Foreign exchange risk is the risk of changes in the foreign exchange rate or the value of a currency. The level of change or movement cannot be determined with certainty making any counterparty with exposure in that be exposed to the market volatility or uncertainty.

Transaction exposure refers to the gains or losses made on foreign exchange transactions due to the changes in the exchange rate between the transaction date and the payment or settlement date if the exposure or transaction is unhedged.

Translation risk refers to the movement in values either gains or losses of the balance sheet due to the consolidation of the assets and liabilities into a reporting currency from various currencies.

Economic exposure refers to the long term changes in the value of a foreign firm due to the unexpected changes in the exchange rate movements.

• Nature of the company’s products
  The products of the company should enable it generate adequate sales and profits that are sustainable for it to be attractive to venture capital investment.
• Expertise in production
  Technical ability should be demonstrated through efficient production and value driven skills and competencies.
• Expertise in management
  Management should demonstrate commitment, skills, and experience in promoting the objectives of the organization.
• The market and competition
  The company’s proposal should demonstrate that it has a competitive strategy to maintain and expand its market share.
• Future profits
  The prospects of the company in generating future profits are realistically expressed in its business plan and proposal.
• Board membership
  The company should have a board of directors who will take decisions and consider the interest of the stakeholders.
• Risk borne by existing shareholders
  Significant part of the company’s funding is from its owners who also bear the major part of the company’s risk.                     (Any 5 points)

Note: Candidates who use any rate above 12.5% for “b” and follow the correct process should get full marks even if the IRR is not equal to 15.67%

A stock split simply divides existing outstanding shares held by shareholders into multiple shares. i.e. if you own one share before a 2-for-1 split, you will own 2 shares after. A scrip issue works in almost the same way except that instead of having your shares split into 2, the company issues you one additional fully paid share free of charge so that you will also own 2 shares after the bonus issue.

One of the major reasons why companies declare bonus issues is that a higher number of shares improves float and liquidity and thereby traded volumes of the stock. A lower price also makes the stock seem more affordable to small retail investors, who might otherwise give it a miss at high price levels. Another aspect of a bonus issue is that it reflects the confidence of the company in its ability to service a larger equity base. Thus, bonus issues are said to be a good signaling mechanism on the company’s capacity to deliver future benefits to shareholders in terms of increased dividend.

Overcapitalization refers to a situation where a company has more or excess capital at its disposal than what is required for its normal and optimal operation or utilization. When a company has issued more debt and equity than its assets are worth. An overcapitalized company might be paying more than it needs to in interest and dividends. Reducing debt, buying back shares and restructuring the company are possible solutions to this problem.

Overtrading is a situation where a company or firm has insufficient or inadequate cash or near cash resources at its disposal to conduct its operations due to rapid growth. The indicators of overtrading are:

• High utilization of trade credit with large creditor positions.
• Large turnovers with no corresponding increase in cash or cash equivalents.
• Funding or liquidity challenges etc.

Extra Profit:
Contribution Sales Ratio = (30-27)/30 = 3/30 = 10%
Increase in sales revenue: 25% x 6,000,000 = 1,500,000
Increase in contribution = 10% x 1,500,000 = 150,000
Extra investments if all accounts or customers received 60 days ( 2 months):
Average accounts receivable after increase sales = 2/12 x 7,500,000 = 1,250,000
Less current accounts receivable (1/12 x 6,000,000)                              = 500,000
.                                                                                                                  ——————-

Increase in accounts receivable                                                                  750,000
Increase in inventories                                                                                 250,000
.                                                                                                                 ——————–
.                                                                                                                       1,000,000
Less increase in accounts payables                                                             50,000
.                                                                                                                    ——————–
.                                                                                                                        950,000
Return on investment = 150,000/ 950,000 = 15.8%

Increase in accounts receivables = 2/12 x 1,500,000         = 250,000
Increase in inventories                                                            = 250,000
.                                                                                              ——————-
.                                                                                                    500,000
Less increase in accounts payables                                         50,000
.                                                                                                 ————–
.                                                                                                     450,000
.                                                                                                ———————
Return on investment = 150,000/ 450,000 = 33.33% 

The policy is worthwhile if the existing customers stick to the 1 month and new customers or accounts take the 2 months. The return on the latter is 33.33% which has crossed the required rate of return of 28%.

