Caselet / Scenario

Supreme Doors, which makes industrial doors, has a manufacturing tradition going back more than 200 years. It began by making agricultural equipment and diversified into its present line twenty years ago.

The firm, which employs 60 people and has a turnover of £5.5 million, moved its manufacturing plant to the Western Cape region in South Africa 10 years ago.

Around 8% of its annual turnover is from export sales.

The company recently participated in a trade mission to Turkey in a bid to build a presence in the country. As a result, they teamed up with a Turkish company, which has a long experience of importing doors from the United States.

“The problem with selling doors overseas is the after-sales service,” explains Export Manager John Warwick. “Industrial doors are machines and therefore they need servicing, as such we decided that if we wanted to export we needed local partners in each country to carry out preventative servicing & reactive maintenance.”

Supreme Doors recognised Turkey as a good prospect particularly for its top-selling industrial doors used in industrial cold stores.

“Turkey is a gateway between Europe and Asia and has been holding its own during the recession,” adds Mr Warwick. “Our partners recognised a growing market in Turkey for cold storage.

Traditionally in Turkey people eat fresh food so there hasn’t been much of a market for frozen food. But that’s changing and younger Turkish people are increasingly eating frozen food.

“This Turkish company approached us because they recognised a growing need for fast acting freezer doors in their own and also surrounding countries. They came over to South Africa to see the doors in operation, and the result is that we’ve signed a two year agreement with them.”

Supreme Doors is now gearing up for a fully-blown marketing campaign in the country. It is getting promotional material produced in the Turkish language and is participating in the TurkeyBuild exhibition in Istanbul next spring.

Question 1

After attending the TurkishBuild exhibition in Istanbul, Mr Warwick is eager to get a foothold into the Turkish market but are concerned about payment options, as it seems that the market has become very competitive.

Taking this into account, Mr Warwick advised the potential buyer that the proposed payment term for the sale will be a documentary bill for collection, 30 days from invoice date. The potential buyer contacted Supreme Doors and recommended a clean collection, 60 days from invoice date.

Not understanding the difference between the two payment terms, he contacted their bank’s international trade division for an explanation.

As the bank official, explain the main differences, in practical terms, using the information provided in this scenario, between the documentary and clean collection In your discussion highlight the advantages and disadvantages for Supreme Doors.

This question relates to the case study provided. 10
One mark per discussion point.
Question 2
Further to the discussions on possible payment options and taking the above into consideration, explain to Mr Warwick, for Turkey, when one should consider an irrevocable documentary credit vs a confirmed irrevocable documentary credit.

This question relates to the case study provided. One mark per discussion point.
Question 3

(4)

Mr Warwick had a meeting with the company’s financial officer regarding ways in which they can better manage the effect of exchange rate fluctuations for their South African manufacturing plant.

Currently the plant imports parts from China and the USA (USD) and their exports will predominately be in USD.

The financial officer for the SA manufacturing plant emailed them the transactions for the month of April 2023.

08 April Receive USD 45 000

12 April Import Payment USD 30 000

20 April Import Payment USD 10 000

23 April Receive USD 35 000

25 April Agency Payment USD 8 000

By considering a combination of the CFC account, Spot rate and FEC contracts; propose how Supreme Doors can use these options to better manage their risk due to exchange rate fluctuations. (6) As the South African financial officer, your explanation should also include a short definition of each (6)

This question relates to the case study provided.
12

Two marks per explanation of each option and 6 marks on the option that can be used to manage the risk.
One mark per discussion point
Question 4

The future of the traditional way in which banks operate in terms of for example payment methods and funding are changing due to technology such as “blockchain”.

Your study guide covers the traditional ways of bank operations; looking towards the future how-ever, do additional research to answer the following:

a)
Define what is meant with “blockchain technology” (not referring to bitcoin). (3)

b)
How would this technology influence the documentary credit process? (6) All research must be referenced.
Information obtained from Wikipedia will not be marked.

(9)
One mark per discussion point
Question 5
Mr Warwick met with the Board of Directors who gave a clear directive that the company was never to have an uncovered foreign exchange risk. Mr Warwick and the financial officer met after receiving these instructions and began drawing up a schedule of the company’s exchange risk profile. This has now been completed as illustrated below.

Supreme Doors have been exporting to Turkey now for some time and a major client “Turkish Cold Solution” always remits funds for value date on the last working day of the month.

Forward cover contracts are therefore always arranged with delivery on the last day of the month.

SUPREME DOORS.

Foreign Exchange Exposure Report (US dollars)
Anticipated Receipts at May 31

Details of existing foreign exchange contracts are as follows:

Note: In all situations involving swaps, be sure to reflect the relevant calculations in the company’s bank account. Ignore any compounding effect on interest rates.

a)
On May 31 the following exchange rates apply for the SA rand against the US dollar:

Spot 3 months 4 months
7,2205/7,2335 835/885 1095/1145

By showing your calculations, which exchange rates would be used to establish the forward exchange contracts necessary to comply with the Chairman’s directive? (4)

Calculate the anticipated accruals in rands for each forward contract, including for those in existence prior to the establishment of the new contracts. (5)

b)
On June 25 Supreme Doors are advised by their customer in Turkey that payment of USD 35 000, originally scheduled for June 30, had been withheld pending a quality dispute. Payment had provisionally been scheduled for July 31.

The following exchange rates are quoted on June 30:

Spot 1 month
7,1428/7,1578 280/330

By way of reflecting debits and credits in your bank account, illustrate how you would set about extending the contract until July 31. (13)

What impact has this extension on the cash flow of the company? Briefly state the changes that arise in the profitability of this particular transaction.
(2)

c)
On July 20 Supreme Doors are advised by the customer that the quality dispute had been the result of their error and to make amends they are advancing the payment of USD 67 000 due on August 31 by one month.

The following exchange rates are quoted on July 31:

Spot 1 month
7,2715/7,2865 285/335

In the same way as in question b) above, describe how you would take early receipt of the funds considering that the forward exchange contract will only mature on the 31st of August. (13)

What effect will this early delivery have on the cash flow?
Briefly state what changes may occur in the profitability of this particular transaction.
(3)

(40)

Mark allocation per cost item / discussion point

Answers to Above Questions on Trade and Finance

Answer 1: An analysis of the given case scenario indicates Mr Warwick has many payment options available in the Turkish market. According to the case scenario, Mr Warwick is interested in a 30 day payment term whereas the potential buyer is interested in a 60 day payment term. There is a significant difference between both these payment terms and the main difference is..