Subject: Business    / Finance
Question

1. If interest rate parity exists and transactions costs are zero, the hedging of payables/receivables with a forward contract hedge will yield the same result as a money market hedge on payables/receivables. (Points : 3.7)

True

False

Question 2. 2. With regard to hedging translation exposure, translation losses are tax deductible, and gains on forward contracts used to hedge translation exposure not taxed. (Points : 3.7)

True

False

Question 3. 3. If a U.S. firm’s expenses are more susceptible to exchange rate movements than revenue, the firm will benefit if the dollar weakens. (Points : 3.7)

True

False

Question 4. 4. Which of the following is NOT a form of political risk? (Points : 3.7)

Exchange rate movements

Currency inconvertibility

Blockage of fund transfers

All of the above are forms of political risk.

Question 5. 5. ____ is NOT a cost-related motive for direct foreign investment. (Points : 3.7)

Using foreign factors of production

Fully benefiting from economies of scale

React to exchange rate movements

Exploiting monopolistic advantages

Question 6. 6. ____ exposure is the degree to which the value of contractual transactions can be affected by exchange rate fluctuations.

(Points : 3.7)

Translation

Economic

Transaction

None of the above

Question 7. 7. Genetech, a U.S. firm, plans to invest a new project in either the United States or U.K. Once completed, it will continue 40% of the firm’s total funds invested in itself. The remaining 60% of its investment in its business is exclusively in the U.S. Characteristics of the proposed project are forecasted for a 3-year period for both a U.S. and a British location as follows:

CHARACTERISTICS OF PROPOSED PROJECT

IF LOCATED IN THE UNITED STATES IF LOCATED IN THE UNITED KINGDOM

Existing Business

Mean expected annual return on investment (after taxes) 20% 25% 25%

Standard deviation of expected annual after-tax returns on investment 0.1 0.15 0.35

Correlation of expected annual after-tax returns on investment with after-tax returns of prevailing U.S. business 0.8 -0.7

(Points : 3.7)

Since the expected return is the same whether the new project is located in the U.S. or in U.K., the standard deviation of the expected return is used to make the decision. The standard deviation is 12.00% if located in the U.S., whereas the standard deviation is 20.00% if located in the U.K.. Consequently, the new project shall be located in the U.S..

Since the expected return is the same whether the new project is located in the U.S. or in U.K., the standard deviation of the expected return is used to make the decision. The standard deviation is 1.30% if located in the U.S., whereas the standard deviation is 1.14% if located in the U.K.. Consequently, the new project shall be located in the U.K..

Since the expected return is the same whether the new project is located in the U.S. or in U.K., the standard deviation of the expected return is used to make the decision. The standard deviation is 11.38% if located in the U.S., whereas the standard deviation is 18.70% if located in the U.K.. Consequently, the new project shall be located in the U.S..

Since the expected return is the same whether the new project is located in the U.S. or in U.K., the standard deviation of the expected return is used to make the decision. The standard deviation is 11.38% if located in the U.S., whereas the standard deviation is 10.70% if located in the U.K.. Consequently, the new project shall be located in the U.K..

Question 8. 8. Springfield, Inc., produces furniture and has no international business. Its major competitors import most of their furniture from Mexico and then sell it out of retail stores in the United States. How will Springfield, Inc., be affected if Mexican peso weakens over time? (Points : 3.7)

It’ll be favorably affected.

It’ll be unfavorably affected.

It’ll not be affected because Springfield has no international business.

Question 9. 9. Decko Inc. would like to assess the country risk of Mexico. Decko has identified various political and financial risk factors, as shown below.

Political Risk Factor Assigned Rating Assigned Weight

Blockage of fund transfers 5 40%

Bureaucracy 3 60%

Financial Risk Factor Assigned Rating Assigned Weight

Interest rate 1 15%

Inflation 4 35%

Exchange rate 5 50%

Decko has assigned an overall rating of 60 percent to political risk factors and of 40 percent to financial risk factors. Decko is NOT WILLING to consider Mexico for investment if the country risk rating is below 3.70. Should Decko consider Mexico for investment? (Points : 3.7)

Yes, since the overall rating calculated is 4.05 greater than 3.70.

No, since the overall rating calculated is 3.53 smaller than 3.70.

Yes, since the overall rating calculated is 3.90 greater than 3.70.

No, since the overall rating calculated is 3.40 smaller 3.70.

Yes, since the overall rating calculated is 3.80 greater than 3.70.

