Monday, January 19, 2015

Financial Management (Chapter 19: International Business Finance)

19.1   Foreign Exchange Markets and Currency Exchange Rates

1) Trading in foreign exchange markets is dominated by
A) Russian rubles, Indian rupees and Indonesian rupeas.
B) Spanish pesetas, German marks, French francs.
C) Chinese renminbis, Saudi ryals, pesos of various Latin American countries.
D) U. S. dollars, the British pound, the euro and the yen.


2) Participants in foreign exchange trading include
A) importers and exporters.
B) investors and portfolio managers.
C) currency traders.
D) all of the above.


3) Suppose International Trading Enterprises purchased 25,000 kilograms of Belgian chocolate for a price of 100,000 euros. If the current exchange rate is .77000 euros to the U.S. dollar, what is the purchase price of the chocolate in dollars?
A) $19,250
B) $770,000
C) $77,000
D) $129,870


4) A spot transaction occurs when one currency is
A) deposited in a foreign bank.
B) immediately exchanged for another currency.
C) exchanged for another currency at a specified price.
D) traded for another at an agreed-upon future price.


5) Forward rates are quoted
A) in direct form.
B) in indirect form.
C) at a premium or discount.
D) all of the above.


6) If the quote for a forward exchange contract is greater than the computed price, the forward contract is
A) overvalued.
B) undervalued.
C) a good buy.
D) at equilibrium.



7) Buying and selling in more than one market to make a riskless profit is called
A) profit maximization.
B) arbitrage.
C) international trading.
D) cannot be determined from the above information.


8) After the U.S. dollar, the most widely traded currency is
A) the Saudi riyal.
B) the euro.
C) the Swiss franc.
D) the Canadian dollar.


9) Which of the following statements about exchange rates is true?
A) Exchange rates are fixed by international agreements.
B) Exchange fluctuate between currencies but are fixed in terms of gold.
C) Exchange rates fluctuate constantly.
D) Are regulated by a special committee of the United Nations.



10) What keeps foreign exchange quotes in two different countries in line with each other?
A) Cross rates
B) Forward rates
C) Arbitrage
D) Spot rates


11) An attempt to profit by converting dollars to yen, yen to euros, and euros back to dollars would be an example of
A) arbitrage.
B) speculation.
C) hedging.
D) intervention.


12) An investor purchased 20,000,000 Japanese yen at an exchange rate of 101.31 yen to the dollar. The yen cost her ________.  Round answer to the nearest dollar.
A) $202,620
B) $19,741
C) $197,414
D) $20,262,000



13) An investor purchased 1,000,000 Canadian dollars at an exchange rate of 1.0309 Canadian dollars to the U.S. dollar. The Canadian dollars cost her
A) $103,090.
B) $970,026.
C) $1,030,927.
D) $97,000.


14) An investor purchased Canadian dollars at an exchange rate of $0.97 U.S. to 1 Canadian dollar. The Canadian dollars cost her $1,000,000 (U.S. dollars). How many Canadian dollars did she buy?
A) $103,090
B) $970,026
C) $1,030,927
D) $97,000


15) Assume that an investor purchased 200,000,000 Japanese yen in New York at an exchange rate of 101 yen to the dollar and simultaneously sold the yen in Tokyo at an exchange rate of 99 Japanese yen to the dollar. Further assume that there was no cost associated with this transaction. What profit or loss did the investor make? Round your answer to the nearest dollar.
A) ($400,040) loss
B) $40,004
C) ($40,004) loss
D) $400,040 profit



16) Transactions carried out in the foreign exchange markets include
A) spot transactions.
B) forward exchange contracts which allow the exchange of one currency for another today.
C) swaps.
D) both A and B.


