multinational financial management: an...

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Chapter 1

Multinational Financial Management: An Overview

1. The commonly accepted goal of the MNC is to: A) maximize short-term earnings. B) maximize shareholder wealth. C) minimize risk. D) A and C. E) maximize international sales. ANSWER: B 2. With regard to corporate goals, an MNC is mostly concerned with maximizing ____________,

and a purely domestic firm is mostly concerned with maximizing ____________. A) shareholder wealth; short-term earnings B) shareholder wealth; shareholder wealth C) short-term earnings; sales volume D) short-term earnings; shareholder wealth ANSWER: B 3. For the MNC, agency costs are typically: A) non-existent. B) larger than agency costs of a small purely domestic firm. C) smaller than agency costs of a small purely domestic firm. D) the same as agency costs of a small purely domestic firm. ANSWER: B 4. Which of the following is not a form of corporate control that could reduce agency problems for an

MNC? A) stock options. B) hostile takeover threat. C) investor monitoring. D) all of the above are forms of corporate control that could reduce agency problems for an MNC.

ANSWER: D

358 International Financial Management

5. A recent study by McKinsey & Co. found that investors assign a higher value to firms that exhibit ________ corporate governance standards and are likely to ________ ethical constraints. A) high; not obey B) high; obey C) low; not obey D) low; obey

ANSWER: B 6. Which of the following theories identifies specialization as a reason for international business? A) theory of comparative advantage. B) imperfect markets theory. C) product cycle theory. D) none of the above ANSWER: A 7. Which of the following theories identifies the non-transferability of resources as a reason for

international business? A) theory of comparative advantage. B) imperfect markets theory. C) product cycle theory. D) none of the above ANSWER: B 8. Which of the following theories suggests that firms seek to penetrate new markets over time? A) theory of comparative advantage. B) imperfect markets theory. C) product cycle theory. D) none of the above ANSWER: C 9. Which of the following industries would most likely take advantage of lower costs in some less

developed foreign countries? A) assembly line production. B) specialized professional services. C) nuclear missile planning. D) planning for more sophisticated computer technology. ANSWER: A 10. Due to the risks involved in international business, firms should: A) only consider international business in major countries. B) maintain international business to no more than 20% of total business. C) maintain international business to no more than 35% of total business. D) none of the above ANSWER: D

Chapter 1: Multinational Financial Management: An Overview 359

11. A product cycle is the process by which a firm provides a specialized sales or service strategy, support assistance, and possibly an initial investment in the franchise in exchange for periodic fees. A) true. B) false. ANSWER: B

12. Licensing is the process by which a firm provides its technology (copyrights, patents, trademarks,

or trade names) in exchange for fees or some other specified benefits. A) true. B) false. ANSWER: A

13. The agency costs of an MNC are likely to be lower if it: A) scatters its subsidiaries across many foreign countries. B) increases its volume of international business. C) uses a centralized management style. D) A and B. ANSWER: C 14. An indirect benefit to the MNC of following a worldwide code of ethics is: A) it allows them to receive special tax breaks in less developed countries. B) it puts them at a competitive advantage in foreign markets. C) the worldwide credibility associated with maintaining such standards can increase global

demand for the MNC's products. D) A and B. ANSWER: C 15. The term privatization is typically used to describe: A) firms that are purchased by their managers. B) firms that are purchased by the government. C) firms that are bought out by other firms. D) government operations that are purchased by corporations and other investors. ANSWER: D 16. According to the text, products and services are generally becoming _______ standardized across

countries, which tends to _______ the globalization of business. A) more; encourage B) more; discourage C) less; discourage D) less; encourage ANSWER: A


17. Franchising is the process by which national governments sell state owned operations to corporations and other investors. A) true. B) false. ANSWER: B

18. Which of the following is not a major event that increased international business opportunities in

Europe? A) the Single European Act. B) the removal of the Berlin Wall. C) the inception of the euro. D) the reduction in the number of countries participating in the European Union.

ANSWER: D 19. The Single European Act of 1987 was primarily intended to: A) create more trade barriers between European countries. B) unify East Germany and West Germany. C) provide financial support for Eastern Europe. D) make regulations more uniform across industrialized countries in Europe. ANSWER: D 20. The Single European Act of 1987: A) reduced competition in most industries. B) eliminated competition in many industries. C) reduced efficiency in most industries. D) increased competition in most industries. ANSWER: D 21. In comparing exporting to direct foreign investment (DFI), an exporting operation will likely incur

__________ fixed production costs and __________ transportation costs than DFI. A) higher; higher B) higher; lower C) lower; lower D) lower; higher ANSWER: D 22. Which of the following is an example of direct foreign investment? A) exporting to a country. B) establishing licensing arrangements in a country. C) purchasing existing companies in a country. D) investing directly (without brokers) in foreign stocks. ANSWER: C


23. According to the text, a disadvantage of licensing is that: A) it prevents a firm from importing. B) it is difficult to ensure quality control of the production process. C) it prevents a firm from exporting. D) none of the above ANSWER: B 24. _____________ are most commonly classified as a direct foreign investment. A) Foreign acquisitions B) Purchases of international stocks C) Licensing agreements D) Exporting transactions ANSWER: A 25. Imperfect markets represent conditions under which factors of production are immobile.

A) true. B) false. ANSWER: B

26. Privatization is a venture that is jointly owned and operated by two or more firms.


27. The main provision of the North American Free Trade Agreement (NAFTA) was that: A) the Mexican peso's value be tied to the Canadian dollar. B) Mexico be allowed to privatize its business. C) Mexico must impose a minimum wage that is similar to the minimum wage in the U.S. D) none of the above ANSWER: D 28. Which of the following is not mentioned in the text as a constraint interfering with the MNC goal?

A) economic constraints. B) environmental constraints. C) regulatory constraints. D) ethical constraints.

ANSWER: A


29. Which of the following is not a provision or result of the Single European Act of 1987? A) increased regulatory uniformity among European countries. B) the phasing in of a common currency for all European countries by 1992. C) the removal of many taxes on goods traded between European countries. D) firms’ ability to achieve economies of scale. E) all of the above

ANSWER: B

30. Which of the following is not mentioned in the text as an additional risk resulting from

international business? A) exchange rate fluctuations. B) political risk. C) interest rate risk. D) exposure to foreign economies.

ANSWER: C

31. Licensing obligates a firm to provide _____________, while franchising obligates a firm to provide _______________. A) a specialized sales or service strategy; its technology B) its technology; a specialized sales or service strategy C) its technology; its technology D) a specialized sales or service strategy; a specialized sales or service strategy E) its technology; an initial investment

ANSWER: B

32. Which of the following is not a way in which agency problems can be reduced through corporate control? A) executive compensation. B) threat of hostile takeover. C) acquisition of a foreign subsidiary. D) monitoring by large shareholders.

ANSWER: C

33. The goal of a multinational corporation (MNC) is the maximization of shareholder wealth.

A) true. B) false.

ANSWER: A

34. A centralized management style, where major decisions about a foreign subsidiary are made by

the parent company, results in an increase in agency costs. A) true. B) false.

ANSWER: B


35. In some countries, bribes are commonplace. If a U.S.-based MNC decides to adhere to a strict code of ethics and not pay bribes, its subsidiary may be at a competitive disadvantage in the foreign country. A) true. B) false. ANSWER: A

36. Due to the larger opportunity set of funding sources around the world from which an MNC can

choose, an MNC may be able to obtain capital at a lower cost than a purely domestic firm. A) true. B) false. ANSWER: A

37. The Single European Act of 1987 made regulations more uniform among European countries.

However, the cost of achieving this goal resulted in the imposition of additional taxes on goods traded between these countries. A) true. B) false. ANSWER: B

38. The North American Free Trade Agreement (NAFTA) of 1993 eliminated trade barriers between

the United States and Mexico. A) true. B) false. ANSWER: A

39. Although MNCs may need to convert currencies occasionally, they do not face any exchange rate

risk, as exchange rates are stable over time. A) true. B) false. ANSWER: B

40. One of the most prevalent factors conflicting with the realization of the goal of an MNC is the

existence of agency problems. A) true. B) false. ANSWER: A

41. A centralized management style for an MNC results in relatively high agency costs.



42. The imperfect markets theory states that factors of production are somewhat immobile, allowing firms to capitalize on a foreign country’s resources. A) true. B) false. ANSWER: A

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Chapter 2

International Flow of Funds 1. Recently, the U.S. experienced an annual balance of trade representing a __________. A) large surplus (exceeding $100 billion) B) small surplus C) level of zero D) deficit ANSWER: D 2. A high home inflation rate relative to other countries would _______ the home country’s current

account balance, other things equal. A high growth in the home income level relative to other countries would _______ the home country’s current account balance, other things equal.

A) increase; increase B) increase; decrease C) decrease; decrease D) decrease; increase ANSWER: C 3. If a country’s government imposes a tariff on imported goods, that country’s current account

balance will likely __________ (assuming no retaliation by other governments). A) decrease B) increase C) remain unaffected D) either A or C are possible ANSWER: B 4. _________ purchases more U.S. exports than any other country. A) Japan B) United Kingdom C) Mexico D) Canada ANSWER: D


5. An increase in the current account deficit will place _______ pressure on the home currency value, other things equal.

A) upward B) downward C) no D) upward or downward (depending on the size of the deficit) ANSWER: B 6. If the home currency begins to appreciate against other currencies, this should ____________ the

current account balance, other things equal (assume that substitutes are readily available in the countries, and that the prices charged by firms remain the same).

A) increase B) have no impact on C) reduce D) all of the above are equally possible ANSWER: C 7. The International Financial Corporation was established to: A) enhance development solely in Asia through grants. B) enhance economic development through non-subsidized loans (at market interest rates). C) enhance economic development through low-interest rate loans (below-market rates). D) enhance economic development of the private sector through investment in stock of

corporations. ANSWER: D 8. The World Bank was established to: A) enhance development solely in Asia through grants. B) enhance economic development through non-subsidized loans (at market interest rates). C) enhance economic development through low-interest rate loans (below-market rates). D) enhance economic development of the private sector through investment in stock of

corporations. ANSWER: B 9. The International Development Association was established to: A) enhance development solely in Asia through grants. B) enhance economic development through non-subsidized loans (at market interest rates). C) enhance economic development through low-interest rate loans (below-market rates). D) enhance economic development of the private sector through investment in stock of

corporations. ANSWER: C

Chapter 2: International Flow of Funds 367

10. Which of the following would likely have the least direct influence on a country’s current account?

A) inflation. B) national income. C) exchange rates. D) tariffs. E) a tax on income earned from foreign stocks. ANSWER: E 11. The “J curve” effect describes: A) the continuous long-term inverse relationship between a country’s current account balance and

the country’s growth in gross national product. B) the short-run tendency for a country’s balance of trade to deteriorate even while its currency is

depreciating. C) the tendency for exporters to initially reduce the price of goods when their own currency

appreciates. D) the reaction of a country’s currency to initially depreciate after the country’s inflation rate

declines. ANSWER: B 12. An increase in the use of quotas is expected to: A) reduce the country’s current account balance, if other governments do not retaliate. B) increase the country’s current account balance, if other governments do not retaliate. C) have no impact on the country’s current account balance unless other governments retaliate. D) increase the volume of a country’s trade with other countries. ANSWER: B 13. The U.S. typically has a balance-of-trade surplus in its trade with __________ . A) China B) Japan C) A and B D) none of the above ANSWER: D 14. The North American Free Trade Agreement (NAFTA) increased restrictions on: A) trade between Canada and Mexico. B) trade between Canada and the U.S. C) direct foreign investment in Mexico by U.S. firms. D) none of the above. ANSWER: D


15. According to the text, international trade (exports plus imports combined) as a percentage of GDP is:

A) higher in the U.S. than in European countries. B) lower in the U.S. than in European countries. C) higher in the U.S. than in about half the European countries, and lower in the U.S. than the

others. D) about the same in the U.S. as in European countries. ANSWER: B 16. The direct foreign investment positions by U.S. firms have generally ________ over time; the

direct foreign investment positions in the U.S. by non-U.S. firms have generally ______ over time. A) increased; increased B) increased; decreased C) decreased; decreased D) decreased; increased ANSWER: A 17. Which of the following is the biggest target of direct foreign investment by U.S. firms? A) Mexico. B) Japan. C) United Kingdom. D) Germany. ANSWER: C 18. The primary component of the current account is the: A) balance of trade. B) balance of money market flows. C) balance of capital market flows. D) unilateral transfers. ANSWER: A 19. As a result of the European Union, restrictions on exports between _______ were reduced or

eliminated. A) member countries and the U.S. B) member countries C) member countries and European non-members D) none of the above ANSWER: B


20. Over time, international trade (exports plus imports) as a percentage of GDP has: A) increased for most major countries. B) decreased for most major countries. C) stayed about constant for most major countries. D) increased for about half the major countries and decreased for the others. ANSWER: A 21. Which is not a concern about the North American Free Trade Agreement (NAFTA)? A) its impact on U.S. inflation. B) its impact on U.S. unemployment. C) lower environmental standards in Mexico. D) different health laws for workers in Mexico. ANSWER: A 22. A General Agreement on Tariffs and Trade (GATT) accord in 1993 called for: A) increased trade restrictions outside of North America. B) lower trade restrictions around the world. C) uniform environmental standards around the world. D) uniform worker health laws. ANSWER: B 23. Which of the following is not a commonly occurring subtle trade restriction?

A) Firms based in one country are not subject to certain restrictions and can produce products at a lower cost than firms in other countries.

B) Firms based in a country receive subsidies from their government, produce products, and then export those products at a cheap price.

C) Firms based in one country are allowed by their government to offer bribes to large customers when pursuing business deals in a particular industry.

D) All of the above describe commonly occurring subtle trade restrictions. ANSWER: D 24. The demand for U.S. exports tends to increase when: A) economic growth in foreign countries decreases.

B) the currencies of foreign countries strengthen against the dollar. C) U.S. inflation rises.

D) none of the above ANSWER: B 25. “Dumping” is used in the text to represent the: A) exporting of goods that do not meet quality standards. B) sales of junk bonds to foreign countries. C) removal of foreign subsidiaries by the host government. D) exporting of goods at prices below cost. ANSWER: D


26. ______________ is (are) income received by investors on foreign investments in financial assets (securities). A) Portfolio income B) Direct foreign income C) Unilateral transfers D) Factor income

ANSWER: D 27. A weak home currency may not be a perfect solution to correct a balance of trade deficit because:

A) it reduces the prices of imports paid by local companies. B) it increases the prices of exports by local companies. C) it prevents international trade transactions from being prearranged. D) foreign companies may reduce the prices of their products to stay competitive. ANSWER: D

28. Intracompany trade makes up approximately _____ percent of all international trade. A) 50 B) 70 C) 25 D) 13 E) 5

ANSWER: A 29. Like the International Monetary Fund (IMF), the _______________ is composed of a collection of

nations as members. However, unlike the IMF, it uses the private rather than the government sector to achieve its objectives. A) World Bank B) International Financial Corporation (IFC) C) World Trade Organization (WTO) D) International Development Association (IDA) E) Bank for International Settlements (BIS)

ANSWER: B 30. The World Bank’s Multilateral Investment Guarantee Agency (MIGA):

A) offers various forms of export insurance. B) offers various forms of import insurance. C) offers various forms of exchange rate risk insurance. D) provides loans to developing countries. E) offers various forms of political risk insurance.

ANSWER: E


31. Also known as the “central banks’ central bank,” the __________ attempts to facilitate cooperation among countries with regard to international transactions and provides assistance to countries experiencing a financial crisis. A) World Bank B) International Financial Corporation (IFC) C) World Trade Organization D) International Development Association (IDA) E) Bank for International Settlements (BIS)

ANSWER: E 32. Direct foreign investment into the U.S. represents a ________.

A) capital inflow B) trade inflow C) capital outflow D) trade outflow

ANSWER: A 33. A balance-of-trade surplus indicates an excess of merchandise imports over merchandise exports.

A) true. B) false.

ANSWER: B 34. A weakening of the U.S. dollar with respect to the British pound would likely reduce the U.S.

exports to Britain and increase U.S. imports from Britain. A) true. B) false.

ANSWER: B

35. The World Bank extends loans only to developed nations, while the International Development

Association (IDA) extends loans only to developing nations. A) true. B) false.

ANSWER: B

36. The World Bank frequently enters into cofinancing agreements. Under these agreements,

financing is provided by the World Bank and/or official aid agencies, export credit agencies, or commercial banks. A) true. B) false.

ANSWER: A


37. The balance of payments is a measurement of all transactions between domestic and foreign residents over a specified period of time. A) true. B) false.

ANSWER: A

38. Changes in country ownership of long-term and short-term assets are measured in the balance of

payments with the capital account. A) true. B) false.

ANSWER: A

39. Portfolio investment represents transactions involving long-term financial assets (such as stocks

and bonds) between countries that do not affect the transfer of control. A) true. B) false.

ANSWER: A

40. The current account represents the investment in fixed assets in foreign countries that can be used

to conduct business operations. A) true. B) false.

ANSWER: B

41. Exporting of products by one country to other countries at prices below cost is called elasticity.

A) true. B) false.

ANSWER: B

42. Direct foreign investment by U.S.-based MNCs occurs primarily in the Bahamas and Brazil.

A) true. B) false.

ANSWER: B 43. The J curve effect is the initial worsening of the U.S. trade balance due to a weakening dollar

because of established trade relationships that are not easily changed; as the dollar weakens, the dollar value of imports initially rises before the U.S. trade balance is improved. A) true. B) false.

ANSWER: A


44. Portfolio investments represent transactions involving long-term financial assets (such as stocks and bonds) between countries that do not affect the transfer of control. A) true. B) false.

ANSWER: A 45. Intracompany trade represents the exporting of products by one country to other countries below

cost. A) true. B) false.

ANSWER: B 46. A tariff is a maximum limit on imports.

A) true. B) false.

ANSWER: B

374

Chapter 3

International Financial Markets 1. Assume that a bank's bid rate on Swiss francs is $.45 and its ask rate is $.47. Its bid-ask

percentage spread is: A) about 4.44%. B) about 4.26%. C) about 4.03%. D) about 4.17%. ANSWER: B SOLUTION: Bid-ask percentage spread = ($.47 - $.45)/$.47 = 4.26% 2. Assume that a bank's bid rate on Japanese yen is $.0041 and its ask rate is $.0043. Its bid-ask

percentage spread is: A) about 4.99%. B) about 4.88%. C) about 4.65%. D) about 4.43%. ANSWER: C SOLUTION: Bid-ask percentage spread = ($.0043 - $.0041)/$.0043 = 4.65% 3. The bid/ask spread for small retail transactions is commonly in the range of ______ percent; the

bid/ask spread for wholesale transactions is commonly in the range of ______ percent. A) 3 to 7; .01 to .03 B) 2 to 5; .05 to .10 C) 10 to 15; .01 to .03 D) 1 to 2; .05 to .07

ANSWER: A

Chapter 3: International Financial Markets 375

4. _______is not a factor that affects the bid/ask spread. A) Order costs B) Inventory costs

C) Volume D) All of the above factors affect the bid/ask spread

ANSWER: D 5. The forward rate is the exchange rate used for immediate exchange of currencies.

A) true. B) false.

ANSWER: B 6. The ask quote is the price for which a bank offers to sell a currency.

A) true. B) false.

ANSWER: A 7. According to the text, the forward rate is commonly used for: A) hedging. B) Eurocurrency transactions. C) Eurocredit transactions. D) Eurobond transactions. ANSWER: A 8. If a U.S. firm desires to avoid the risk from exchange rate fluctuations, and it is receiving 100,000

in 90 days, it could: A) obtain a 90-day forward purchase contract on euros. B) obtain a 90-day forward sale contract on euros. C) purchase euros 90 days from now at the spot rate. D) sell euros 90 days from now at the spot rate. ANSWER: B 9. If a U.S. firm desires to avoid the risk from exchange rate fluctuations, and it will need C$200,000

in 90 days to make payment on imports from Canada, it could: A) obtain a 90-day forward purchase contract on Canadian dollars. B) obtain a 90-day forward sale contract on Canadian dollars. C) purchase Canadian dollars 90 days from now at the spot rate. D) sell Canadian dollars 90 days from now at the spot rate. ANSWER: A


10. Assume the Canadian dollar is equal to $.88 and the Peruvian Sol is equal to $.35. The value of the Peruvian Sol in Canadian dollars is:

A) about .3621 Canadian dollars. B) about .3977 Canadian dollars. C) about 2.36 Canadian dollars. D) about 2.51 Canadian dollars. ANSWER: B SOLUTION: $.35/$.88 = .3977 11. Which of the following is not true with respect to spot market liquidity?

A) The more willing buyers and sellers there are, the more liquid a market is. B) The spot markets for heavily traded currencies such as the Japanese yen are very liquid. C) A currency’s liquidity affects the ease with which an MNC can obtain or sell that currency. D) If a currency is illiquid, an MNC is typically able to quickly purchase that currency at a

reasonable exchange rate. ANSWER: D 12. Forward markets for currencies of developing countries are: A) prohibited. B) less liquid than markets for developed countries. C) more liquid than markets for developed countries. D) only available for use by government agencies. ANSWER: B 13. A forward contract can be used to lock in the __________ of a specified currency for a future

point in time. A) purchase price B) sale price C) A or B D) none of the above ANSWER: C 14. The forward market:

A) for euros is very illiquid. B) for Eastern European countries is very liquid. C) does not exist for some currencies. D) none of the above

ANSWER: C


15. _______ is not a bank characteristic important to customers in need of foreign exchange. A) Quote competitiveness B) Speed of execution C) Forecasting advice D) Advice about current market conditions E) All of the above are important bank characteristics to customers in need of foreign exchange.

ANSWER: E 16. The Basel II accord would:

A) replace the Basel Accord. B) reduce the amount of capital banks are required to hold. C) require banks to take more risks and to document their risk. D) correct some inconsistencies that still exist.

ANSWER: D 17. The international money market primarily concentrates on: A) short-term lending (one year or less). B) medium-term lending. C) long-term lending. D) placing bonds with investors. E) placing newly issued stock in foreign markets. ANSWER: A 18. The international credit market primarily concentrates on: A) short-term lending (less than one year). B) medium-term lending. C) long-term lending. D) providing an exchange of foreign currencies for firms who need them. E) placing newly issued stock in foreign markets. ANSWER: B 19. The main participants in the international money market are: A) consumers. B) small firms. C) large corporations. D) small European firms needing European currencies for international trade. ANSWER: C


20. LIBOR is: A) the interest rate commonly charged for loans between banks. B) the average inflation rate in European countries. C) the maximum loan rate ceiling on loans in the international money market. D) the maximum deposit rate ceiling on deposits in the international money market. E) the maximum interest rate offered on bonds that are issued in London. ANSWER: A 21. A syndicated Eurocredit loan: A) represents a loan by a single bank to a syndicate of corporations. B) represents a loan by a single bank to a syndicate of country governments. C) represents a direct loan by a syndicate of oil-producing exporters to a less developed country. D) represents a loan by a group of banks to a borrower. E) A and B ANSWER: D 22. The international money market is primarily served by: A) the governments of European countries, which directly intervene in foreign currency markets. B) government agencies such as the International Monetary Fund that enhance development of

countries. C) several large banks that accept deposits and provide loans in various currencies. D) small banks that convert foreign currency for tourists and business visitors. ANSWER: C 23. International money market transactions normally represent: A) the equivalent of $1 million or more. B) the equivalent of $1,000 to $10,000. C) the equivalent of between $10,000 and $100,000. D) the equivalent of between $100,000 and $200,000. ANSWER: A 24. A put option is the amount or percentage by which the existing spot rate exceeds the forward rate.

A) true. B) false.

ANSWER: B 25. From 1944 to 1971, the exchange rate between any two currencies was typically: A) fixed within narrow boundaries. B) floating, but subject to central bank intervention. C) floating, and not subject to central bank intervention.

D) nonexistent; that is currencies were not exchanged, but gold was used to pay for all foreign transactions.

ANSWER: A


26. As a result of the Smithsonian Agreement, the U.S. dollar was: A) the currency to be used by all countries as a medium of exchange for international trade. B) forced to be freely floating relative to all currencies without any boundaries. C) devalued relative to major currencies. D) revalued (upward) relative to major currencies. ANSWER: C 27. According to the text, the average foreign exchange trading around the world ________ per day. A) equals about $200 billion B) equals about $400 billion C) equals about $700 billion D) exceeds $1 trillion ANSWER: D 28. Assume a Japanese firm invoices exports to the U.S. in U.S. dollars. Assume that the forward rate

and spot rate of the Japanese yen are equal. If the Japanese firm expects the U.S. dollar to _______ against the yen, it would likely wish to hedge. It could hedge by _______ dollars forward.

A) depreciate; buying B) depreciate; selling C) appreciate; selling D) appreciate; buying ANSWER: B 29. Loans of one year or longer extended by banks in Europe are called: A) Eurocurrency loans. B) Eurocredit loans. C) Eurobond loans. D) Parallel loans. ANSWER: B 30. Futures contracts are typically _______; forward contracts are typically _______. A) sold on an exchange; sold on an exchange B) offered by commercial banks; sold on an exchange C) sold on an exchange; offered by commercial banks D) offered by commercial banks; offered by commercial banks ANSWER: C 31. Eurobonds: A) are usually issued in bearer form. B) typically carry several protective covenants. C) cannot contain call provisions. D) A and B ANSWER: A


32. Which of the following is true? A) Non-U.S. firms may desire to issue bonds in the U.S. due to less regulations in the U.S. B) U.S. firms may desire to issue bonds in the U.S. due to less regulations in the U.S. C) U.S. firms may desire to issue bonds in the non-U.S. markets due to less regulations in

non-U.S. countries. D) A and B ANSWER: C 33. Eurobonds: A) can be issued only by European firms. B) can be sold only to European investors. C) A and B D) none of the above ANSWER: D 34. Which currency is used the most to denominate Eurobonds? A) the British pound. B) the Japanese yen. C) the U.S. dollar. D) the Swiss franc. ANSWER: C 35. When the foreign exchange market opens in the U.S. each morning, the opening exchange rate

quotations will be based on the: A) closing prices in the U.S. during the previous day. B) closing prices in Canada during the previous day. C) prevailing prices in locations where the foreign exchange markets have been open. D) officially set by central banks before the U.S. market opens. ANSWER: C 36. The U.S. dollar is not ever used as a medium of exchange in: A) industrialized countries outside the U.S. B) in any Latin American countries. C) in Eastern European countries where foreign exchange restrictions exist. D) none of the above ANSWER: D


37. Which of the following is not true regarding the Bretton Woods Agreement? A) It called for fixed exchange rates between currencies. B) Governments intervened to prevent exchange rates from moving more than 1 percent above or

below their initially established levels. C) The agreement lasted from 1944 until 1971. D) Each country used gold to back its currency. E) All of the above are true regarding the Bretton Woods Agreement.

