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CFA Institute Exam CFA-Level-II Topic 3 Question 83 Discussion

Actual exam question for CFA Institute's CFA Level II Chartered Financial Analyst exam
Question #: 83
Topic #: 3
[All CFA Level II Chartered Financial Analyst 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:

Show Suggested Answer Hide Answer
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:

Shannon
3 months ago
Alright, let's do this. Option A is tempting, but I think Walker wants to protect against a drop in silver and the Aussie dollar, so a short position in silver and a long position in the US dollar is the way to go. Gotta love that LIBOR term structure, am I right? It's like a crystal ball for interest rates.
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Pauline
1 months ago
The LIBOR term structure is definitely a useful tool for predicting interest rate changes.
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Dominga
1 months ago
Yeah, Walker definitely wants to hedge against the depreciation of silver and the Australian dollar.
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Erasmo
1 months ago
I agree, a short position in silver and a long position in the US dollar seems like the safer bet.
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Alayna
2 months ago
The LIBOR term structure is definitely a useful tool for predicting interest rate changes.
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Royal
2 months ago
It's important for Walker to make the right decision to protect Lothar Corporation's interests.
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Matilda
2 months ago
The LIBOR term structure is definitely a useful tool for predicting interest rate changes.
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Gearldine
2 months ago
Yeah, Walker definitely wants to hedge against those potential depreciations.
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Kerry
2 months ago
I agree, option C seems like the best choice to protect against the drop in silver and the Aussie dollar.
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Serina
2 months ago
Yeah, Walker definitely wants to hedge against those potential depreciations.
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Dante
3 months ago
I agree, option C seems like the best choice to protect against the drop in silver and the Aussie dollar.
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Claribel
3 months ago
Ooh, this is a tricky one. I wonder if Walker has a side gig as a professional wrestler, because he's really trying to put 'Lothar' through the wringer here. But I digress, I think option B is the answer - go long on silver, short on the Aussie dollar. Gotta hedge that currency risk, am I right?
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Cheryl
3 months ago
Hmm, let's see. Walker is worried about the price of silver and the Australian dollar depreciating over the next eight months. So he'll want to take a short position in silver and the Aussie dollar to protect against those downward moves. Seems like option C is the way to go.
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Ruthann
3 months ago
User 2
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Hyun
3 months ago
User 1
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Hassie
4 months ago
This question is really testing our understanding of commodity and currency hedging. I think the key is figuring out what Walker's concerns are and then choosing the appropriate forward contracts to mitigate those risks.
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Salley
2 months ago
Exactly, it's all about managing the risks associated with the market fluctuations.
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Nana
3 months ago
That way, he can hedge against potential losses from the depreciation of both silver and the Australian dollar.
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Alethea
3 months ago
So, he should establish a long position in a silver forward contract and a short position in an Australian dollar currency forward contract.
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Georgiana
3 months ago
I think Walker's main concern is the depreciation of silver and the Australian dollar.
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Lorrie
4 months ago
I believe option B would be the most appropriate strategy for Walker in this situation.
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Chara
4 months ago
I agree. It's important to mitigate the risk of currency and commodity price fluctuations.
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Meghan
4 months ago
I think Walker should consider hedging against the depreciation of silver and the Australian dollar.
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