MULTINATIONAL FINANCIAL CHAPTER 17 MANAGEMENT(Difficulty Levels: Easy, Easy/Medium, Medium, Medium/Hard, and Hard) Please see the preface for information on the AACSB letter indicators (F, M, etc.) on the subject lines. Multiple Choice: True/False (17-2) Multinational fin. mgmt. 1 F T Answer: a EASY . Multinational financial management requires that financial analysts consider the effects of changing currency values. a. True b. False (17-2) Multinational fin. mgmt. 2 F T Answer: b EASY . Legal and economic differences among countries, although important, do NOT pose significant problems for most multinational corporations when they coordinate and control worldwide operations and subsidiaries. a. True b. False (17-3) Currency appreciation 3 F T Answer: a EASY . When the value of the U.S. dollar appreciates against another country's currency, we may purchase more of the foreign currency with a dollar. a. True b. False (17-3) Floating exchange rates 4 F T Answer: a EASY . The United States and most other major industrialized nations currently operate under a system of floating exchange rates. a. True b. False (17-4) Exchange rates 5 F T Answer: b EASY . Exchange rate quotations consist solely of direct quotations. a. True b. False (17-4) Cross rates 6 F T Answer: a EASY . Calculating a currency cross rate involves determining the exchange rate for two currencies by using a third currency as a base. Chapter 17: Multinational True/False Page 165 a. True b. False (17-9) Eurodollars 7 F T Answer: a EASY . A Eurodollar is a U.S. dollar deposited in a bank outside the United States. a. True b. False (17-9) LIBOR 8 F T Answer: b EASY . LIBOR is an acronym for London Interbank Offer Rate, which is an average of interest rates offered by London banks to smaller U.S. corporations. a. True b. False (17-10) Exchange rate risk 9 F T Answer: a EASY . Exchange rate risk is the risk that the cash flows from a foreign project, when converted to the parent company's currency, will be worth less than was originally projected because of exchange rate changes. a. True b. False (17-11) Political risk 10 F T Answer: b EASY . Because political risk is seldom negotiable, it cannot be explicitly addressed in multinational corporate financial analysis. a. True b. False (17-5) Forward market hedging 11 F T Answer: b MEDIUM . Individuals and corporations can buy or sell forward currencies to hedge their exchange rate exposure. Essentially, the process involves simultaneously selling the currency expected to appreciate in value and buying the currency expected to depreciate. a. True b. False (17-5) Discount on forward rate 12 F T Answer: a MEDIUM . If an investor can obtain more of a foreign currency for a dollar in the forward market than in the spot market, then the forward currency is said to be selling at a discount to the spot rate. a. True b. False (17-5) Premium on forward rate F T Answer: a MEDIUM Page 166 True/False Chapter 17: Multinational 13 . If a dollar will buy fewer units of a foreign currency in the forward market than in the spot market, then the forward currency is said to be selling at a premium to the spot rate. a. True b. False Chapter 17: Multinational True/False Page 167 (17-8) Currency value and inflation 14 F T Answer: a MEDIUM . A foreign currency will, on average, depreciate against the U.S. dollar at a percentage rate approximately equal to the amount by which its inflation rate exceeds that of the United States. a. True b. False (17-11) Relevant investment CFs 15 F T Answer: b MEDIUM . The cash flows relevant for a foreign investment should, from the parent company's perspective, include the financial cash flows that the subsidiary can legally send back to the parent company plus the cash flows that must remain in the foreign country. a. True b. False (17-11) For. proj. cost of capital 16 F T Answer: a MEDIUM . The