ANSWER: D

38. A Japanese yen is worth $.0080, and a Fijian dollar (F$) is worth $.5900. What is the value of the

yen in Fijian dollars (i.e., how many Fijian dollars do you need to buy a yen)? A) 73.75. B) 125. C) 1.69. D) 0.014. E) none of the above

ANSWER: D SOLUTION: ($.008/$.59) = F$.014/¥ 39. The existence of imperfect markets has prevented the internationalization of financial markets.

A) true. B) false.

ANSWER: B

40. Under the gold standard, each currency was convertible into gold at a specified rate, and the

exchange rate between two currencies was determined by their relative convertibility rates per ounce of gold. A) true. B) false.

ANSWER: A

41. An investor engaging in a transaction whereby he or she contracts to purchase British pounds one

year from now is an example of a spot market transaction. A) true. B) false.

ANSWER: B 42. The Single European Act and the Basel Accord prevented a trend toward increased globalization

in the banking industry. A) true. B) false.

ANSWER: B


43. A cross exchange rate expresses the amount of one foreign currency per unit of another foreign currency. A) true. B) false.

ANSWER: A

44. A currency put option provides the right, but not the obligation, to buy a specific currency at a

specific price within a specific period of time. A) true. B) false.

ANSWER: B

45. The strike price is also known as the premium price.

A) true. B) false.

ANSWER: B

46. The interest rate commonly charged for loans between banks is called the cross rate.

A) true. B) false.

ANSWER: B 47. The Bretton Woods Agreement is a 1988 accord between 12 countries to standardize banks’

capital requirements across countries; the resulting capital ratios are computed using risk-weighted assets. A) true. B) false.

ANSWER: B 48. The Basel Accord is a 1987 agreement among the major European countries to make regulations

more uniform across European countries and to reduce taxes on goods traded between these countries. A) true. B) false.

ANSWER: B 49. A futures contract is a contract specifying a standard volume of a particular currency to be

exchanged on a specific settlement date. A) true. B) false.

ANSWER: A


50. Eurobonds are certificates representing bundles of stock. A) true. B) false.

ANSWER: B 51. A share of the ADR of a Dutch firm represents one share of that firm’s stock that is traded on a

Dutch stock exchange. The share price of the firm was 15 euros when the Dutch market closed. As the U.S. market opens, the euro is worth $1.10. Thus, the price of the ADR should be _____. A) $13.64 B) $15.00 C) $16.50 D) 16.50 euros E) none of the above

ANSWER: C SOLUTION: 15 x $1.10 = $16.50 52. The ADR of a British firm is convertible into 3 shares of stock. The share price of the firm was 30

pounds when the British market closed. When the U.S. market opens, the pound is worth $1.63. The price of this ADR should be $_______. A) 48.90 B) 146.70 C) 55.21 D) none of the above

ANSWER: B SOLUTION: 3 x 30 x $1.63 = $146.70

384

Chapter 4

Exchange Rate Determination 1. The value of the Australian dollar (A$) today is $0.73. Yesterday, the value of the Australian dollar

was $0.69. The Australian dollar ________ by _______%. A) depreciated; 5.80 B) depreciated; 4.00 C) appreciated; 5.80 D) appreciated; 4.00

ANSWER: C SOLUTION: ($0.73 - $0.69)/$0.69 = 5.80% 2. If a currency’s spot rate market is ________, its exchange rate is likely to be __________ to a

single large purchase or sale transaction. A) liquid; highly sensitive B) illiquid; insensitive C) illiquid; highly sensitive D) none of the above.

ANSWER: C 3. _________ is not a factor that causes currency supply and demand schedules to change.

A) Relative inflation rates B) Relative interest rates C) Relative income levels D) Expectations E) All of the above are factors that cause currency supply and demand schedules to change.

ANSWER: E

Chapter 4: Exchange Rate Determination 385

4. A large increase in the income level in Mexico along with no growth in the U.S. income level is normally expected to cause (assuming no change in interest rates or other factors) a(n) ______ in Mexican demand for U.S. goods, and the Mexican peso should _______.

A) increase; appreciate B) increase; depreciate C) decrease; depreciate D) decrease; appreciate ANSWER: B 5. An increase in U.S. interest rates relative to German interest rates would likely ________ the U.S.

demand for euros and _________ the supply of euros for sale. A) reduce; increase B) increase; reduce C) reduce; reduce D) increase; increase

ANSWER: A 6. Investors from Germany, the United States, and Britain frequently invest in each other based on

prevailing interest rates. If British interest rates increase, German investors are likely to buy ________ dollar-denominated securities, and the euro is likely to _________ relative to the dollar. A) fewer; depreciate B) fewer; appreciate C) more; depreciate D) more; appreciate

ANSWER: A 7. When the “real” interest rate is relatively low in a given country, then the currency of that country

is typically expected to be: A) weak, since the country’s quoted interest rate would be high relative to the inflation rate. B) strong, since the country’s quoted interest rate would be low relative to the inflation rate. C) strong, since the country’s quoted interest rate would be high relative to the inflation rate. D) weak, since the country’s quoted interest rate would be low relative to the inflation rate. ANSWER: D 8. Assume that the inflation rate becomes much higher in the U.K. relative to the U.S. This will

place ____________ pressure on the value of the British pound. Also, assume that interest rates in the U.K. begin to rise relative to interest rates in the U.S. The change in interest rates will place ____________ pressure on the value of the British pound.

A) upward; downward B) upward; upward C) downward; upward D) downward; downward ANSWER: C


9. In general, when speculating on exchange rate movements, the speculator will borrow the currency that is expected to appreciate and invest in the country whose currency is expected to depreciate. A) true. B) false.

ANSWER: B 10. Baylor Bank believes the New Zealand dollar will appreciate over the next five days from $.48 to

$.50. The following annual interest rates apply: Currency Lending Rate Borrowing Rate Dollars 7.10% 7.50% New Zealand dollar (NZ$) 6.80% 7.25% Baylor Bank has the capacity to borrow either NZ$10 million or $5 million. If Baylor Bank’s

forecast if correct, what will its dollar profit be from speculation over the five-day period (assuming it does not use any of its existing consumer deposits to capitalize on its expectations)?

A) $521,325. B) $500,520. C) $104,262. D) $413,419. E) $208,044. ANSWER: E SOLUTION: 1. Borrow $5 million. 2. Convert to NZ$: $5,000,000/$.48 = NZ$10,416,667. 3. Invest the NZ$ at an annualized rate of 6.80% over five days. NZ$10,416,667 x [1 + 6.80% (5/360)] = NZ$10,426,505 4. Convert the NZ$ back to dollars: NZ$10,426,505 x $.50 = $5,213,252 5. Repay the dollars borrowed. The repayment amount is: $5,000,000 x [1 + 7.5% (5/360)] = $5,000,000 x [1.00104] = $5,005,208


6. After repaying the loan, the remaining dollar profit is:

$5,213,252 - $5,005,208 = $208,044 11. Assume the following information regarding U.S. and European annualized interest rates:

Currency Lending Rate Borrowing Rate U.S. Dollar ($) 6.73% 7.20% Euro (€) 6.80% 7.28% Milly Bank can borrow either $20 million or €20 million. The current spot rate of the euro is $1.13. Furthermore, Milly Bank expects the spot rate of the euro to be $1.10 in 90 days. What is Milly Bank’s dollar profit from speculating if the spot rate of the euro is indeed $1.10 in 90 days? A) $579,845. B) $583,800. C) $588,200. D) $584,245. E) $980,245.

ANSWER: A

SOLUTION:

1. Borrow €20 million. 2. Convert the €20 million to €20,000,000 x $1.13 = $22,600,000.

3. Invest the $22,600,000 at an annualized rate of 6.73% for 90 days.

$22,600,000 x [1 + 6.73% (90/360)] = $22,980, 245

4. Determine euros owed: €20,000,000 x [1 + 7.28% (90/360)] = €20,364,000. 5. Determine dollars needed to repay euro loan: €20,364,000 x $1.10 = $22,400,400.

6. The dollar profit is $22,980,245 - $22,400,400 = $579,845.


12. The equilibrium exchange rate of pounds is $1.70. At an exchange rate of $1.72 per pound: A) U.S. demand for pounds would exceed the supply of pounds for sale and there would be a

shortage of pounds in the foreign exchange market. B) U.S. demand for pounds would be less than the supply of pounds for sale and there would be a

shortage of pounds in the foreign exchange market. C) U.S. demand for pounds would exceed the supply of pounds for sale and there would be a

surplus of pounds in the foreign exchange market. D) U.S. demand for pounds would be less than the supply of pounds for sale and there would be a

surplus of pounds in the foreign exchange market. E) U.S. demand for pounds would be equal to the supply of pounds for sale and there would be a

shortage of pounds in the foreign exchange market. ANSWER: D 13. Assume that Swiss investors have francs available to invest in securities, and they initially view

U.S. and British interest rates as equally attractive. Now assume that U.S. interest rates increase while British interest rates stay the same. This would likely cause:

A) the Swiss demand for dollars to decrease and the dollar will depreciate against the pound. B) the Swiss demand for dollars to increase and the dollar will depreciate against the Swiss franc. C) the Swiss demand for dollars to increase and the dollar will appreciate against the Swiss franc. D) the Swiss demand for dollars to decrease and the dollar will appreciate against the pound. ANSWER: C 14. The real interest rate adjusts the nominal interest rate for: A) exchange rate movements. B) income growth. C) inflation. D) government controls. E) none of the above ANSWER: C

15. If U.S. inflation suddenly increased while European inflation stayed the same, there would be:

A) an increased U.S. demand for euros and an increased supply of euros for sale. B) a decreased U.S. demand for euros and an increased supply of euros for sale. C) a decreased U.S. demand for euros and a decreased supply of euros for sale. D) an increased U.S. demand for euros and a decreased supply of euros for sale.

ANSWER: D


16. If inflation in New Zealand suddenly increased while U.S. inflation stayed the same, there would be: A) an inward shift in the demand schedule for NZ$ and an outward shift in the supply schedule

for NZ$. B) an outward shift in the demand schedule for NZ$ and an inward shift in the supply schedule

for NZ$. C) an outward shift in the demand schedule for NZ$ and an outward shift in the supply schedule

for NZ$. D) an inward shift in the demand schedule for NZ$ and an inward shift in the supply schedule for

NZ$. ANSWER: A 17. If the U.S. and Japan engage in much financial flows but little trade, _______ directly influences

their exchange rate the most. If the U.S. and Switzerland engage in much trade but little financial flows, _______ directly influences their exchange rate the most.

A) interest rate differentials; interest rate differentials B) inflation and interest rate differentials; interest rate differentials C) income and interest rate differentials; inflation differentials D) interest rate differentials; inflation and income differentials E) inflation and income differentials; interest rate differentials ANSWER: D 18. If inflation increases substantially in Australia while U.S. inflation remains unchanged, this is

expected to place _______ pressure on the value of the Australian dollar with respect to the U.S. dollar.

A) upward B) downward

C) either upward or downward (depending on the degree of the increase in Australian inflation) D) none of the above; there will be no impact ANSWER: B 19. Assume that British corporations begin to purchase more supplies from the U.S. as a result of

several labor strikes by British suppliers. This action reflects: A) an increased demand for British pounds. B) a decrease in the demand for British pounds. C) an increase in the supply of British pounds for sale. D) a decrease in the supply of British pounds for sale. ANSWER: C 20. The exchange rates of smaller countries are very stable because the market for their currency is

very liquid. A) true. B) false.

ANSWER: B


21. The phrase “the dollar was mixed in trading” means that: A) the dollar was strong in some periods and weak in other periods over the last month. B) the volume of trading was very high in some periods and low in other periods. C) the dollar was involved in some currency transactions, but not others. D) the dollar strengthened against some currencies and weakened against others. ANSWER: D 22. Assume that the U.S. places a strict quota on goods imported from Chile and that Chile does not

retaliate. Holding other factors constant, this event should immediately cause the U.S. demand for Chilean pesos to _______ and the value of the peso to _______.

A) increase; increase B) increase; decline C) decline; decline D) decline; increase ANSWER: C 23. Any event that increases the U.S. demand for euros should result in a(an) _______ in the value of

the euro with respect to _______, other things being equal. A) increase; U.S. dollar B) increase; nondollar currencies C) decrease; nondollar currencies D) decrease; U.S. dollar ANSWER: A 24. Any event that reduces the U.S. demand for Japanese yen should result in a(an) _______ in the

value of the Japanese yen with respect to _______, other things being equal. A) increase; U.S. dollar B) increase; nondollar currencies C) decrease; nondollar currencies D) decrease; U.S. dollar ANSWER: D 25. Any event that increases the supply of British pounds to be exchanged for U.S. dollars should

result in a(an) _______ in the value of the British pound with respect to _______, other things being equal.

A) increase; U.S. dollar B) increase; nondollar currencies C) decrease; nondollar currencies D) decrease; U.S. dollar ANSWER: D


26. Any event that reduces the supply of Swiss francs to be exchanged for U.S. dollars should result in a(an) _______ in the value of the Swiss franc with respect to _______, other things being equal.

A) increase; U.S. dollar B) increase; nondollar currencies C) decrease; nondollar currencies D) decrease; U.S. dollar ANSWER: A 27. Assume that the U.S. experiences a significant decline in income, while Japan’s income remains

steady. This event should place _______ pressure on the value of the Japanese yen, other things being equal. (Assume that interest rates and other factors are not affected.)

A) upward B) downward C) no D) upward and downward (offsetting) ANSWER: B 28. News of a potential surge in U.S. inflation and zero Chilean inflation places _______ pressure on

the value of the Chilean peso. The pressure will occur _______. A) upward; only after the U.S. inflation surges B) downward; only after the U.S. inflation surges C) upward; immediately D) downward; immediately ANSWER: C 29. Assume that Canada places a strict quota on goods imported from the U.S. and that the U.S. does

not retaliate. Holding other factors constant, this event should immediately cause the supply of Canadian dollars to be exchanged for U.S. dollars to __________ and the value of the Canadian dollar to __________.

A) increase; increase B) increase; decline C) decline; decline D) decline; increase ANSWER: D 30. Assume that Japan places a strict quota on goods imported from the U.S. and the U.S. places a

strict quota on goods imported from Japan. This event should immediately cause the U.S. demand for Japanese yen to _______, and the supply of Japanese yen to be exchanged for U.S. dollars to _______.

A) increase; increase B) increase; decline C) decline; decline D) decline; increase ANSWER: C


31. Which of the following is not mentioned in the text as a factor affecting exchange rates? A) relative interest rates. B) relative inflation rates. C) government controls. D) expectations. E) all of the above are mentioned in the text as factors affecting exchange rates.

ANSWER: E

32. If a country experiences high inflation relative to the U.S., its exports to the U.S. should _______________, its imports should ___________, and there is __________ pressure on its currency’s equilibrium value. A) decrease; increase; upward B) decrease; decrease; upward C) increase; decrease; downward D) decrease; increase; downward E) increase; decrease; upward

ANSWER: C

33. If a country experiences an increase in interest rates relative to U.S. interest rates, the inflow of

U.S. funds to purchase its securities should _____________, the outflow of its funds to purchase U.S. securities should ___________, and there is ______________ pressure on its currency’s equilibrium value. A) increase; decrease; downward B) decrease; increase; upward C) increase; decrease; upward D) decrease; increase; downward E) increase; increase; upward

ANSWER: C

34. An increase in U.S. inflation relative to Singapore inflation places upward pressure on the

Singapore dollar. A) true. B) false.

ANSWER: A

35. When expecting a foreign currency to depreciate, a possible way to speculate on this movement is

to borrow dollars, convert the proceeds to the foreign currency, lend in the foreign country, and use the proceeds from this investment to repay the dollar loan. A) true. B) false.

ANSWER: B


36. Since supply and demand for a currency are constant (primarily due to government intervention), currency values seldom fluctuate. A) true. B) false.

ANSWER: B

37. Relatively high Japanese inflation may result in an increase in the supply of yen for sale and a

reduction in the demand for yen. A) true. B) false.

ANSWER: A

38. The main effect of interest rate movements on exchange rates is through their effect on

international trade. A) true. B) false.

ANSWER: B

39. Country X frequently engages in trade flows with the U.S. (such as imports and exports). Country

Y frequently engages in capital flows with the U.S. (such as financial investments). Everything else held constant, an increase in U.S. interest rates would affect the exchange rate of Country X’s currency more than the exchange rate of Country Y’s currency. A) true. B) false.

ANSWER: B

40. Increases in relative income in one country vs. another result in an increase in that country’s

currency value. A) true. B) false. ANSWER: F

41. Trade-related foreign exchange transactions are more responsive to news than financial flow

transactions. A) true. B) false.

ANSWER: F

42. Signals regarding future actions of market participants in the foreign exchange market sometimes

result in overreactions. A) true. B) false.

ANSWER: T


43. The markets that have a smaller amount of foreign exchange trading for speculatory purposes than for trade purposes will likely experience more volatility than those where trade flows play a larger role. A) true. B) false.

ANSWER: T

44. Liquidity of a currency can affect the extent to which speculation can impact the currency’s value.

A) true. B) false.

ANSWER: T

45. Forecasting a currency’s future value is difficult, because it is difficult to identify how the factors

affecting the currency value will change, and how they will interact to impact the currency’s value. A) true. B) false.

ANSWER: T

395

Chapter 5

Currency Derivatives 1. Kalons, Inc. is a U.S.-based MNC that frequently imports raw materials from Canada. Kalons is

typically invoiced for these goods in Canadian dollars and is concerned that the Canadian dollar will appreciate in the near future. Which of the following is not an appropriate hedging technique under these circumstances? A) purchase Canadian dollars forward. B) purchase Canadian dollar futures contracts. C) purchase Canadian dollar put options. D) purchase Canadian dollar call options.

ANSWER: C 2. Graylon, Inc., based in Washington, exports products to a German firm and will receive payment

of €200,000 in three months. On June1, the spot rate of the euro was $1.12, and the 3-month forward rate was $1.10. On June 1, Graylon negotiated a forward contract with a bank to sell €200,000 forward in three months.The spot rate of the euroon September 1 is $1.15. Graylon will receive $_________ for the euros.

A) 224,000 B) 220,000 C) 200,000 D) 230,000 ANSWER: B SOLUTION: €200,000 x $1.10 = $220,000


3. The one-year forward rate of the British pound is quoted at $1.60, and the spot rate of the British pound is quoted at $1.63. The forward ________ is _______ percent. A) discount; 1.9 B) discount; 1.8 C) premium; 1.9 D) premium; 1.8

ANSWER: B SOLUTION: (F/S) – 1 = ($1.60/$1.63) – 1 = -1.8 percent. 4. The 90-day forward rate for the euro is $1.07, while the current spot rate of the euro is $1.05. What

is the annualized forward premium or discount of the euro? A) 1.9 percent discount. B) 1.9 percent premium. C) 7.6 percent premium. D) 7.6 percent discount. ANSWER: C SOLUTION: [(F/S) – 1] x 360/90 = 7.6 percent. 5. Thornton, Inc. needs to invest five million Nepalese rupees in its Nepalese subsidiary to support

local operations. Thornton would like its subsidiary to repay the rupees in one year. Thornton would like to engage in a swap transaction. Thus, Thornton would: A) convert the rupees to dollars in the spot market today and convert rupees to dollars in one year

at today’s forward rate. B) convert the dollars to rupees in the spot market today and convert dollars to rupees in one year

at the prevailing spot rate. C) convert the dollars to rupees in the spot market today and convert rupees to dollars in one year

at today’s forward rate. D) convert the dollars to rupees in the spot market today and convert rupees to dollars in one year

at the prevailing spot rate. ANSWER: C 6. In the U.S., the typical currency futures contract is based on a currency value in terms of:

A) euros. B) U.S. dollars. C) British pounds. D) Canadian dollars.

ANSWER: B

Chapter 5: Currency Derivatives 397

7. Currency futures contracts sold on an exchange: A) contain a commitment to the owner, and are standardized. B) contain a commitment to the owner, and can be tailored to the desire of the owner. C) contain a right but not a commitment to the owner, and can be tailored to the desire of the

owner. D) contain a right but not a commitment to the owner, and are standardized. ANSWER: A 8. Currency options sold through an options exchange: A) contain a commitment to the owner, and are standardized. B) contain a commitment to the owner, and can be tailored to the desire of the owner. C) contain a right but not a commitment to the owner, and can be tailored to the desire of the

owner. D) contain a right but not a commitment to the owner, and are standardized. ANSWER: D 9. Currency options are traded through the GLOBEX system at the:

A) Chicago Board Options Exchange when the trading floor is open. B) Chicago Mercantile Exchange when the trading floor is open. C) Chicago Mercantile Exchange even after the trading floor is closed. D) Philadelphia Exchange even after the trading floor is closed. E) Chicago Board Options Exchange even after the trading floor is closed.

ANSWER: C 10. Forward contracts: A) contain a commitment to the owner, and are standardized. B) contain a commitment to the owner, and can be tailored to the desire of the owner.

C) contain a right but not a commitment to the owner, and can be tailored to the desire of the owner.

D) contain a right but not a commitment to the owner, and are standardized. ANSWER: B 11. Which of the following is the most likely strategy for a U.S. firm that will be receiving Swiss

francs in the future and desires to avoid exchange rate risk (assume the firm has no offsetting position in francs)?

A) purchase a call option on francs. B) sell a futures contract on francs. C) obtain a forward contract to purchase francs forward. D) all of the above are appropriate strategies for the scenario described. ANSWER: B


12. Which of the following is the most unlikely strategy for a U.S. firm that will be purchasing Swiss francs in the future and desires to avoid exchange rate risk (assume the firm has no offsetting position in francs)?

A) purchase a call option on francs. B) obtain a forward contract to purchase francs forward. C) sell a futures contract on francs. D) all of the above are appropriate strategies for the scenario described. ANSWER: C 13. If your firm expects the euro to substantially depreciate, it could speculate by _______ euro call

options or _______ euros forward in the forward exchange market. A) selling; selling B) selling; purchasing C) purchasing; purchasing D) purchasing; selling ANSWER: A 14. When you own _______, there is no obligation on your part; however, when you own _______,

there is an obligation on your part. A) call options; put options B) futures contracts; call options C) forward contracts; futures contracts D) put options; forward contracts ANSWER: D 15. The greater the variability of a currency, the _______ will be the premium of a call option on this

currency, and the _______ will be the premium of a put option on this currency, other things equal.

A) greater; lower B) greater; greater C) lower; greater D) lower; lower ANSWER: B 16. When currency options are not standardized and traded over-the-counter, there is ______ liquidity

and a ________ bid/ask spread. A) less; narrower B) more; narrower C) more; wider D) less; wider

ANSWER: D


17. The shorter the time to the expiration date for a currency, the _______ will be the premium of a call option, and the _______ will be the premium of a put option, other things equal.

A) greater; greater B) greater; lower C) lower; lower D) lower; greater ANSWER: C 18. Assume that a speculator purchases a put option on British pounds (with a strike price of $1.50)

for $.05 per unit. A pound option represents 31,250 units. Assume that at the time of the purchase, the spot rate of the pound is $1.51 and continually rises to $1.62 by the expiration date. The highest net profit possible for the speculator based on the information above is:

A) $1,562.50. B) -$1,562.50. C) -$1,250.00. D) -$625.00. ANSWER: B SOLUTION: The premium of the option is $.05 x (31,250 units) = $1,562.50. Since the option

will not be exercised, the net profit is -$1,562.50. 19. Which of the following is true? A) The futures market is primarily used by speculators while the forward market is primarily used

for hedging. B) The futures market is primarily used for hedging while the forward market is primarily used

for speculating. C) The futures market and the forward market are primarily used for speculating. D) The futures market and the forward market are primarily used for hedging. ANSWER: A 20. Which of the following is true? A) Most forward contracts between firms and banks are for speculative purposes. B) Most future contracts represent a conservative approach by firms to hedge foreign trade. C) The forward contracts offered by banks have maturities for only four possible dates in the

future. D) none of the above ANSWER: D 21. If you expect the euro to depreciate, it would be appropriate to _______ for speculative purposes. A) buy a euro call and buy a euro put B) buy a euro call and sell a euro put C) sell a euro call and sell a euro put D) sell a euro call and buy a euro put ANSWER: D


22. If you expect the British pound to appreciate, you could speculate by _______ pound call options or _______ pound put options.

A) purchasing; selling B) purchasing; purchasing C) selling; selling D) selling; purchasing ANSWER: A 23. Which of the following is correct? A) The longer the time to maturity, the less the value of a currency call option, other things equal. B) The longer the time to maturity, the less the value of a currency put option, other things equal. C) The higher the spot rate relative to the exercise price, the greater the value of a currency put

option, other things equal. D) The lower the exercise price relative to the spot rate, the greater the value of a currency call

option, other things equal. ANSWER: D 24. Research has found that the options market is:

A) efficient before controlling for transaction costs. B) efficient after controlling for transaction costs. C) highly inefficient. D) none of the above

ANSWER: B 25. Assume no transactions costs exist for any futures or forward contracts. The price of British

pound futures with a settlement date 180 days from now will: A) definitely be above the 180-day forward rate. B) definitely be below the 180-day forward rate. C) be about the same as the 180-day forward rate. D) none of the above; there is no relation between the futures and forward prices. ANSWER: C 26. Assume that a currency’s spot and future prices are the same, and the currency’s interest rate is

higher than the U.S. rate. The actions of U.S. investors to lock in this higher foreign return would _______ the currency’s spot rate and _______ the currency’s futures price.

