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FIN 602 – Financial Markets & Institutions

FIN602

Final Assignment

A. Critical review (25 points)

Reading: IMPACT OF FINANCIAL CRISIS ON DEVELOPING COUNTRIES,

Luminiţa Horhotă, Cristina Nicoleta Matei, 2009

Requirement: Write a short critical review in your own words of the required reading. This review must not be longer than 2 pages and can be as short as 200 words (count one page as having page between 250 and 300 words).

B. Assignment (25 points)

Up-to-date interest rates are available from the Federal Reserve at

http://www.federalreserve.gov/releases . Locate the current rate on the following:

a. Prime rate

b. Federal funds

c. Commercial paper (financial)

d. Certificates of deposit

e. Discount rate

f. One-month Eurodollar deposits

Compare the rates for items a–c to those reported in Table 11.1. Have short-term rates generally

increased or decreased? Then write an essay to discuss question “What are the different theories

explaining the term structure of interest rates? How can forward rates of interest be derived from the

term structure of interest rates?”. Use your own example to elaborate. This is a short 2 to 3-page

essay (One page should contain between 250 and 300 words in total, including footnotes).

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FIN 602 – Financial Markets & Institutions

TABLE 11.1 Sample Money Market Rates, April 8, 2010Instrument Interest Rate (%)Prime rate 3.25Federal funds 0.19Commercial paper 0.231 month CDs (secondary market) 0.23London interbank offer rate 0.45Eurodollar 0.30Treasury bills (4 week) 0.16Source: Federal Reserve Statistical Bulletin, Table H15, April 9, 2010.

C. Case study (50 points)

Paretti Textiles, SpA, located in Milan, Italy, is a wholly owned subsidiary of Conti Industries, an

industrial fabrics manufacturer based in Darien, Connecticut, USA. In late 1993 the Treasurer of

Conti, Mr. Richard Baden, was looking at the currency exposure of the Italian subsidiary. In previous

years, Conti had incurred translation losses resulting from the depreciation of the Italian lira, for

which Baden had been criticized. Although Conti was profitable, this had not always been the case,

and the company could not afford further currency losses. (See Exhibits I and II.) Baden was

determined to put in place an economically sound, and defensible, hedging strategy for the

forthcoming year.

Paretti specialized in the production and marketing of printing blankets, a specialized fabric used in

newspaper and magazine printing. In 1992 it had $34 million sales in Europe and $6 million in the

USA. Its sales were denominated as follows: USD 16.8%, DEM 15.6%, ILR 14.5%, FFR 14.3% and

UK£ 13.9%. All production was in Italy. Paretti's main competition was a subsidiary of Merida, the

US textiles company, and a Japanese company. However in Europe, Paretti had exclusive

relationships with its distributors in Italy, Germany, France and the United Kingdom. In exchange

for this exclusivity, Paretti never raised prices to its customers once price lists were printed at the

beginning of each year.

Conti did not have a consistent foreign-exchange hedging policy. However, in August 1993, as the

European Monetary System appeared to be undergoing severe strains, Baden had decided to hedge

some of the anticipated earnings from Paretti for 1994. Accordingly, he sold $1.5 million equivalent

of Italian lire for 9 months forward delivery.

Under US accounting rules, Conti used the local currency of the country of operation as the

functional currency for purposes of translating Paretti's local currency asset and liability accounts at

currency exchange rates into Conti's reporting currency, the US dollar. The resulting translation

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FIN 602 – Financial Markets & Institutions

adjustments were accumulated as a separate component of shareholders' equity (see Exhibit III

). Gains and losses resulting from translating asset and liability accounts that were

denominated in currencies other than the functional currency were included in income.

Questions

a) In your view, how does a change in the value of the Italian lira affect Conti's earnings and

balance sheet?

b) What hedging strategy do you recommend for Conti's Italian subsidiary?

Notes

The assignment is to be referenced using APA style referencing and formatting

The assignment should use Times New Roman font, size 12, with 1.5 line spacing.

To submit:

o Name the file "[ID]_[Full name]_FIN 602_Final assignment".

o Submit to BDMonline (bdm.edu.vn) under your username before deadline by

individual. Your latest submitted version will be transferred to your lecturer at

deadline. Late submission will be penalized according to UBIS Policy.