cost of capital may be different for a foreign project than for an equivalent domestic project because foreign projects may be more or less risky. a. True b. False (17-11) Risk and int'l. investment 17 F T Answer: a MEDIUM . When considering the risk of a foreign investment, a higher risk might arise from exchange rate risk and political risk while lower risk might result from international diversification. a. True b. False Multiple Choice: Conceptual (17-1) Motive for going global 18 C T Answer: e EASY . Which of the following are reasons why companies move into international operations? a. To take advantage of lower production costs in regions where labor costs are relatively low. b. To develop new markets for the firm's products. c. To better serve their primary customers. d. Because important raw materials are located abroad. e. All of the above. Page 168 Conceptual M/C Chapter 17: Multinational (17-2) Multinational fin. mgmt. 19 C T Answer: a EASY . Multinational financial management requires that a. The effects of changing currency values be included in financial analyses. b. Legal and economic differences need not be considered in financial decisions because these differences are insignificant. c. Political risk should be excluded from multinational corporate financial analyses. d. Traditional U.S. and European financial models incorporating the existence of a competitive marketplace not be recast when analyzing projects in other parts of the world. e. Cultural differences need not be accounted for when considering firm goals and employee management. (17-8) Currency depreciation 20 C T Answer: a MEDIUM . If the inflation rate in the United States is greater than the inflation rate in Britain, other things held constant, the British pound will a. b. c. d. e. Appreciate against the U.S. dollar. Depreciate against the U.S. dollar. Remain unchanged against the U.S. dollar. Appreciate against other major currencies. Appreciate against the dollar and other major currencies. C T Answer: a MEDIUM (17-6) Interest rate parity 21 . In Japan, 90-day securities have a 4% annualized return and 180-day securities have a 5% annualized return. In the United States, 90-day securities have a 4% annualized return and 180-day securities have an annualized return of 4.5%. All securities are of equal risk, and Japanese securities are denominated in terms of the Japanese yen. Assuming that interest rate parity holds in all markets, which of the following statements is most CORRECT? a. The yen-dollar spot exchange rate equals the yen-dollar exchange rate in the 90-day forward market. b. The yen-dollar spot exchange rate equals the yen-dollar exchange rate in the 180-day forward market. c. The yen-dollar exchange rate in the 90-day forward market equals the yen-dollar exchange rate in the 180-day forward market. d. The yen-dollar exchange rate in the 180-day forward market equals the yen-dollar exchange rate in the 90-day spot market. e. The relationship between spot and forward interest rates cannot be inferred. Chapter 17: Multinational Conceptual M/C Page 169 (17-9) Int'l. bond markets 22 C T Answer: d MEDIUM . Which of the following statements is NOT CORRECT? a. Any bond sold outside the country of the borrower is called an international bond. b. Foreign bonds and Eurobonds are two important types of international bonds. c. Foreign bonds are bonds sold by a foreign borrower but denominated in the currency of the country in which the issue is sold. d. The term Eurobond applies only to foreign bonds denominated in U.S. currency. e. A Eurodollar is a U.S. dollar deposited in a bank outside the U.S. (17-6) Interest rate parity 23 C T Answer: c MEDIUM/HARD . Currently, a U.S. trader notes that in the 6-month forward market, the Japanese yen is selling at a premium (that is, you receive more dollars per yen in the forward market than