A) put upward pressure on; put upward pressure on B) put downward pressure on; put upward pressure on C) put upward pressure on; put downward pressure on D) put downward pressure on; put downward pressure on ANSWER: C


27. A firm sells a currency futures contract, then decides before the settlement date that it no longer wants to maintain such a position. It can close out its position by:

A) buying an identical futures contract. B) selling an identical futures contract. C) buying a futures contract with a different settlement date. D) selling a futures contract for a different amount of currency. E) purchasing a put option contract in the same currency. ANSWER: A 28. If the spot rate of the euro increased substantially over a one-month period, the futures price on

euros would likely ______________ over that same period. A) increase slightly B) decrease substantially C) increase substantially D) stay the same ANSWER: C 29. A U.S. firm is bidding for a project needed by the Swiss government. The firm will not know if

the bid is accepted until three months from now. The firm will need Swiss francs to cover expenses but will be paid by the Swiss government in dollars if it is hired for the project. The firm can best insulate itself against exchange rate exposure by:

A) selling futures in francs. B) buying futures in francs. C) buying franc put options. D) buying franc call options. ANSWER: D 30. A firm wants to use an option to hedge 12.5 million in receivables from New Zealand firms. The

premium is $.03. The exercise price is $.55. If the option is exercised, what is the total amount of dollars received (after accounting for the premium paid)?

A) $6,875,000. B) $7,250,000. C) $7,000,000. D) $6,500,000. E) none of the above ANSWER: D SOLUTION: Dollars received from exercising option = NZ$12.5 million x $.55 = $6,875,000.

Premium paid for options = NZ$12.5 million x $.03 = $375,000. Amount of dollars received minus premium = $6,500,000.


31. If you purchase a straddle on euros, this implies that you: A) finance the purchase of a call option by selling a put option in the euros. B) finance the purchase of a call option by selling a call option in the euros. C) finance the purchase of a put option by selling a put option in the euros. D) finance the purchase of a put option by selling a call option in the euros. E) none of the above ANSWER: E 32. The premium on a pound put option is $.03 per unit. The exercise price is $1.60. The break-even

point is _______ for the buyer of the put, and _______ for the seller of the put. (Assume zero transactions costs and that the buyer and seller of the put option are speculators.)

A) $1.63; $1.63 B) $1.63; $1.60 C) $1.63; $1.57 D) $1.57; $1.63 E) none of the above ANSWER: E SOLUTION: Break-even point on put option to both the buyer and seller is $1.60 - $.03 = $1.57. 33. The existing spot rate of the Canadian dollar is $.82. The premium on a Canadian dollar call

option is $.04. The exercise price is $.81. The option will be exercised on the expiration date if at all. If the spot rate on the expiration date is $.87, the profit as a percent of the initial investment (the premium paid) is:

A) 0 percent. B) 25 percent. C) 50 percent. D) 150 percent. E) none of the above ANSWER: C SOLUTION: The net profit per unit is: $.87 - $.81 - $.04 = $.02. The net profit per unit as a

percent of the initial investment per unit is: $.02/$.04 = 50%. 34. You purchase a call option on pounds for a premium of $.03 per unit, with an exercise price of

$1.64; the option will not be exercised until the expiration date, if at all. If the spot rate on the expiration date is $1.65, your net profit per unit is:

A) -$.03. B) -$.02. C) -$.01. D) $.02. E) none of the above ANSWER: B SOLUTION: Net profit per unit = $1.65 - $1.64 - $.03 = -$.02.


35. You purchase a put option on Swiss francs for a premium of $.02, with an exercise price of $.61. The option will not be exercised until the expiration date, if at all. If the spot rate on the expiration date is $.58, your net profit per unit is:

A) -$.03. B) -$.02. C) -$.01. D) $.02. E) none of the above ANSWER: E SOLUTION: Net profit per unit = $.61 - $.58 - $.02 = $.01. 36. You are a speculator who sells a call option on Swiss francs for a premium of $.06, with an

exercise price of $.64. The option will not be exercised until the expiration date, if at all. If the spot rate of the Swiss franc is $.69 on the expiration date, your net profit per unit, assuming that you have to buy Swiss francs in the market to fulfil your obligation, is:

A) -$.02. B) -$.01. C) $.01. D) $.02. E) none of the above ANSWER: C SOLUTION: Net profit per unit = $.64 + $.06 - $.69 = $.01. 37. You are a speculator who sells a put option on Canadian dollars for a premium of $.03 per unit,

with an exercise price of $.86. The option will not be exercised until the expiration date, if at all. If the spot rate of the Canadian dollar is $.78 on the expiration date, your net profit per unit is:

A) -$.08. B) -$.03. C) $.05. D) $.08. E) none of the above ANSWER: E SOLUTION: Net profit = $.78 + $.03 - $.86 = -$.05. 38. European currency options can be exercised _______; American currency options can be

exercised _______. A) any time up to the expiration date; any time up to the expiration date B) any time up to the expiration date; only on the expiration date C) only on the expiration date; only on the expiration date D) only on the expiration date; any time up to the expiration date ANSWER: D


39. Macomb Corporation is a U.S. firm that invoices some of its exports in Japanese yen. If it expects the yen to weaken, it could _______ to hedge the exchange rate risk on those exports.

A) sell yen put options B) buy yen call options C) buy futures contracts on yen D) sell futures contracts on yen ANSWER: D 40. A call option on Australian dollars has a strike (exercise) price of $.56. The present exchange rate

is $.59. This call option can be referred to as: A) in the money. B) out of the money. C) at the money. D) at a discount. ANSWER: A 41. A put option on British pounds has a strike (exercise) price of $1.48. The present exchange rate is

$1.55. This put option can be referred to as: A) in the money. B) out of the money. C) at the money. D) at a discount. ANSWER: B 42. Which of the following is not an instrument used by U.S.-based MNCs to cover their foreign

currency positions? A) forward contracts. B) futures contracts. C) non-deliverable forward contracts. D) options. E) all of the above are instruments used to cover foreign currency positions.

ANSWER: E

43. When the futures price on euros is below the forward rate on euros for the same settlement date,

astute investors may attempt to simultaneously __________ euros forward and __________ euro futures. A) sell; sell B) buy; sell C) sell; buy D) buy; buy

ANSWER: B


44. When the futures price is equal to the spot rate of a given currency, and the foreign country exhibits a higher interest rate than the U.S. interest rate, astute investors may attempt to simultaneously __________ the foreign currency, invest it in the foreign country, and __________ futures in the foreign currency. A) buy; buy B) sell; buy C) buy; sell D) buy; buy

ANSWER: C

45. Which of the following would result in a profit of a euro futures contract when the euro

depreciates? A) buy a euro futures contract; sell a futures contract after the euro has depreciated. B) sell a euro futures contract; buy a futures contract after the euro has depreciated. C) buy a euro futures contract; buy an additional futures contract after the euro has depreciated. D) none of the above would result in a profit when the euro depreciates.

ANSWER: B

46. Which of the following is not true regarding options?

A) Options are traded on exchanges, never over-the-counter. B) Similar to futures contracts, margin requirements are normally imposed on option traders. C) Although commissions for options are fixed per transaction, multiple contracts may be

involved in a transaction, thus lowering the commission per contract. D) Currency options can be classified as either put or call options. E) All of the above are true.

ANSWER: A

47. A U.S. corporation has purchased currency put options to hedge a 100,000 Canadian dollar (C$)

receivable. The premium is $.01 and the exercise price of the option is $.75. If the spot rate at the time of maturity is $.85, what is the net amount received by the corporation if it acts rationally? A) $74,000. B) $84,000. C) $75,000. D) $85,000.

ANSWER: B

SOLUTION: Dollars received from selling Canadian dollars in the spot market = C$100,000 x $.85 = $85,000. Premium paid for options = C$100,000 x $.01 = $1,000. Amount of dollars received less premium = $84,000.


48. A U.S. corporation has purchased currency call options to hedge a 70,000 pound payable. The premium is $.02 and the exercise price of the option is $.50. If the spot rate at the time of maturity is $.65, what is the total amount paid by the corporation if it acts rationally? A) $33,600. B) $46,900. C) $44,100. D) $36,400.

ANSWER: D

SOLUTION: Dollars paid when exercising the option = £70,000 x $.50 = $35,000. Premium paid

for options = £70,000 x $.02 = $1,400. Amount of dollars paid = $35,000 + $1,400 = $36,400. 49. Frank is an option speculator. He anticipates the Danish kroner to appreciate from its current level

of $.19 to $.21. Currently, kroner call options are available with an exercise price of $.18 and a premium of $.02. Should Frank attempt to buy this option? If the future spot rate of the Danish kroner is indeed $.21, what is his profit or loss per unit? A) no; -$0.01. B) yes; $0.01. C) yes; -$0.01. D) yes; $0.03.

ANSWER: B

SOLUTION: The net profit per unit is: $.21 - $.18 - $.02 = $.01.

50. Carl is an option writer. In anticipation of a depreciation of the British pound from its current level

of $1.50 to $1.45, he has written a call option with an exercise price of $1.51 and a premium of $.02. If the spot rate at the option’s maturity turns out to be $1.54, what is Carl’s profit or loss per unit (assuming the buyer of the option acts rationally)? A) -$0.01. B) $0.01. C) -$0.04. D) $0.04. E) -$0.03.

ANSWER: A

SOLUTION: The net profit per unit is $1.51 + $.02 - $1.54 = -$.01.


51. Johnson, Inc., a U.S.-based MNC, will need 10 million Thai baht on August 1. It is now May 1. Johnson has negotiated a non-deliverable forward contract with its bank. The reference rate is the baht’s closing exchange rate (in $) quoted by Thailand’s central bank in 90 days. The baht’s spot rate today is $.02. If the rate quoted by Thailand’s central bank on August 1 is $.022, Johnson will ________ $__________. A) pay; 20,000 B) be paid; 20,000 C) pay; 2,000 D) be paid; 2,000 E) none of the above

ANSWER: B

SOLUTION: Amount received per unit = $.022 - $.02 = $.002 x THB10,000,0000 = $20,000.

52. If the observed put option premium is less than what is suggested by the put-call parity equation,

astute arbitrageurs could make a profit by ________ the put option, ___________ the call option, and __________ the underlying currency. A) selling; buying; buying B) buying; selling; buying C) selling; buying; selling D) buying; buying; buying

ANSWER: B

53. A put option premium has a lower bound that is equal to the greater of zero and the difference

between the underlying ____________________ prices. The upper bound of a call option premium is the _______________ price. A) spot and exercise; exercise B) spot and exercise; spot C) exercise and spot; exercise D) exercise and spot; spot

ANSWER: C

54. A call option premium has a lower bound that is equal to the greater of zero and the difference

between the underlying ____________________ prices. The upper bound of a call option premium is the _______________ price. A) spot and exercise; exercise B) spot and exercise; spot C) exercise and spot; exercise D) exercise and spot; spot

ANSWER: B


55. Assume the spot rate of the Swiss franc is $.62 and the one-year forward rate is $.66. The forward rate exhibits a _______ of _______.

A) premium; about 6% B) discount; about 6% C) discount; about 6.45% D) premium; about 6.45% ANSWER: D SOLUTION: Premium = (Forward rate - Spot rate)/Spot rate = ($.66 - $.62)/$.62 = 6.45% 56. Assume the spot rate of a currency is $.37 and the 90-day forward rate is $.36. The forward rate

of this currency exhibits a _______ of _______ on an annualized basis. A) discount; 11.11% B) premium; 11.11% C) premium; 10.81% D) discount; 10.81% ANSWER: D SOLUTION: Discount = [(FR - SR)/SR] x (360/90) = [($.36 - $.37)/$.37] x (360/90) = -10.81% (Discount) 57. Which of the following are exchange traded?

A) forward contracts. B) futures contracts. C) options. D) B and C.

ANSWER: B

58. Conditional currency options are:

A) options that do not require premiums. B) options where the premiums are canceled if a trigger level is reached. C) options that allow the buyer to decide what currency the option will be settled in. D) none of the above

ANSWER: B


59. Which of the following are true regarding the options markets? A) Hedgers and speculators both attempt to lower risk. B) Hedgers attempt to lower risk, while speculators attempt to make riskless profits. C) Hedgers and speculators are both necessary in order for the market to be liquid. D) all of the above

ANSWER: C

60. The premium of a currency put option will increase if:

A) the volatility of the underlying asset goes up. B) the time to maturity goes up. C) the spot rate declines. D) none of the above

ANSWER: D

61. Which of the following is true of options?

A) The writer decides whether the option will be exercised. B) The writer pays the buyer the option premium. C) The buyer decides if the option will be exercised. D) More than one of these.

ANSWER: C

62. The purchase of a currency put option would be appropriate for which of the following?

A) Investors who expect to buy a foreign bond in one month. B) Corporations who expect to buy foreign currency to finance foreign subsidiaries. C) Corporations who expect to collect on a foreign account receivable in one month. D) all of the above

ANSWER: B

63. If you have bought the right to sell, you are a:

A) call writer. B) put buyer. C) futures buyer. D) put writer.

ANSWER: B

64. If you have a position where you might be obligated to buy Euros, you are:

A) a call writer. B) a put writer. C) a put buyer. D) a futures seller.

ANSWER: C


65. Which of the following is true for futures, but not for forwards? A) actual delivery. B) no transactions costs. C) self regulation. D) none of the above

ANSWER: D

66. Your company expects to receive 5,000,000 Japanese yen 60 days from now. You decide to hedge

your position by selling Japanese yen forward. The current spot rate of the yen is $.0089, while the forward rate is $.0095. You expect the spot rate in 60 days to be $.0090. How many dollars will you receive for the 5,000,000 yen 60 days from now? A) $44,500. B) $45,000. C) $526 million. D) $47,500.

ANSWER: D SOLUTION: ¥5,000,000 x $.0095/¥ = $47,500

67. The spot rate for the Singapore dollar is $.588. The 30-day forward rate is $.590. The forward rate

contains an annualized __________ of ___________%. A) discount; -4.07 B) premium; 4.07 C) discount; -4.08 D) premium; 4.08 E) premium; 3.40

ANSWER: D

SOLUTION: ($.59 - $.588)/$.588 x (360/30) = 4.08%

68. Non-deliverable forward contracts (NDFs) are frequently used for currencies in emerging markets.

A) true. B) false.

ANSWER: A

69. The price of a futures contract will generally vary significantly from that of a forward contract.

A) true. B) false.

ANSWER: B


70. If the futures rate is lower than the forward rate, astute investors would attempt to simultaneously buy futures and sell forward. Such actions would place downward pressure on the futures price and upward pressure on the forward rate. A) true. B) false.

ANSWER: B

71. Forward contracts are usually liquidated by actual delivery of the currency, while futures contracts

are usually liquidated by offsetting transactions. A) true. B) false.

ANSWER: A

72. If an investor who previously sold futures contracts wishes to liquidate his or her position, he or

she could sell futures contracts with the same maturity date. A) true. B) false.

ANSWER: B

73. Since futures contracts are traded on an exchange, the exchange will always take the “other side”

of the transaction in terms of accepting the credit risk. A) true. B) false.

ANSWER: A

74. Currency options are only traded on exchanges. That is, there is no over-the-counter market for

options. A) true. B) false.

ANSWER: B

75. Both call and put option premiums are affected by the level of the existing spot price relative to

the strike price; for example, a high spot price relative to the strike price will result in a relatively high premium for a call option but a relatively low premium for a put option. A) true. B) false.

ANSWER: A

76. The writer of a call option is obligated to sell the underlying currency to the buyer of the option if

the option is exercised. A) true. B) false.

ANSWER: A


77. The lower bound of the call option premium is the greater of zero and the difference between the spot rate and the exercise price; the upper bound of a currency call option is the spot rate. A) true. B) false.

ANSWER: A

78. The lower bound of a put option premium is the greater of zero and the difference between the

exercise price and the spot rate; the upper bound of a currency put option is the exercise price. A) true. B) false.

ANSWER: A

79. Due to put-call parity, we can use the same formula to price calls and puts.

A) true. B) false.

ANSWER: B

80. If an actual put option premium is less than what is suggested by the put-call parity relationship,

arbitrage can be conducted. A) true. B) false.

ANSWER: A 81. If the futures rate is above the forward rate, actions by rational investors would put upward

pressure on the forward rate and downward pressure on the futures rate. A) true. B) false.

ANSWER: A

82. Futures contracts are standardized with respect to delivery date and the futures price specified for

the settlement date. A) true. B) false.

ANSWER: B

83. If an investor who has previously purchased a futures contract wishes to liquidate his or her

position, he or she would sell an identical futures contract with the same settlement date. A) true. B) false.

ANSWER: A


84. Margin requirements are deposits placed by investors in futures contracts with their respective brokerage firms when they take their position. They are intended to minimize credit risk associated with futures contracts. A) true. B) false.

ANSWER: A

85. A European option can only be exercised at the expiration date, while an American option can be

exercised any time prior to the expiration date. A) true. B) false.

ANSWER: A

86. The highest amount a buyer of a call or a put option can lose is the exercise price.

A) true. B) false.

ANSWER: B

87. A straddle is a speculative strategy that represents the purchase of both a call and a put.

A) true. B) false.

ANSWER: A

88. A currency put option is a contract specifying a standard volume of a particular currency to be

exchanged on a specific settlement date. A) true. B) false.

ANSWER: B

89. An implicit forward contract is a new type of forward contract that does not result in the actual

exchange of currencies in the future. A) true. B) false.

ANSWER: B

90. An option writer is the seller of a call or a put option.

A) true. B) false.

ANSWER: A


91. The forward premium is the price specified in a call or put option. A) true. B) false.

ANSWER: B

92. An MNC frequently uses either forward or futures contracts to hedge its exposure to foreign

receivables. To do so, the MNC can either sell the foreign currency forward or sell futures. A) true. B) false.

ANSWER: A

93. Hedgers should buy puts if they are hedging an expected inflow of foreign currency. A) true. B) false. ANSWER: A

94. Forward contracts are the best technique for managing exposure arising from project bidding. A) true. B) false. ANSWER: B

95. The US options exchanges are regulated by the SEC. A) true. B) false. ANSWER: A

96. It is possible to have an opportunity loss when using futures to hedge. A) true. B) false. ANSWER: A

97. Margin is used in the forward market to mitigate default risk. A) true. B) false. ANSWER: B

98. There are no transactions costs associated with trading futures or options. A) true. B) false. ANSWER: B


99. Futures and options are available for crossrates. A) true. B) false. ANSWER: A

100. Options can be traded on an exchange or over the counter. A) true. B) false. ANSWER: A

101. The writer of an uncovered call can experience a loss limited to the option premium. A) true. B) false. ANSWER: B

102. American style options can be exercised any time up to maturity. A) true. B) false. ANSWER: B

103. As mentioned in the text, the most common maturities for forward rates are: A) one, three, six, and twelve months. B) one, three, six, and twelve years. C) two, three, and five years. D) two, three, and five weeks. ANSWER: A

416

Chapter 6

Government Influence on Exchange Rates 1. To force the value of the pound to appreciate against the dollar, the Federal Reserve should: A) sell dollars for pounds in the foreign exchange market and the European Central Bank (ECB)

should sell dollars for pounds in the foreign exchange market. B) sell pounds for dollars in the foreign exchange market and the European Central Bank (ECB)

should sell dollars for pounds in the foreign exchange market. C) sell pounds for dollars in the foreign exchange market and the European Central Bank (ECB)

should not intervene. D) sell dollars for pounds in the foreign exchange market and the European Central Bank (ECB)

should sell pounds for dollars in the foreign exchange market. ANSWER: A 2. A weak dollar is normally expected to cause: A) high unemployment and high inflation in the U.S. B) high unemployment and low inflation in the U.S. C) low unemployment and low inflation in the U.S. D) low unemployment and high inflation in the U.S. ANSWER: D 3. A strong dollar is normally expected to cause: A) high unemployment and high inflation in the U.S. B) high unemployment and low inflation in the U.S. C) low unemployment and low inflation in the U.S. D) low unemployment and high inflation in the U.S. ANSWER: B

Chapter 6: Government Influence on Exchange Rates 417

4. To force the value of the British pound to depreciate against the dollar, the Federal Reserve should:

A) sell dollars for pounds in the foreign exchange market and the Bank of England should sell dollars for pounds in the foreign exchange market.

B) sell pounds for dollars in the foreign exchange market and the Bank of England should sell dollars for pounds in the foreign exchange market.

C) sell pounds for dollars in the foreign exchange market and the Bank of England should sell pounds for dollars in the foreign exchange market.

D) sell dollars for pounds in the foreign exchange market and the Bank of England should sell pounds for dollars in the foreign exchange market.

ANSWER: C 5. Consider two countries that trade with each other, called X and Y. According to the text, inflation

in Country X will have a greater impact on inflation in Country Y under the _______ system. Now, consider two other countries that trade with each other, called A and B. Unemployment in Country A will have a greater impact on unemployment in Country B under the _______ system.

A) floating rate; fixed rate B) floating rate; floating rate C) fixed rate; fixed rate D) fixed rate; floating rate ANSWER: C 6. A primary result of the Bretton Woods Agreement was: A) the establishment of the European Monetary System (EMS). B) establishing specific rules for when tariffs and quotas could be imposed by governments. C) establishing that exchange rates of most major currencies were to be allowed to fluctuate 1%

above or below their initially set values. D) establishing that exchange rates of most major currencies were to be allowed to fluctuate

freely without boundaries (although the central banks did have the right to intervene when necessary).

ANSWER: C 7. A primary result of the Smithsonian Agreement was: A) the establishment of the European Monetary System (EMS). B) establishing that exchange rates of most major countries were to be allowed to fluctuate 2.25%

above or below their initially set values. C) establishing specific rules for when tariffs and quotas could be imposed by governments. D) establishing that exchange rates of most major currencies were to be allowed to fluctuate

freely without boundaries (although the central banks did have the right to intervene when necessary).

ANSWER: B


8. Under a fixed exchange rate system: A) a foreign exchange market does not exist. B) central bank intervention in the foreign exchange market is not necessary. C) central bank intervention in the foreign exchange market is often necessary. D) central bank intervention in the foreign exchange market is not allowed. ANSWER: C 9. Under a managed float exchange rate system, the Fed may attempt to stimulate the U.S. economy

by _______ the dollar. Such an adjustment in the dollar’s value should _______ the U.S. demand for products produced by major foreign countries.

A) weakening; increase B) weakening; decrease C) strengthening; increase D) strengthening; decrease ANSWER: B 10. The value of the Canadian dollar, Japanese yen, and Australian dollar with respect to the U.S.

dollar are part of a: A) pegged system. B) fixed system. C) managed float system. D) crawling peg system. ANSWER: C 11. The interest rate of a country with a currency board:

A) is less stable than it would be without a currency board. B) is typically below the interest rate of the currency to which it is tied. C) will move in tandem with the interest rate of the currency to which it is tied. D) is completely independent of the interest rate of the currency to which it is tied.

ANSWER: C 12. The currency of country X is pegged to the currency of country Y. Assume that county Y’s

currency depreciates against the currency of country Z. It is likely that country X will export _______ to country Z and import _______ from country Z. A) more; more B) less; less C) more; less D) less; more

ANSWER: C


13. Assume countries A, B, and C produce goods that are substitutes of each other and that these countries engage in trade with each other. Assume that country A’s currency floats against country B’s currency, and that country C’s currency is pegged to B’s. If A’s currency depreciates against B, then A’s exports to C should _______, and A’s imports from C should _______.

A) decrease; increase B) decrease; decrease C) increase; decrease D) increase; increase ANSWER: C 14. Assume a central bank exchanges its currency for other foreign currencies in the foreign exchange

market, but does not adjust for the resulting change in the money supply. This is an example of: A) pegged intervention. B) indirect intervention. C) nonsterilized intervention. D) sterilized intervention. E) A and D ANSWER: C 15. If the Fed desires to weaken the dollar without affecting the dollar money supply, it should: A) exchange dollars for foreign currencies, and sell some of its existing Treasury security

holdings for dollars. B) exchange foreign currencies for dollars, and sell some of its existing Treasury security

holdings for dollars. C) exchange dollars for foreign currencies, and buy existing Treasury securities with dollars. D) exchange foreign currencies for dollars, and buy existing Treasury securities with dollars. ANSWER: A 16. Which of the following is an example of direct intervention in foreign exchange markets? A) lowering interest rates. B) increasing the discount rate. C) exchanging dollars for foreign currency. D) imposing barriers on international trade. ANSWER: C 17. A strong dollar places _______ pressure on inflation, which in turn places _______ pressure on

the dollar. A) upward; upward B) downward; upward C) upward; downward D) downward; downward ANSWER: B


18. The Fed may use a stimulative monetary policy with least concern about causing inflation if the dollar’s value is expected to:

A) remain stable. B) strengthen. C) weaken. D) none of the above will have an impact on inflation. ANSWER: B 19. A weaker dollar places _______ pressure on U.S. inflation, which in turn places _______ pressure

on U.S. interest rates, which places _______ pressure on U.S. bond prices. A) upward; downward; upward B) upward; downward; downward C) upward; upward; downward D) downward; upward; upward E) downward; downward; upward ANSWER: C 20. The euro is the currency:

A) adopted in all western European countries as of 1999. B) adopted in all eastern European countries as of 1999. C) adopted in all European countries as of 1999. D) none of the above

ANSWER: D 21. Assume that Lithuania (a member of the European Union) wishes to adopt the euro as its currency.

Which of the following is not a requirement Lithuania must meet? A) restrict the movements of the euro relative to its home currency within a range of plus or minus

15 percent from an initially set exchange rate. B) limit inflation. C) limit the Lithuanian budget deficit. D) increase GDP growth by 3% annually.

ANSWER: D 22. The exchange rate mechanism (ERM) refers to the method of linking __________ currencies to

each other within boundaries. A) Latin American B) European C) Asian D) North American ANSWER: B


23. Countries that have adopted the euro must agree on a single ________ policy. A) monetary B) fiscal C) worker compensation D) foreign relations

ANSWER: A 24. The exchange rate mechanism (ERM) crisis in 1992 represents the __________ in German interest

rates that caused other European interest rates to __________, and resulted in less aggregate spending.

A) increase; increase B) increase; decrease C) decrease; decrease D) decrease; increase ANSWER: A 25. The risk-free interest rates among countries that have adopted the euro should: A) are not necessarily similar to risk-free rates in other countries. B) should equal the U.S. risk-free rate. C) should equal the risk-free rates in other European countries. D) should equal the risk-free rates in Asian countries. ANSWER: A 26. Which of the following is true regarding the euro?

A) Exchange rate risk between participating European currencies is completely eliminated, encouraging more trade and capital flows across European borders.

B) It allows for more consistent economic conditions across countries. C) It prevents each country from conducting its own monetary policy. D) All of the above are true.

ANSWER: D

27. It has been argued that the exchange rate can be used as a policy tool. Assume that the U.S.

government would like to reduce unemployment. Which of the following is an appropriate action given this scenario? A) weaken the dollar. B) strengthen the dollar. C) buy dollars with foreign currency in the foreign exchange market. D) implement a tight monetary policy.