• Translation risk is best managed by using matching. For example, in purchasing an asset in a foreign country, a company should raise the funds for the purchase in the foreign currency so both the asset and liability are in the same currency. There are a number of ways to hedge transaction risk internally. Matching, for example, could mean paying for imports in the same currency that a company invoices its exports in.
• Alternatively, a company could invoice customers in the domestic currency and find a supplier which does the same. The problem with this method, though, is that the company may lose foreign sales and also restrict the potential suppliers it can purchase from.
• Companies can also manage transaction risk by leading and lagging payments according to their expectations of exchange rate movements.

• Alignment of management goals with the shareholder value maximisation. This applies to the form of compensation/rewards provided for the Directors. It should be such that their actions will create a win-win situation for both the Directors and the shareholders. This process leads to goal congruence where the goals of the Directors that can influence them to pursue their personal interest are aligned with the goals of the shareholders.
• Various corporate governance controls also push the Directors to act in the interest of shareholders. Shareholders are responsible for the appointment of Directors, and the Directors in turn appoint their managers. Just as Directors can fire nonperforming managers, the shareholders can also replace the Directors if they consider them to be nonperforming. Again monitoring of management performance through periodic audit (internal and external) and other attestation arrangements will enable weaknesses in systems to be identified and steps taking to address those weaknesses.
• Provide a practical framework of reference for reviewing and modernising existing policy solutions in line with good practice. Promoting a culture in which conflicts of interest are properly identified and resolved or managed.

• Staff motivation
• Top service to customers
• Growth
• Market leadership in research and development
• Social responsibility
• Environmental sustainability
• Diversification purposes etc.                                                                    (Any 3 points)

Agency problem occurs when managers or management take decisions that are not consistent with the objectives of shareholder value maximization. Contributors to this agency problem are: divergence of ownership and control, goals of managers differing from those of share holders because of personal interest and asymmetry of information between managers and shareholders.

• Use of performance related reward scheme: in the form of pay and bonuses based on satisfactory performance of managers in delivering shareholder value.
• Executive share option scheme: where managers or executives are allowed to buy the shares of the company at a fixed price within a particular period. The option will only have value if the market price is better than the price they will pay for exercising the option. This will encourage goal congruence between managers and shareholders.
• Threat of firing or dismissal: Managers or directors can be forced out by the shareholders if they are unhappy with their performance through shareholder meetings. This method can put pressure on managers or directors to perform.
• Key Market participants like institutional investors such as fund managers, pension houses, insurance companies who have larger shareholdings can exercise that to push managers to perform or be voted out.
• Monitoring and control of managers performance through the use of external and internal auditors, Board committees and review consultants.                                                                                                                                 (Any 3 points)

• Liquidity preference theory: Explains that the yield curve is likely to be upward sloping (i.e. lower yield for shorter maturities and higher yield for longer maturities) as investors prefer having cash sooner to having cash later. Therefore, investors want a higher compensation to invest in longer-term security/loans, which has much of their cash flows occurring later; and lower compensation to invest in short-term security/loans, which has much of their cash flows occurring sooner. In conclusion, the longer term interest rates tend to be higher than shorter term interest rates, and the yield curve slopes upwards.
• Expectations theory: Explains that interest rates reflect expectations of future changes in interest rates. When interest rates are expected to rise in the future, longer-term interest rates will be higher than shorter-term interest rates, and the yield curve will slope upward. When interest rates are expected to fall, shorter-term interest rates may be higher than longer-term interest rates, and the yield curve becomes downward sloping.
• Market segmentation theory: Explains that the slope of the yield curve will reflect conditions in the different segments of the market. Suppose the debt market is segmented into short-term debt market and long-term debt market. If during a period, there are few lenders who are willing to offer long-term loans but more borrowers who demand long-term loans, there will be shortage of funds in the market for long-term funds and excess fund in the market for short-term funds. Consequently, interest rates on long-term loans will be higher than rates on short-term loans, and the yield curve will be upward sloping.
• Government policy: Government may influence level of interest rate in the economy through its monetary policy. A policy with the effect of keeping interest rates relatively high may force short-term interest rates higher than long-term rates. For instance, as the Government of Ghana borrows more through the 182-day Treasury bill than the 1-year note, the annualised interest rate on the 182-day bill is higher than the annual rate on 1-year note as of August 28, 2015.