you do in the spot market), while the British pound is selling at a discount. Which of the following statements is CORRECT? a. If interest rate parity holds, 6-month interest rates should be the same in the U.S., Britain, and Japan. b. If interest rate parity holds among the three countries, the United States should have the highest 6-month interest rates and Japan should have the lowest rates. c. If interest rate parity holds among the three countries, Britain should have the highest 6-month interest rates and Japan should have the lowest rates. d. If interest rate parity holds among the three countries, Japan should have the highest 6-month interest rates and Britain should have the lowest rates. e. If interest rate parity holds among the three countries, the United States should have the highest 6-month interest rates and Britain should have the lowest rates. (17-6) Interest rate parity 24 C T Answer: b HARD . Today in the spot market $1 = 1.82 Swiss francs and $1 = 130 Japanese yen. In the 90-day forward market, $1 = 1.84 Swiss francs and $1 = 127 Japanese yen. Assume that interest rate parity holds worldwide. Which of the following statements is most CORRECT? a. Interest rates on 90-day risk-free U.S. securities are higher than the interest rates on 90-day risk-free Swiss securities. b. Interest rates on 90-day risk-free U.S. securities are higher than the interest rates on 90-day risk-free Japanese securities. c. Interest rates on 90-day risk-free U.S. securities equal the interest rates on 90-day risk-free Japanese securities. d. Since interest rate parity holds interest rates should be the same in all three countries. e. Interest rates on 90-day risk-free U.S. securities equal the interest rates on 90-day risk-free Swiss securities. Page 170 Conceptual M/C Chapter 17: Multinational Chapter 17: Multinational Conceptual M/C Page 171 Problems Problems with * in the topic line are nonalgorithmic. (17-4) Exchange rates 25 C T Answer: d EASY . If one Swiss franc can purchase $0.76 U.S. dollars, how many Swiss francs can one U.S. dollar buy? a. b. c. d. e. 0.9592 1.0658 1.1842 1.3158 1.4474 C T Answer: b EASY (17-4) Exchange rates 26 . If one U.S. dollar buys 1.64 Canadian dollars, how many U.S. dollars can you purchase for one Canadian dollar? a. b. c. d. e. 0.5488 0.6098 0.6707 0.7378 0.8116 C T Answer: a EASY (17-4) Exchange rates 27 . If one British pound can purchase $1.98 U.S. dollars, how many British pounds can one U.S. dollar buy? a. b. c. d. e. 0.5051 0.5556 0.6111 0.6722 0.7394 C T Answer: e EASY (17-4) Exchange rates 28 . If one U.S. dollar buys 0.63 euro, how many dollars can you purchase for one euro? a. b. c. d. e. 1.0414 1.1571 1.2857 1.4286 1.5873 C T Answer: b EASY (17-4) Exchange rates 29 . If one U.S. dollar sells for 0.60 British pound, how many dollars should one British pound sell for? a. 1.0935 b. 1.2150 c. 1.3500 Page 172 Problems Chapter 17: Multinational d. 1.5000 e. 1.6667 Chapter 17: Multinational Problems Page 173 (17-4) Currency appreciation 30 C T Answer: a EASY . Suppose 144 yen could be purchased in the foreign exchange market for one U.S. dollar today. If the yen depreciates by 8.0% tomorrow, how many yen could one U.S. dollar buy tomorrow? a. b. c. d. e. 155.5200 163.2960 171.4608 180.0338 189.0355 C T Answer: d EASY (17-9) Eurobonds vs. domestic bonds 31 . Suppose a foreign investor who holds tax-exempt Eurobonds paying 9% is considering investing in an equivalent-risk domestic bond in a country with a 28% withholding tax on interest paid to foreigners. If 9% after-tax is the investor's required return, what before-tax rate would the domestic bond need to pay to provide the required after-tax return? a. b. c. d. e. 9.11% 10.13% 11.25% 12.50% 13.75% C T Answer: e EASY (17-10) Exchange rate risk 32 . Suppose DeGraw Corporation, a U.S. exporter, sold a solar heating station