17) Assume that an investor owned 5,000 shares of Anheuser-Busch Corporation common stock prior to the acquisition by InBev of Belgium. At the time of the acquisition, the dollar was worth .77 euros. Further assume that the purchase price was equal to 54 euros per share. What was the sales price of Anheuser Busch common stock per share in U.S. dollars?
A) $41.58
B) $54
C) $77
D) $70.13
Answer:  D


18) One U.S. dollar buys 101.31 yen and 12.536 Mexican pesos. What is price of pesos in yen?
A) 8.0815
B) .12374
C) .08082
D) 12.3740



19) Assume that an importer of wine were to purchase 5,000 cases of premium French Bordeaux for 700,000 euros. Further assume that the quoted exchange rates are as follows: spot rate = .770 euros to the U.S. dollar; 30-day forward rate = .775 euros to the U.S. dollar; and 90-day forward rate = .778 euros to the U.S. dollar. If the actual currency exchange rate at the time payment is due in 90 days is equal to the forward rate of .778 euros to the U.S. dollar, how much would the wine cost the importer in U.S. dollars if payment is made in 90 days? Round to the nearest dollar.
A) $89,743
B) $909,091
C) $544,600
D) $899,743


20) You are leaving Mexico and have 3,200 pesos to change into dollars. The exchange rate is 12.5 pesos to the dollar. How many dollars will you receive?
A) $256
B) $400
C) $2,560
D) $40


21) You are on your way to a beautiful Mexican resort. The current exchange rate is 12 pesos to the dollar. When you arrive, you convert 1,000 US$ for how many pesos?
A) 12,000 pesos
B) 1,200 pesos
C) 8,333 pesos
D) 83.33 pesos



22) Assume that a buyer of Italian wine saw the following quotes: spot rate of .75 euros to the U.S. dollar; 30-day forward rate of .747 euros to the U.S. dollar; 90-day forward rate of .744 euros to the U.S. dollar. What does this information imply?
A) The forward euro is selling at a premium as compared with the spot euro.
B) The dollar is expected to maintain the same value in the near future relative to the euro.
C) The forward euro is selling at a discount as compared with the spot euro.
D) None of the above.


Use the following information to answer the following question(s).

Below is an excerpt from Table 19.1, Foreign Exchange Rates (December 26, 2012) that appears in your text. (Sources The Wall Street Journal, Reuters)

     Country/Currency                            In US$                                  Per US$
                                                                                                                            
        India (Rupee)                                 .01818                                 55.0155
        Britain (Pound)                             1.6133                                      .6198
        1-mos forward                               1.6133                                      .6198
        3-mos forward                               1.6130                                      .6200
        6-mos forward                               1.6128                                      .6200
        Canada (Dollar)                            1.0074                                      .9927
        Switzerland franc                         1.0917                                      .9160
        1-mos forward                               1.0928                                      .9151
        3-mos forward                               1.0939                                      .9141
        6-mos forward                               1.0961                                      .9123

23) To buy one Indian Rupee you would need
A) 1.818 cents.
B) 55.0155 cents.
C) 18.18 cents.
D) .01818 cents.



24) The number of pounds you can purchase per U.S. dollar is
A) 1.6133.
B) 6.198.
C) 0.6198.
D) 16.133.


25) Assume that your firm must pay 10,000,000 rupees to an Indian firm. How much will you have to pay in U.S. dollars?
A) $1,817,670
B) $181,767
C) $550,155
D) $5,502


26) Assume that your firm must pay $4,000 to a Swiss firm. In Swiss francs, the Swiss firm will receive
A) 3,908.80 Swiss francs.
B) 3,913 Swiss francs.
C) 39,088 Swiss francs.
D) 4,093.20 Swiss francs.



27) The Swiss franc to British pound exchange rate is
A) 1.4719 Swiss francs to the pound.
B) 14.7185 Swiss francs to the pound.
C) .6198 Swiss francs to the pound.
D) 1.0917 Swiss francs to the pound.


28) The British pound to Swiss franc exchange rate is
A) 1.4719 British pounds to the Swiss franc.
B) 14.719 British pounds to the Swiss franc.
C) .6794 British pounds to the Swiss franc.
D) 1.0917 British pounds to the Swiss franc.


29) The direct 3 month forward rate for UK pounds is
A) .16130
B) 6.2000
C) 1.6130
D) .6200



30) Based on the forward rates in table 19.1, the British pound is expected to
A) stay the same against the dollar.
B) weaken against the dollar.
C) fluctuate randomly against the dollar.
D) strengthen against the dollar.


