Chapter #6

1. Exchange Rate Systems. Compare and contrast the fixed, freely floating, and managed float
exchange rate systems. What are some advantages and disadvantages of freely floating
exchange rate system Versus a fixed exchange rate system?

Q#3.Direct Intervention. How can a central bank use di rect intervention to change the value of a
currency? Explain why a central bank may desire to smooth exchange rate movements of its
currency.

Q#4. Indirect Intervention. How can a central bank use indirect intervention to change the value
of a currency?

Chapter 7

Q# 4. Bank A quotes a bid rate of $0.300 and an ask rate of $0.305 for the Malaysian ringgit (MYR).
Bank B quotes a bid rate of $0.306and an ask rate of $0.310 for the ringgit. What will be the profit for
an investor that has $500,000 available to conduct locational arbirage?

a. $2,041,667

b. $9,804 C. $500 d. $1,639

Q# 10 Your just received a gift from a friend consisting of 1,000 Thai baht, which you would like to
exchange for Australian dollars (A$). You observe that exchange rate quotes for the baht are
currently $0.023, while quotes for the Australian dollar are $0.576. How many Australian dollars
should you expect to receive for your baht?

a. A$39.93 b. A$25,043.48 C. A$553.00

d. None of the above

Q#11. Hewitt Bank quotes a for the Canadian Dollar (CS) of S0.821. The cross exchange rate quoted
by the bank for the Canadian dollar is ¥I18.00. You have $5,000 to conduct triangular arbitrage. How
much will you end up with if

You conduct triangular arbitrage? A. $6,053.27 b. $5,030,45 c. S6,090.13

d. Triangular arbitrage is not possible in this case

Q #12. National Bank quotes the following for the British pound and the New Zealand dollar:
Value of a British pound (£) in S Value of a New Zealand dollar (NZS) in $ Value of a British pound in

New Zealand dollars

Quoted Bid Price $1.61 $0.55

NZ$2.95

Quoted Ask Price $1.62 $0.56

NZS2.96

Assume you have $10,000 to conduct triangular arbitrage. What is your profit from implementing
this strategy

a. $77.64 b. S197.53 c. S15.43 d. $111.80

Q#15. Assume the following information:

1) You have $900,000 to invest

2) Current spot rate of Australian dollar (AS) is $0.62

3)180-day forward rate of the Australian dollar is $0.64

4)180-day interest rate in the U.S. is 3.5%

5) 180-day interest rate in Australia is 3.0g

If you conduct covered interest arbitrage, what is the dollar profit you will have realized after 180
days?

A $56,903.23 b $61,548.39 C. $27,000 d. $31,500

Q# 16. Assume the following information:

1) You have $400,000 to invest

2) Current spot rate of Sudanese dinar (SDD) is $0.00570

3) 90-day forward rate of the dinar is $0.00569

4) 90-day interest rate in the U.S. is 4.0%

5) 90-day interest rate in Sudan is 4.2%

If you conduct covered interest arbitrage, what amount will you have after 90 days?

A. $416,000.00 b. $416,800.00

C. $424,242.86 d. $416,068.77

e. none of the above

Q#17. Assume the following information:

2) Current spot rate of Greek drachma (GRD) is $0.00350

3) Expected spot rate of drachma in 90 days is $0.00354

4) 90-day forward rate of the drachma is $0.00356

5) 90-day interest rate in the U.S. is 3.7%

6) 90-day interest rate in Greece is 4.0%

If you conduct covered interest arbitrage, the return you will realize after 90 days is

a. 5.19 b. 4.00 C. 5.78 d. 3.70

e.none of the above

Chapter# 8
Q# 15. Nominal interest rates in Cyprus are 7%, while nominal interest rates in the U.S. are 59%. The
spot rate for the Cyprus pound (CYP) is $1.50. According to the international Fisher effect (IFE), the
Cyprus pound should adjust to a new level of

a. $1.47 b. S1.53 c. $1.43 d. $1.57

Q#16. Real interest rates in the U.K. are 6%, while real interest rates in the U.S. are 5%. The spot rate
for the British pound (£) is $1.50. According to the international Fisher effect (IFE), the British pound
should adjust to a new level of

a. $1.49 b. $1.51 C. $1.44

d. The international Fisher effect suggests none of the above

Q#17. You have an opportunity to invest in Australia at an interest rate of 8%. Moreover, you expect
the Australian dollar (AS) to appreciate by 2%. Your effective return from this investment is

a. 8.00% b. 6.00% C. 10.16% d. 5.88%

Chapter #10
Q#4. Subsidiary A of Mega Corporation has net inflows in Australian dollars of A$1,000,000. While
Subsidiary B has net outflows in Australian dollars of A$1,500,000. The expected Exchange rate of the
Australian dollar is $0.55. What is the net inflow or outflow as measured In U.S. dollars?