ANSWER: A


28. It has been argued that the exchange rate can be used as a policy tool. Assume that the U.S. government would like to reduce inflation. Which of the following is an appropriate action given this scenario? A) sell dollars for foreign currency. B) buy dollars with foreign currency. C) lower interest rates. D) none of the above

ANSWER: B

29. To strengthen the dollar using sterilized intervention, the Fed would _____________ dollars and

simultaneously ____________ Treasury securities. A) buy; sell B) sell; buy C) buy; buy D) sell; sell

ANSWER: C

30. As foreign exchange activity has grown:

A) central bank intervention has become more effective. B) central bank intervention has become more frequent. C) central bank intervention has become less effective. D) none of the above

ANSWER: C

31. When using indirect intervention, a central bank is likely to focus on:

A) inflation. B) interest rates. C) income levels. D) expectations of future exchange rates.

ANSWER: B

32. Which of the following countries was probably the least affected (directly or indirectly) by the

Asian crisis? A) Thailand. B) Indonesia. C) Russia. D) China. E) Malaysia.

ANSWER: D


33. Which of the following is not true regarding Thailand? A) Thailand was one of the slowest growing countries over the 1985-1994 period. B) High levels of spending and low levels of saving placed upward pressure on prices of real

estate, products, and on Thailand’s local interest rate. C) Thailand’s baht was linked to the dollar prior to July 1997, which made Thailand an attractive

site for foreign investors. D) Thai banks provided many loans that were very risky in their attempt to make use of all of

their funds. E) All of the above are true.

ANSWER: A

34. The term “target zone arrangement” refers to a: A) situation where countries adjust their national economic policies to maintain exchange rates

within some predetermined limits. B) system where several central banks act in a coordinated intervention to keep the price of one

country’s currency within reasonable trading ranges. C) system where currencies are pegged to gold, or to hard currency. D) system where local currencies are replaced by dollars.

ANSWER: A 35. During the period 1944-1971, the U.S. used a __________ system. A) euro exchange rate B) fixed C) dirty float D) flexible ANSWER: B 36. Which of the following are examples of currency controls? A) import restrictions. B) prohibition of remittance of funds. C) ceilings on granting credit to foreign firms. D) all of the above ANSWER: D 37. From a financial management perspective, which of the following is true regarding the

introduction of the Euro? A) U.S.-based MNCs are not subject to exchange rate risk when they have transactions in euros. B) The euro is pegged to all other European currencies. C) Transactions costs decline for MNCs that conduct transactions within Europe. D) The euro replaced the British pound.

ANSWER: C


38. Which of the following countries have not adopted the Euro as of January 1, 2004? A) Germany B) Italy C) Iceland D) Denmark

ANSWER: C 39. Which of the following are true about the Southeast Asian currency crisis? A) It was preceded by several years of large capital inflows to Asia. B) It was preceded by a five-year recession in Asia. C) Asian interest rates declined during the crisis. D) Asian exchange rates were converted from floating to fixed to resolve the crisis. ANSWER: D 40. Under a fixed exchange rate system, U.S. inflation would have a greater impact on inflation in

other countries than it would under a freely floating exchange rate system. A) true. B) false.

ANSWER: A

41. An advantage of a fixed exchange rate system is that governments are not required to constantly

intervene in the foreign exchange market to maintain exchange rates within specified boundaries. A) true. B) false.

ANSWER: B

42. Under the system known as the “dirty” float, official boundaries for the exchange rate exist, but

they are wider than they are under a fixed exchange rate system. A) true. B) false.

ANSWER: B

43. Under a pegged exchange rate system, the home currency’s value is pegged to a foreign currency

or to some unit of account. A) true. B) false.

ANSWER: A


44. A major advantage of the euro is the complete elimination of exchange rate risk on transactions between participating European countries, which encourages more trade and capital flows within Europe. A) true. B) false.

ANSWER: A

45. The European countries conforming to the euro are completely insulated from movements in the euro’s value with respect to other currencies. A) true. B) false.

ANSWER: B

46. The establishment of the euro allows for more consistent economic conditions across countries but

eliminates the power of any individual European country to solve local economic problems with its own unique monetary policy. A) true. B) false.

ANSWER: A

47. The Asian crisis is generally believed to have started in Japan.

A) true. B) false.

ANSWER: B

48. A possible reason why China was less affected by the Asian crisis is that its government exerts

more influence on private enterprise than the governments of other Asian countries. A) true. B) false.

ANSWER: A

49. Currency devaluation can boost a country’s exports, but currency revaluation can increase foreign

competition. A) true. B) false.

ANSWER: A

50. Market forces are the determinant of exchange rates in a freely floating exchange rate system.

A) true. B) false.

ANSWER: A


51. If a government wishes to stimulate its economy in the form of increased foreign demand for its country’s products, it could attempt to weaken its currency. A) true. B) false.

ANSWER: A

52. In a sterilized exchange rate arrangement, a country’s home currency value is pegged to a foreign

currency or to some unit of account. A) true. B) false.

ANSWER: B

53. The Bank of England is responsible for setting the monetary policy for the European countries

participating in the euro. A) true. B) false.

ANSWER: B

54. The Fed’s indirect method of intervention is to trade dollars for or against other currencies.

A) true. B) false.

ANSWER: B

55. A potential advantage of exchange rate target zones is that they may stabilize international trade

patterns by reducing exchange rate volatility. A) true. B) false.

ANSWER: A

56. The Bretton Woods Agreement created a system under which exchange rates are determined by

market forces without intervention by various governments. A) true. B) false.

ANSWER: B

57. Nonsterilized intervention is intervention by a central bank in the foreign exchange market without adjusting for the change in money supply. A) true. B) false.

ANSWER: A


58. The euro is pegged to other currencies of European countries that have not adopted the euro. A) true. B) false.

ANSWER: A

59. The Smithsonian Agreement was reached in September 1985 by seven major industrialized countries to systematically weaken the dollar. A) true. B) false.

ANSWER: B

60. An example of indirect intervention by the Bank of Japan would be for the Bank of Japan to use interest rates to increase the value of the Yen vs. the dollar. A) true. B) false.

ANSWER: A

61. A strong home currency can harm exports; exporters typically benefit from a weaker home country currency. A) true. B) false.

ANSWER: A

62. An advantage of freely floating exchange rates is that a country with floating exchange rates is

more insulated from unemployment problems in other countries. A) true. B) false.

ANSWER: A

63. All European countries now use the euro as their currency.

A) true. B) false.

ANSWER: B

64. A country with a currency board does not have control over its local interest rates.

A) true. B) false.

ANSWER: A


65. Dollarization refers to the replacement of local currency with U.S. dollars. A) true. B) false.

ANSWER: A

66. A country with fixed exchange rates often faces constraints on growth.

A) true. B) false.

ANSWER: A

67. The Bretton Woods Agreement called for the establishment of a single European currency.

A) true. B) false.

ANSWER: B

68. The European Central Bank is responsible for monetary policy in all participating European

countries. A) true. B) false.

ANSWER: A

429

Chapter 7

International Arbitrage and Interest Rate Parity 1. Due to _______, market forces should realign the relationship between the interest rate differential

of two currencies and the forward premium (or discount) on the forward exchange rate between the two currencies.

A) forward realignment arbitrage B) triangular arbitrage C) covered interest arbitrage D) locational arbitrage ANSWER: C 2. Due to _______, market forces should realign the spot rate of a currency among banks. A) forward realignment arbitrage B) triangular arbitrage C) covered interest arbitrage D) locational arbitrage ANSWER: D 3. Due to _______, market forces should realign the cross exchange rate between two foreign

currencies based on the spot exchange rates of the two currencies against the U.S. dollar. A) forward realignment arbitrage B) triangular arbitrage C) covered interest arbitrage D) locational arbitrage ANSWER: B 4. If interest rate parity exists, then _______ is not feasible. A) forward realignment arbitrage B) triangular arbitrage C) covered interest arbitrage D) locational arbitrage ANSWER: C


5. In which case will locational arbitrage most likely be feasible? A) One bank’s ask price for a currency is greater than another bank’s bid price for the currency. B) One bank’s bid price for a currency is greater than another bank’s ask price for the currency. C) One bank’s ask price for a currency is less than another bank’s ask price for the currency. D) One bank’s bid price for a currency is less than another bank’s bid price for the currency. ANSWER: B 6. When using _______, funds are not tied up for any length of time. A) covered interest arbitrage B) locational arbitrage C) triangular arbitrage D) B and C ANSWER: D 7. When using _______, funds are typically tied up for a significant period of time. A) covered interest arbitrage B) locational arbitrage C) triangular arbitrage D) B and C ANSWER: A 8. Assume that the interest rate in the home country of Currency X is a much higher interest rate than

the U.S. interest rate. According to interest rate parity, the forward rate of Currency X: A) should exhibit a discount. B) should exhibit a premium. C) should be zero (i.e., it should equal its spot rate). D) B or C ANSWER: A 9. If the interest rate is higher in the U.S. than in the United Kingdom, and if the forward rate of the

British pound (in U.S. dollars) is the same as the pound’s spot rate, then: A) U.S. investors could possibly benefit from covered interest arbitrage. B) British investors could possibly benefit from covered interest arbitrage. C) neither U.S. nor British investors could benefit from covered interest arbitrage. D) A and B ANSWER: B

Chapter 7: International Arbitrage and Interest Rate Parity 431

10. If the interest rate is lower in the U.S. than in the United Kingdom, and if the forward rate of the British pound is the same as its spot rate:

A) U.S. investors could possibly benefit from covered interest arbitrage. B) British investors could possibly benefit from covered interest arbitrage. C) neither U.S. nor British investors could benefit from covered interest arbitrage. D) A and B ANSWER: A 11. Assume that the U.S. investors are benefiting from covered interest arbitrage due to high interest

rates on euros. Which of the following forces should result from the act of this covered interest arbitrage?

A) downward pressure on the euro’s spot rate. B) downward pressure on the euro’s forward rate. C) downward pressure on the U.S. interest rate. D) upward pressure on the euro’s interest rate. ANSWER: B 12. Assume that Swiss investors are benefiting from covered interest arbitrage due to a high U.S.

interest rate. Which of the following forces results from the act of this covered interest arbitrage? A) upward pressure on the Swiss franc’s spot rate. B) upward pressure on the U.S. interest rate. C) downward pressure on the Swiss interest rate. D) upward pressure on the Swiss franc’s forward rate. ANSWER: D 13. Assume that a U.S. firm can invest funds for one year in the U.S. at 12% or invest funds in

Mexico at 14%. The spot rate of the peso is $.10 while the one-year forward rate of the peso is $.10. If U.S. firms attempt to use covered interest arbitrage, what forces should occur?

A) spot rate of peso increases; forward rate of peso decreases. B) spot rate of peso decreases; forward rate of peso increases. C) spot rate of peso decreases; forward rate of peso decreases. D) spot rate of peso increases; forward rate of peso increases. ANSWER: A


14. Assume the bid rate of a New Zealand dollar is $.33 while the ask rate is $.335 at Bank X. Assume the bid rate of the New Zealand dollar is $.32 while the ask rate is $.325 at Bank Y. Given this information, what would be your gain if you use $1,000,000 and execute locational arbitrage? That is, how much will you end up with over and above the $1,000,000 you started with?

A) $15,385. B) $15,625. C) $22,136. D) $31,250. ANSWER: A SOLUTION: $1,000,000/$.325 = NZ$3,076,923 x $.33 = $1,015,385. Thus, the profit is $15,385. 15. Based on interest rate parity, the larger the degree by which the foreign interest rate exceeds the

U.S. interest rate, the: A) larger will be the forward discount of the foreign currency. B) larger will be the forward premium of the foreign currency. C) smaller will be the forward premium of the foreign currency. D) smaller will be the forward discount of the foreign currency. ANSWER: A 16. Assume the following information: You have $1,000,000 to invest Current spot rate of pound = $1.30 90-day forward rate of pound = $1.28 3-month deposit rate in U.S. = 3% 3-month deposit rate in Great Britain = 4% If you use covered interest arbitrage for a 90-day investment, what will be the amount of U.S.

dollars you will have after 90 days? A) $1,024,000. B) $1,030,000. C) $1,040,000. D) $1,034,000. E) none of the above ANSWER: A

SOLUTION: $1,000,000/$1.30 = 769,231 pounds x (1.04) = 800,000 pounds x 1.28 = $1,024,000


17. Assume that the U.S. interest rate is 10%, while the British interest rate is 15%. If interest rate parity exists, then:

A) British investors who invest in the United Kingdom will achieve the same return as U.S. investors who invest in the U.S.

B) U.S. investors will earn a higher rate of return when using covered interest arbitrage than what they would earn in the U.S.

C) U.S. investors will earn 15% whether they use covered interest arbitrage or invest in the U.S. D) U.S. investors will earn 10% whether they use covered interest arbitrage or invest in the U.S. ANSWER: D 18. Assume the following information: U.S. investors have $1,000,000 to invest 1-year deposit rate offered on U.S. dollars = 12% 1-year deposit rate offered on Singapore dollars = 10% 1-year forward rate of Singapore dollars = $.412 Spot rate of Singapore dollar = $.400 Given this information: A) interest rate parity exists and covered interest arbitrage by U.S. investors results in the same

yield as investing domestically. B) interest rate parity doesn’t exist and covered interest arbitrage by U.S. investors results in a

yield above what is possible domestically. C) interest rate parity exists and covered interest arbitrage by U.S. investors results in a yield

above what is possible domestically. D) interest rate parity doesn’t exist and covered interest arbitrage by U.S. investors results in a

yield below what is possible domestically. ANSWER: B SOLUTION: $1,000,000/$.400 = S$2,500,000 x (1.1) = S$2,750,000 x $.412 = $1,133,000 Yield = ($1,133,000 - $1,000,000)/$1,000,000 = 13.3% This yield exceeds what is possible domestically.


19. Assume the following information: Current spot rate of New Zealand dollar = $.41 Forecasted spot rate of New Zealand dollar 1 year from now = $.43 One-year forward rate of the New Zealand dollar = $.42 Annual interest rate on New Zealand dollars = 8% Annual interest rate on U.S. dollars = 9% Given the information in this question, the return from covered interest arbitrage by U.S. investors

with $500,000 to invest is _______%. A) about 11.97 B) about 9.63 C) about 11.12 D) about 11.64 E) about 10.63 ANSWER: E SOLUTION: $500,000/$.41 = NZ$1,219,512 x (1.08) = NZ$1,317,073 x .42 = $553,171 Yield = ($553,171 - $500,000)/$500,000 = 10.63% 20. Assume the following bid and ask rates of the pound for two banks as shown below: Bid Ask Bank A $1.41 $1.42 Bank B $1.39 $1.40 As locational arbitrage occurs: A) the bid rate for pounds at Bank A will increase; the ask rate for pounds at Bank B will

increase. B) the bid rate for pounds at Bank A will increase; the ask rate for pounds at Bank B will

decrease. C) the bid rate for pounds at Bank A will decrease; the ask rate for pounds at Bank B will

decrease. D) the bid rate for pounds at Bank A will decrease; the ask rate for pounds at Bank B will

increase. ANSWER: D


21. Assume the bid rate of a Singapore dollar is $.40 while the ask rate is $.41 at Bank X. Assume the bid rate of a Singapore dollar is $.42 while the ask rate is $.425 at Bank Z. Given this information, what would be your gain if you use $1,000,000 and execute locational arbitrage? That is, how much will you end up with over and above the $1,000,000 you started with?

A) $11,764. B) -$11,964. C) $36,585. D) $24,390. E) $18,219. ANSWER: D SOLUTION: $1,000,000/$.41 = S2,439,024 x $.42 = $1,024,390 22. Based on interest rate parity, the larger the degree by which the U.S. interest rate exceeds the

foreign interest rate, the: A) larger will be the forward discount of the foreign currency. B) larger will be the forward premium of the foreign currency. C) smaller will be the forward premium of the foreign currency. D) smaller will be the forward discount of the foreign currency. ANSWER: B 23. Assume the following exchange rates: $1 = NZ$3, NZ$1 = MXP2, and $1 = MXP5. Given this

information, as you and others perform triangular arbitrage, the exchange rate of the New Zealand dollar (NZ) with respect to the U.S. dollar should _______, and the exchange rate of the Mexican peso (MXP) with respect to the U.S. dollar should _______.

A) appreciate; depreciate B) depreciate; appreciate C) depreciate; depreciate D) appreciate; appreciate E) remain stable; appreciate ANSWER: A


24. Assume the following information: Spot rate today of Swiss franc = $.60 1-year forward rate as of today for Swiss franc = $.63 Expected spot rate 1 year from now = $.64 Rate on 1-year deposits denominated in Swiss francs = 7% Rate on 1-year deposits denominated in U.S. dollars = 9% From the perspective of U.S. investors with $1,000,000, covered interest arbitrage would yield a

rate of return of ______%. A) 5.00 B) 12.35 C) 15.50 D) 14.13 E) 11.22 ANSWER: B SOLUTION: $1,000,000/$.60 = SF1,666,667 x (1.07) = SF1,783,333 x $.63 = $1,123,500 Yield = ($1,123,500 - $1,000,000)/$1,000,000 = 12.35% 25. Assume the following information for a bank quoting on spot exchange rates: Exchange rate of Singapore dollar in U.S. $ = $ .32 Exchange rate of pound in U.S. $ = $1.50 Exchange rate of pound in Singapore dollars = S$4.50 Based on the information given, as you and others perform triangular arbitrage, what should

logically happen to the spot exchange rates? A) The Singapore dollar value in U.S. dollars should appreciate, the pound value in U.S. dollars

should appreciate, and the pound value in Singapore dollars should depreciate. B) The Singapore dollar value in U.S. dollars should depreciate, the pound value in U.S. dollars

should appreciate, and the pound value in Singapore dollars should depreciate. C) The Singapore dollar value in U.S. dollars should depreciate, the pound value in U.S. dollars

should appreciate, and the pound value in Singapore dollars should appreciate. D) The Singapore dollar value in U.S. dollars should appreciate, the pound value in U.S. dollars

should depreciate, and the pound value in Singapore dollars should appreciate. ANSWER: D


26. Assume the British pound is worth $1.60, and the Canadian dollar is worth $.80. What is the value of the Canadian dollar in pounds?

A) 2.0. B) 2.40. C) .80. D) .50. E) none of the above ANSWER: D SOLUTION: $.80/$1.60 = 0.50 27. Assume that the euro’s interest rates are higher than U.S. interest rates, and that interest rate parity

exists. Which of the following is true? A) Americans using covered interest arbitrage earn the same rate of return as Germans who

attempt covered interest arbitrage. B) Americans who invest in the U.S. earn the same rate of return as Germans who attempt

covered interest arbitrage. C) Americans who invest in the U.S. earn the same rate of return as Germans who invest in

Germany D) A and B E) None of the above ANSWER: E 28. Assume the U.S. interest rate is 2% higher than the Swiss rate, and the forward rate of the Swiss

franc has a 4% premium. Given this information: A) Swiss investors who attempt covered interest arbitrage earn the same rate of return as if they

invested in Switzerland. B) U.S. investors who attempt covered interest arbitrage earn a higher rate of return than if they

invested in the U.S. C) A and B D) none of the above ANSWER: B 29. Assume that British interest rates are higher than U.S. rates, and that the spot rate equals the

forward rate. Covered interest arbitrage puts _______ pressure on the pound’s spot rate, and _______ pressure on the pound’s forward rate.

A) downward; downward B) downward; upward C) upward; downward D) upward; upward ANSWER: C


30. Assume that interest rate parity holds, and the euro’s interest rate is 9% while the U.S. interest rate is 12%. Then the euro’s interest rate increases to 11% while the U.S. interest rate remains the same. As a result of the increase in the interest rate on euros, the euro’s forward _______ will _______ in order to maintain interest rate parity.

A) discount; increase B) discount; decrease C) premium; increase D) premium; decrease ANSWER: D 31. Assume the bid rate of a Swiss franc is $.57 while the ask rate is $.579 at Bank X. Assume the bid

rate of the Swiss franc is $.560 while the ask rate is $.566 at Bank Y. Given this information, what would be your gain if you use $1,000,000 and execute locational arbitrage? That is, how much will you end up with over and above the $1,000,000 you started with?

A) $7,067. B) $8,556. C) $10,114. D) $12,238. ANSWER: A

SOLUTION: $1,000,000/$.566 = SF1,766,784 x $.57 = $1,007,067. Thus, the profit is $7,067. 32. Assume the following information: You have $1,000,000 to invest Current spot rate of pound = $1.60 90-day forward rate of pound = $1.57 3-month deposit rate in U.S. = 3% 3-month deposit rate in U.K. = 4% If you use covered interest arbitrage for a 90-day investment, what will be the amount of U.S.

dollars you will have after 90 days? A) $1,020,500. B) $1,045,600. C) $1,073,330. D) $1,094,230. E) $1,116,250.

ANSWER: A

SOLUTION: $1,000,000/$1.60 = 625,000 pounds x (1.04) = 650,000 pounds x 1.57 = $1,020,500


33. Assume the following information: U.S. investors have $1,000,000 to invest 1-year deposit rate offered by U.S. banks = 12% 1-year deposit rate offered on Swiss francs = 10% 1-year forward rate of Swiss francs = $.62 Spot rate of Swiss franc = $.60 Given this information: A) interest rate parity exists and covered interest arbitrage by U.S. investors results in the same

yield as investing domestically. B) interest rate parity doesn’t exist and covered interest arbitrage by U.S. investors results in a

yield above what is possible domestically. C) interest rate parity exists and covered interest arbitrage by U.S. investors results in a yield

above what is possible domestically. D) interest rate parity doesn’t exist and covered interest arbitrage by U.S. investors results in a

yield below what is possible domestically. ANSWER: B SOLUTION: $1,000,000/$.60 = SF1,666,667 x (1.1) = SF1,833,333 x $.62 = $1,136,667 Yield = ($1,136,667 - $1,000,000)/$1,000,000 = 13.7% This yield exceeds what is possible domestically. 34. Assume the following information: Current spot rate of Australian dollar = $.64 Forecasted spot rate of Australian dollar 1 year from now = $.59 1-year forward rate of Australian dollar = $.62 Annual interest rate for Australian dollar deposit = 9% Annual interest rate in the U.S. = 6% Given the information in this question, the return from covered interest arbitrage by U.S. investors

with $500,000 to invest is _______%. A) about 6.00 B) about 9.00 C) about 7.33 D) about 8.14 E) about 5.59 ANSWER: E SOLUTION: $500,000/$.64 = A$781,250 x (1.09) = A$851,563 x $.62 = $527,969 Yield = ($527,969 - $500,000)/$500,000 = 5.59%


35. Assume the following bid and ask rates of the pound for two banks as shown below: Bid Ask Bank C $1.61 $1.63 Bank D $1.58 $1.60 As locational arbitrage occurs: A) the bid rate for pounds at Bank C will increase; the ask rate for pounds at Bank D will

increase. B) the bid rate for pounds at Bank C will increase; the ask rate for pounds at Bank D will

decrease. C) the bid rate for pounds at Bank C will decrease; the ask rate for pounds at Bank D will

decrease. D) the bid rate for pounds at Bank C will decrease; the ask rate for pounds at Bank D will

increase. ANSWER: D 36. Assume the bid rate of an Australian dollar is $.60 while the ask rate is $.61 at Bank Q. Assume

the bid rate of an Australian dollar is $.62 while the ask rate is $.625 at Bank V. Given this information, what would be your gain if you use $1,000,000 and execute locational arbitrage? That is, how much will you end up with over and above the $1,000,000 you started with?

A) $10,003. B) $12,063. C) $14,441. D) $16,393. E) $18,219. ANSWER: D SOLUTION: $1,000,000/$.61 = A$1,639,344 x $.62 = $1,016,393. thus, the profit is $16,393.


37. Assume the following information for a bank quoting on spot exchange rates: Exchange rate of Singapore dollar in U.S. $ = $.60 Exchange rate of pound in U.S. $ = $1.50 Exchange rate of pound in Singapore dollars = S$2.6 Based on the information given, as you and others perform triangular arbitrage, what should

logically happen to the spot exchange rates? A) The Singapore dollar value in U.S. dollars should appreciate, the pound value in U.S. dollars

should appreciate, and the pound value in Singapore dollars should depreciate. B) The Singapore dollar value in U.S. dollars should depreciate, the pound value in U.S. dollars

should appreciate, and the pound value in Singapore dollars should depreciate. C) The Singapore dollar value in U.S. dollars should depreciate, the pound value in U.S. dollars

should appreciate, and the pound value in Singapore dollars should appreciate. D) The Singapore dollar value in U.S. dollars should appreciate, the pound value in U.S. dollars

should depreciate, and the pound value in Singapore dollars should appreciate. ANSWER: B 38. Bank A quotes a bid rate of $.300 and an ask rate of $.305 for the Malaysian ringgit (MYR). Bank

B quotes a bid rate of $.306 and an ask rate of $.310 for the ringgit. What will be the profit for an investor who has $500,000 available to conduct locational arbitrage? A) $2,041,667. B) $9,804. C) $500. D) $1,639.

ANSWER: D

SOLUTION: $500,000/$.305 = MYR1,639,344 x $.306 = $501,639. Thus, the profit is $1,639.

39. Which of the following is an example of triangular arbitrage initiation?

A) buying a currency at one bank’s ask and selling at another bank’s bid, which is higher than the former bank’s ask.

B) buying Singapore dollars from a bank (quoted at $.55) that has quoted the South African rand (SAR)/Singapore dollar (S$) exchange rate at SAR2.50 when the spot rate for the rand is $.20.

C) buying Singapore dollars from a bank (quoted at $.55) that has quoted the South African rand/Singapore dollar exchange rate at SAR3.00 when the spot rate for the rand is $.20.

D) converting funds to a foreign currency and investing the funds overseas.

ANSWER: C


40. You 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 $.023, while quotes for the Australian dollar are $.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

ANSWER: A

SOLUTION: $.023/$.576 x THB1,000 = A$39.93.

41. National Bank quotes the following for the British pound and the New Zealand dollar:

Quoted Bid Price Quoted Ask Price Value of a British pound (£) in $ $1.61 $1.62 Value of a New Zealand dollar (NZ$) in $ $.55 $.56 Value of a British pound in New Zealand dollars NZ$2.95 NZ$2.96

Assume you have $10,000 to conduct triangular arbitrage. What is your profit from implementing this strategy? A) $77.64. B) $197.53. C) $15.43. D) $111.80.