31) The following are the prices in the foreign exchange market between the U.S. dollar and a foreign currency (fc). Spot 0.6335US$/fc; three-month forward 0.6375US$/fc. What was the discount or premium on three-month forward for the foreign currency?
A) 0.63% premium
B) 0.40% premium
C) 0.63% discount
D) 0.40% discount


32) Assume that a firm purchases foreign currency in order to complete the purchase of raw material from an overseas supplier. The currency is purchased today at an exchange rate that is good only for today. This transaction is referred to as a(n) ________ transaction.
A) forward
B) arbitrage
C) spot
D) hedge



33) Forward exchange rates
A) reduce uncertainty about future value of currencies.
B) are always slightly lower than the spot rate.
C) reflect expectations about the future value of currencies.
D) both A and C.


34) A trader who simultaneously bought Swiss francs in New York for .9772 and sold them in Zurich for .9774 would be practicing
A) simple arbitrage.
B) inside trading.
C) compound arbitrage.
D) parity exploitation.


35) A dealer in New York offers to buy U.K. pounds for $1.60 and sell them for $1.605. The different prices are due to
A) arbitrage.
B) a tax on currency transactions.
C) the bid-ask spread.
D) supply and demand.



36) The exchange rate that represents the number of units of a home currency that is required to purchase one unit of a foreign currency is referred to as a(n) ________ quote.
A) forward
B) direct
C) market
D) indirect


37) The exchange rate that represents the number of units of a foreign currency that can be purchased with one unit of a home currency is referred to as a(n) ________ quote.
A) forward
B) direct
C) market
D) indirect


38) A foreign exchange dealer in New York posts an ask price of .01818 for Indian rupees and a bid price of .01820. What is the dealer's profit on the simultaneous purchase and sale of 1 million rupees?
A) $20 profit
B) ($20 )loss
C) $200 profit
D) ($2) loss



39) The international currency system that presently exists is best described as a ________ rate currency system.
A) parity
B) fixed
C) multinational
D) floating


40) A cross rate is the computation of an exchange rate for a currency from the exchange rates of two other countries.
Answer:  TRUE


41) The asked rate is the price a customer will receive from a foreign currency trader when selling a foreign currency.
Answer:  FALSE


42) The foreign exchange market is similar in form to the New York Stock Exchange.
Answer:  FALSE



43) Arbitrage eliminates forward discounts and premiums across the markets of a single currency.
Answer:  FALSE


44) Arbitrage is the process of buying and selling in one market in order to make a riskless profit.
Answer:  TRUE


45) The efficiency of foreign currency markets is ensured, in large measure, by the process of arbitrageurs.
Answer:  TRUE


46) A direct quote in Bombay tells one how many British pounds can buy one Indian rupee.
Answer:  FALSE


47) The bid rate (also called the offer rate) is the number of units of home currency paid to a customer in exchange for their foreign currency.
Answer:  FALSE


48) The foreign exchange market provides a physical entity that transfers the purchasing power from one currency to another.
Answer:  FALSE


49) Foreign exchange transactions carried out in the spot market entails an agreement today to deliver a specific number of units of currency on a future date in return for a specified number of units of another currency.
Answer:  FALSE


50) Transactions carried out in the foreign exchange markets can include direct or indirect exchange rate quotes.
Answer:  TRUE


51) Spot transactions are made immediately in the market place at the market price.
Answer:  TRUE



52) Spot exchange markets are efficient due to arbitrage forces.
Answer:  TRUE


53) When banks transact in foreign currencies, the direct bid quote is greater than the direct asked quote.
Answer:  FALSE


54) The forward rate is the same as the spot rate that will prevail in the future.
Answer:  FALSE


55) The major advantage of the forward market is risk reduction.
Answer:  TRUE


56) Spot exchange markets have the potential for arbitrage opportunities for a long period of time.
Answer:  FALSE



57) The difference between the asked price and the bid price is known as the spread.
Answer:  TRUE


58) A narrow spread indicates efficiency in the spot exchange market.
Answer:  TRUE


59) Forward contracts are usually quoted for periods greater than one year.
Answer:  FALSE


60) Forward rates, like spot rates, are quoted in both direct and indirect form.
Answer:  TRUE


61) Forward contracts benefit only the customer due to a reduction in uncertainty.
Answer:  FALSE




62) What is the role of arbitrage in the foreign exchange markets?

Answer:  Foreign exchange quotes should be consistent with each other so that the exchange rates in all markets will be the same. If a currency could be purchased for one price in, for example, Paris and sold at a higher price in another market, say New York, then arbitrageurs would buy aggressively in Paris, increasing demand, and sell in New York, increasing supply. The increased buying activity in one market and selling activity in the other would soon eliminate the price differential.


