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CFA Institute Exam CFA-Level-II Topic 2 Question 85 Discussion

Actual exam question for CFA Institute's CFA-Level-II exam
Question #: 85
Topic #: 2
[All CFA-Level-II Questions]

James Walker is the Chief Financial Officer for Lothar Corporation, a U .S . mining company that specializes in worldwide exploration for and excavation of precious metals. Lothar Corporation generally tries to maintain a debt-to-capital ratio of approximately 45% and has successfully done so for the past seven years. Due to the time lag between the discovery of an extractable vein of metal and the eventual sale of the excavated material, the company frequently must issue short-term debt to fund its operations. Issuing these one to six month notes sometimes pushes Lothar's debt to capital ratio above their long-term target, but the cash provided from the short-term financing is necessary to complete the majority of the company's mining projects.

Walker has estimated that extraction of silver deposits in southern Australia has eight months until project completion. However, funding for the project will run out in approximately six months. In order to cover the funding gap. Walker will have to issue short-term notes with a principal value of $1,275,000 at an unknown future interest rate. To mitigate the interest rate uncertainty, Walker has decided to enter into a forward rate agreement (FRA) based on LIBOR which currently has a term structure as shown in Exhibit 1.

Three months after establishing the position in the forward rate agreement, LIBOR interest rates have shifted causing the value of Lothar's FRA . position to change as well. The new LIBOR term structure is shown in Exhibit 2.

While Walker is estimating the change in the value of the original FRA position, he receives a memo from the Chief Operating Officer of Lochar Corporation, Maria Steiner, informing him of a major delay in one of the company's South African mining projects. In the memo, Stciner states the following: "As usual, the project delay will require a short-term loan to cover funding shortage that will accompany the extra time until project completion. I have estimated that in 210 days, we will require a 90-day project loan in the amount of $2,350,000.1 would like you to establish another FRA position, this time with a contract rate of 6.95%."

When the silver is removed from ihe mine, it will be sold to an Australian subsidiary before being exported. Walker is concerned that the price of silver and the Australian dollar will both depreciate over the next eight months. Which of the following strategies will be most appropriate given Walker's expectations? Hstablish a:

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Suggested Answer: C

The company will need to sell silver in eight months. Thus, if the price of silver is expected to fall over that time frame, Walker should be short a forward contract on the price of silver to lock in a higher selling price now. Walker will also need to convert Australian dollars to U .S . dollars after the extracted Australian silver is sold. Thus, he is effectively Jong Australian dollars and will need either a short currency forward contract on Australian dollars or equivalently a long currency forward contract on U .S . dollars if he expects the Australian dollar to depreciate. (Study Session 16, LOS 58.a)


Contribute your Thoughts:

Alex
3 months ago
Option B is the way to go. A long position in silver and a short position in the Aussie dollar will help offset the risks Walker is concerned about. Gotta love those forward contracts!
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Twana
2 months ago
It's important for Walker to consider all possible outcomes and choose the strategy that aligns with his expectations.
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Earleen
2 months ago
Forward contracts can definitely help manage risks in uncertain market conditions.
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Tayna
2 months ago
Definitely, it's important to consider all the variables when making these decisions.
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Blair
2 months ago
Forward contracts can really help manage risks in situations like this.
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Mitzie
2 months ago
I agree, option B seems like the best choice to hedge against the potential depreciation of silver and the Australian dollar.
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Kaitlyn
3 months ago
Yeah, a long position in silver and a short position in the Aussie dollar sounds like a good hedge.
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Alysa
3 months ago
I agree, option B seems like the best choice here.
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Lajuana
3 months ago
I'm sensing some serious pressure on Walker to get this right. The company's mining projects rely on his financial wizardry, so no room for error here.
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Serina
2 months ago
User 2
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Kara
3 months ago
User 1
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Artie
3 months ago
Hopefully Walker can navigate through these challenges successfully, the company's projects depend on it.
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Ngoc
3 months ago
I agree, a long position in a silver forward contract and a short position in an Australian dollar currency forward contract makes sense.
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Nobuko
3 months ago
I think Walker should go with option B, it seems like the best strategy given the circumstances.
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Cherrie
3 months ago
Haha, I bet Walker is really sweating this one. Trying to juggle all those financial instruments, it's like a circus act! But hey, that's the life of a CFO, right?
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Deandrea
4 months ago
I agree, option B seems like the most appropriate strategy.
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Wayne
4 months ago
Because he is concerned about the depreciation of the Australian dollar.
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Tijuana
4 months ago
Why do you think that?
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Brett
4 months ago
The key here is to hedge against the potential depreciation of both the silver price and the Australian dollar. Option B seems to be the best strategy to accomplish this.
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Raylene
2 months ago
Yes, we need to act quickly to mitigate any potential losses due to depreciation.
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Shawna
3 months ago
Let's make sure to establish the right positions for the silver and Australian dollar forward contracts.
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Kara
3 months ago
I agree, option B seems like the best choice to protect against depreciation.
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Fernanda
3 months ago
I think we should go with option B for the hedging strategy.
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Wayne
4 months ago
I think Walker should consider option B.
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