ANSWER: C SOLUTION: $10,000/$1.62 = £6,172.84 x 2.95 = NZ$18,209.88 x $.55 = $10,015.43. Thus, the profit is $15.43.


42. Assume the following information: You have $900,000 to invest Current spot rate of Australian dollar (A$) = $.62 180-day forward rate of the Australian dollar = $.64 180-day interest rate in the U.S. = 3.5% 180-day interest rate in Australia = 3.0% If you conduct covered interest arbitrage, what is the dollar profit you will have realized after 180 days? A) $56,903. B) $61,548. C) $27,000. D) $31,500.

ANSWER: A

SOLUTION: $900,000/$.62 = A$1,451,612 x (1.03) = A$1,495,161 x $.64 = $956,903. Thus, the profit is $56,903.

43. Assume the following information: You have $400,000 to invest Current spot rate of Sudanese dinar (SDD) = $.00570 90-day forward rate of the dinar = $.00569 90-day interest rate in the U.S. = 4.0% 90-day interest rate in Sudan = 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

ANSWER: D

SOLUTION: $400,000/$.0057 = SDD70,175,438.60 x (1.042) = SDD73,122,807.02 x $.00569 = $416,068.77


44. Assume the following information:

You have $300,000 to invest The spot bid rate for the euro (€) is $1.08 The spot ask quote for the euro is $1.10 The 180-day forward rate (bid) of the euro is $1.08 The 180-day forward rate (ask) of the euro is $1.10 The 180-day interest rate in the U.S. is 6% The 180-day interest rate in Europe is 8%

If you conduct covered interest arbitrage, what amount will you have after 180 days?

A) $318,109.10. B) $330,000.00. C) $312,218.20. D) $323,888.90. E) none of the above

ANSWER: A SOLUTION: $300,000/$1.10 = €277,777.80 x (1.08)

= €294,444.40 x $1.08 = $318,109.10

45. Refer to the previous question. If you conduct covered interest arbitrage, what is your percentage

return after 180 days? Is covered interest arbitrage feasible in this situation? A) 7.96%; feasible B) 6.04%; feasible C) 6.04%; not feasible D) 4.07%; not feasible E) 10.00%; feasible

ANSWER: B SOLUTION: $318,109.10/$300,000 – 1 = 6.04%. Since this rate is slightly higher than the U.S. interest rate of 6%, covered interest arbitrage is feasible.

46. According to interest rate parity (IRP):

A) the forward rate differs from the spot rate by a sufficient amount to offset the inflation differential between two currencies.

B) the future spot rate differs from the current spot rate by a sufficient amount to offset the interest rate differential between two currencies.

C) the future spot rate differs from the current spot rate by a sufficient amount to offset the inflation differential between two currencies.

D) the forward rate differs from the spot rate by a sufficient amount to offset the interest rate differential between two currencies.

ANSWER: D


47. Assume that interest rate parity holds. The Mexican interest rate is 50%, and the U.S. interest rate is 8%. Subsequently, the U.S. interest rate decreases to 7%. According to interest rate parity, the peso’s forward ___________ will __________. A) premium; increase B) discount; decrease C) discount; increase D) premium; decrease

ANSWER: C 48. If the cross exchange rate of two nondollar currencies implied by their individual spot rates with

respect to the dollar is less than the cross exchange rate quoted by a bank, locational arbitrage is possible. A) true. B) false.

ANSWER: B

49. For locational arbitrage to be possible, one bank’s ask rate must be higher than another bank’s bid

rate for a currency. A) true. B) false.

ANSWER: B

50. Assume locational arbitrage is possible and involves two different banks. The realignment that

would occur due to market forces would increase one bank’s ask rate and would decrease the other bank’s bid rate. A) true. B) false.

ANSWER: A

51. Triangular arbitrage tends to force a relationship between the interest rates of two countries and

their forward exchange rate premium or discount. A) true. B) false.

ANSWER: B

52. The interest rate on euros is 8%. The interest rate in the U.S. is 5%. The euro’s forward rate should exhibit a premium of about 3%. A) true. B) false.

ANSWER: B


53. Capitalizing on discrepancies in quoted prices involving no risk and no investment of funds is referred to as interest rate parity. A) true. B) false.

ANSWER: B

54. Realignment in the exchange rates of banks will eliminate locational arbitrage. More specifically,

market forces will increase the ask rate of the bank from which the currency was bought to conduct locational arbitrage and will decrease the bid rate of the bank to which the currency was sold to conduct locational arbitrage. A) true. B) false.

ANSWER: A

55. Locational arbitrage involves investing in a foreign country and covering against exchange rate

risk by engaging in forward contracts. A) true. B) false.

ANSWER: B

56. To capitalize on high foreign interest rates using covered interest arbitrage, a U.S. investor would

convert dollars to the foreign currency, invest in the foreign country, and simultaneously sell the foreign currency forward. A) true. B) false.

ANSWER: A

57. If interest rate parity (IRP) exists, then the rate of return achieved from covered interest arbitrage

should be equal to the rate available in the foreign country. A) true. B) false.

ANSWER: B

58. If interest rate parity (IRP) exists, then triangular arbitrage will not be possible.

A) true. B) false.

ANSWER: B

447

Chapter 8

Relationships among Inflation, Interest Rates, and Exchange Rates

1. Assume a two-country world: Country A and Country B. Which of the following is correct about

purchasing power parity (PPP) as related to these two countries? A) If Country A’s inflation rate exceeds Country B’s inflation rate, Country A’s currency will

weaken. B) If Country A’s interest rate exceeds Country B’s inflation rate, Country A’s currency will

weaken. C) If Country A’s interest rate exceeds Country B’s inflation rate, Country A’s currency will

strengthen. D) If Country B’s inflation rate exceeds Country A’s inflation rate, Country A’s currency will

weaken. ANSWER: A 2. Given a home country and a foreign country, purchasing power parity (PPP) suggests that: A) a home currency will depreciate if the current home inflation rate exceeds the current foreign

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

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

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

inflation rate. ANSWER: D


3. The international Fisher effect (IFE) suggests that: A) a home currency will depreciate if the current home interest rate exceeds the current foreign

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

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

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

inflation rate. ANSWER: A 4. Because there are a variety of factors in addition to inflation that affect exchange rates, this will: A) reduce the probability that PPP shall hold. B) increase the probability that PPP shall hold. C) increase the probability the IFE will hold. D) B and C ANSWER: A 5. Because there are sometimes no substitutes for traded goods, this will: A) reduce the probability that PPP shall hold. B) increase the probability that PPP shall hold. C) increase the probability the IFE will hold. D) B and C ANSWER: A 6. According to the IFE, if British interest rates exceed U.S. interest rates: A) the British pound’s value will remain constant. B) the British pound will depreciate against the dollar. C) the British inflation rate will decrease. D) the forward rate of the British pound will contain a premium. E) today’s forward rate of the British pound will equal today’s spot rate. ANSWER: B 7. Given a home country and a foreign country, the international Fisher effect (IFE) suggests that: A) the nominal interest rates of both countries are the same. B) the inflation rates of both countries are the same. C) the exchange rates of both countries will move in a similar direction against other currencies. D) none of the above ANSWER: D

Chapter 8: Relationships among Inflation, Interest Rates, and Exchange Rates 449

8. Given a home country and a foreign country, purchasing power parity suggests that: A) the inflation rates of both countries will be the same. B) the nominal interest rates of both countries will be the same. C) A and B D) none of the above ANSWER: D 9. If interest rates on the euro are consistently below U.S. interest rates, then for the international

Fisher effect (IFE) to hold: A) the value of the euro would often appreciate against the dollar. B) the value of the euro would often depreciate against the dollar. C) the value of the euro would remain constant most of the time.

D) the value of the euro would appreciate in some periods and depreciate in other periods, but on average have a zero rate of appreciation.

ANSWER: A 10. If the international Fisher effect (IFE) did not hold based on historical data, then this suggests that: A) some corporations with excess cash can lock in a guaranteed higher return on future foreign

short-term investments. B) some corporations with excess cash could have generated profits on average from covered

interest arbitrage. C) some corporations with excess cash could have generated higher profits on average from

foreign short-term investments than from domestic short-term investments. D) most corporations that consistently invest in foreign short-term investments would have

generated the same profits (on average) as from domestic short-term investments. ANSWER: C 11. Under purchasing power parity, the future spot exchange rate is a function of the initial spot rate in

equilibrium and: A) the income differential. B) the forward discount or premium. C) the inflation differential. D) none of the above ANSWER: C


12. According to the international Fisher effect, if U.S. investors expect a 5% rate of domestic inflation over one year, and a 2% rate of inflation in European countries that use the euro, and require a 3% real return on investments over one year, the nominal interest rate on one-year U.S. Treasury securities would be:

A) 2%. B) 3%. C) -2%. D) 5%. E) 8%. ANSWER: E SOLUTION: 5% + 3% = 8% 13. According to the international Fisher effect, if investors in all countries require the same real rate

of return, the differential in nominal interest rates between any two countries: A) follows their exchange rate movement. B) is due to their inflation differentials. C) is zero. D) is constant over time. E) C and D ANSWER: B 14. Assume that U.S. and British investors require a real return of 2%. If the nominal U.S. interest

rate is 15%, and the nominal British rate is 13%, then according to the IFE, the British inflation rate is expected to be about _______ the U.S. inflation rate, and the British pound is expected to _______.

A) 2 percentage points above; depreciate by about 2% B) 3 percentage points above; depreciate by about 3% C) 3 percentage points below; appreciate by about 3% D) 3 percentage points below; depreciate by about 3% E) 2 percentage points below; appreciate by about 2% ANSWER: E 15. Assume U.S. and Swiss investors require a real rate of return of 3%. Assume the nominal U.S.

interest rate is 6% and the nominal Swiss rate is 4%. According to the international Fisher effect, the franc will _______ by about _______.

A) appreciate; 3% B) appreciate; 1% C) depreciate; 3% D) depreciate; 2% E) appreciate; 2% ANSWER: E


16. Assume that the U.S. and Chile nominal interest rates are equal. Then, the U.S. nominal interest rate decreases while the Chilean nominal interest rate remains stable. According to the international Fisher effect, this implies expectations of _______ than before, and that the Chilean peso should _______ against the dollar.

A) lower U.S. inflation; depreciate B) lower U.S. inflation; appreciate C) higher U.S. inflation; depreciate D) higher U.S. inflation; appreciate ANSWER: A 17. According to the international Fisher effect, if Venezuela has a much higher nominal rate than

other countries, its inflation rate will likely be _______ than other countries, and its currency will _______.

A) lower; strengthen B) lower; weaken C) higher; weaken D) higher; strengthen ANSWER: C 18. If interest rate parity holds, then the one-year forward rate of a currency will ______ the predicted

spot rate of the currency in one year according to the international Fisher effect. A) greater than B) less than C) equal to D) answer is dependent on whether the forward rate has a discount or premium ANSWER: C 19. The Fisher effect is used to determine the: A) real inflation rate. B) real interest rate. C) real spot rate. D) real forward rate. ANSWER: B 20. Latin American countries have historically experienced relatively high inflation, and their

currencies have weakened. This information is somewhat consistent with the concept of: A) interest rate parity. B) locational arbitrage. C) purchasing power parity. D) the exchange rate mechanism. ANSWER: C


21. Assume that the inflation rate in Barbados is 3.20%, while the inflation rate in the U.S. is 3.00%. According to PPP, the Barbados dollar (BBD) should ___________ by _________%. A) appreciate; 0.1938% B) depreciate; 0.1938% C) appreciate; 0.1942% D) depreciate; 0.1942%

ANSWER: B

SOLUTION: (1.03/1.032) - 1 = -.1938%.

22. The inflation rate in the U.S. is 3%, while the inflation rate in Japan is 1.3%. The current exchange

rate for the Japanese yen (¥) is $0.0075. After supply and demand for the Japanese yen has adjusted in the manner suggested by purchasing power parity, the new exchange rate for the yen will be: A) $0.0076. B) $0.0075. C) $0.0074. D) $0.0131. E) none of the above

ANSWER: A SOLUTION: (1.03/1.013) x $.0075 = $.0076

23. Assume that the U.S. inflation rate rate is higher than the New Zealand inflation rate. This will

cause U.S. consumers to ______________ their imports from New Zealand and New Zealand consumers to ______________ their imports from the U.S. According to purchasing power parity (PPP), this will results in a(n) ___________ of the New Zealand dollar (NZ$). A) reduce; increase; appreciation B) increase; reduce; appreciation C) reduce; increase; depreciation D) reduce; increase; appreciation

ANSWER: B


24. The following regression analysis was conducted for the inflation rate information and exchange rate of the British pound:

e a a IIBPUS

B

= +++

−⎛

⎝⎜

⎞

⎠⎟ +0 1

11

1( )( )

μ

Regression results indicate that a0 = 0 and a1 2= . Therefore:

A) purchasing power parity holds. B) purchasing power parity overestimated the exchange rate change during the period under

examination. C) purchasing power parity underestimated the exchange rate change during the period under

examination. D) purchasing power parity will overestimate the exchange rate change of the British pound in

the future.

ANSWER: C 25. Which of the following is indicated by research regarding purchasing power parity (PPP)?

A) PPP clearly holds in the short run. B) Deviations from PPP are reduced in the long run. C) PPP clearly holds in the long run. D) There is no relationship between inflation differentials and exchange rate movements in the

short run or long run.

ANSWER: B 26. Nominal interest rates in Cyprus are 7%, while nominal interest rates in the U.S. are 5%. 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) $1.53. C) $1.43. D) $1.57.

ANSWER: A

SOLUTION: (1.05/1.07) x (1.50) = $1.47.


27. If nominal British interest rates are 3% and nominal U.S. interest rates are 6%, then the British pound (£) is expected to ____________ by about _________%, according to the international Fisher effect (IFE). A) depreciate; 2.9 B) appreciate; 2.9 C) depreciate; 1.0 D) appreciate; 1.0 E) none of the above

ANSWER: B SOLUTION: (1.06/1.03) – 1 = 2.9%.

28. You have an opportunity to invest in Australia at an interest rate of 8%. Moreover, you expect the

Australian dollar (A$) to appreciate by 2%. Your effective return from this investment is: A) 8.00%. B) 6.00%. C) 10.16%. D) 5.88%.

ANSWER: C

SOLUTION: (1.08 x 1.02) - 1 = 10.16%.

29. Which of the following is not true regarding IRP, PPP, and the IFE?

A) IRP suggests that a currency’s spot rate will change according to interest rate differentials. B) PPP suggests that a currency’s spot rate will change according to inflation differentials. C) The IFE suggests that a currency’s spot rate will change according to interest rate differentials. D) All of the above are true.

ANSWER: A

30. The relative form of purchasing power parity (PPP) accounts for the possibility of market

imperfections such as transportation costs, tariffs, and quotas in establishing a relationship between inflation rates and exchange rate changes. A) true. B) false.

ANSWER: A

31. According to the international Fisher effect (IFE), the exchange rate percentage change should be

approximately equal to the differential in income levels between two countries. A) true. B) false.

ANSWER: B


32. Research indicates that deviations from purchasing power parity (PPP) are reduced over the long run. A) true. B) false.

ANSWER: A

33. The IFE theory suggests that foreign currencies with relatively high interest rates will appreciate

because the high nominal interest rates reflect expected inflation. A) true. B) false.

ANSWER: B

34. The interest rate parity theory offers a direct explanation regarding why exchange rates change over time. A) true. B) false.

ANSWER: B

35. If interest rate parity holds, and the international Fisher effect (IFE) holds, foreign currencies with

relatively high interest rates should have forward discounts and those currencies would be expected to depreciate. A) true. B) false.

ANSWER: A

36. Interest rate parity can only hold if purchasing power parity holds. A) true. B) false. ANSWER: B

37. If interest rate parity holds, then the international Fisher effect must hold. A) true. B) false.

ANSWER: B

456

Chapter 9

Forecasting Exchange Rates 1. Which of the following forecasting techniques would best represent the use of today’s forward

exchange rate to forecast the future exchange rate? A) fundamental forecasting. B) market-based forecasting. C) technical forecasting. D) mixed forecasting. ANSWER: B 2. Which of the following forecasting techniques would best represent sole use of today’s spot

exchange rate of the euro to forecast the euro’s future exchange rate? A) fundamental forecasting. B) market-based forecasting. C) technical forecasting. D) mixed forecasting. ANSWER: B 3. Which of the following forecasting techniques would best represent the use of relationships

between economic factors and exchange rate movements to forecast the future exchange rate? A) fundamental forecasting. B) market-based forecasting. C) technical forecasting. D) mixed forecasting. ANSWER: A 4. Which of the following forecasting techniques would best represent the sole use of the pattern of

historical currency values of the euro to predict the euro’s future currency value? A) fundamental forecasting. B) market-based forecasting. C) technical forecasting. D) mixed forecasting. ANSWER: C

Chapter 9: Forecasting Exchange Rates 457

5. If a particular currency is consistently declining substantially over time, then a market-based forecast will usually have:

A) underestimated the future exchange rates over time. B) overestimated the future exchange rates over time. C) forecasted future exchange rates accurately. D) forecasted future exchange rates inaccurately but without any bias toward consistent

underestimating or overestimating. ANSWER: B 6. According to the text, the analysis of currencies forecasted with use of the forward rate suggests

that: A) currencies exhibited about the same mean forecast errors as a percent of the realized value. B) the Canadian dollar can be forecasted by U.S. firms with greater accuracy than other

currencies. C) the Swiss franc can be forecasted by U.S. firms with greater accuracy than other currencies. D) none of the above ANSWER: B 7. Assume the following information: Predicted Value of Realized Value of Period New Zealand Dollar New Zealand Dollar 1 $.52 $.50 2 .54 .60 3 .44 .40 4 .51 .50 Given this information, the mean absolute forecast error as a percentage of the realized value is

about: A) 1.5%. B) 26%. C) 6%. D) 6.5%. E) none of the above ANSWER: D SOLUTION: [|$.52 - $.50|/$.50 + |$.54 - $.60|/$.60 + |$.44 - $.40|/$.40 + |$.51 - $.50|/$.50)]/4 = [.04 + .10 + .10 + .02]/4 = .065 = 6.50%


8. If it was determined that the movement of exchange rates was not related to previous exchange rate values, this implies that a __________ is not valuable for speculating on expected exchange rate movements.

A) technical forecast technique B) fundamental forecast technique C) none of the above D) all of the above ANSWER: A 9. Which of the following is true? A) Nominal forecast errors cannot be negative. B) Nominal forecast errors are negative when the forecasted rate exceeds the realized rate. C) Absolute forecast errors are negative when the forecasted rate exceeds the realized rate. D) None of the above. ANSWER: D 10. Which of the following is true according to the text? A) Forecasts in recent years have been very accurate. B) Use of the absolute forecast error as a percent of the realized value is a good measure to use in

detecting a forecast bias. C) Forecasting errors are smaller when focused on longer term periods. D) None of the above. ANSWER: D 11. A fundamental forecast that uses multiple values of the influential factors is an example of: A) sensitivity analysis. B) discriminant analysis. C) technical analysis. D) factor analysis. ANSWER: A 12. When the value from the prior period of an influential factor affects the forecast in the future

period, this is an example of a: A) lagged input. B) instantaneous input. C) simultaneous input. D) B and C ANSWER: A


13. Assume a forecasting model uses inflation differentials and interest rate differentials to forecast the exchange rate. Assume the regression coefficient of the interest rate differential variable is -.5, and the coefficient of the inflation differential variable is .4. Which of the following is true?

A) The interest rate variable is inversely related to the exchange rate, and the inflation variable is directly (positively) related to the interest rate variable.

B) The interest rate variable is inversely related to the exchange rate, and the inflation variable is directly related to the exchange rate.

C) The interest rate variable is directly related to the exchange rate, and the inflation variable is directly related to the exchange rate.

D) The interest rate variable is directly related to the exchange rate, and the inflation variable is directly related to the interest rate variable.

ANSWER: B 14. Which of the following is not a limitation of fundamental forecasting? A) uncertain timing of impact. B) forecasts are needed for factors that have a lagged impact. C) omission of other relevant factors from the model. D) possible change in sensitivity of the forecasted variable to each factor over time. E) none of the above ANSWER: B 15. Assume that interest rate parity holds. The U.S. five-year interest rate is 5% annualized, and the

Mexican five-year interest rate is 8% annualized. Today’s spot rate of the Mexican peso is $.20. What is the approximate five-year forecast of the peso’s spot rate if the five-year forward rate is used as a forecast?

A) $.131. B) $.226. C) $.262. D) $.140. E) $.174. ANSWER: E SOLUTION: (1.05)5/(1.08)5 -1 = -13%; $.20[1 + (-13%)] = $.174 16. Assume that the forward rate is used to forecast the spot rate. The forward rate of the Canadian

dollar contains a 6% discount. Today’s spot rate of the Canadian dollar is $.80. The spot rate forecasted for one year ahead is:

A) $.860. B) $.848. C) $.740. D) $.752. E) none of the above ANSWER: D SOLUTION: $.80 × [1 + (-6%)] = $.752


17. If today’s exchange rate reflects all relevant public information about the euro’s exchange rate, but not all relevant private information, then _______ would be refuted.

A) weak-form efficiency B) semistrong-form efficiency C) strong-form efficiency D) A and B E) B and C ANSWER: D 18. According to the text, research supports _______ in foreign exchange markets. A) weak-form efficiency B) semistrong-form efficiency C) strong-form efficiency D) A and B E) B and C ANSWER: D 19. Assume that the U.S. interest rate is 11 percent, while Australia’s one-year interest rate is 12

percent. Assume interest rate parity holds. If the one-year forward rate of the Australian dollar was used to forecast the future spot rate, the forecast would reflect an expectation of:

A) depreciation in the Australian dollar’s value over the next year. B) appreciation in the Australian dollar’s value over the next year. C) no change in the Australian dollar’s value over the next year. D) information on future interest rates is needed to answer this question. ANSWER: A 20. If the forward rate was expected to be an unbiased estimate of the future spot rate, and interest rate

parity holds, then: A) covered interest arbitrage is feasible. B) the international Fisher effect (IFE) is supported. C) the international Fisher effect (IFE) is refuted. D) the average absolute error from forecasting would equal zero. ANSWER: B 21. Which of the following is not a forecasting technique mentioned in your text?

A) accounting-based forecasting. B) technical forecasting. C) fundamental forecasting. D) market-based forecasting.

ANSWER: A


22. The following regression model was estimated to forecast the value of the Malaysian ringgit (MYR):

MYR a a INC a INFt t t t= + + +− −0 1 1 2 1 μ ,

where MYR is the quarterly change in the ringgit, INF is the previous quarterly percentage change in the inflation differential, and INC is the previous quarterly percentage change in the income growth differential. Regression results indicate coefficients of a0 = .005; a1 = .4; and a2 = .7. The most recent quarterly percentage change in the inflation differential is -5%, while the most recent quarterly percentage change in the income differential is 3%. Using this information, the forecast for the percentage change in the ringgit is: A) 4.60%. B) -1.80%. C) 5.2%. D) -4.60%. E) none of the above

ANSWER: B SOLUTION: MYRt = .005 + (.4)(.03) + (.7)(-.05) = -1.80% 23. The following regression model was estimated by Delta Corporation to forecast the value of the

Indian rupee (INR):

INR a a INT a INFt t t t= + + +−0 1 2 1 μ ,

where INR is the quarterly change in the rupee, INT is the real interest rate differential in period t between the U.S. and India, and INF is the inflation rate differential between the U.S. and India in the previous period. Regression results indicate coefficients of a0 = .003; a1 = -.5; and a2 = .8. Assume that INFt −1 = 2%. However, the interest rate differential is not known at the beginning of period t and must be estimated. Delta Corp. has developed the following probability distribution:

Probability Possible Outcome 30% -2% 40% -3% 30% -4%

The expected change in the Indian rupee in period t is: A) 3.40%. B) 0.40%. C) 3.10%. D) 1.70%. E) none of the above

ANSWER: A SOLUTION: E INTt[ ] = (-.02)(.3) + (-.03)(.4) + (-.04)(.3) = -3.00% INRt = .003 + (-.5)(-.03) + (.8)(.02) = 3.40%


24. Huge Corporation has just initiated a market-based forecast system using the forward rate as an estimate of the future spot rate of the Japanese yen (¥) and the Australian dollar (A$). Listed below are the forecasted and realized values for the last period:

Currency Forecasted Value Realized Value Australian dollar $.60 $.55 Japanese yen $.0067 $.0069

According to this information and using the absolute forecast error as a percentage of the realized value, Huge Corp. has forecasted the _______________ more accurately by ____________%. A) yen; 6.19% B) Australian dollar; 6.19% C) yen; 5.34% D) Australian dollar; 5.34% E) none of the above

ANSWER: A SOLUTION: Absolute forecast error for the Australian dollar = (|.60 - .55|)/.55 = 9.09% Absolute forecast error for the Japanese yen = (|.0067 - .0069|)/.0069 = 2.90% Therefore, Huge Corp. has estimated the Japanese yen more accurately by

approximately 6.19%. 25. Gamma Corporation has incurred large losses over the last ten years due to exchange rate

fluctuations of the Egyptian pound (EGP), even though the company has used a market-based forecast based on the forward rate. Consequently, management believes its forecasts to be biased. The following regression model was estimated to determine if the forecasts over the last ten years were biased:

S a a Ft t t= + +−0 1 1 μ ,

where St is the spot rate of the pound in year t and Ft−1 is the forward rate of the pound in year t-1. Regression results reveal coefficients of a0 = 0 and a1 = 1.3. Thus, Gamma has reason to believe that its past forecasts have ______________ the realized spot rate. A) overestimated B) underestimated C) correctly estimated D) none of the above

ANSWER: B


26. Which of the following is not a method of forecasting exchange rate volatility? A) using the absolute forecast error as a percentage of the realized value. B) using the volatility of historical exchange rate movements as a forecast for the future. C) using a time series of volatility patterns in previous periods. D) deriving the exchange rate’s implied standard deviation from the currency option pricing

model.