63) A dealer in London posts an ask rate of .6238 and a bid rate of .6237. How much, in U.K. pounds, would it cost to purchase $100,000. For how much in pounds could you sell $100,000?

Answer:  $100,000 could be purchased for 62,380 British pounds and sold for 62,370 British pounds.


64) What is the difference between forward rates and spot rates? What is the purpose of forward contracts?

Answer:  The spot rate for a currency is the price that is paid for immediate delivery "on the spot." Forward rates are the prices paid for currency that is to be delivered at some point in the future, such as 30, 60 or 90 days. Forward transactions are useful for importers and exporters because they allow buyers and sellers to fix the value of payments in advance, in their own currencies.


65) What is the difference between and "ask" quote and a "bid" quote.

Answer:  Currency traders make a small (in percentage terms) profit by purchasing at a slightly lower price, the "bid" rate and selling at a slightly higher price, the "ask" rate.



66) As December 26, 2012, the spot rate for Swiss francs was 1.0917.  The 3 month forward rate was 1.0939.
Compute the annualized percentage rate premium or discount for Swiss francs.

Answer:  (1.0939 - 1.0917)/1.0917 × 365/180 = .002283. The annualized premium is .4086%.


67) One U.S. dollar buys 12.9923 Mexican pesos and .7585 euros. What is the peso/euro exchange rate.

Answer:  12.9923/.7585 = 17.1289 pesos per euro.


19.2   Interest Rate and Purchasing-Power Parity

1) A theory that relates the ratios of spot and forward exchange to differences in interest rates in two countries or currency zones is known as
A) interest rate parity.
B) purchasing power parity.
C) market efficiency.
D) forward/spot equivalence hypothesis.


2) The interplay between interest rate differentials and exchange rates such that both adjust until the foreign exchange market and the money market reach equilibrium is called the
A) purchasing power parity theory.
B) balance of payments quantum theory.
C) interest rate parity theory.
D) arbitrage markets theory.


3) Which of the following statements is true?
A) The forward rate is the same as the spot rate that will prevail in the future.
B) Only the forward rate is known.
C) An indirect quote is the exchange rate that indicates the number of units of the home currency required to buy one unit of foreign currency.
D) Both B and C.


4) The purchasing power parity theory is least likely to apply to the price of
A) oral surgery.
B) smart phones.
C) crude oil.
D) cane sugar.


5) The 1 year interest rate in the U.S. is 1%. The spot exchange rate for yen is 84.81 to the dollar. The 6 months forward rate is 84.78 to the dollar. These prices indicate that interest rates in Japan, on an annualized basis, are about
A) .07% lower.
B) .07% higher.
C) .035% higher.
D) .7% lower.



6) The 1 year interest rate in the U.S. is 1%. The spot exchange rate for Canadian dollars 1.007 to the U.S.dollar. The 6 months forward rate is 1.0068 to the U.S. dollar. These prices indicate that interest rates in Canada, on an annualized basis, are about
A) .08% lower.
B) .08% higher.
C) .04% higher.
D) .8% lower.


7) The spot exchange rate for Canadian dollars is .1.007 to the U.S.dollar. The 6 months forward rate is 1.0068 to the U.S. dollar. The interest rate in Canada (annual) is 1.02%. What is the U. S. interest rate?
A) 1.00%
B) 1.04%
C) 1.08%
D) .9800%


8) A barrel of oil currently costs $85 in U.S. dollars. The current exchange rate is $1.32 U. S. to the euro. If purchasing power parity prevails what is the price of a barrel of oil in euros?
A) 71.43 euros
B) 145.29 euros
C) 112.20 euros
D) 64.39 euros



9) 10,000 bushels of corn currently sells in the U. S. for $57,300. The current exchange rate is 55.02 rupees to the dollar. If purchasing power parity prevails, what is the price of 10,000 bushels of corn in rupees?
A) 2,152,646 rupees
B) 10,414.44 rupees
C) 55,020 rupees
D) 215,265 rupees


10) The current spot exchange rate between the Japanese yen and the U.S. dollar is 84.61 Y/US$. The yen is expected to appreciate by 4% against the dollar over the next year. What do you expect the spot exchange rate between the yen and the dollar to be one year from now?
A) 91.51 Y/US$
B) 87.99 Y/US$
C) 81.36 Y/US$
D) 103.08 Y/US$


11) According to the domestic Fisher effect, if the inflation rate is 3% and the real rate of interest is 2%, the nominal rate of interest will be
A) 5.06%.
B) 5.00%.
C) 6%.
D) 8.15%.



