It is 1, January 2016 and you are the Chief Risk Management Officer of an Irish company, Clonliffe Cottage Cheese Manufacturing Limited. You have been a member of the board of directors for ten years and advise the board on all risk-related matters.
Assessment Requirement:
You are required to prepare a report for the board of directors of your company. The report will contain your advice/analysis on four issues that the members of the board have to consider. These issues are set out below.
1. Recommend a currency risk-management strategy for a foreign exchange transaction due in three months time. Explain the rationale of your foreign exchange strategy.
2. Calculate the current value of the debt in the company's balance sheet. Analyse and comment on the financial risk this debt might create for the company, and explain your reasoning. Use the guidelines shown below.
3. A new member will join the board shortly. This person has led the cheese manufacturing operations of the business for the past five years, so until now, has had no executive responsibility for risk management within a company. You are required to prepare a briefing note explaining the role, objectives and techniques of the risk management function within the company for the new board member.
4. The returns on the company pension fund have been quite mixed in recent years, see table below Section 4. The value of the portfolio was €35m at 31.12.2015, but the Trustees have expressed their concern about the investment performance and have asked you for an independent risk assessment including a value-at-risk calculation and an explanation of what this might mean.
Notes for Individual Sections.
Section 1. Details of the foreign exchange transaction;
The company expects a payment from a UK customer of £565 million, due 90 days.
Current spot rate: £0.7791 per € Euro
90-day forward rate: £0.7691 per € Euro
UK Deposit Rate (annual %) 1.50%
UK Borrowing Rate (annual %) 1.78%
Euro Deposit Rate (annual %) 1.00%
Euro Borrowing Rate (annual %) 1.20%
Company W.A.C.C (ann. %) 4.50%
Put option available: Premium 1.00% Strike price £0.7800 per €
Call option available: Premium 1.50% Strike price £0.7800 per €
The company's Foreign Exchange advisor forecasts the spot £ STG/€ exchange rate will be £0.7700 per € Euro in 90 days.
Section 2. The company's debt portfolio consists of the following bonds.
Corporate Debt Portfolio
Bond Issue: Nominal Value (€)
2.05 Clonliffe Cheese Manufacturing Ltd. Corporate 2017 200,000,000
4.5% Clonliffe Cheese Manufacturing Ltd. Corporate 2018 150,000,000
5.0% Clonliffe Cheese Manufacturing Ltd. Corporate 2023 150,000,000
6.0% Clonliffe Cheese Manufacturing Ltd. Corporate 2030 500,000,000
7.5% Clonliffe Cheese Manufacturing Ltd. Corporate 2038 900,000,000
*** Assume all bonds follow calendar year. Eg 4.5% of 2018 matures 31.12.2018, and that all bonds pay coupon semi-annually.
The following interest rates apply in the market.
Zero- Interest Rates:
Maturity: 6mths 12mths 18mths 24mths
Yield : 0.5% 0.65% 0.80% 1.10%
Corporate Bond Yields:
Maturity: 3yr 8yr 11yr 25yr
Yield : 1.0% 2.3% 2.8% 4.10%
Section 2 Guidelines:
Calculate the value of the Company's debt portfolio using the data shown above. Assume the company finances 65% of its balance sheet with its bonds.
Calculate the duration of each bond and explain how these values may be interpreted. Calculate the duration of the bond portfolio.
Discuss how changes in market interest rates in the future, might affect Clonliffe Cottage Cheese Manufacturing Ltd. balance sheet. Describe a risk management strategy that the firm might consider to address this interest rate risk.
Section 4 Guidelines :
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Pension Fund
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2007
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2008
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2009
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2010
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2011
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2012
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2013
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2014
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2015
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Annual Return (%)
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+32%
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-32%
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-1.3%
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+11%
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+10%
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+22%
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+18%
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6%
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+20%
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Value
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€35m
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Consider 95% confidence level.
Portfolio Value €35,000,000
Recap of Assignment Requirements:
Write a report for the Board of Directors of this company. The report should be approximately 2500 words long. It may be shorter, but it should not exceed 2500 words (excluding appendices) - Ignore
Your report should include Four sections.
Section 1.Should recommend a hedging strategy for the consideration of the board, in respect of the FX payment and justify the recommendation.
Section 2. Should contain an analysis of Clonliffe Cottage Cheese Manufacturing Ltd.'s corporate debt portfolio from an interest- rate risk perspective and suggest an approach to managing this risk for the board to consider, following the above guidelines.
Section 3. Should provide an explanation and an overview for the new member of the board regarding the role of the risk management function within the company. It should also describe the objectives of the risk management function as well as the techniques of the risk management function within the company.
Section 4. Should contain an analysis of the risk of the pension fund situation.