to a Japanese customer at a price of 143.5 million yen, when the exchange rate was 140 yen per dollar. In order to close the sale, DeGraw agreed to make the bill payable in yen, thus agreeing to take some exchange rate risk for the transaction. The terms were net 6 months. If the yen fell against the dollar such that one dollar would buy 154.4 yen when the invoice was paid, what dollar amount would DeGraw actually receive after it exchanged yen for U.S. dollars? a. b. c. d. e. $757,005.48 $796,847.88 $838,787.24 $882,933.94 $929,404.15 C T Answer: b MEDIUM (17-4) Cross rates 33 . Suppose the exchange rate between U.S. dollars and Swiss francs is SF 1.41 = $1.00, and the exchange rate between the U.S. dollar and the euro is $1.00 = 0.64 euros. What is the cross rate of Swiss francs to euros? a. b. c. d. e. 1.9828 2.2031 2.4234 2.6658 2.9324 Page 174 Problems Chapter 17: Multinational (17-4) Cross rates 34 C T Answer: b MEDIUM . Suppose that currently, 1 British pound equals 1.98 U.S. dollars and 1 U.S. dollar equals 1.02 Swiss francs. How many Swiss francs are needed to purchase 1 pound? a. b. c. d. e. 1.9691 2.0196 2.0701 2.1218 2.1749 C T Answer: c MEDIUM (17-4) Cross rates 35 . A currency trader observes the following quotes in the spot market: 1 U.S. dollar = 122 Japanese yen 1 British pound = 2.25 Swiss francs 1 British pound = 1.65 U.S. dollars Given this information, how many yen can be purchased for 1 Swiss franc? a. b. c. d. e. 0.8505 0.8723 0.8947 0.9170 0.9400 C T Answer: c MEDIUM (17-4) Cross rates 36 . A currency trader observes the following quotes in the spot market: 1 U.S. dollar = 10.875 Mexican pesos 1 British pound = 6.205 Danish krone 1 British pound = 1.98 U.S. dollars Given this information, how many Mexican pesos can be purchased for 1 Danish krone? a. b. c. d. e. 2.7490 2.8195 2.8918 2.9641 3.0382 C T Answer: d MEDIUM (17-5) Forward rates* 37 . If the spot rate of the Israeli shekel is 5.51 shekels per dollar and the 180-day forward rate is 5.97 shekels per dollar, then the forward rate for the Israeli shekel is selling at a ______________ to the spot rate. a. b. c. d. 6.09% 6.76% 7.51% 8.35% premium premium discount discount Problems Page 175 Chapter 17: Multinational e. 9.18% discount Page 176 Problems Chapter 17: Multinational (17-5) Currency depreciation 38 C T Answer: d MEDIUM . Suppose one British pound can purchase 1.82 U.S. dollars today in the foreign exchange market, and currency forecasters predict that the U.S. dollar will depreciate by 12.0% against the pound over the next 30 days. How many dollars will a pound buy in 30 days? a. b. c. d. e. $1.4860 $1.6511 $1.8346 $2.0384 $2.2422 C T Answer: e MEDIUM (17-5) Forward market hedge 39 . Stover Corporation, a U.S. based importer, makes a purchase of crystal glassware from a firm in Switzerland for 39,960 Swiss francs, or $24,000, at the spot rate of 1.665 francs per dollar. The terms of the purchase are net 90 days, and the U.S. firm wants to cover this trade payable with a forward market hedge to eliminate its exchange rate risk. Suppose the firm completes a forward hedge at the 90-day forward rate of 1.682 francs. If the spot rate in 90 days is actually 1.64 francs, how much will the U.S. firm have saved or lost in U.S. dollars by hedging its exchange rate exposure? a. b. c. d. e. $399 $444 $493 $548 $608 C T Answer: d MEDIUM (17-5) Forward market hedge 40 . Suppose a U.S. firm buys $200,000 worth of television tubes from a Mexican manufacturer for delivery in 60 days with payment to be made in 90 days (30 days after the goods are received). The rising U.S. deficit has caused the dollar to depreciate against the peso recently. The current exchange rate is 5.50 pesos per U.S. dollar. The 90-day forward rate is 5.45 pesos/dollar. The firm goes into the forward market today and buys enough Mexican pesos at the 90-day forward rate to