Question 10. 10. Joan Smith does not believe that the international Fisher effect (IFE) holds. Current one-year interest rates in Europe are 15 percent, while one-year interest rates in the U.S. are 11 percent. Joan converts $100,000 to euros and invests them in France. One year later, she converts the euros back to dollars. The current spot rate of the euro is $1.20.

If the spot rate of the euro in one year is $1.15, what is Joan’s percentage return from her strategy? (Points : 3.7)

10.21%

120.00%

20.00%

110.21%

-3.45%

Question 11. 11. Springfield Co. is a U.S. company with sales to Canada amounting to C$10 million. Its cost of materials attributable to the purchase of Canadian goods is C$5 million. Its interest expense on Canadian loans is C$3 million. Given these exact figures above, the dollar value of Springfield’s cash flows would ____ if the Canadian dollar appreciates. (Points : 3.7)

unaffected

decrease

increase

Question 12. 12. Which of the following is NOT a correct statement? (Points : 3.7)

A macro-assessment of country risk is adjusted for the particular business of the firm involved.

A project finance refers to the financing of long-term infrastructure, industrial projects and public services based upon a non-recourse or limited recourse financial structure where project debt and equity used to finance the project are paid back from the cashflow generated by the project.

With regard to hedging transaction exposure, lagging refers to the delay of payment by a subsidiary if the currency denominating the payable is expected to depreciate.

None of the above

Question 13. 13. Assume that Jacob Co. (a U.S. firm) measures its economic exposure to movements in the British pound by applying regression analysis to data over the last 36 quarters:

SP = b0 + b1e + u

where SP represents the percentage change in Jacob’s stock price per quarter,e represents the percentage change in the British pound value per quarter, and u is an error term. Based on the analysis, the b0 coefficient is estimated to be zero and the b1 coefficient is estimated to be 0.5 and is statistically significant. Jacob Co. believes that the movement in the value of the pound over the next quarter will be mostly driven by the International Fisher Effect.The prevailing quarterly interest rate in the U.K. is HIGHER than the prevailing quarterly interest rate in the U.S. Would you expect that Jacob’s value will be favorably affected, unfavorably affected, or not affected by the pound’s movement over the next quarter?

(Points : 3.7)

Favorably Affected

Unfavorably Affected

Not Affected

Question 14. 14. Which of the following is NOT a strategy used to reduce exposure to a host government takeover? (Points : 3.7)

Use a project finance

Purchase insurance

Use a short-term horizon

Borrow local funds

All of the above are strategies to reduce exposure to a host government takeover.

Question 15. 15. To reduce economic exposure when a foreign currency has a greater impact on cash inflows, an MNC could (Points : 3.7)

restructure debt to increase debt payments in the foreign currency

increase its level of foreign sales

reduce its foreign supply orders

all of the above

Question 16. 16. Schnell Co. expects to pay €20,000 in one month for its imports from France. It also expects to receive €200,000 for its exports to Belgium in one month. Schnell estimates the standard deviation of monthly percentage changes of the euro to be 3.5 percent over the last 50 months. Assume that these percentage changes are normally distributed. Using the value-at-risk (VAR)method based on a 99% confidence level, what is the maximum one month loss in dollars if the expected percentage change of the euro during next month is 2%? Assume that current spot rate of the euro (before considering the maximum one-month loss) is $1.15 per euro. (95% confidence interval is 1.645 ?, 97.5% confidence interval is 1.96?, and 99% confidence interval is 2.326 ?) (Points : 3.7)

-$15,032.21

-$12,711.87

-$12,861.28

-$11,987.10

Question 17. 17. B&G Inc.(An American Firm) is approached by South African government to engage in a project over the next year. The investment in the project totals 10 million South African Rand (ZAR). The project is expected to generate cash inflows ZAR 14 million next year. The spot rate today is $0.11 per ZAR.

B&G has to borrow the funds necessary to undertake the project and incurs financing costs of 15%. The South Africa government offers a parallel loan to B&G. That is, the South Africa government will give B&G ZAR 10 million loan in exchange for a loan in dollars at the current exchange rate. The same amount will be returned to both parties at the end of the project. B&G will pay the South Africa government 10% interest on the ZAR 10 million loan. The South Africa government will pay B&G 4% interest on the dollar loan.