12) According to the domestic Fisher effect, if the inflation rate is 5%, and the nominal rate of interest is 7%, the real rate of interest is
A) 2.00%.
B) 1.904%.
C) 4.65%.
D) 0.5252%.


13) According to the international Fisher effect, if the nominal interest rate in Russia is 9.5% and the inflation rate is 8%, the real rate of interest is approximately
A) 18.26%.
B) 6.5%.
C) 1.5%.
D) -1.5%.


14) The nominal rate of interest in Russia is 9.5% and the inflation rate is 8%. The nominal rate of interest in Spain is 3% and the inflation rate is 1%. Which country has the higher real rate of interest?
A) Russia
B) Spain
C) There is no difference.
D) There is not enough information.



15) The nominal rate of interest in Russia is 9.5% and the inflation rate is 8%. The nominal rate of interest in Canada is 2.5% and the inflation rate is zero. We would expect
A) the ruble to strengthen against the dollar.
B) the exchange rate between the Canadian dollar and the ruble to stay the same because of interest rate parity.
C) the exchange rate between the Canadian dollar and the ruble to stay the same because of purchasing price parity.
D) the Canadian dollar to strengthen against the ruble.


16) Which of the following statements is true?
A) Interest rate parity indicates that the forward premium or discount should be greater than the differences in the national interest rates for securities of the same maturity.
B) Purchasing power parity indicates that, in the long run, exchange rates adjust to reflect international differences in inflation so that the purchasing power of each currency tends to remain the same.
C) The International Fisher Effect indicates that the nominal interest rate should be the same all over the world at all times if the market is efficient.
D) Both B and C.


17) Which of the following is a conceptual method for keeping the foreign currency market in equilibrium?
A) The purchasing power parity mechanisms
B) The balance of trade mechanisms
C) Government intervention through central banks
D) The interest rate parity mechanisms



18) Assume that in 1990 a Toyota Corolla sold for 1,476,000 yen in Japan and $8,200 in the U.S.  The car still sells for the same amount of yen today, but the current exchange rate is 85 yen per dollar, what is the car selling for today in U.S. dollars?
A) $14,760
B) $17,365
C) $18,204
D) $9,647


19) If a currency's forward price in U. S. dollars is higher than the spot price, interest rates are higher in the foreign country than they are in the U.S.
Answer:  FALSE


20) If a currency's forward price in U. S. dollars is lower than the spot price, interest rates are higher in the foreign country than they are in the U.S.
Answer:  TRUE


21) Purchasing price parity is more likely to be the case for common commodities than for personal services.
Answer:  TRUE



22) If a country has high interest rates because of inflation, the forward price of its currency will be higher than the spot price.
Answer:  FALSE


23) Prices differences of identical items in different currencies can best be explained by the international Fisher effect.
Answer:  FALSE


24) The forward price of currencies can be either higher, lower or even the same as the spot price.
Answer:  TRUE


25) The price of a Big Mac is more or less the same everywhere in the world.
Answer:  FALSE


26)  What is meant by interest rate parity?

Answer:  Interest rate parity is the theory that explains the differences between spot rates and forward rates by relating them to differing interest rates in the two countries. Interest rate parity can be expressed by the following identity: Difference in interest rates=ratio of the forward and the spot rates.



27) Assume that the interest rate in India is 10% while in Europe it is 3% and that the exchange rate is 65.50 rupees to the euro. What would we expect the 6 month exchange rate to be?

Answer:  The higher interest rate in India implies that the rupee will weaken against the euro. Specifically, (1 + .03/2)/(1 + .10/2)=Forward Exchange Rate/65.50 so the 6 month forward exchange rate should be 67.76 rupees to the euro.


28) What is the law of one price? How does it apply to foreign exchange rates?