completely cover its trade obligation. Assume the spot rate in 90 days is 5.30 Mexican pesos per U.S. dollar. How much in U.S. dollars did the firm save by eliminating its foreign exchange currency risk with its forward market hedge? a. b. c. d. e. $4,897.59 $5,155.36 $5,426.69 $5,712.31 $5,997.92 Chapter 17: Multinational Problems Page 177 (17-6) Interest rate parity 41 C T Answer: b MEDIUM . Suppose 90-day investments in Britain have a 6% annualized return and a 1.5% quarterly (90-day) return. In the U.S., 90-day investments of similar risk have a 4% annualized return and a 1% quarterly (90-day) return. In the 90-day forward market, 1 British pound equals $1.65. If interest rate parity holds, what is the spot exchange rate ($/£)? a. b. c. d. e. $1.4924 $1.6582 $1.8240 $2.0064 $2.2070 C T Answer: c MEDIUM (17-7) Purchasing power parity 42 . Suppose hockey skates sell in Canada for 105 Canadian dollars, and 1 Canadian dollar equals 0.71 U.S. dollars. If purchasing power parity (PPP) holds, what is the price of hockey skates in the United States? a. b. c. d. e. $60.39 $67.10 $74.55 $82.01 $90.21 C T Answer: a MEDIUM (17-9) Exchange fluctuations 43 . Suppose 6 months ago a Swiss investor bought a 6-month U.S. Treasury bill at a price of $9,708.74, with a maturity value of $10,000. The exchange rate at that time was 1.420 Swiss francs per dollar. Today, at maturity, the exchange rate is 1.324 Swiss francs per dollar. What is the annualized rate of return to the Swiss investor? a. b. c. d. e. -7.93% -7.13% -6.42% -5.78% -5.20% C T Answer: c MEDIUM (17-10) Exchg. rates & asset val. 44 . In 1985, a given Japanese imported automobile sold for 1,476,000 yen, or $8,200. If the car still sold for the same amount of yen today but the current exchange rate is 144 yen per dollar, what would the car be selling for today in U.S. dollars? a. b. c. d. e. $8,303 $9,225 $10,250 $11,275 $12,403 Page 178 Problems Chapter 17: Multinational (17-10) Inventory and exchg. rates 45 C T Answer: b MEDIUM . Suppose one year ago, Hein Company had inventory in Britain valued at 240,000 pounds. The exchange rate for dollars to pounds was 1£ = 2 U.S. dollars. This year the exchange rate is 1£ = 1.82 U.S. dollars. The inventory in Britain is still valued at 240,000 pounds. What is the gain or loss in inventory value in U.S. dollars as a result of the change in exchange rates? a. b. c. d. e. -$38,880.00 -$43,200.00 -$47,520.00 -$52,272.00 -$57,499.20 C T Answer: e MEDIUM/HARD (17-5) Exchg. rates & req. return 46 . One year ago, a U.S. investor converted dollars to yen and purchased 100 shares of stock in a Japanese company at a price of 3,150 yen per share. The stock's total purchase cost was 315,000 yen. At the time of purchase, in the currency market 1 yen equaled $0.00952. Today, the stock is selling at a price of 3,465 yen per share, and in the currency market $1 equals 130 yen. The stock does not pay a dividend. If the investor were to sell the stock today and convert the proceeds back to dollars, what would be his realized return on his initial dollar investment from holding the stock? a. b. c. d. e. -13.51% -12.87% -12.26% -11.67% -11.12% C T Answer: d MEDIUM/HARD (17-7) Purchasing power parity 47 . A product sells for $750 in the United States. The spot exchange rate is $1 to 1.65 Swiss francs. If purchasing power parity (PPP) holds, what is the price of the product in Switzerland? a. b. c. d. e. 902.14 1,002.38 1,113.75 1,237.50 1,361.25 C T Answer: e MEDIUM/HARD (17-7) Purchasing power parity 48 . A box of candy costs 28.80 Swiss francs in Switzerland and $20 in the United States. Assuming that purchasing power parity (PPP) holds, how many Swiss francs are required to purchase one U.S. dollar? a. b. c. d. e. 0.9448 1.0498 1.1664 1.2960 1.4400 Problems Page 179 Chapter 17: Multinational Page 180 Problems Chapter 17: Multinational (17-6) Interest rate parity 49 C T Answer: d HARD . Suppose in the spot market 1 U.S. dollar equals 1.60 Canadian dollars. 