ANSWER: A 27. If a foreign currency is expected to ____________ substantially against the parent’s currency, the

parent may prefer to ____________ the remittance of subsidiary earnings. A) weaken; delay B) weaken; expedite C) appreciate; expedite D) none of the above

ANSWER: B

28. If an MNC invests excess cash in a foreign county, it would like the foreign currency to

_________; if an MNC issues bonds denominated in a foreign currency, it would like the foreign currency to __________. A) appreciate; depreciate B) appreciate; appreciate C) depreciate; depreciate D) depreciate; appreciate

ANSWER: A

29. Severus Co. has to pay 5 million Canadian dollars for supplies it recently received from Canada.

Today, the Canadian dollar has appreciated by 2 percent against the U.S. dollar. Severus has determined that whenever the Canadian dollar appreciates against the U.S. dollar by more than 1 percent, it experiences a reversal of 40 percent on the following day. Based on this information, the Canadian dollar is expected to __________ tomorrow, and Severus would prefer to make payment __________. A) depreciate by .8%; today B) depreciate by .8%; tomorrow C) appreciate by .8%; today D) appreciate by .8%; tomorrow

ANSWER: B

SOLUTION: %8.0%)40(%)2(1 −=−×=+te 30. Corporations tend to make only limited use of technical forecasting because it typically focuses on

the near future, which is not very helpful for developing corporate policies. A) true. B) false.

ANSWER: A


31. Sulsa Inc. uses fundamental forecasting. Using regression analysis, it has determined the following equation for the euro:

11

121

1.19.005.

euro

−−

−−

++=

++=

tt

ttot

INCINF

INCbINFbb

The most recent quarterly percentage change in the inflation differential between the U.S. and Europe was 2 percent, while the most recent quarterly percentage change in the income growth differential between the U.S. and Europe was -1 percent. Based on this information, the forecast for the euro is a(n) __________ of _______%. A) appreciation; 3.4 B) depreciation; 3.4 C) appreciation; 0.7 D) appreciation; 1.2

ANSWER: D SOLUTION: %2.1)01.(1.1)02(.9.005.euro =−++=t

32. The U.S. inflation rate is expected to be 4 percent over the next year, while the European inflation

rate is expected to be 3 percent. The current spot rate of the euro is $1.03. Using purchasing power parity, the expected spot rate at the end of one year is $________. A) 1.02 B) 1.03 C) 1.04 D) none of the above

ANSWER: C

SOLUTION: 04.1$)0097.1(03.1$)(

0097.103.104.1

1 ==

=−=

+t

f

SE

e

33. If the one-year forward rate for the euro is $1.07, while the current spot rate is $1.05, the expected

percentage change in the euro is ______%. A) 1.90 B) 2.00 C) -1.87 D) none of the above

ANSWER: A SOLUTION: %90.1105.1/07.1)( =−=eE


34. If both interest rate parity and the international Fisher effect hold, then between the forward rate and the spot rate, the _________ rate should provide more accurate forecasts for currencies in _____-inflation countries. A) spot; high B) spot; low C) forward; high D) forward; low

ANSWER: C

35. If a foreign country’s interest rate is similar to the U.S. rate, the forward rate premium or discount

will be _________, meaning that the forward rate and spot rate will provide ________ forecasts. A) substantial; similar B) substantial; very different C) close to zero; similar D) close to zero; very different

ANSWER: C

36. Factors such as economic growth, inflation, and interest rates are an integral part of __________

forecasting. A) technical B) fundamental C) market-based D) none of the above

ANSWER: B

37. Silicon Co. has forecasted the Canadian dollar for the most recent period to be $0.73. The realized

value of the Canadian dollar in the most recent period was $0.80. Thus, the absolute forecast error as a percentage of the realized value was ______%. A) 9.6 B) -9.6 C) 8.8 D) -8.8

ANSWER: C

SOLUTION: %8.880.0

80.073.0=

−

38. The absolute forecast error of a currency is _________, on average, in periods when the currency

is more __________. A) lower; volatile B) higher; stable C) lower; stable D) none of the above

ANSWER: C


39. If the foreign exchange market is ________ efficient, then historical and current exchange rate information is not useful for forecasting exchange rate movements. A) weak-form B) semistrong-form C) strong form D) all of the above

ANSWER: D

40. Foreign exchange markets are generally found to be at least ___________ efficient.

A) weak-form B) semistrong-form C) strong form D) none of the above

ANSWER: B

41. MNCs can forecast exchange rate volatility to determine the potential range surrounding their

exchange rate forecast. A) true. B) false.

ANSWER: A

42. If the pattern of currency values over time appears random, then technical forecasting is

appropriate. A) true. B) false.

ANSWER: B

43. Inflation and interest rate differentials between the U.S. and foreign countries are examples of

variables that could be used in fundamental forecasting. A) true. B) false.

ANSWER: A

44. A regression analysis of the Australian dollar value on the inflation differential between the U.S.

and Australia produced a coefficient of .8. Thus, for every 1% increase in the inflation differential, the Australian dollar is expected to depreciate by .8%. A) true. B) false.

ANSWER: B


45. The most sophisticated forecasting techniques provide consistently accurate forecasts. A) true. B) false.

ANSWER: B

46. If the forward rate is used as an indicator of the future spot rate, the spot rate is expected to

appreciate or depreciate by the same amount as the forward premium or discount, respectively. A) true. B) false.

ANSWER: A

47. Research indicates that currency forecasting services almost always outperform forecasts based on

the forward rate. A) true. B) false.

ANSWER: B

48. When measuring forecast performance of different currencies, it is often useful to adjust for their

relative sizes. Thus, percentages, rather than nominal amounts, are often used to compute forecast errors. A) true. B) false.

ANSWER: A

49. The closer graphical points are to the perfect forecast line, the better is the forecast.

A) true. B) false.

ANSWER: A

50. Foreign exchange markets appear to be strong-form efficient.

A) true. B) false.

ANSWER: B

51. A motivation for forecasting exchange rate volatility is to obtain a range surrounding the forecast.

A) true. B) false.

ANSWER: A


52. Two methods to assess exchange rate volatility are the volatility of historical exchange rate movements and the exchange rate’s implied standard deviation from the currency option pricing model. A) true. B) false.

ANSWER: A

53. Market-based forecasting involves the use of historical exchange rate data to predict future values.

A) true. B) false.

ANSWER: B

54. Fundamental models examine moving averages over time and thus allow the development of a

forecasting rule. A) true. B) false.

ANSWER: B

55. A forecasting technique based on fundamental relationships between economic variables and

exchange rates, such as inflation, is referred to as technical forecasting. A) true. B) false.

ANSWER: B

56. Usually, fundamental forecasting is used for short-term forecasts, while technical forecasting is

used for longer-term forecasts. A) true. B) false.

ANSWER: B

57. If points are scattered evenly on both sides of the perfect forecast line, then the forecast appears to

be very accurate. A) true. B) false.

ANSWER: B

58. If foreign exchange markets are strong-form efficient, then all relevant public and private

information is already reflected in today’s exchange rates. A) true. B) false.

ANSWER: A

469

Chapter 10

Measuring Exposure to Exchange Rate Fluctuations 1. Translation exposure reflects: A) the exposure of a firm’s ongoing international transactions to exchange rate fluctuations. B) the exposure of a firm’s local currency value to transactions between foreign exchange traders. C) the exposure of a firm’s financial statements to exchange rate fluctuations. D) the exposure of a firm’s cash flows to exchange rate fluctuations. ANSWER: C 2. Transaction exposure reflects: A) the exposure of a firm’s ongoing international transactions to exchange rate fluctuations. B) the exposure of a firm’s local currency value to transactions between foreign exchange traders. C) the exposure of a firm’s financial statements to exchange rate fluctuations. D) the exposure of a firm’s cash flows to exchange rate fluctuations. ANSWER: A 3. Economic exposure refers to: A) the exposure of a firm’s ongoing international transactions to exchange rate fluctuations. B) the exposure of a firm’s local currency value to transactions between foreign exchange traders. C) the exposure of a firm’s financial statements to exchange rate fluctuations. D) the exposure of a firm’s cash flows to exchange rate fluctuations. E) the exposure of a country’s economy (specifically GNP) to exchange rate fluctuations. ANSWER: D


4. Diz Co. is a U.S.-based MNC with net cash inflows of euros and net cash inflows of Swiss francs. These two currencies are highly correlated in their movements against the dollar. Yanta Co. is a U.S.-based MNC that has the same level of net cash flows in these currencies as Diz Co. except that its euros represent net cash outflows. Which firm has a higher exposure to exchange rate risk?

A) Diz Co. B) Yanta Co. C) the firms have about the same level of exposure. D) neither firm has any exposure. ANSWER: A 5. Jacko Co. is a U.S.-based MNC with net cash inflows of Singapore dollars and net cash inflows of

Sunland francs. These two currencies are highly negatively correlated in their movements against the dollar. Kriner Co. is a U.S.-based MNC that has the same exposure as Jacko Co. in these currencies, except that its Sunland francs represent cash outflows. Which firm has a high exposure to exchange rate risk?

A) Jacko Co. B) Kriner Co. C) the firms have about the same level of exposure. D) neither firm has any exposure. ANSWER: B 6. According to the text, currency variability levels _______ perfectly stable over time, and currency

correlations _______ perfectly stable over time. A) are; are not B) are; are C) are not; are not D) are not; are ANSWER: C 7. Which of the following operations benefits from appreciation of the firm’s local currency? A) borrowing in a foreign currency and converting the funds to the local currency prior to the

appreciation. B) receiving earnings dividends from foreign subsidiaries. C) purchasing supplies locally rather than overseas. D) exporting to foreign countries. ANSWER: A

Chapter 10: Measuring Exposure to Exchange Rate Fluctuations 471

8. Which of the following operations benefits from depreciation of the firm’s local currency? A) borrowing in a foreign country and converting the funds to the local currency prior to the

depreciation. B) purchasing foreign supplies. C) investing in foreign bank accounts denominated in foreign currencies prior to depreciation of

the local currency. D) A and B ANSWER: C 9. Economic exposure can affect: A) MNCs only. B) purely domestic firms only. C) A and B D) none of the above ANSWER: C 10. Under FASB 52: A) translation gains and losses are included in the reported net income. B) translation gains and losses are included in stockholder’s equity. C) A and B D) none of the above ANSWER: B 11. Assume that the British pound and Swiss franc are highly correlated. A U.S. firm anticipates the

equivalent of $1 million cash outflows in francs and the equivalent of $1 million cash outflows in pounds. During a _______ cycle, the firm is _______ affected by its exposure.

A) strong dollar; favorably B) weak dollar; not C) strong dollar; not D) weak dollar; favorably ANSWER: A 12. A U.S. MNC has the equivalent of $1 million cash outflows in each of two highly negatively

correlated currencies. During _______ dollar cycles, cash outflows are _______. A) weak; somewhat stable B) weak; favorably affected C) weak; adversely affected D) none of the above ANSWER: A


13. Magent Co. is a U.S. company that has exposure to the Swiss francs (SF) and Danish kroner (DK). It has net inflows of SF200 million and net outflows of DK500 million. The present exchange rate of the SF is about $.40 while the present exchange rate of the DK is $.10. Magent Co. has not hedged these positions. The SF and DK are highly correlated in their movements against the dollar. If the dollar weakens, then Magent Co. will:

A) benefit, because the dollar value of its SF position exceeds the dollar value of its DK position. B) benefit, because the dollar value of its DK position exceeds the dollar value of its SF position. C) be adversely affected, because the dollar value of its SF position exceeds the dollar value of its

DK position. D) be adversely affected, because the dollar value of its DK position exceeds the dollar value of

its SF position. ANSWER: A 14. Generally, MNCs with less foreign costs than foreign revenue will be _______ affected by a

_______ foreign currency. A) favorably; stronger B) not; stronger C) favorably; weaker D) not; weaker E) B and D ANSWER: A 15. When the dollar strengthens, the reported consolidated earnings of U.S.-based MNCs are _______

affected by translation exposure. When the dollar weakens, the reported consolidated earnings are __________ affected.

A) favorably; favorably affected but by a smaller degree B) favorably; favorably affected by a higher degree C) unfavorably; favorably affected D) favorably; unfavorably affected ANSWER: C 16. A firm produces goods for which substitute goods are produced in all countries. Appreciation of

the firm’s local currency should: A) increase local sales as it reduces foreign competition in local markets. B) increase the firm’s exports denominated in the local currency. C) increase the returns earned on the firm’s foreign bank deposits. D) increase the firm’s cash outflow required to pay for imported supplies denominated in a

foreign currency. E) none of the above ANSWER: E


17. A firm produces goods for which substitute goods are produced in all countries. Depreciation of the firm’s local currency should:

A) decrease local sales as foreign competition in local markets is reduced. B) decrease the firm’s exports denominated in the local currency. C) decrease the returns earned on the firm’s foreign bank deposits. D) decrease the firm’s cash outflow required to pay for imported supplies denominated in a

foreign currency. E) none of the above ANSWER: E 18. If a U.S. firm’s cost of goods sold exposure is much greater than its sales exposure in Switzerland,

there is a _______ overall impact of the Swiss franc’s depreciation against the dollar on _______. A) positive; interest expenses B) positive; gross profit C) negative; gross profit D) negative; interest expenses ANSWER: B 19. Assume that your firm is an importer of Mexican chairs denominated in pesos. Your competition

is mainly U.S. producers of chairs. You wish to assess the relationship between the percentage change in its stock price (SPt) and the percentage change in the peso’s value relative to the dollar (PESOt). SPt is the dependent variable. You apply the regression model to an earlier subperiod and a more recent subperiod. In the recent subperiod, you increased your importing volume. You should expect that the regression coefficient in the PESOt variable would be _______ in the first subperiod and _______ in the second subperiod.

A) negative; positive B) positive; positive C) positive; negative D) negative; negative ANSWER: D 20. A set of currency cash inflows is more volatile if the correlations are low.

A) true. B) false.

ANSWER: B 21. Which of the following is not a form of exposure to exchange rate fluctuations?

A) transaction exposure. B) credit exposure. C) economic exposure. D) translation exposure.

ANSWER: B


22. 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 $.55. What is the net inflow or outflow as measured in U.S. dollars? A) $500,000 outflow. B) $500,000 inflow. C) $275,000 inflow. D) $275,000 outflow.

ANSWER: D

SOLUTION: A$1,000,000 - A$1,500,000 = -A$500,000 x $.55 = -$275,000

23. Dubas Co. is a U.S.-based MNC that has a subsidiary in Germany and another subsidiary in

Greece. Both subsidiaries frequently remit their earnings back to the parent company. The German subsidiary generated a net outflow of €2,000,000 this year, while the Greek subsidiary generated a net inflow of €1,500,000. What is the net inflow or outflow as measured in U.S. dollars this year? The exchange rate for the euro is $1.05. A) $3,675,000 outflow B) $525,000 outflow C) $525,000 inflow D) $210,000 outflow

ANSWER: B SOLUTION: -€2,000,000 + €1,500,000 = -€500,000 x $1.05 = -$525,000

24. One argument for exchange rate irrelevance is that:

A) MNCs can hedge exchange rate exposure much more effectively than individual investors. B) diversified stakeholders will not be affected by exchange rate movements because of

offsetting effects. C) purchasing power parity does not hold very well. D) MNCs are typically not diversified across numerous countries.

ANSWER: B

25. ___________ exposure is the degree to which the value of future cash transactions can be affected

by exchange rate fluctuations. A) Transaction B) Economic C) Translation D) None of the above

ANSWER: A


26. If an MNC expects cash inflows of equal amounts in two currencies, and the two currencies are ___________ correlated, the MNC’s transaction exposure is relatively ___________. A) negatively; high B) negatively; low C) positively; low D) none of the above

ANSWER: B

27. If an MNC has a net inflow in one currency and a net outflow of about the same amount in another

currency, then the MNCs’ transaction exposure is _______ is the two currencies are ________ correlated. A) high; positively B) low; negatively C) high; negatively D) none of the above

ANSWER: C

28. Cerra Co. expects to receive 5 million euros tomorrow as a result of selling goods to the

Netherlands. Cerra estimates the standard deviation of daily percentage changes of the euro to be 1 percent over the last 100 days. Assume that these percentage changes are normally distributed. Using the value-at-risk (VAR) method based on a 95% confidence level, what is the maximum one-day loss if the expected percentage change of the euro tomorrow is 0.5%? A) -0.5% B) -2.2% C) -1.5% D) -1.2%

ANSWER: D SOLUTION: %2.1%)165.1(%5.0 −=×−

29. Cerra Co. expects to receive 5 million euros tomorrow as a result of selling goods to the

Netherlands. Cerra estimates the standard deviation of daily percentage changes of the euro to be 1 percent over the last 100 days. Assume that these percentage changes are normally distributed. Using the value-at-risk (VAR) method based on a 95% confidence level, what is the maximum one-day loss in dollars if the expected percentage change of the euro tomorrow is 0.5%? The current spot rate of the euro (before considering the maximum one-day loss) is $1.01. A) -$75,750. B) -$60,600. C) -$111,100. D) -$25,250.

ANSWER: B

SOLUTION: 600,60$000,000,5)012.(01.1$

%2.1%)165.1(%5.0−=×−×

−=×−


30. The maximum one-day loss computed for the value-at-risk (VAR) method, does not depend on: A) the expected percentage change in the currency for the next day. B) the standard deviation of the daily percentage changes in the currency over a previous period. C) the current level of interest rates. D) the confidence level used.

ANSWER: C

31. Volusia, Inc. is a U.S.-based exporting firm that expects to receive payments denominated in both

euros and Canadian dollars in one month. Based on today’s spot rates, the dollar value of the funds to be received is estimated at $500,000 for the euros and $300,000 for the Canadian dollars. Based on data for the last fifty months, Volusia estimates the standard deviation of monthly percentage changes to be 8 percent for the euro and 3 percent for the Canadian dollar. The correlation coefficient between the euro and the Canadian dollar is 0.30. What is the portfolio standard deviation? A) 3.00%. B) 5.44%. C) 17.98%. D) none of the above

ANSWER: B

SOLUTION: %44.5)03)(.08)(.30)(.375)(.625(.2)03(.)375(.)08(.)625(. 2222 =++=pσ 32. Volusia, Inc. is a U.S.-based exporting firm that expects to receive payments denominated in both

euros and Canadian dollars in one month. Based on today’s spot rates, the dollar value of the funds to be received is estimated at $500,000 for the euros and $300,000 for the Canadian dollars. Based on data for the last fifty months, Volusia estimates the standard deviation of monthly percentage changes to be 8 percent for the euro and 3 percent for the Canadian dollar. The correlation coefficient between the euro and the Canadian dollar is 0.30. Assuming an expected percentage change of 0 percent for each currency during the next month, what is the maximum one-month loss of the currency portfolio? Use a 95 percent confidence level and assume the monthly percentage changes for each currency are normally distributed. A) -9.00%. B) -30.00%. C) -5.00%. D) none of the above

ANSWER: A

SOLUTION: %00.9%)44.565.1(%0

%44.5)03)(.08)(.30)(.375)(.625(.2)03(.)375(.)08(.)625(. 2222

−=×−

=++=pσ


33. Appreciation in a firm’s local currency causes a(n) __________ in cash inflows and a(n) _________ in cash outflows. A) reduction; reduction B) increase; increase C) increase; reduction D) reduction; increase

ANSWER: A

34. In general, a firm that concentrates on local sales, has very little foreign competition, and obtains

foreign supplies (denominated in foreign currencies) will likely ___________ a(n) __________ local currency. A) be hurt by; appreciated B) benefit from; depreciated C) be hurt by; depreciated D) none of the above

ANSWER: C

35. The __________ the percentage of an MNC’s business conducted by its foreign subsidiaries, the

_________ the percentage of a given financial statement item that is susceptible to translation exposure. A) greater; smaller B) smaller; greater C) greater; greater D) none of the above

ANSWER: C

36. Under FASB 52, consolidated earnings are sensitive to the functional currency’s weighted average

exchange rate. A) true. B) false.

ANSWER: A

37. If the U.S. dollar appreciates:

A) an MNC’s U.S. sales will probably decrease. B) an MNC’s exports denominated in U.S. dollars will probably increase. C) an MNC’s interest owed on foreign funds borrowed will probably increase. D) an MNC’s exports denominated in foreign currencies will probably increase. E) all of the above

ANSWER: A


38. Assume that Mill Corporation, a U.S.-based MNC, has applied the following regression model to estimate the sensitivity of its cash flows to exchange rate movements:

PCF a a et t t= + +0 1 μ

where the term on the left-hand side is the percentage change in inflation-adjusted cash flows measured in the firm’s home currency over period t, and et is the percentage change in the exchange rate of the currency over period t. The regression model estimates a coefficient of a1 of 2. This indicates that: A) if the foreign currency appreciates by 1%, Mill’s cash flows will decline by 2%. B) if the foreign currency appreciates by 1%, Mill’s cash flows will decline by .2%. C) if the foreign currency depreciates by 1%, Mill’s cash flows will increase by 2%. D) if the foreign currency depreciates by 1%, Mill’s cash flows will decline by 2%. E) none of the above

ANSWER: B

39. ______________ is(are) not a determinant of translation exposure.

A) The MNC’s degree of foreign involvement B) The locations of foreign subsidiaries C) The local (domestic) earnings of the MNC D) The accounting methods used

ANSWER: C

40. The following regression model was run by a U.S.-based MNC to determine its degree of

economic exposure as it relates to the Australian dollar and Sudanese dinar (SDD):

PCF a a et t t= + +0 1 μ

where the term on the left-hand side is the percentage change in inflation-adjusted cash flows measured in the firm’s home currency over period t, and et is the percentage change in the exchange rate of the currency over period t. The regression was run over two subperiods for each of the two currencies, with the following results:

Regression Coefficient ( a1 ) Regression Coefficient ( a1 ) Currency Earlier Subperiod Recent Subperiod Australian dollar (A$) -.80 .10 Sudanese dinar (SDD) .20 .25


Based on these results, which of the following statements is probably not true? A) The MNC was more sensitive to movements in the Australian dollar than in the dinar in the

earlier subperiod. B) The MNC was more sensitive to movements in the dinar than in the Australian dollar in the

more recent subperiod. C) The MNC probably had more outflows than inflows in Australian dollars in the earlier

subperiod. D) The MNC probably had more inflows than outflows denominated in dinar in the more recent

subperiod. E) All of the above are true.

ANSWER: C 41. Consider an MNC that is exposed to the Taiwan dollar (TWD) and the Egyptian pound (EGP).

25% of the MNC’s funds are Taiwan dollars and 75% are pounds. The standard deviation of exchange movements is 7% for Taiwan dollars and 5% for pounds. The correlation coefficient between movements in the value of the Taiwan dollar and the pound is .7. Based on this information, the standard deviation of this two-currency portfolio is approximately: A) 5.13%. B) 2.63%. C) 4.33%. D) 5.55%.

ANSWER: A

SOLUTION: %13.5)7)(.05)(.07)(.75)(.25(.2)05(.)75(.)07(.)25(. 2222 =++=pσ 42. Consider an MNC that is exposed to the Bulgarian lev (BGL) and the Romanian leu (ROL). 30%

of the MNC’s funds are lev and 70% are leu. The standard deviation of exchange movements is 10% for lev and 15% for leu. The correlation coefficient between movements in the value of the lev and the leu is .85. Based on this information, the standard deviation of this two-currency portfolio is approximately: A) 17.28%. B) 13.15%. C) 14.50%. D) 12.04%.

ANSWER: B

SOLUTION: σ p = + + =(. ) (. ) (. ) (. ) (. )(. )(. )(. )(. ) .30 10 70 15 2 30 70 10 15 85 1315%2 2 2 2 43. One argument why exchange rate risk is irrelevant to corporations is that shareholders can deal

with this risk individually. A) true. B) false.

ANSWER: A


44. Because creditors may prefer that firms maintain low exposure to exchange rate risk, exchange rate movements may cause earnings to be more volatile, and because investors may prefer corporations to perform hedging for them, exchange rate risk is probably relevant. A) true. B) false.

ANSWER: A

45. A firm’s transaction exposure in any foreign currency is based solely on the size of its open

position in that currency. A) true. B) false.

ANSWER: B

46. Two highly negatively correlated currencies act almost as if they are the same currency.

A) true. B) false.

ANSWER: B

47. The transaction exposure of two inflow currencies is offset when the correlation between the

currencies is high. A) true. B) false.

ANSWER: B

48. The Canadian dollar consistently appears to move almost independently of other currencies. That is it exhibits low correlations with the other currencies. A) true. B) false.

ANSWER: A

49. U.S. exporters may not necessarily benefit from weak-dollar periods if foreign competitors are

willing to reduce their profit margin. A) true. B) false.

ANSWER: A

50. If the functional currencies for reporting purposes are highly correlated, translation exposure is

magnified. A) true. B) false.

ANSWER: A


51. Translation exposure is less of a concern when earnings are not remitted by the subsidiary to the parent. A) true. B) false.

ANSWER: A

52. Assume a regression is run of the firm’s stock price percentage change on the percentage change

in the foreign currency. The coefficient is negative. This implies that the company’s stock price increases if the foreign currency appreciates. A) true. B) false.

ANSWER: B

53. A company may become more exposed or sensitive to an individual currency’s movements over

time for several reasons, including a reduction in hedging, a greater involvement in the foreign country, or an increased use of the foreign currency. A) true. B) false.

ANSWER: A

54. Regression analysis cannot be used to assess the sensitivity of a company’s performance to

economic conditions because economic conditions are unpredictable. A) true. B) false.

ANSWER: A 55. A high correlation between two currencies would be desirable for achieving low exchange rate

risk if one is an inflow currency and the other is an outflow currency. A) true. B) false.

ANSWER: A

56. Firms with more in foreign costs than in foreign revenues will be favorably affected by a stronger

foreign currency. A) true. B) false.

ANSWER: B

57. The exposure of an MNC’s consolidated financial statements to exchange rate fluctuations is

known as transaction exposure. A) true. B) false.

ANSWER: B


58. In general, translation exposure is more closely monitored when the foreign earnings of the subsidiaries are more likely to be remitted to the parent. A) true. B) false.

ANSWER: A

59. A reduction in hedging will probably reduce transaction exposure.

A) true. B) false.