Answer:  The law of one price states that under certain conditions, the same item should sell for the equivalent price in different currencies. It should not be possible to make a profit by buying a barrel of oil in dollars and simultaneously selling it in euros or yen, or the reverse.


29) Jean-Marc lives in Besançon, a French city near the Swiss border. The exchange rate is 1.20 Swiss francs to the euro. If Jean-Marc's shopping cart of groceries typically costs him 80 euros, what should it cost him if he drives across the border to Switzerland? Do you think that purchase price parity would apply in this situation?

Answer:  If purchase price parity applies, Jean-Marc's groceries should cost him approximately 80 × 1.20 =96 Swiss francs. Although some items might be priced differently because of taxes or brand preferences, it is unlikely that a grocery cart of diverse items would be priced very differently when it is easily possible for customers to drive from one location to the other. 

If groceries were significantly less expensive on one or the other side of the border, local merchants in the more expensive country would be unable to compete or survive.



19.3   Capital Budgeting for Direct Foreign Investment

1) Which of the following international business activities constitutes a foreign direct investment? All firms mentioned are U.S. based.
A) Yanqui Spirits imports a 1000 cases of rum from the Dominican Republic.
B) WMT Inc. opens a big-box retail facility in Nicaragua.
C) Condor University runs training sessions for Indonesian civil servants on its California Campus.
D) Merkizer Pharmaceuticals licenses an Indian company to manufacture a drug under its patents.


2) One reason for international investment is that
A) the economies of many countries are growing faster than that of the U.S.
B) price-earnings (P/E) ratios are higher in foreign countries.
C) doing business in foreign countries is simpler than in the U.S.
D) raw materials are typically cheaper in other countries than in the U.S.


3) In 2012, the U.S. comprised approximately ________ of the world's stock market capitalization.
A) 20%
B) 53%
C) 75%
D) 90%



4) The spot exchange rate for the Thai bhat is 33.135 bhat to the dollar. The 1 year forward rate is 34.175. Ramo Corp. has undertaken a capital project in Bangkok that is expected to produce a cash flow of 17,087,500 bhat at the end of the first year. The company will discount cash flows at a rate of 14%. What is the present value of the first year cash flow in U.S. dollars.
A) $14,989,035
B) $500,000
C) $438,596
D) $452,363


5) The spot exchange rate for the Thai bhat is 30.000 bhat to the dollar or .00333 dollar to the bhat. For capital budgeting purposes, Ramo Corp needs to estimate the exchange rate 5 years from now. The U.S. interest rate is 2%; the interest rate in Thailand is 6%. The estimated 5 year forward rate is
A) 24.75 bhat to the dollar.
B) 36.36 bhat to the dollar.
C) 40.15 bhat to the dollar.
D) 27.17 bhat to the dollar.


6) RAH Inc., a U.S. corporation is evaluating a proposal to construct and lease an office building in Kiev. RAH's weighted average cost of capital is 11%. The risk free rate in the U.S. is 3.75%. RAH believes that conditions in Kiev warrant a required rate of return that is 12% above the risk-free rate. Cash flows from the hotel project should be discounted at
A) 23%.
B) 14.75%.
C) 15.75%.
D) 12%.



7) Some complexities of conducting international business include
A) multiple currencies.
B) differing legal requirements.
C) restrictions on repatriating earnings.
D) all of the above.


8) When multinational companies evaluate capital investments in foreign countries, they discount
A) pre-tax earnings of the foreign subsidiary.
B) foreign earnings at home country discount rates.
C) only earnings that are expected to be transferred back to the parent company.
D) all cash flows in the foreign currency at the host country discount rates.


9) Exchange rate risk
A) arises from the fact that the spot exchange rate on a future date is a random variable.
B) applies only to certain types of international businesses.
C) has been phased out due to recent international legislation.
D) is not a significant factor in foreign investment decisions.


10) Exchange rate risk
A) exists when the contract is written in terms of the foreign currency.
B) exists also in direct foreign investments and foreign portfolio investments.
C) does not exist if the international trade contract is written in terms of the domestic currency.
D) all of the above.


11) Risks of foreign direct investment potentially include
A) exchange rate fluctuations.
B) political instability.
C) competition from foreign competitors.
D) all of the above.


12) An important motive for direct foreign investment is to
A) gain entry to markets with economies growing faster than the U.S.
B) insulate the firm from fluctuations in the value of the dollar.
C) diversify political risks.
D) increase a project's NPV by using lower foreign discount rates.