If the ZAR depreciates to $0.08 per ZAR next year, analyze the investment results without using the parallel loan. Ignore the time value of money. (Points : 3.7)

-$145,000

$45,000

$320,000

$300,000

None of the above

Question 18. 18. Continued from Question 17, what is the investment results using the parallel loan? Ignore the time value of money (Points : 3.7)

$320,000

$119,000

$213,500

$98,750

None of the above

Question 19. 19. You believe that IRP presently exists. The nominal annual interest rate in Mexico is 20%. The nominal annual interest rate in the U.S. is 2%. You expect that annual inflation will be about 8% in Mexico and 5% in the U.S. The spot rate of the Mexican peso is $.15 per Mexican peso.

You will receive 1 million Mexican pesos in one year.

Determine the amount of dollars that you will receive if you use a forward hedge. (Points : 3.7)

$127,500

$150,000

$176,471

$123,529

Question 20. 20. Continued from Question 19, determine the expected amount of dollars that you will receive if you do not hedge and believe in purchasing power parity (PPP). (Points : 3.7)

$150,000.00

$145,714.29

$145,833.33

$127,500.00

$154,285.71

Question 21. 21. Given a home country and a foreign country, purchasing power parity (PPP) suggests that: (Points : 3.7)

a home currency will depreciate if the current foreign inflation rate exceeds the current home inflation rate.

a home currency will appreciate if the current home interest rate exceeds the current foreign interest rate.

a home currency will appreciate if the current foreign inflation rate exceeds the current home inflation rate.

a home currency will depreciate if the current home interest rate exceeds the current foreign interest rate.

Question 22. 22. Assume the following information:

You have $1,000,000 to invest:

Current spot rate of Swiss franc = $0.62

1-year forward rate of Swiss franc = $0.64

1-year deposit rate in U.S. = 10%

1-year deposit rate in Swiss = 8%

If you use covered interest arbitrage for a 1-year investment, what will be the amount of U.S. dollars you will have after one year?

(Points : 3.7)

$1,024,000.22.

$1,114,838.71.

$1,040,677.20.

$1,135,462.67.

Question 23. 23. Assume the following information:

Bid Ask

£ in $ (i.e. $/£) $1.40 $1.41

NZ$ in $ (i.e. $/NZ$) $.64 $.66

£ in NZ$ (i.e. NZ$/£) NZ$2.21 NZ$2.22

You have $10,000. Can you use triangular arbitrage to generate a profit? (Points : 3.7)

Yes, I can earn arbitrage profits of $15.43.

Yes, I can earn arbitrage profits of $31.21.

Yes, I can earn arbitrage profits of $20.18.

No, it is impossible to earn arbitrage profits.

Question 24. 24. Which of the following is not true regarding IRP, PPP, and the IFE? (Points : 3.7)

The IFE suggests that a currency’s spot rate will change according to interest rate differentials.

IRP suggests that a currency’s spot rate will change according to interest rate differentials.

PPP suggests that a currency’s spot rate will change according to inflation rate differentials.

Question 25. 25. UCD (U.S. based MNC) will receive 250,000 euros in one year. The spot exchange rate today is $1.20 per euro. It observes that

1.The one-year interest rate for euros is 8%, and the one-year interest rate for U.S. dollars is 3%.

2.In the option market, there is one-year call option or put option available. Both options have the same exercise price of $1.18 per euro, and a premium of $0.04 per euro.

3.In the forward market, the one-year forward rate exhibits a 5% discount from the current spot exchange rate.

How should UCD utilize the forward market to hedge the exchange rate risk for its future receivables? And what shall be the amount received based on this hedging strategy? (Note: UCD can only buy or sell the forward contract at the forward rate available in the forward market described in bullet 3.) (Points : 3.7)

Buy a one-year forward contract for the amount of 250,000 euros at the forward rate of $1.20. One year later, UCD will fulfill its obligation and receives the amount of $300,000.

Sell a one-year forward contract for the amount of 250,000 euros at the forward rate of $1.20. One year later, UCD will fulfill its obligation and receives the amount of $300,000.

Buy a one-year forward contract for the amount of 250,000 euros at the forward rate of $1.14. One year later, UCD will fulfill its obligation and receives the amount of $285,000.

Sell a one-year forward contract for the amount of 250,000 euros at the forward rate of $1.14. One year later, UCD will fulfill its obligation and receives the amount of $285,000.