ANSWER: B

483

Chapter 11

Managing Transaction Exposure 1. Assume zero transaction costs. If the 90-day forward rate of the euro is an accurate estimate of the

spot rate 90 days from now, then the real cost of hedging payables will be: A) positive. B) negative. C) positive if the forward rate exhibits a premium, and negative if the forward rate exhibits a

discount. D) zero. ANSWER: D 2. Assume zero transaction costs. If the 180-day forward rate is an accurate estimate of the spot rate

180 days from now, then the real cost of hedging receivables will be: A) positive. B) negative. C) positive if the forward rate exhibits a premium, and negative if the forward rate exhibits a

discount. D) zero. ANSWER: D


3. Assume the following information: U.S. deposit rate for 1 year = 11% U.S. borrowing rate for 1 year = 12% Swiss deposit rate for 1 year = 8% Swiss borrowing rate for 1 year = 10% Swiss forward rate for 1 year = $.40 Swiss franc spot rate = $.39 Also assume that a U.S. exporter denominates its Swiss exports in Swiss francs and expects to

receive SF600,000 in 1 year. Using the information above, what will be the approximate value of these exports in 1 year in U.S.

dollars given that the firm executes a forward hedge? A) $234,000. B) $238,584. C) $240,000. D) $236,127. ANSWER: C SOLUTION: SF600,000 × $.40 = $240,000 4. Assume the following information: U.S. deposit rate for 1 year = 11% U.S. borrowing rate for 1 year = 12% New Zealand deposit rate for 1 year = 8% New Zealand borrowing rate for 1 year = 10% New Zealand dollar forward rate for 1 year = $.40 New Zealand dollar spot rate = $.39 Also assume that a U.S. exporter denominates its New Zealand exports in NZ$ and expects to

receive NZ$600,000 in 1 year. You are a consultant for this firm. Using the information above, what will be the approximate value of these exports in 1 year in U.S.

dollars given that the firm executes a money market hedge? A) $238,584. B) $240,000. C) $234,000. D) $236,127. ANSWER: D SOLUTION: 1. Borrow NZ$545,455 (NZ$600,000/1.1) = NZ$545,455. 2. Convert NZ$545,455 to $212,727 (at $.39 per NZ$). 3. Invest $212,727 to accumulate $236,127 ($212,727 × 1.11) = $236,127.

Chapter 11: Managing Transaction Exposure 485

5. An example of cross-hedging is: A) find two currencies that are highly positively correlated; match the payables of the one

currency to the receivables of the other currency. B) use the forward market to sell forward whatever currencies you will receive. C) use the forward market to buy forward whatever currencies you will receive. D) B and C ANSWER: A 6. Which of the following reflects a hedge of net receivables in British pounds by a U.S. firm? A) purchase a currency put option in British pounds. B) sell pounds forward. C) borrow U.S. dollars, convert them to pounds, and invest them in a British pound deposit. D) A and B ANSWER: D 7. Which of the following reflects a hedge of net payables on British pounds by a U.S. firm? A) purchase a currency put option in British pounds. B) sell pounds forward. C) sell a currency call option in British pounds. D) borrow U.S. dollars, convert them to pounds, and invest them in a British pound deposit. E) A and B ANSWER: D 8. If Lazer Co. desired to lock in the maximum it would have to pay for its net payables in euros but

wanted to be able to capitalize if the euro depreciates substantially against the dollar by the time payment is to be made, the most appropriate hedge would be:

A) a money market hedge. B) purchasing euro put options. C) a forward purchase of euros. D) purchasing euro call options. E) selling euro call options. ANSWER: D 9. If a Salerno Inc. desired to lock in a minimum rate at which it could sell its net receivables in

Japanese yen but wanted to be able to capitalize if the yen appreciates substantially against the dollar by the time payment arrives, the most appropriate hedge would be:

A) a money market hedge. B) a forward sale of yen. C) purchasing yen call options. D) purchasing yen put options. E) selling yen put options. ANSWER: D


10. The real cost of hedging payables with a forward contract equals: A) the nominal cost of hedging minus the nominal cost of not hedging. B) the nominal cost of not hedging minus the nominal cost of hedging. C) the nominal cost of hedging divided by the nominal cost of not hedging. D) the nominal cost of not hedging divided by the nominal cost of hedging. ANSWER: A 11. From the perspective Detroit Co. that has payables in Mexican pesos and receivables in Canadian

dollars, hedging the payables would be most desirable if the expected real cost of hedging payables is _______, and hedging the receivables would be most desirable if the expected real cost of hedging receivables is _______.

A) negative; positive B) zero; positive C) zero; zero D) positive; negative E) negative; negative ANSWER: E 12. Use the following information to calculate the dollar cost of using a money market hedge to hedge

200,000 pounds of payables due in 180 days. Assume the firm has no excess cash. Assume the spot rate of the pound is $2.02, the 180-day forward rate is $2.00. The British interest rate is 5%, and the U.S. interest rate is 4% over the 180-day period.

A) $391,210. B) $396,190. C) $388,210. D) $384,761. E) none of the above ANSWER: E SOLUTION: 1. Need to invest £190,476 (£200,000/1.05) = £190,476. 2. Need to exchange $384,762 to obtain the £190,476 (£190,476 × $2.02) = $384,762. 3. At the end of 180 days, need $400,152 to repay loan ($384,762 × 1.04) = $400,152. 13. Assume that Cooper Co. will not use its cash balances in a money market hedge. When deciding

between a forward hedge and a money market hedge, it _______ determine which hedge is preferable before implementing the hedge. It _______ determine whether either hedge will outperform an unhedged strategy before implementing the hedge.

A) can; can B) can; cannot C) cannot; can D) cannot; cannot ANSWER: B


14. Foghat Co. has 1,000,000 euros as receivables due in 30 days, and is certain that the euro will depreciate substantially over time. Assuming that the firm is correct, the ideal strategy is to:

A) sell euros forward. B) purchase euro currency put options. C) purchase euro currency call options. D) purchase euros forward. E) remain unhedged. ANSWER: A 15. Spears Co. will receive SF1,000,000 in 30 days. Use the following information to determine the

total dollar amount received (after accounting for the option premium) if the firm purchases and exercises a put option:

Exercise price = $.61 Premium = $.02 Spot rate = $.60 Expected spot rate in 30 days = $.56 30-day forward rate = $.62 A) $630,000. B) $610,000. C) $600,000. D) $590,000. E) $580,000. ANSWER: D SOLUTION: ($.61 - $.02) × SF1,000,000 = $590,000 16. A _______ involves an exchange of currencies between two parties, with a promise to

re-exchange currencies at a specified exchange rate and future date. A) long-term forward contract B) currency swap C) parallel loan D) money market hedge ANSWER: C 17. If interest rate parity exists and transactions costs are zero, the hedging of payables in euros with a

forward hedge will _______. A) have the same result as a call option hedge on payables B) have the same result as a put option hedge on payables C) have the same result as a money market hedge on payables D) require more dollars than a money market hedge E) A and D ANSWER: C


18. Assume that Parker Company will receive SF200,000 in 360 days. Assume the following interest rates:

U.S. Switzerland 360-day borrowing rate 7% 5% 360-day deposit rate 6% 4% Assume the forward rate of the Swiss franc is $.50 and the spot rate of the Swiss franc is $.48. If

Parker Company uses a money market hedge, it will receive _______ in 360 days. A) $101,904 B) $101,923 C) $98,769 D) $96,914 E) $92,307 ANSWER: D SOLUTION: 1. Borrow SF190,476 (SF200,000/1.05) = SF190,476. 2. Convert SF190,476 to $91,428 (SF190,476 × $.48) = $91,428. 3. Invest $91,428 at 6% to accumulate $96,914 ($91,428 × 1.06) = $96,914. 19. The forward rate of the Swiss franc is $.50. The spot rate of the Swiss franc is $.48. The

following interest rates exist: U.S. Switzerland 360-day borrowing rate 7% 5% 360-day deposit rate 6% 4% You need to purchase SF200,000 in 360 days. If you use a money market hedge, the amount of

dollars you need in 360 days is: A) $101,904. B) $101,923. C) $98,770. D) $96,914. E) $92,307. ANSWER: C SOLUTION: 1. Need to invest SF192,308 (SF200,000/1.04) = SF192,308. 2. Need to borrow $92,308 to exchange for SF192,308 (SF192,308 × $.48) = $92,308. 3. At the end of 360 days, need $98,769 to repay the loan ($92,308 × 1.07) = $98,770.


20. Your company will receive C$600,000 in 90 days. The 90-day forward rate in the Canadian dollar is $.80. If you use a forward hedge, you will:

A) receive $750,000 today. B) receive $750,000 in 90 days. C) pay $750,000 in 90 days. D) receive $480,000 today. E) receive $480,000 in 90 days. ANSWER: E SOLUTION: C$600,000 × $0.80 = $480,000 21. A call option exists on British pounds with an exercise price of $1.60, a 90-day expiration date,

and a premium of $.03 per unit. A put option exists on British pounds with an exercise price of $1.60, a 90-day expiration date, and a premium of $.02 per unit. You plan to purchase options to cover your future receivables of 700,000 pounds in 90 days. You will exercise the option in 90 days (if at all). You expect the spot rate of the pound to be $1.57 in 90 days. Determine the amount of dollars to be received, after deducting payment for the option premium.

A) $1,169,000. B) $1,099,000. C) $1,106,000. D) $1,143,100. E) $1,134,000. ANSWER: C SOLUTION: ($1.60 - $.02) × £700,000 = $1,106,000 22. Assume that Smith Corporation will need to purchase 200,000 British pounds in 90 days. A call

option exists on British pounds with an exercise price of $1.68, a 90-day expiration date, and a premium of $.04. A put option exists on British pounds, with an exercise price of $1.69, a 90-day expiration date, and a premium of $.03. Smith Corporation plans to purchase options to cover its future payables. It will exercise the option in 90 days (if at all). It expects the spot rate of the pound to be $1.76 in 90 days. Determine the amount of dollars it will pay for the payables, including the amount paid for the option premium.

A) $360,000. B) $338,000. C) $332,000. D) $336,000. E) $344,000. ANSWER: E SOLUTION: ($1.68 + $.04) × £200,000 = $344,000


23. Assume that Kramer Co. will receive SF800,000 in 90 days. Today’s spot rate of the Swiss franc is $.62, and the 90-day forward rate is $.635. Kramer has developed the following probability distribution for the spot rate in 90 days:

Possible Spot Rate in 90 Days Probability $.61 10% $.63 20% $.64 40% $.65 30% The probability that the forward hedge will result in more dollars received than not hedging is: A) 10%. B) 20%. C) 30%. D) 50%. E) 70%. ANSWER: C SOLUTION: The forward hedge will result in more dollars if the spot rate is less than the forward

rate, which is true in the first two cases. 24. Assume that Jones Co. will need to purchase 100,000 Singapore dollars (S$) in 180 days. Today’s

spot rate of the S$ is $.50, and the 180-day forward rate is $.53. A call option on S$ exists, with an exercise price of $.52, a premium of $.02, and a 180-day expiration date. A put option on S$ exists, with an exercise price of $.51, a premium of $.02, and a 180-day expiration date. Jones has developed the following probability distribution for the spot rate in 180 days:

Possible Spot Rate in 90 Days Probability $.48 10% $.53 60% $.55 30% The probability that the forward hedge will result in a higher payment than the options hedge is

_______ (include the amount paid for the premium when estimating the U.S. dollars required for the options hedge).

A) 0% B) 10% C) 30% D) 40% E) 70% ANSWER: B SOLUTION: There is a 10% probability that the call option will not be exercised. In that case,

Jones will pay $.48 × S$100,000 = $48,000, which is less than the amount paid with the forward hedge ($.53 × S$100,000 = $53,000).


25. Assume that Patton Co. will receive 100,000 New Zealand dollars (NZ$) in 180 days. Today’s spot rate of the NZ$ is $.50, and the 180-day forward rate is $.51. A call option on NZ$ exists, with an exercise price of $.52, a premium of $.02, and a 180-day expiration date. A put option on NZ$ exists with an exercise price of $.51, a premium of $.02, and a 180-day expiration date. Patton Co. has developed the following probability distribution for the spot rate in 180 days:

Possible Spot Rate in 90 Days Probability $.48 10% $.49 60% $.55 30% The probability that the forward hedge will result in more U.S. dollars received than the options

hedge is _______ (deduct the amount paid for the premium when estimating the U.S. dollars received on the options hedge).

A) 10% B) 30% C) 40% D) 70% E) none of the above ANSWER: D SOLUTION: The put option will be exercised in the first two cases, resulting in an amount

received per unit of $.51 - $.02 = $.49. Thus, the forward hedge will result in more U.S. dollars received ($.51 per unit).

26. The ______________ hedge is not a technique to eliminate transaction exposure discussed in your

text. A) index B) futures C) forward D) money market E) currency option

ANSWER: A

27. Money Corp. frequently uses a forward hedge to hedge its Malaysian ringgit (MYR) receivables.

For the next month, Money has identified its net exposure to the ringgit as being MYR1,500,000. The 30-day forward rate is $.23. Furthermore, Money’s financial center has indicated that the possible values of the Malaysian ringgit at the end of next month are $.20 and $.25, with probabilities of .30 and .70, respectively. Based on this information, what is the expected real cost of hedging receivables? A) $0. B) -$7,500. C) $7,500. D) none of the above

ANSWER: C


SOLUTION: RCH MYR MYRRCH MYR MYRE RCH

( ) ( , , $0. ) ( , , $0. ) $45,( ) ( , , $0. ) ( , , $0. ) $30,

[ ] (. )( , ) (. )( , ) ,

1 1 500 000 20 1 500 000 23 0002 1 500 000 25 1 500 000 23 000

30 45 000 7 30 000 7 500

= × − × = −= × − × == − + =

28. Hanson Corp. frequently uses a forward hedge to hedge its British pound (£) payables. For the

next quarter, Hanson has identified its net exposure to the pound as being £1,000,000. The 90-day forward rate is $1.50. Furthermore, Hanson’s financial center has indicated that the possible values of the British pound at the end of next quarter are $1.57 and $1.59, with probabilities of .50 and .50, respectively. Based on this information, what is the expected real cost of hedging payables? A) $80,000. B) -$80,000. C) $1,570,000. D) $1,580,000.

ANSWER: B

SOLUTION:

000,80)000,90)(50(.)000,70)(50(.][000,90$)59.1$000,000,1£()50.1$000,000,1£()2(000,70$)57.1$000,000,1£()50.1$000,000,1£()1(

−=−+−=−=×−×=−=×−×=

RCHERCHRCH

The following information refers to questions 29 and 30. U.S. Jordan 360-day borrowing rate 6% 5% 360-day deposit rate 5% 4% 29. Perkins Corp. will receive 250,000 Jordanian dinar (JOD) in 360 days. The current spot rate of the

dinar is $1.48, while the 360-day forward rate is $1.50. How much will Perkins receive in 360 days from implementing a money market hedge (assume any receipts before the date of the receivable are invested)? A) $377,115. B) $373,558. C) $363,019. D) $370,000.

ANSWER: D SOLUTION: 1. Borrow JOD238,095.24 (JOD250,000/1.05) = JOD238,095.24. 2. Convert JOD238,095.24 to $352,380.95 (JOD238,095.24 × $1.48) = $352,380.95. 3. Invest $352,380.95 at 5% to accumulate $370,000 ($352,280.95 × 1.05) = $370,000.


30. Pablo Corp. will need 150,000 Jordanian dinar (JOD) in 360 days. The current spot rate of the dinar is $1.48, while the 360-day forward rate is $1.46. What is Pablo’s cost from implementing a money market hedge (assume Pablo does not have any excess cash)? A) $224,135. B) $226,269. C) $224,114. D) $223,212.

ANSWER: B

SOLUTION: 1. Need to invest JOD144,230.76 (JOD150,000/1.04) = JOD144,230.76. 2. Need to convert $213,461.52 to obtain the JOD144,230.76 dinar (JOD144,230.76 × $1.48) =

$213,461.52. 3. At the end of 360 days, need $226,269.22 ($213,461.52 x 1.06) = $226,269.21.

31. Lorre Company needs 200,000 Canadian dollars (C$) in 90 days and is trying to determine

whether or not to hedge this position. Lorre has developed the following probability distribution for the Canadian dollar:

Possible Value of Canadian Dollar in 90 Days Probability $0.54 15% 0.57 25% 0.58 35% 0.59 25%

The 90-day forward rate of the Canadian dollar is $.575, and the expected spot rate of the Canadian dollar in 90 days is $.55. If Lorre implements a forward hedge, what is the probability that hedging will be more costly to the firm than not hedging? A) 40%. B) 60%. C) 15%. D) 85%.

ANSWER: A SOLUTION: Since Lorre locks into the $.575 with a forward contract, the first two cases would

have been cheaper had Lorre not hedged (15% + 25% = 40%).


32. Quasik Corporation will be receiving 300,000 Canadian dollars (C$) in 90 days. Currently, a 90-day call option with an exercise price of $.75 and a premium of $.01 is available. Also, a 90-day put option with an exercise price of $.73 and a premium of $.01 is available. Quasik plans to purchase options to hedge its receivable position. Assuming that the spot rate in 90 days is $.71, what is the net amount received from the currency option hedge? A) $219,000. B) $222,000. C) $216,000. D) $213,000.

ANSWER: C SOLUTION: ($.73 - $.01) x 300,000 = $216,000. 33. FAB Corporation will need 200,000 Canadian dollars (C$) in 90 days to cover a payable position.

Currently, a 90-day call option with an exercise price of $.75 and a premium of $.01 is available. Also, a 90-day put option with an exercise price of $.73 and a premium of $.01 is available. FAB plans to purchase options to hedge its payable position. Assuming that the spot rate in 90 days is $.71, what is the net amount paid, assuming FAB wishes to minimize its cost? A) $140,000. B) $148,000. C) $152,000. D) $150,000.

ANSWER: A

SOLUTION: ($.71 - $.01) x 200,000 = $140,000. Note: the call option is not exercised since the spot rate is less than the exercise price.

34. You are the treasurer of Arizona Corporation and must decide how to hedge (if at all) future

receivables of 350,000 Australian dollars (A$) 180 days from now. Put options are available for a premium of $.02 per unit and an exercise price of $.50 per Australian dollar. The forecasted spot rate of the Australian dollar in 180 days is:

Future Spot Rate Probability $.46 20% $.48 30% $.52 50% The 90-day forward rate of the Australian dollar is $.50.

What is the probability that the put option will be exercised (assuming Arizona purchased it)? A) 0%. B) 80%. C) 50%. D) none of the above

ANSWER: C


SOLUTION: Arizona will exercise when the exercise price is greater than the future spot (20% + 30% = 50%).

35. If interest rate parity exists, and transaction costs do not exist, the money market hedge will yield

the same result as the ___________ hedge. A) put option B) forward C) call option D) none of the above

ANSWER: B

36. Which of the following is the least effective way of hedging transaction exposure in the long run?

A) long-term forward contract. B) currency swap. C) parallel loan. D) money market hedge.

ANSWER: D 37. When a perfect hedge is not available to eliminate transaction exposure, the firm may consider

methods to at least reduce exposure, such as ___________. A) leading B) lagging C) cross-hedging D) currency diversification E) all of the above

ANSWER: E 38. Sometimes the overall performance of an MNC may already be insulated by offsetting effects

between subsidiaries and it may not be necessary to hedge the position of each individual subsidiary. A) true. B) false.

ANSWER: A 39. To hedge a ___________ in a foreign currency, a firm may _________ a currency futures contract

for that currency. A) receivable; purchase B) payable; sell C) payable; purchase D) none of the above

ANSWER: C


40. A forward contract hedge is very similar to a futures contract hedge, except that _________ contracts are commonly used for _________ transactions. A) forward; small B) futures; large C) forward; large D) none of the above

ANSWER: C 41. Celine Co. will need €500,000 in 90 days to pay for German imports. Today’s 90-day forward rate

of the euro is $1.07. There is a 40 percent chance that the spot rate of the euro in 90 days will be $1.02, and a 60 percent chance that the spot rate of the euro in 90 days will be $1.09. Based on this information, the expected value of the real cost of hedging payables is $________. A) -35,000 B) 25,000 C) -1,000 D) 1,000

ANSWER: D SOLUTION: 000,1$60.0000,25$40.0000,35$][ =×+×−=pRCHE 42. In a forward hedge, if the forward rate is an accurate predictor of the future spot rate, the real cost

of hedging payables will be: A) highly positive. B) highly negative. C) zero. D) none of the above

ANSWER: C 43. If an MNC is hedging various currencies, it should measure the real cost of hedging in each

currency as a dollar amount for comparison purposes. A) true. B) false.

ANSWER: B


44. Samsong Inc. needs €1,000,000 in 30 days. Samsong can earn 5 percent annualized on a German security. The current spot rate for the euro is $1.00. Samsong can borrow funds in the U.S. at an annualized interest rate of 6 percent. If Samsong uses a money market hedge, how much should it borrow in the U.S.? A) $952,381. B) $995,851. C) $943,396. D) $995,025.

ANSWER: B SOLUTION: 851,995$)]360/30%5(1/[000,000,1 =×+ 45. Samsong Inc. needs €1,000,000 in 30 days. Samsong can earn 5 percent annualized on a German

security. The current spot rate for the euro is $1.00. Samsong can borrow funds in the U.S. at an annualized interest rate of 6 percent. If Samsong uses a money market hedge to hedge the payable, what is the cost of implementing the hedge? A) $1,000,000. B) $1,055,602. C) $1,000,830. D) $1,045,644.

ANSWER: C

SOLUTION: 1. Borrow $995,851 from a U.S. bank (€1,000,000 x $1.00 x [1 + (.05 x 30/360)] 2. Convert $995,851 to €995,851, given the exchange rate of $1.00 per euro. 3. Use the euros to purchase a German security that offers 0.42% interest over 30 days. 4. Repay the U.S. loan in 30 days, plus interest; the amount owed is $1,000,830 (computed as

$995,851 x [1 + (.06 x 30/360)]. 46. Since the results of both a money market hedge and a forward hedge are known beforehand, an

MNC can implement the one that is more feasible. A) true. B) false.

ANSWER: A 47. If interest rate parity exists, and transaction costs do not exist, the _________ hedge will yield the

same result as the _________ hedge. A) money market; futures B) money market; options C) money market; forward D) forward; options

ANSWER: C


48. To hedge a contingent exposure, in which an MNC’s exposure is contingent on a specific event occurring, the appropriate hedge would be a(n) __________ hedge. A) money market B) futures C) forward D) options

ANSWER: D 49. A ___________ is not a technique for hedging long-term transaction exposure.

A) long-term forward contact B) long-term futures contract C) currency swap D) parallel loan

ANSWER: B 50. A __________ involves an exchange of currencies between two parties, with a promise to

reexchange currencies at a specified exchange rate and future date. A) long-term forward contract B) currency swap C) parallel loan D) interest rate swap

ANSWER: C 51. Hedging the position of individual subsidiaries is generally necessary, even if the overall

performance of the MNC is already insulated by the offsetting positions between subsidiaries. A) true. B) false.

ANSWER: B

52. If an MNC is extremely risk-averse, it may decide to hedge even though its hedging analysis

indicates that remaining unhedged will probably be less costly than hedging. A) true. B) false.

ANSWER: A

53. A money market hedge involves taking a money market position to cover a future payables or

receivables position. A) true. B) false.

ANSWER: A


54. To hedge a payable position with a currency option hedge, an MNC would write a call option. A) true. B) false.

ANSWER: B 55. MNCs generally do not need to hedge because shareholders can hedge their own risk.

A) true. B) false.

ANSWER: B

56. Currency futures are very similar to forward contracts, except that they are standardized and are

more appropriate for firms that prefer to hedge in smaller amounts. A) true. B) false.

ANSWER: A

57. To hedge payables with futures, an MNC would sell futures; to hedge receivables with futures, an

MNC would buy futures. A) true. B) false.

ANSWER: B

58. When the real cost of hedging is positive, this implies that hedging was more favorable than not

hedging. A) true. B) false.

ANSWER: B

59. A futures hedge involves taking a money market position to cover a future payables or receivables position. A) true. B) false.

ANSWER: B

60. If interest rate parity (IRP) exists, then the money market hedge will yield the same result as the

options hedge. A) true. B) false.

ANSWER: B


61. The price at which a currency put option allows the holder to sell a currency is called the settlement price. A) true. B) false.

ANSWER: B

62. A put option essentially represents two swaps of currencies, one swap at the inception of the loan

contract and another swap at a specified date in the future. A) true. B) false.

ANSWER: B

63. The hedging of a foreign currency for which no forward contract is available with a highly

correlated currency for which a forward contract is available is referred to as cross-hedging. A) true. B) false.

ANSWER: A

501

Chapter 12

Managing Economic Exposure and Translation Exposure

1. Depreciation of the euro relative to the U.S. dollar will cause a U.S.-based multinational firm’s

reported earnings (from the consolidated income statement) to _______. If a firm desired to protect against this possibility, it could stabilize its reported earnings by _______ euros forward in the foreign exchange market.

A) be reduced; purchasing B) be reduced; selling C) increase; selling D) increase; purchasing ANSWER: B 2. Springfield Co., based in the U.S., has a cost of goods sold attributable to foreign material orders

that exceeds its foreign revenue. All foreign transactions are denominated in the foreign currency of concern. This firm would _______ a stronger dollar and would _______ a weaker dollar.

A) benefit from; be unaffected by B) benefit from; be adversely affected by C) be unaffected by; be adversely affected by D) be unaffected by; benefit from E) benefit from; benefit from ANSWER: B 3. Whitewater Co. is a U.S. company with sales to Canada amounting to C$8 million. Its cost of

goods sold attributable to the purchase of Canadian goods is C$6 million. Its interest expense on Canadian loans is C$4 million. Given these exact figures above, the dollar value of Whitewater’s “earnings before interest and taxes” would _______ if the Canadian dollar appreciates; the dollar value of Whitewater’s “earnings before taxes” would _______ if the Canadian dollar appreciates.

A) increase; increase B) decrease; increase C) decrease; decrease D) increase; decrease E) increase; be unaffected ANSWER: D


4. Sycamore (a U.S. firm) has no subsidiaries and presently has sales to Mexican customers amounting to MXP98 million, while its peso-denominated expenses amount to MXP41 million. If it shifts its material orders from its Mexican suppliers to U.S. suppliers, it could reduce peso-denominated expenses by MXP12 million and increase dollar-denominated expenses by $800,000. This strategy would _______ the Sycamore’s exposure to changes in the peso’s movements against the U.S. dollar. Regardless of whether the firm shifts expenses, it is likely to perform better when the peso is valued _______ relative to the dollar.

A) reduce; high B) reduce; low C) increase; low D) increase; high ANSWER: D 5. Which of the following is an example of economic exposure but not an example of transaction

exposure? A) An increase in the dollar’s value hurts a U.S. firm’s domestic sales because foreign

competitors are able to increase their sales to U.S. customers. B) An increase in the pound’s value increases the U.S. firm’s cost of British pound payables. C) A decrease in the peso’s value decreases a U.S. firm’s dollar value of peso receivables. D) A decrease in the Swiss franc’s value decreases the dollar value of interest payments on a

Swiss deposit sent to a U.S. firm by a Swiss bank. ANSWER: A 6. Rockford Co. is a U.S. manufacturing firm that produces goods in the U.S. and sells all products

to retail stores in the U.K.; the goods are denominated in pounds. It finances a small portion of its business with pound-denominated loans from British banks. Which of the following is true? (Assume that the amount of products to be sold is guaranteed by contracts.)