13) If the net present value of a direct foreign investment is negative, the multinational firm should
A) reject any proposals.
B) consider establishing a sales office.
C) consider licensing.
D) both A and C.



14) The most serious type of political risk involves
A) restrictive labor concerning hiring, wages and layoffs.
B) major changes in tax rates.
C) price and wage controls.
D) expropriation of assets with limited compensation.


15) Capital markets in foreign countries
A) offer lower returns than those obtainable in the domestic capital markets.
B) provide international diversification.
C) in general are becoming less integrated due to the widespread availability of interest rate and currency swaps.
D) increase portfolio betas.


16) Expropriation of plant and equipment without compensation is an example of financial risk from direct foreign investments.
Answer:  FALSE


17) Economic exposure refers to the overall impact of exchange rate changes on the value of the firm.
Answer:  TRUE



18) The cost of debt used in the international investment decision is the lesser of the parent's or the subsidiary's cost of debt.
Answer:  FALSE


19) Because a large part of a subsidiary's equity funds comes from the parent, the subsidiary should use the same cost of equity as the parent.
Answer:  FALSE


20) Millheim Electronics is an American firm operating in India, whose government refuses to allow Millheim to send its earnings out of the country. This is an example of repatriation of profits.
Answer:  FALSE


21) Multinational corporations can have lower cost of capital and more continuous access to external finance compared to a domestic firm.
Answer:  TRUE


22) The relevant sources of risk for direct foreign investment capital budgeting decisions are the same as those faced when making domestic capital budgeting decisions.
Answer:  FALSE



23) The interest rate in the U.S. is 4%, in Switzerland it is 3%. The spot rate is 1.0232 USD to the Swiss franc. A U.S. based hotel chain needs to project forward exchange rates for the next five years. Complete the table below.

Year   Spot Rate
x rate differential
Forward Rate
0


1


2


3


4


5



Answer: 
Year   Spot Rate
x rate differential
Forward Rate
0   $0.9700/SF
1
$0 .9700/SF
1    $0.9700/SF
1.00977
$0.9794/SF
2    $0.9700/SF
(1.00977)2
$0.9890/SF
3    $0.9700/SF
(1.00977)3
$0.9987/SF
4    $0.9700/SF
(1.00977)4
$1.0085/SF
5    $0.9700/SF
(1.00977)5
$1.01832/SF


24) The spot exchange rate for the Thai bhat is 33.135 bhat to the dollar. The Host Hotel Company will be able to repatriate profits from its luxury resort hotel in Phuket in 5 years. It has estimated the 5 year forward rate at 38 bhat to the dollar. The risk-free rate in the U.S. is 4% and Host uses an 11 % risk premium for investments of this type. If the expected accumulated profits after 5 years are 100 million bhat, what is their present value in U.S. dollars.

Answer:  Present value in bhats is 100,000,000/(1 + .04 + .11)5 = 49,717,674. Dividing the PV in bhats by the forward price of 38 bhats to the dollar, we obtain $1,308,360.



25) What are some of the potential risks, other than exchange rate risk, that need to be considered in foreign direct investment decisions.

Answer:  Business risks involve issues such as product acceptance in foreign markets, competitive practices, legal protections for physical and intellectual property and the like. Financial risk could arise from the way in which the investment is financed. 

Political risk involves possible expropriation of property, locked up funds that cannot be converted into parent company currency, price controls, unexpected changes in tax rates, restrictive employment policies and the like. Unfortunately, these risks tend to be greater in the areas of greatest opportunity.


26) Briefly discuss the factors that multinational firms consider in arriving at capital structure decisions.

Answer:  Multinational firms should consider several factors in arriving at capital structure decisions. First, firms should consider how the capital structure of its local affiliates is influenced by the local norms of the industry and in that country. It is noted that norms will vary from country to country. Second, the local affiliate capital structure needs to reflect corporate attitudes toward exchange rate and political risk in that country. 

These risks would normally lead to higher levels of debt and other local capital. Third, the capital structure of the local affiliate must reflect home country requirements with regard to the company's consolidated capital structure. Last, the optimal capital structure should reflect wider access to financial markets as well as the ability to diversify economic and political risks.

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