6-month Canadian securities have an annualized return of 6% (and thus a 6-month periodic return of 3%). 6-month U.S. securities have an annualized return of 6.5% and a periodic return of 3.25%. If interest rate parity holds, what is the U.S. dollar-Canadian dollar exchange rate in the 180-day forward market? In other words, how many Canadian dollars are required to purchase one U.S. dollar in the 180-day forward market? a. b. c. d. e. 1.2727 1.4141 1.5712 1.7458 1.9203 C T Answer: e HARD (17-10) EAR on foreign debt 50 . Blenman Corporation, based in the United States, arranged a 2-year, $1,000,000 loan to fund a project in Mexico. The loan is denominated in Mexican pesos, carries a 10.0% nominal rate, and requires equal semiannual payments. The exchange rate at the time of the loan was 5.75 pesos per dollar, but it dropped to 5.10 pesos per dollar before the first payment came due. The loan was not hedged in the foreign exchange market. Thus, Blenman must convert U.S. funds to Mexican pesos to make its payments. If the exchange rate remains at 5.10 pesos per dollar through the end of the loan period, what effective annual interest rate will Blenman end up paying on the loan? a. b. c. d. e. 17.76% 18.69% 19.67% 20.71% 21.80% Chapter 17: Multinational Problems Page 181 ANSWERS AND SOLUTIONS CHAPTER 17 Page 182 Answers Chapter 17: Multinational 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. (17-2) Multinational fin. mgmt. (17-2) Multinational fin. mgmt. (17-3) Currency appreciation (17-3) Floating exchange rates (17-4) Exchange rates (17-4) Cross rates (17-9) Eurodollars (17-9) LIBOR (17-10) Exchange rate risk (17-11) Political risk (17-5) Forward market hedging (17-5) Discount on forward rate (17-5) Premium on forward rate (17-8) Currency value and inflation (17-11) Relevant investment CFs (17-11) For. proj. cost of capital (17-11) Risk and int'l. investment (17-1) Motive for going global (17-2) Multinational fin. mgmt. (17-8) Currency depreciation (17-6) Interest rate parity (17-9) Int'l. bond markets (17-6) Interest rate parity F T F T F T F T F T F T F T F T F T F T F T F T F T F T F T F T F T C T C T C T C T C T C T Answer: a Answer: b Answer: a Answer: a Answer: b Answer: a Answer: a Answer: b Answer: a Answer: b Answer: b Answer: a Answer: a Answer: a Answer: b Answer: a Answer: a Answer: e Answer: a Answer: a Answer: a Answer: d Answer: c EASY EASY EASY EASY EASY EASY EASY EASY EASY EASY MEDIUM MEDIUM MEDIUM MEDIUM MEDIUM MEDIUM MEDIUM EASY EASY MEDIUM MEDIUM MEDIUM MEDIUM/HARD As the yen is selling at a premium, this means that the interest rates in Japan are lower than in the U.S. Thus, when you invest in yen, you get part of your return from the interest rate and part when you convert back to dollars. The opposite is true of the rates in Britain. 24. (17-6) Interest rate parity C T Answer: b HARD The easiest way to do this is to make an example up. Assume the annual interest rate in the U.S. is 16%. Suppose in the U.S. you start off with $1.00, so after 90 days you will have $1.00 × (1 + 0.16/4) = $1.04. In Switzerland, you will start with 1.00 × 1.82 = SF 1.82 and end up with 1.04 × 1.84 = SF 1.9136. The return in Switzerland is 1.9136/1.82 – 1 = 5.14%. (This is higher than the 4% U.S. rate.) In Japan, you will start with 1.00 × 130 = 130 yen and end up with 1.04 × 127 = 132.08 yen. The return is 132.08/130 – 1 = 1.6%. (This is lower than the 4% U.S. rate.) 25. (17-4) Exchange rates 1 Swiss franc = 0.76 U.S. dollar U.S. dollar = 1/0.76 Swiss francs Swiss francs 1 U.S. $ can purchase = 1.3158 C T Answer: d EASY 26. (17-4) Exchange rates 1 U.S. dollar = 1.64 Canadian dollars Canadian dollar = 1/1.64 U.S. dollars U.S. dollars 1 C$ can purchase = 0.6098 C T Answer: b EASY 27. (17-4) Exchange