1. Assume that this year you decide not to implement the marketing campaign that you
considered previously. Instead, you will invest some of this year’s profits and then use this
money to cover the campaign next year. You can retain the profits earned this year by
investing them in a Chinese bank where interest rates are high, or you could invest the
profits in coco bonds which are US dollar-denominated. At the end of the year, you could
convert the dollars back to Chinese yuan to pay for the marketing campaign. Explain how you
would decide between these two alternatives.
2. Assume that for the expansion of the China business company you decided to invest five
million Chinese yuan in your Chinese subsidiary to support local operations. You would like
your subsidiary to repay the yuan in one year. In order to protect against a depreciation in yuan
you would like to engage in a swap transaction. Explain how you would structure the swap
3. Chinese interest rates are normally substantially higher than Australia interest rates.
a) Assuming that interest rate parity exists, do you think hedging with a forward rate would be
beneficial if the spot rate of the Chinese yuan was expected to decline slightly over time?
b) Would hedging with a money market hedge be beneficial if the spot rate of the Chinese
yuan was expected to decline slightly over time (assume zero transaction costs)? Explain.
c) What does this imply about the inflation differential (Chinese inflation minus Australian
inflation), assuming that the real interest rate is the same in both countries? Does this imply
that the Chinese yuan will appreciate or depreciate? Explain.
d) Explain how your business would likely be affected if the central bank of China used
indirect intervention by lowering Chinese interest rates (assume inflationary expectations
have not changed).
e) It may be argued that the high Chinese interest rate should entice Australian investors to
invest in China money market securities, which could cause the yuan to appreciate.
Reconcile this theory with your answer in part (c). If you believe that the high Chinese
interest rate will not entice Australian investors, explain your reasoning.
4. Assume that your Chinese business invoices are in Chinese yuan.
a) You are already aware that a decline in the value of the yuan could reduce your Australian
dollar cash flows. Yet, according to purchasing power parity, a weak yuan should occur
only in response to a high level of Chinese inflation, and such high inflation should increase
your profits. If this theory holds precisely, then your cash flows would not really be
exposed. Should you be concerned about your exposure, or not? Explain.
b) Assume that as a small foreign owned business in Beijing, you are unable to negotiate a
good rate for a forward contract to hedge your receivables. How else might you be able to
reduce the risk of a depreciation in Chinese yuan? List, explain and illustrate what other
instruments you can use to hedge your future cash remittance to Australia.