I. $500,000 outflow b. $500,000 inflow

7. A-MNC Corp. Has inflows in Indian rupees (INR) and outflows in Pakistani rupees (PKR). B-MNC
Corp. Has inflows in Indian rupees and inflows in Pakistani rupees. The Indian and Pakistani rupees
are highly positively correlated. Everything else being equal, which firm has higher transaction
exposure? A. B-MNC

B. A-MNC

C. The two firms have equal degrees of transaction exposure

D. None of the above

Q#15, Bronson Corp. Assesses its economic exposure by determining the sensitivity of its earnings to
exchange rates. Bronson has a subsidiary in Algeria that is expected to generate earnings before
taxes (EBT) of 100 million Algerian dinars (DZD) during the upcoming year. Bronson’s U.S. business is
not affected by exchange rate movements. Furthermore, Bronson has identified three possible
exchange rates of the dinar for the upcoming year, which are SO.015, $0.017, and $0.019. Based on
this information, which of the following is not true?

A. Bronson is hurt by a depreciation of the dinar.

B. Bronson benefits from an appreciation of the dinar.

C. If the current exchange rate of the dinar is $0.014, Bronson has no economic exposure.

D. If the current exchange rate of the dinar is $0.020, Bronson has at least some economic exposure.

e. All of the above are true.

CHAPTER NO 14

The following information refers to questions 1l through 13.

Assume that Baps Corporation is considering the establishment of a subsidiary in Norway. The initial
investment required by the parent is $5,000,000. If the project is undertaken, Baps would terminate
the project after four years. Baps’ cost of capital is 13%, and the project is of the same Risk as Baps’
existing projects. All cash flows generated from the project will be remitted to the parent at the end
of each year. Listed below are the estimated cash flows the Norwegian Subsidiary will generate over
the project’s lifetime in Norwegian kroner (NOK):

Year 1 Year 2

Year 3 Year 4

NOK10,000,000 NOK15,000,000

NOK17,000,000 NOK20,000,000
The current exchange rate of the Norwegian kroner is $0.135. Baps’ exchange rate forecast for the
Norwegian kroner over the project’s lifetime is listed below:

Year 1 Year 2

Year 3 Year 4

$0.13 $0.14

$0.12 $0.15

Q# 11. What is the net present value of the Norwegian project?

A. -$803,848

b. $5,803,848

C. $1,048,828

d. None of the above

Q#12. Assume that NOK8,000,000 of the cash flow in year 4 represents the salvage value. Baps is
not completely certain that the salvage value will be this amount and wishes to determine the break-
even salvage value, which is $

a. 510,088.04

b. 0

C. 1,710,088

d. 1,040,000

Q#13. Baps is also uncertain regarding the cost of capital. Recently, Norway has been involved in
some political turmoil. What is the net present value (NPV) of this project if a 16% cost of capital is
used instead of 13%?

a. -$17,602.62

b. $8,000,000

C. $1,048,829

d. $645,147

Q#17. Petrus Company has a unique opportunity to invest in a two-year project in Australia. The
values.

