instructions: Answer Question One and Any Other Two Questions

QUESTION ONE (30 marks)

a) Explain the four stages of risk management process (10marks)

b) You have been retained by management of an international group to advice the
management of its foreign exchange exposure
i) Explain to the management the main types of foreign exchange exposure.
(8marks)
ii) Advice on policies which the corporate treasurer could consider to provide a valid
and relevant methods of reducing exposure to foreign exchange risk.
(12marks)

QUESTION TWO (20 marks)

a) Outline any six causes of interest rate fluctuations. (6marks)

b) State the assumptions of option pricing model derived by Back and Scholes.
(5marks)
c) Consider the following data relevant to valuing a European-style call option and a non-
dividend paying stock exercise price sh40, risk free rate 9%,. Time to expiry six months
and a standard deviation of 25%. Spot price sh36. Determine the black Back and Scholes
option using the above information (9marks)

1|Page
QUESTION THREE (20 marks)

a) Price risk is the risk to earnings arising from change in the value of options. Give five
price risk factors and pertinent aspects of options. (10marks)
b) Define the following terms as used in financial risk management (3marks)
i) Transaction risk
ii) Translation risk
iii) Economic risk
c) On January 15th Sam sold nifty futures contract for sh538,000 for this he had to pay
initial margin of sh400,000 to his brother. Each nifty future is for delivery of 200 niftier.
On 30th January the index closed at 2890. Determine the profit or loss made in this trade.
(3marks)
st
d) On 1 March 2016 a Kenyan importer purchased goods from USA worth USD 140,000
to be paid for two months later on 30th April 2016. Kenya shilling futures were available
in the money market and could be bought in blocks of sh100,000 and each future contract
cost sh1000. Spot exchange rate on 1st March 2016 was Ksh76.50=1USD. Two month
forward exchange rate on 30th April 2016 was Ksh79.50=1USD and the closing rate for
futures was sh77.5=1USD. Determine the net loss or gain made. (4marks)

QUESTION FOUR (20 marks)

a) Give five differences between forward contract and future contracts (5marks)
b) Define sneaps contract and give any six advantages of sneaps contracts to investors.
(7marks)
c) A US company is to invoice European customer for 850,000 Euros payable in 3 months
time. The manager is considering using two methods
i) Borrow Euros now converting the loan into dollars and repaying the Euro-loan
from the expected receipts in 3 months time.
ii) Enter in 3 month forward exchange contract with the companys bank to sell
850,000 Euros
Spot rate exchange 0.7834 Euros=1USD
3 months forward exchange rate 0.7688 Euros=1USD
Annual interest rate for 3 month borrowing in Euros is 3%. For investing in
dollars 5%
Advice the US company on the best method to adopt (show your workings)
(8marks)

2|Page