rates 1 British pound = 1.98 U.S. dollar U.S. dollar = 1/1.98 British pounds British pounds 1 U.S. $ can purchase = 0.5051 C T Answer: a EASY 28. (17-4) Exchange rates 1 U.S. dollar = 0.63 euro Euro = 1/0.630 U.S. dollar U.S. dollars 1 euro can purchase = 1.5873 C T Answer: e EASY 29. (17-4) Exchange rates 1 U.S. dollar = 0.60 pound Pound = 1/0.600 U.S. dollar U.S. dollars 1 euro can purchase = 1.6667 C T Answer: b EASY 30. (17-4) Currency appreciation C T Answer: a EASY One dollar = 144.0000 Yen Depreciation 8% If yen depreciates against the dollar, the dollar will purchase more yen. U.S. dollar now = 144.00 × (1 + 0.08) U.S. dollar now = 155.5200 31. (17-9) Eurobonds vs. domestic bonds rd AT 9.00% Tax rate 28.00% C T Answer: d EASY rd BT = r d AT/(1 – T) rd BT = 9.00%/72.00% rd BT = 12.50% 32. (17-10) Exchange rate risk Spot rate at t = 0 Exchange rate at t = 0.5 Years Payable 0 140.0 yen per $ 154.4 yen per $ C T (Numbers in millions) Answer: e EASY 0.5 143.5 yen Dollar value of payable = Payable in Yen/Yen exchange rate at t = 0.5 $ Value at t = 0.5 $929,404.15 33. (17-4) Cross rates One U.S. dollar = 1.41 SF One U.S. dollar = 0.64 € SF/€ = SF/$ × $/€ SF/€ = 1.4100 × 1.5625 SF/€ = 2.2031 34. (17-4) Cross rates £ = $1.98 $ = 1.02 SF SF/£ = SF/$ × $/£ SF/£ = 1.0200 × 1.9800 SF/£ = 2.0196 35. (17-4) Cross rates £ = 2.25 SF £ = $1.65 $ = 1.22 ¥ ¥/SF = ¥/$ × $/£ × £/SF ¥/SF = 1.2200 × 1.6500 × 0.4444 ¥/SF = 0.8947 36. (17-4) Cross rates £ = 6.205 DK £ = $1.65 $ = 10.875 MP MP/DK = MP/$ × $/£ × £/DK MP/DK = 10.8750 × 1.6500 × 0.1612 MP/DK = 2.8918 37. (17-5) Forward rates* Spot rate: $ = 180-day forward rate 5.51 shekels 5.97 shekels C T Answer: d MEDIUM C T Answer: c MEDIUM C T Answer: c MEDIUM C T Answer: b MEDIUM C T Answer: b MEDIUM Because one can obtain more Israeli shekels for a dollar in the forward market, the forward currency is selling at a discount to the spot rate. The amount of the discount is calculated as: (Forward rate − Spot rate)/Spot rate. % Discount = 8.35% 38. (17-5) Currency depreciation British pound Dollar depreciation $1.82 12.00% C T Answer: d MEDIUM The British pound will appreciate against the dollar by 12.00% British pound = $/£ × (1 + % $ depreciation) British pound = $2.0384 39. (17-5) Forward market hedge Price of glassware in SF Dollar price of glassware Spot rate, SF/$ 90-day forward rate, SF/$ Spot rate in 90 days, SF/$ Price of glassware in SF $ Cost at spot in 90 days Forward contract ($) Savings from forward contract 39,960 SF $24,000 1.6650 SF 1.6820 SF 1.6400 SF 0 C T Answer: e MEDIUM 30 60 90 39,960 $24,366 $23,757 $ 608 40. (17-5) Forward market hedge Television tubes Dollar price of glassware Spot rate, MP/$ 90-day forward rate, MP/$ Spot rate in 90 days, MP/$ 200,000 $24,000 5.5000 MP 5.4500 MP 5.3000 SF 0 Trade obligation in MP (Tubes × Spot rate) $ Cost at spot in 90 days Forward contract ($) Savings from forward contract C T Answer: d MEDIUM 30 60 90 $1,100,000.00 $207,547.17 $201,834.86 $ 5,712.31 41. (17-6) Interest rate parity 90-day rf , (Annual/4) 90-day rh , (Annual/4) 90-day forward rate ($/£) 1.50% 1.00% $1.65 C T Answer: b MEDIUM Forward exchange rate (1 + rh ) = Spot exchange rate (1 + rf ) $1.65 1.0100 = Spot exchange rate 1.0150 $1.65 = 0.995074 Spot exchange rate $1.65 = 0.995074 × Spot exchange rate $1.6582 = Spot exchange rate 42. (17-7) Purchasing power parity Price of skates, C$ Spot exchange rate, $/C$ Ph =Pf × Spot rate Ph = 105.00 × $0.71 105.00 C$ $0.71 C T Answer: c MEDIUM Ph = $74.55 43. (17-9) Exchange fluctuations 6-mos. Treasury bill, VB Maturity value Spot rate, SF/$ 6-mos Fwd rate, SF/$ Time CF, in $ CF, in SF $9,708.74 $10,000.00 1.420 SF 1.324 SF 0 -$9,708.74 -13,786.41 6 months $10,000.00 13,240.00 C T Answer: a MEDIUM Now, calculate the 6-month return to the Swiss investor after exchanging US $ for SF: N 1 PV -13,786.41 PMT 0 FV 