Project is expected to generate 1,000,000 Australian dollars (A$) in the first year and 2,000,000
Australian dollars in the second. Petrus would have to invest $1,500,000 in the project. Petrus’ has
determined that the cost of capital for similar projects is 14%. What is the net present value of this
project if the spot rate of the Australian dollar for the two years is

Forecasted to be $0.55 and $0.60, respectively’? a. $2,905,817 b. -$94, 183 C. $916,128

d. None of the above

Input for Multinational Capital Budgeting

. Initial investment

. includes cost and working capital

. Consumer demand

. use market share percentage forecast to obtain den

. use other MNCs that entered the area as a guide

. sometimes difficult, because no predecessors

Factors to Consider in Multinational Capital Budgeting

.Exchange rate fluctuations

.at a minimum, should perform a scenario analysis I Inflation

. Can be volatile over time depending on the country under consideration

. may inflate earnings, but will probably be offset by currency depreciation

. could delay remittance of inflated earnings until currency depreciation subsides

. Financing arrangement

. must consider foreign interest expense explicitly if subsidiary partially finances the project

. different from domestic projects

. cash flows remitted to parent are overstated if foreign interest expense is not explicitly considered

. foreign financing will enhance NPV if loan rate is lower than parent’s cost of capital

. the higher the investment by the parent (as opposed to the subsidiary), the higher the

Exchange rate exposure

Adjusting Project Assessment for Risk

- Risk-adjusted discount rate

- the greater the uncertainty, the larger the discount rate

- since risk in a foreign country may be volatile, could use a different discount rate for each year

- problem: arbitrary

- Sensitivity analysis
- use alternative estimates for input variables to determine how sensitive NPV is to change

- Simulation

- obtain a probability distribution of NPV based on a range of possible values for one or more input
variables

- Computer randomly picks values for each variable and computes NPV for each iteration I risk-return
analysis of international projects

- efficient frontier may be higher for international diversification

- minimum risk for given return

- maximum return for given risk

- choice of location on frontier depends on MNC’s degree of risk aversion

- frontier may differ depending on type of product firm sells and markets in which firm operates

- overall, MNCs should diversify among products and geographical markets

Chapter #15

Why Valuations of A Target May Vary Among MNCs

I. Cash flow estimates can differ due to

plans for target's management Tax laws

I Exchange rate effects I time of remittance

I Required rate of return I desired use for target

I local risk-free interest rate

I differences in ability to use financial leverage

Other Types of Multinational Restructuring

International partial acquisitions 187

I involves the purchase of part of the existing stock of a foreign firm

I requires less funds than a total acquisition

I valuation must take degree of control into consideration I International

I acquisitions of privatized businesses

I attractive because of potential for increased efficiency

I. valuation more difficult because:

I uncertain future cash flows

I uncertain economic conditions uncertain exchange rates

| uncertain interest rates

- lack of established stock markets

International alliances

-includes joint ventures and licensing agreements

- Smaller initial outlay and smaller cash flows

I International divestitures

I projects previously undertaken may no longer be feasible due to changing cost of capital, Taxes, or
exchange rates

I expected cash flows from previous acquisitions in Asia declined because of

I declining economic growth

| weak currencies

I businesses may not be sold because offers may be lower than valuation

I new investment in Asia may be worthwhile because of

I low property values

I cheap businesses for sale I strong dollar

I Asian firms close to bankruptcy

I government willingness to allow foreign acquisitions

I valuation of a potential divestiture

I compare present value if project is continued to proceeds from divestiture

The following information refers to Questions 13 to 1S.

. Klimewsky, Inc., a U.S.-based MNC, has screened several targets. Based on economic and political
considerations, only one eligible target remains in Malaysia.

.Klimewsky would like you to value this target and has provided you with the following information:

.Klimewsky expects to keep the target for three years, at which time it expects to sell the firn for 500
million Malaysian ringgit (MYR) after deducting the amount for any taxes paid.

.Klimewsky expects a strong Malaysian economy. Consequently, the estimates for revenues for the
next year are MYR300 million. Revenues are expected to increase by 9% over the following two
years.

.Cost of goods sold are expected to be 60% of revenues.

.Selling and administrative expenses are expected to be MYR40 million in each of the next three
years.
.The Malaysian tax rate on the target’s earnings is expected to be 30%.

.Depreciation expenses are expected to be MYRI5 million per year for each of the next three years.

.The target will need MYR9 million in cash each year to support existing operations. The target’s
current stock price is MYR35 per share.

. The target has 11 million shares outstanding.

Any cash flows remaining after taxes are remitted by the target to Klimewsky, Inc. Klimewsky uses
the prevailing exchange rate of the Malaysian ringgit as the expected exchange rate for the next
three years. This exchange rate is currently $.23.

.Klimewsky’s required rate of return on similar projects is 13%.