Question 26. 26. Continued from Question 25, if UCD decides to use money market hedging strategy to hedge its receivables, how shall UCD implement the strategy? (Points : 3.7)

UCD should first borrow euros for the amount of 250,000 euros. UCD will then go to the foreign exchange market to exchange the amount borrowed into U.S. dollars which yields UCD the amount of $300,000. UCD will deposit the amount exchanged at the bank in the U.S.. One year later, UCD will pay off its euro loan using the euro payments received.

UCD should first borrow U.S. dollars for the amount of 231,481.48. UCD will then go to the foreign exchange market to exchange the amount borrowed into euros which yields UCD the amount of 250,000 euros. UCD will deposit the amount exchanged at the bank in Europe. One year later, UCD will pay off its U.S. dollar loan by using the euro payments received.

UCD should first borrow U.S. dollars for the amount of 300,000. UCD will then go to the foreign exchange market to exchange the amount borrowed into euros which yields UCD the amount of 250,000 euros. UCD will deposit the amount exchanged at the bank in Europe. One year later, UCD will pay off its U.S. dollar loan by using the euro payments received.

UCD should first borrow euros for the amount of 231,481.48 euros. UCD will then go to the foreign exchange market to exchange the amount borrowed into U.S. dollars which yields UCD the amount of $277,777.78. UCD will deposit the amount exchanged at the bank in the U.S.. One year later, UCD will pay off its euro loan using the euro payments received.

Question 27. 27. Continued from Question 26, how many U.S. dollars will UCD end up receiving for its 250,000 euro receivable by using money market hedge? (Points : 3.7)

$285,000.00

$300,000.00

$286,111.11

$238,425.93

Question 28. 28. Continued from Question 25, if UCD decides to use options contracts to hedge its receivables, UCD shall (Points : 3.7)

Buy one-year call options of 250,000 euros with the exercise price $1.18 per euro.

Sell one-year put options of 250,000 euros with the exercise price $1.18 per euro.

Buy one-year put options of 250,000 euros with the exercise price $1.18 per euro.

Question 29. 29. Continued from Question 28, what are the expected U.S. dollars UCD ends up receiving for its 250,000 euro receivable based on its exchange rate forecasting given below?

Scenario Spot Exchange Rate One Year Later Probability

1 $1.14 25%

2 $1.17 60%

3 $1.20 15% (Points : 3.7)

$291,250

$285,750

$282,500

$280,250

Question 30. 30. Based on the calculation of Questions 25, 27, and 29, which hedging strategy will you suggest UCD to take? Why? (Points : 3.7)

Forward contract hedge because UCD will end up receiving the largest amount of U.S. dollars.

Options market hedge because UCD will end up receiving the largest amount of U.S. dollars.

Money market hedge because UCD will end up receiving the largest amount of U.S. dollars.

Question 31. 31. J&J, a U.S. firm, would need to spend $400,000 today on expenses related to its consulting services to Jacobee Company (in France) to improve Jacobee’s performance. In one year, J&J will receive payment from Jacobee, which will be tied to Jacobee’s performance during the year. There is uncertainty about Jacobee’s performance and about Jacobee’s tendency for corruption.

J&J expects that it will receive 500,000 euros if Jacobee achieves strong performance following the consulting job. However, there are two forms of country risk that are a concern to J&J Co. There is a 60 percent chance that Jacobee will achieve strong performance. There is a 40 percent chance that Jacobee will perform poorly, and in this case, J&J will receive a payment of only 420,000 euros.

While there is a 60 percent chance that Jacobee will make its payment to J&J, there is a 40 percent chance that Jacobee will become corrupt, and in this case, Jacobee will not submit any payment to J&J.

Assume that the outcome of Jacobee’s performance is independent of whether Jacobee becomes corrupt. The prevailing spot rate of the euro is $1.20 per euro, but J&J expects that the euro will depreciate by 8 percent in one year, regardless of Jacobee’s performance or whether it is corrupt.

J&J’s cost of capital is 20%.

What is the expected value of the project’s net present value? (Points : 3.7)

-$141,664

-$60,000

-$367,600

-$27,600

-$400,000

Question 32. 32. Continued from Question 31, what is the probability that the project’s NPV will be negative? (Points : 3.7)

0%

100%

40%

60%

64%

my course id international finance. My test range is PPP, IRP, Covered Interest Arbitrage, Locational Arbitrage and Triangular Arbitrage.

chapter8 Relations among inflation, interest rates and exchange rates

chapter10: Measuring exposure to exchange rate fluctuations

chapter11: Managing economic exposure

chapter 12: Managing economic exposure and translation exposure

chapter13&16: Direct foreign investment& country risk analysis

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