13,240.00 I/YR, 6-mos. -3.96% Annual rate = 2 × 6 mos. return Annual rate = -7.93% 44. (17-10) Exchg. rates & asset val. C T 1985 price in yen of automobile 1985 price in dollars of automobile Today's exchange rate: ¥/$ 1,476,000 yen $8,200 144 yen Answer: c MEDIUM Today's $ price = 1985 yen price/Today's exchange rate Today's $ price = 1,476,000/144 Today's $ price = $10,250 45. (17-10) Inventory and exchg. rates Inventory value Spot rate, $/£ 1 yr. ago Current spot rate $/£ 240,000 £ $2.00 $1.82 C T Answer: b MEDIUM Dollar value of inventory this year = Current spot rate $/£ × £ inv. value = $436,800.00 Dollar value of inventory last year = Last year’s spot rate $/£ × £ inv. value = $480,000.00 Change in inv value = -$43,200.00 46. (17-5) Exchg. rates & req. return Shares bought Last year's stock price/share in yen $/yen exchange rate at purchase Current stock price/share in yen Yen/$ spot exchange rate C T Answer: e MEDIUM/HARD 100 3,150 ¥ $0.00952 3,465 ¥ 130 ¥ $ investment in stock = No. of shares × Yen purchase price × $/yen rate at purchase $ investment in stock = 100 × 3,150 × $0.00952 $ investment in stock = $2,998.80 $ proceeds of sale = (No. of shares × Current yen stock price)/(Yen/$ spot rate) $ proceeds of sale = 100 × 3,465/130 $ proceeds of sale = $2,665.38 Return = ($ proceeds – $ investment)/$ investment Return = ($2,665.38 – $2,998.80)/$2,998.80 Return = -11.12% 47. (17-7) Purchasing power parity Product price in U.S. Spot rate, SF/$ $750.00 1.65 SF C T Answer: d MEDIUM/HARD Formula below requires spot rate to be home currency/foreign currency, so need inverse of spot rate given. Ph = Pf × Spot rate, $/SF $750 = Pf × 0.6061 Pf = 1,237.50 48. (17-7) Purchasing power parity Price of candy in SF Price of candy in $ 28.80 SF $20.00 C T Answer: e MEDIUM/HARD Ph = Pf × Spot rate $20.00 = 28.80 × Spot rate Spot rate, $/SF = $0.6944 per SF Note that the spot rate above gives the number of dollars required to purchase one SF. However, the problem asks for the number of SFs required to purchase one U.S. dollar. Therefore, we need to calculate the inverse of the spot rate above. Spot rate, SF/$ = 1/Spot rate, $/SF Spot rate, SF/$ = 1.4400 49. (17-6) Interest rate parity Spot rate: C$/$ 6-mos r f, (Annual/2) 6-mos r h, (Annual/2) 1.7500 C$ 3.00% 3.25% C T Answer: d HARD Note that the spot rate is in terms of C$/$. However, the formula below needs the spot rate in terms of $/C$, so we need to use the inverse of this spot rate in the formula below. (1 + rh ) Forward exchange rate = Spot exchange rate, $/C$ (1 + rf ) Forward exchange rate 1.0325 = 0.5714 1.0300 Forward exchange rate = 1.0024 0.5714 Forward rate, $/C$ = $0.5728 Note that the forward exchange rate gives the number of U.S dollars for 1 Canadian dollar, but the problem asks for the number of Canadian dollars per U.S. dollar. So, we need the inverse of the number above. Forward exchange rate C$/$ = 1/Forward exchange rate, $/C$ Forward exchange rate C$/$ = 1.7458 50. (17-10) EAR on foreign debt Loan value ($) Length of maturity (years) No. of payments/year Nominal rate Spot rate at loan date (MP/$) Spot rate before 1st payment (MP/$) Calculate MP loan payment: N 4 I/YR 5.000% PV -$5,750,000 FV $0 PMT $1,621,568 Cash flows: MP $ 0 -5,750,000 1,000,000 C T $1,000,000 2 2 10.00% 5.75 MP 5.10 MP Answer: e HARD Calculated as loan value × spot rate at loan date Loan will be paid off at maturity, so FV = 0 1 1,621,568 317,955 2 1,621,568 317,955 3 1,621,568 317,955 4 1,621,568 317,955 6 mos. periods (Spot at loan date) Changed spot rate $ payments are determined by dividing peso payments by the changed spot rate. Calculate I/YR for $ CFs: N 4 PV -$1,000,000 FV $0 PMT $317,955 I/YR 10.36% Use original loan value here This is the nominal semiannual rate, r NOM/N Calculate EAR of loan from periodic rate calculated above: EFF% = (1 + (r NOM/N))N – 1 = 21.80%