Q#13. Based on the information provided above, the net present value of the Malaysian target is S
million.

a. 155.9 b. 111.5

C. 138.0 d. 143.0

e. None of the above

Q#14. The Malaysian target’s value based on its stock price is $million

a.$ 14

b. 1,673.9

C. 111.5

d. 88.6

e. None of the above

Q#15. The target’s board has indicated that it finds a premium of 30 percent appropriate. You have
been asked to negotiate for Klimewsky with the Malaysian target. What is the maximum percentage
premium you should be willing to offer?

a. 30.0%

b. 25.9%

c.You should not offer any premium because the market’s valuation is below Klimewsky’s Valuation

D. None of the above

CHAPTER #19
Payment Methods for International Trade

I General: credit is provided by either the exporter (supplier), importer (buyer), or a financial

institution

I supplier credit - from beginning of production until payment

I supplier may not want to provide financing (risk), in which case the buyer must pay early I Five
basic methods of payment:

I prepayment I letter of credit

I draft (sight/time) I consignment I open account

I Prepayment

I exporter does not ship goods until buyer has paid, usually by wire transfer or draft I supplier is
completely protected

I Letters of credit (LC)

I an instrument issued by a bank on behalf of the importer promising to pay the exporter upon
presentation of the shipping documents I exporter is protected even if buyer never pays

I LC does not guarantee that goods purchased are those shipped I Draft (also called bill of exchange)

I an unconditional promise drawn by one party (usually the exporter) instructing the buyer to pay
the face amount of the draft upon presentation

I does not provide the same protection as an LC, since the bank is not obligated to make payment

I "sight draft" - buyer pays once goods have been shipped and draft is presented to the buyer I
"documents against payment" - if the bank paid for the buyer, it will release shipping documents only
when buyer pays

I "time draft" - buyer only has to sign draft and promises to pay at a specified future date I accepted
draft is called "trade acceptance"

I exporter provides financing

I Consignment

I exporter ships goods but retains title

I importer does not have to pay until goods have been sold

I if importer does not pay exporters, exporter has limited recourse because no draft or LC is involved

I Open account

I the opposite of prepayment

Trade Finance Methods

Provided by banks

Financing methods frequently employed

I factoring

| letters of credit (LC)

| banker’s acceptances

I working capital financing

I medium-term capital goods financing (forfaiting) I countertrade

I Accounts receivable financing

I e.g., goods are shipped open account or with a time draft, but exporter needs money I bank
provides loan to exporter secured by an assignment of the account receivable

I two separate transactions (i.e., if buyer fails to pay, this does not affect exporter’s

Obligation to the bank)

I since international transactions are riskier than domestic ones, loan rates are often higher

I Factoring

- the sale of accounts receivable to a third party (the “factor”) – no recourse I benefits to exporter:

• no administrative duties

• no credit exposure

. immediate payment (improves cash flow) ‘cross-border factoring”

I Letter of credit (LC)

I normally involves two banks (exporter and importer banks)

Government restrictions (political risk) may prevent payment by importer bank (“issuing” bank) even
if it wants to pay

. the exporter may ask its bank (“advising” bank) to confirm the LC, in which case the exporter’s
bank is obligated to honor any drawings made even if the importer’s bank (or the importer) never
pays

I revocable LC – can be cancelled or revoked at any time without prior notification

I irrevocable LC – cannot be cancelled or modified without beneficiary’s consent

I “Refinancing of a sight LC” – importer bank extends loan to importer

I a draft presented under a LC represents exporter’s formal demand for payment

I “Bill of Lading” – receipt for shipment and summary of freight charges (ocean and airway bills)

I endorsed negotiable bill of lading represents title to the goods (I.e., could be used by importer’s
bank as collateral)

“Commercial invoice” – gives exporter’s description of merchandise being sold, including terms of
payment, price, etc
 I if used in conjunction with LC, description of merchandise must correspond exactly to that
contained in LC

I variations of LC

I “standby letter of credit” – a standby arrangement between the importer and his bank to

Fund an LC when necessary

Itransferable LC” – allows the first beneficiary to transfer all or ra part of the original

LC to a third party

I “assignment of proceeds” – original beneficiary assigns proceeds to the end supplier