A) The dollar value of sales is higher if the pound depreciates against the dollar. B) The dollar value of sales is unaffected by the pound’s exchange rate. C) A and B D) None of the above ANSWER: D 7. If a U.S. firm’s expenses are more susceptible to exchange rate movements than revenue, the firm

will _______ if the dollar _______. A) benefit; weakens B) be unaffected; weakens C) be unaffected; strengthens D) benefit; strengthens ANSWER: D

Chapter 12: Managing Economic Exposure and Translation Exposure 503

8. Laketown Co. has some expenses and revenue in euros. If its expenses are more sensitive to exchange rate movements than revenue, it could reduce economic exposure by _______. If its revenues are more sensitive than expenses, it could reduce economic exposure by _______.

A) decreasing foreign revenues; decreasing foreign expenses B) decreasing foreign revenues; increasing foreign expenses C) increasing foreign revenues; decreasing foreign revenues D) decreasing foreign expenses; increasing foreign revenues ANSWER: D 9. Any restructuring of operations that _______ the difference between a foreign currency’s inflows

and outflows may _______ economic exposure. A) reduces; increase B) increases; reduce C) reduces; reduce D) A and B E) none of the above ANSWER: C 10. It is generally least difficult to effectively hedge various types of: A) translation exposure. B) transaction exposure. C) economic exposure. D) A and C ANSWER: B 11. With regard to hedging translation exposure, translation losses _______; and gains on forward

contracts used to hedge translation exposure _______. A) are not tax deductible; are taxed B) are tax deductible; are taxed C) are not tax deductible; are not taxed D) are tax deductible; are not taxed ANSWER: A 12. If a firm is subject to ______, then it must be subject to translation exposure. A) transaction exposure B) economic exposure C) A and B D) none of the above ANSWER: D


13. If the Singapore dollar appreciates against the U.S. dollar over this year, the consolidated earnings of a U.S. company with a subsidiary in Singapore will be ____ as a result of the exchange rate movement.

A) negative B) adversely affected C) favorably affected D) unaffected ANSWER: C 14. Assume a U.S. firm uses a forward contract to hedge all of its translation exposure. Also assume

that the firm underestimated what its foreign earnings would be. Assume that the foreign currency depreciated over the year. The firm would generate a translation _______, which would be _______ than the gain generated by the forward contract.

A) loss; smaller B) loss; larger C) gain; larger D) gain; smaller ANSWER: B 15. A perfect hedge (full coverage) on translation exposure can usually be achieved when: A) using the money market hedge. B) using the forward hedge. C) using the futures hedge. D) none of the above, since a perfect hedge is nearly impossible. ANSWER: D 16. Assume that a Japanese car manufacturer exports cars to U.S. dealerships, which are priced in yen.

The demand for those cars declines when the yen is strong. The manufacturer also produces some cars in the U.S. with U.S. materials and those cars are priced in dollars. The manufacturer could reduce its economic exposure by:

A) closing down most of its plants in the U.S. B) producing more automobiles in the U.S. C) relying completely on Japanese suppliers for its parts. D) pricing its exports in dollars. ANSWER: B


17. Wisconsin Inc. conducts business in Zambia. Years ago, Wisconsin established a subsidiary in Zambia that has consistently generated very large profits denominated in Zambian kwacha. Wisconsin wishes to restructure its operations to reduce economic exposure. Which of the following is not a feasible way of accomplishing this? A) increase Zambian supply orders. B) increase Zambian sales. C) restructure debt to increase debt payments in Zambia. D) reduce Zambian sales.

ANSWER: B

18. Which of the following firms is not exposed to translation exposure? A) firm X, with a fully owned subsidiary that periodically remits earnings generated in Great

Britain to the U.S.-based parent. B) firm Y, with a fully owned subsidiary that periodically generates foreign losses in Sweden; the

parent covers at least some of these losses. C) firm Z, with a fully owned subsidiary that generates substantial earnings in Germany; the

subsidiary never remits earnings but reinvests them in Germany. D) all of the above firms are exposed to translation exposure. ANSWER: D

19. __________ represents any impact of exchange rate fluctuations on a firm’s future cash flows.

A) Translation exposure B) Economic exposure C) Transaction exposure D) None of the above

ANSWER: B

20. An effective for an MNC to assess its economic exposure is to look at the firm’s:

A) income statement. B) liquidity. C) retained earnings. D) level of stochholder’s equity. ANSWER: A

21. If revenues and costs are equally sensitive to exchange rate movements, MNCs may reduce their

economic exposure by restructuring their operations to shift the sources of costs or revenues to other locations so that: A) cash inflows exceed cash outflows in each foreign currency. B) cash outflows exceed cash inflows in each foreign currency. C) cash inflows match cash outflows in each foreign currency. D) none of the above

ANSWER: C


22. Managing economic exposure is generally perceived to be __________ managing transaction exposure. A) more difficult B) less difficult C) just as difficult as D) none of the above

ANSWER: A

23. As opposed to transaction exposure, managing economic exposure involves developing a

________ solution. A) short-term B) long-term C) immediate D) none of the above

ANSWER: B

24. Cierra, Inc. is attempting to assess its degree of economic exposure in euros. In order to do so, it

has applied regression analysis to determine whether the percentage change in its total cash flow is related to the percentage change in the euro. A _______ and statistically significant slope coefficient resulting from this analysis implies that the cash flows are _________ related to the percentage changes in the euro. A) positive; positively B) positive; negatively C) negative; positively D) B and C E) none of the above

ANSWER: A

25. Assume that an MNC’s cash flows are positively related to the movements in a foreign currency.

If the MNC expects the foreign currency to weaken, it could purchase the currency forward to reduce its degree of economic exposure. A) true. B) false.

ANSWER: B

26. An MNC is attempting to reduce its economic exposure by financing a portion of its business with

loans in the foreign currency. If the foreign currency weakens, the MNC will need _______ of the foreign currency to cover the loan payment, while the MNC’s foreign currency revenues will convert to _______ dollars. A) more; fewer B) more; more C) less; fewer D) less; more

ANSWER: C


27. An MNC expects to sell fixed assets it utilizes in Europe in the distant future. In order to hedge the sale of these assets in the distant future, the MNC could create a(n) ___________ that _________ the expected value of the assets in the future. A) asset; matches B) asset; exceeds C) liability; matches D) liability; is less than

ANSWER: C

28. Long-term forward contracts are a possible way to hedge the distant sale of fixed assets in foreign

countries, but they may not be available for many emerging market currencies. A) true. B) false.

ANSWER: A

29. ________ exposure occurs when an MNC translates each subsidiary’s financial data to its home

currency for consolidated financial statements. A) Translation B) Transaction C) Economic D) None of the above

ANSWER: A

30. ______________ is not a limitation of hedging translation exposure.

A) Inaccurate stock price forecasts B) Inadequate forward contracts for some currencies C) Accounting distortions D) Increased transaction exposure

ANSWER: A

31. To hedge translation exposure, MNCs could _______ that their foreign subsidiaries receive as earnings to create a cash outflow in the currency to offset the earnings received in that currency. A) purchase the currency forward B) sell the currency forward C) purchase futures contracts of the currency D) A or C E) none of the above

ANSWER: B


32. Translation losses are __________, while gains on forward contracts used to hedge translation exposure are _______. A) tax deductible; not taxed B) not tax deductible; not taxed C) not tax deductible; taxed D) tax deductible; taxed

ANSWER: D

33. In general, it is more difficult to effectively hedge economic or translation exposure than to hedge

transaction exposure. A) true. B) false.

ANSWER: A

34. A foreign subsidiary with more susceptible expenses than revenue to exchange rate movements

will be favorably affected by an appreciation of the foreign currency. A) true. B) false.

ANSWER: B

35. U.S. firms can attempt to hedge their translation exposure of their European subsidiaries with a

forward purchase of euros. A) true. B) false.

ANSWER: B

36. Hedging translation exposure with forward contracts can backfire if the currency being hedged

depreciates. A) true. B) false.

ANSWER: A

37. A limitation of hedging translation exposure is that translation losses are not tax deductible,

whereas gains on forward contracts used to hedge translation exposure are taxed. A) true. B) false.

ANSWER: A


38. The translation gain (or loss) is simply a paper gain (or loss). Conversely, the gain (or loss) resulting from a hedge strategy is a real gain (or loss). A) true. B) false.

ANSWER: A

39. All MNCs are subject to translation exposure.

A) true. B) false.

ANSWER: B

40. U.S.-based MNCs invoicing in Asian currencies and incurring expenses in Asian currencies were

probably less affected by weakness of Asian currencies than U.S.-based MNCs that invoice in Asian currencies but do not incur expenses in those currencies. A) true. B) false.

ANSWER: A

41. The management of economic exposure is normally focused completely on transactions that will

occur in the next three months. A) true. B) false.

ANSWER: B

42. Transaction exposure results when an MNC translates each subsidiary’s financial data to its home

currency for consolidated financial statements. A) true. B) false.

ANSWER: B

43. Although forward contracts may reduce translation exposure at the expense of increasing

transaction exposure, they are sometimes used to hedge translation exposure. A) true. B) false.

ANSWER: A

510

Chapter 13

Direct Foreign Investment 1. Based on the text, it should be obvious that markets are__________ in reality, and consequently,

monopolistic advantages _________ be exploited. A) perfect; may possibly B) perfect; cannot C) imperfect; may possibly D) imperfect; cannot ANSWER: C 2. When a firm analyzes the feasibility of a project, it should consider the: A) variability of the project’s cash flow. B) correlation of the project’s cash flow relative to the prevailing cash flows of the MNC. C) A and B D) none of the above ANSWER: C 3. The __________ a project’s variability in cash flows, and the __________ the positive correlation

between the project’s cash flow and MNC’s cash flow, the lower the risk of the project. A) higher; higher B) higher; lower C) lower; lower D) lower; higher ANSWER: C 4. Most of the DFI by U.S. firms is Mexico.

A) true. B) false.

ANSWER: B

Chapter 13: Direct Foreign Investment 511

5. Consider Firm “A” and Firm “B” that both produce the same product. Firm “A” would more likely have more stable cash flows if its percentage of foreign sales were __________ and the number of foreign countries it sold products to was __________.

A) higher; large B) higher; small C) lower; small D) higher; large ANSWER: A 6. According to the text, a firm may be able to achieve a “more efficient” project portfolio if it: A) focuses solely on one product. B) focuses solely on one location to market what it produces. C) A and B D) none of the above ANSWER: D 7. According to information in the text, a host government would be least likely to provide incentives

for direct foreign investment (DFI) into its country if the firm planning DFI: A) would compete with local firms of the host country. B) would produce a good not currently available in the host country. C) would produce a good and export it to other countries. D) B and C ANSWER: A 8. If countries are highly influential upon each other, the correlations of their economic growth levels

would likely be __________. A firm would benefit __________ by diversifying sales among these countries relative to another set of countries that were not influential upon each other.

A) high and positive; more B) close to zero; more C) high and positive; less D) close to zero; less ANSWER: C 9. A firm will likely benefit most from diversifying if: A) the correlations between country economies are high. B) the correlations between country economies are low. C) the variability of all country economy levels is high. D) B and C ANSWER: B


10. When a foreign currency is perceived by a firm to be undervalued, the firm may consider direct foreign investment in that country, as the initial outlay should be relatively low. A) true. B) false.

ANSWER: A

11. Consider a country that presently has a high level of unemployment because of weak economic

conditions. Its income levels are very low. This country may be an attractive target as a result of ______ motives by U.S. firms that engage in direct foreign investment.

A) revenue-related B) cost-related C) A and B D) none of the above ANSWER: B 12. Which of the following is a reason to consider international business? A) economies of scale. B) exploit monopolistic advantages. C) diversification. D) all of the above ANSWER: D 13. From the concept of an “efficient frontier,” the point on a frontier that is optimal for all firms: A) is the top point. B) is the point closest to the vertical axis. C) is the point half way between the two end points. D) cannot be determined since firms vary in their willingness to accept risk. ANSWER: D 14. Direct foreign investment is perceived by foreign governments to: A) be a cause of national problems. B) be a remedy for national problems. C) either A or B is possible. D) have no impact on national problems. ANSWER: C 15. Direct foreign investment would typically be welcomed if: A) the products to be produced are substitutes for other locally produced products. B) people from its headquarters country are transferred to the foreign country to work at the

subsidiary. C) the products to be produced are going to be exported. D) all of the above ANSWER: C


16. Assume a U.S. firm initiates direct foreign investment in the U.K.. If the British pound is expected to appreciate against the dollar, the dollar value of earnings remitted to the parent should _______. The parent may request that the subsidiary _______ in order to benefit from the expectation about the pound.

A) increase; postpone remitting earnings until the pound strengthens B) decrease; postpone remitting earnings until the pound strengthens C) decrease; remit earnings immediately before the pound strengthens D) increase; remit earnings immediately before the pound strengthens ANSWER: A 17. Assume the British pound appreciates against the dollar while the Japanese yen depreciates against

the dollar. Which of the following is true? A) Japanese exporters can increase American sales by shifting operations from their British

subsidiaries to Japan. B) British exporters can increase American sales by shifting operations from their Japanese

subsidiaries to Britain. C) American exporters can increase sales to Japan by shifting operations from Japanese

subsidiaries to American subsidiaries. D) B and C ANSWER: A 18. Even if production costs are higher in a foreign country, a U.S. firm may establish a

manufacturing plant in the foreign country now if: A) the host government of that country eliminates all quotas. B) the host government of that country reduces all quotas. C) the host government of that country increases all quotas. D) the host government of that country eliminates all tariffs. ANSWER: C 19. A country with high unemployment could best increase its employment by: A) encouraging foreign firms to establish subsidiaries that produce the same products local firms

produce. B) encouraging foreign firms to establish licensing arrangements for products local firms

produce. C) encouraging foreign firms to establish subsidiaries that produce products local firms do not

produce. D) none of the above would reduce employment. ANSWER: C


20. According to your text, _______________ is a country that has been perceived as one of the most attractive sources of new demand. A) Paraguay B) Morocco C) Sweden D) China

ANSWER: D

21. ____________ is not a disadvantage of direct foreign investment. A) The expense of establishing a foreign subsidiary B) The uncertainty of inflation and exchange rate movements C) Political risk D) All of the above are disadvantages of direct foreign investment

ANSWER: D

22. Assume the correlation coefficient between the returns on the existing project and the return on a

proposed foreign project is 1. Also assume the returns on existing project and the new project are equal, and that the existing project has a lower standard deviation than the proposed project. Under this scenario, undertaking the proposed project will ___________ the variance of the firm’s overall returns. A) decrease B) increase C) decrease or increase, depending on the exact size of the returns and standard deviations D) none of the above

ANSWER: B

23. Which of the following is not true regarding host government attitudes towards direct foreign

investment (DFI)? A) Host governments may offer incentives to MNCs in the form of subsidies in certain

circumstances. B) Host governments generally perceive DFI as a remedy to eliminate a country’s political

problems. C) The ability of a host government to attract DFI is dependent on the country’s markets and

resources. D) Some types of DFI will be more attractive to some governments than to others. E) All of the above are true.

ANSWER: B


24. Which of the following is not true regarding the efficient frontier considered by MNCs? A) There is exactly one point on the efficient frontier that is optimal for every MNC, regardless

of its degree of risk aversion. B) The efficient frontier for international projects will probably lie to the left of the efficient

frontier for domestic projects. C) Each point on the efficient frontier represents a portfolio of projects as opposed to an

individual project. D) A and C are false. E) All of the above are true.

ANSWER: A

25. Which of the following is not an advantage resulting from the Asian crisis that would favor direct

foreign investment in Asia? A) strong local demand for products. B) low production costs. C) weak local currencies. D) all of the above are advantages.

ANSWER: A

26. MNCs commonly consider direct foreign investment because it can improve their profitability and

enhance shareholder wealth. A) true. B) false.

ANSWER: A

27. ______________ is not a revenue-related motive for direct foreign investment.

A) Attracting new sources of demand B) Fully benefiting from economies of scale C) Exploiting monopolistic advantages D) Entering profitable markets

ANSWER: B

28. ____________ is not a cost-related motive for direct foreign investment.

A) Exploiting monopolistic advantages B) Fully benefiting from economies of scale C) Uses foreign factors of production D) Using foreign raw materials

ANSWER: A


29. When a firm perceives that a foreign currency is _________, the firm may attempt direct foreign investment in that country, as the initial outlay should be relatively _______. A) overvalued; high B) overvalued; low C) undervalued; high D) undervalued; low

ANSWER: D

30. Countries that became part of the European Union in 2004 had high labor and production costs

and therefore were not targeted for new DFI by MNCs that wanted to reduce manufacturing costs. A) true. B) false.

ANSWER: B

31. Generally speaking, direct foreign investment by U.S. firms is common in ________ but not to

common in _________. A) Europe; Canada B) Asia; Europe C) Europe; Asia D) none of the above

ANSWER: C

32. The best means to accomplish the revenue-related motive of attracting new sources of demand is

to: A) acquire a competitor that has controlled its local market. B) establish a subsidiary or acquire a competitor in a new market. C) establish a subsidiary in a market where tougher trade restrictions will adversely affect the

firm’s export volume. D) establish subsidiaries in markets whose business cycles differ from those where existing

subsidiaries are based. ANSWER: B

33. To enter markets where superior profits are possible, an MNC should:

A) acquire a competitor that has controlled its local market. B) establish a subsidiary or acquire a competitor in a new market. C) establish a subsidiary in a market where tougher trade restrictions will adversely affect the

firm’s export volume. D) establish subsidiaries in markets whose business cycles differ from those where existing

subsidiaries are based.

ANSWER: A


34. To exploit monopolistic advantages, an MNC should: A) acquire a competitor that has controlled its local market. B) establish a subsidiary or acquire a competitor in a new market. C) establish a subsidiary in a market where tougher trade restrictions will adversely affect the

firm’s export volume. D) establish subsidiaries in markets where competitors are unable to produce the identical

product.

ANSWER: D 35. To fully benefit from economies of scale, an MNC should:

A) establish a subsidiary in a new market that can sell products produced elsewhere. B) establish a subsidiary in a market that has relatively low costs of labor or land. C) establish a subsidiary in a market where raw materials are cheap and accessible. D) participate in a joint venture in order to learn about a production process or other operations.

ANSWER: A

36. To use foreign factors of production, an MNC should:

A) establish a subsidiary in a new market that can sell products produced elsewhere. B) establish a subsidiary in a market that has relatively low costs of labor or land. C) establish a subsidiary in a market where raw materials are cheap and accessible. D) participate in a joint venture in order to learn about a production process or other operations.

ANSWER: B

37. They key to international diversification is selecting foreign projects whose performance levels are

highly correlated over time. A) true. B) false.

ANSWER: B

38. When economic conditions of two countries are ________, then a firm would _______ its risk by

operating in both countries instead of concentrating just in one. A) highly correlated; reduce B) not highly correlated; not reduce C) not highly correlated; reduce D) none of the above

ANSWER: C

39. Along the frontier of efficient project portfolios, exactly one portfolio can be singled out as

“optimal” for all MNCs. A) true. B) false.

ANSWER: B


40. Some governments restrict foreign ownership of local firms. Such restrictions may limit or prevent international acquisitions. A) true. B) false.

ANSWER: A

41. Direct foreign investment (DFI) represents investment in real assets (such as land, buildings, or even existing plants) in foreign countries. A) true. B) false.

ANSWER: A

42. Although direct foreign investment is sometimes conducted, benefits are rarely realized.

A) true. B) false.

ANSWER: B

43. MNCs often attempt to set up production in locations where land and labor are expensive, because

expensive factors of production indicate high demand. A) true. B) false.

ANSWER: B

44. Due to market imperfections, the cost of factors of production (such as labor) may differ

substantially across countries. A) true. B) false.

ANSWER: A

45. In assessing the risk of an individual project, the expected correlation of the new project’s returns

with those of the prevailing business should be considered. A) true. B) false.

ANSWER: A

519

Chapter 14

Multinational Capital Budgeting 1. If a U.S. parent is setting up a French subsidiary, and funds from the subsidiary will be

periodically sent to the parent, the ideal situation from the parent’s perspective is a ____ after the subsidiary is established.

A) strengthening euro B) stable euro C) weak euro D) B and C are both ideal.

ANSWER: A 2. According to the text, in order to develop a distribution of possible net present values from

international projects, a firm should use: A) a risk-adjusted discount rate. B) payback period. C) certainty equivalents. D) simulation. ANSWER: D 3. When evaluating international project cash flows, which of the following factors is relevant? A) future inflation. B) blocked funds. C) exchange rates. D) all of the above ANSWER: D 4. In general, increased investment by the parent in the foreign subsidiary causes more exchange rate

exposure to the parent over time because the cash flows remitted to the parent will be larger. A) true. B) false.

ANSWER: A


5. Blocked funds may penalize a project if the return on the forced reinvestment in the foreign country is less than the required rate of return on the project. A) true. B) false.

ANSWER: A

6. When assessing a German project administered by a German subsidiary of a U.S.-based MNC

solely from the German subsidiary’s perspective, which variable will most likely influence the capital budgeting analysis?

A) the withholding tax rate. B) the euro’s exchange rate. C) the U.S. tax rate on earnings remitted to the U.S. D) the German government’s tax rate. E) A and C ANSWER: D 7. In capital budgeting analysis, the use of a cumulative NPV is useful for: A) determining a probability distribution of NPVs. B) determining the time required to achieve a positive NPV. C) determining how the required rate of return changes over time. D) determining how the cost of capital changes over time. E) A and B ANSWER: B 8. Assume the parent of a U.S.-based MNC plans to completely finance the establishment of its

British subsidiary with existing funds from retained earnings in U.S. operations. According to the text, the discount rate used in the capital budgeting analysis on this project should be most affected by:

A) the cost of borrowing funds in the U.K. B) the cost of borrowing funds in the U.S. C) the parent’s cost of capital. D) A and B ANSWER: C 9. Assume a U.S.-based MNC has a Chilean subsidiary that annually remits 30 million Chilean pesos

to the U.S. If the peso _______, the dollar amount of remitted funds _______. A) appreciates; decreases B) depreciates; is unaffected C) appreciates; is unaffected D) depreciates; decreases E) B and C ANSWER: D

Chapter 14: Multinational Capital Budgeting 521

10. Assume an MNC establishes a subsidiary where it has no other existing business. The present value of parent cash flows from this subsidiary is more sensitive to exchange rate movements when:

A) the subsidiary finances the entire investment by local borrowing. B) the subsidiary finances most of the investment by local borrowing. C) the parent finances most of the investment. D) the parent finances the entire investment. ANSWER: D 11. If an MNC exports to a country, then establishes a subsidiary to produce and sell the same product

in the country, then cash flows from prevailing operations would likely be _______ affected by the project. If an MNC establishes a foreign manufacturing subsidiary that buys components from the parent, the cash flows from prevailing operations would likely be _______ affected by the project.

A) adversely; adversely B) favorably; adversely C) favorably; favorably D) adversely; favorably ANSWER: D 12. An MNC is considering establishing a two-year project in New Zealand with a $30 million initial

investment. The firm’s cost of capital is 12%. The required rate of return on this project is 18%. The project is expected to generate cash flows of NZ$12 million in Year 1 and NZ$30 million in Year 2, excluding the salvage value. Assume no taxes, and a stable exchange rate of $.60 per NZ$ over the next two years. All cash flows are remitted to the parent. What is the break-even salvage value?

A) about NZ$11 million. B) about NZ$15 million. C) about NZ$31 million. D) about NZ$37 million. E) about NZ$25 million. ANSWER: E SOLUTION: 1. NZ$12,000,000 x $.60 = $7,200,000 $7,200,000/(1.18) = $6,101,695 2. NZ$30,000,000 x $.60 = $18,000,000 $18,000,000/(1.18)2 = $12,927,320 $19,029,015 Break-even salvage = [Initial outlay - PV of cash flows] (1 + k)m value = [$30,000,000 - $19,029,015] (1.18)2 = $15,276,000 Break-even salvage value in NZ$ = $15,276,000/$.60 = NZ$25,459,999


13. A firm considers an exporting project and will invoice the exports in dollars. The expected cash flows in dollars would be more difficult if the currency of the foreign country is ________.

A) fixed B) volatile C) stable D) none of the above, as the firm is not exposed ANSWER: B 14. If the parent charges the subsidiary administrative fees, the earnings from the project will appear

low to the parent and high to the subsidiary. A) true. B) false.

ANSWER: B

15. Other things being equal, a blocked funds restriction is more likely to have a significant adverse

effect on a project if the currency of that country is expected to _______ over time, and if the interest rate in that country is relatively ______.

A) appreciate; low B) appreciate; high C) depreciate; high D) depreciate; low ANSWER: D 16. If a multinational project is assessed from the subsidiary’s perspective, withholding taxes are

ignored for project assessment. A) true. B) false.

ANSWER: A

17. Other things being equal, firms from a particular home country will engage in more international

acquisitions if they expect foreign currencies to _______ against their home currency, and if their cost of capital is relatively _______.

A) appreciate; low B) appreciate; high C) depreciate; high D) depreciate; low ANSWER: A


18. The discrepancy between the feasibility of a project in a host country from the perspective of the U.S. parent versus the subsidiary administering the project is likely to be greater for projects in countries where:

A) the taxes are the same as in the U.S. B) there are no blocked fund restrictions. C) the currency of the host country is expected to depreciate consistently. D) none of the above; a discrepancy is not possible. ANSWER: C 19. The break-even salvage value of a particular project is the salvage value necessary to: A) offset any losses incurred by the subsidiary in a given year. B) offset any losses incurred by the MNC overall in a given year. C) make the project have zero profits. D) make the project’s return equal the required rate of return. ANSWER: D 20. The impact of blocked funds on the net present value of a foreign project will be greater if interest

rates are _______ in the host country and there are _______ investment opportunities in the host country.

A) very high; limited B) very low; limited C) very low; numerous D) very high; numerous ANSWER: B 21. One foreign project in Hungary and another in Japan had the same perceived value from the U.S.

parent’s perspective. Then, the exchange rate expectations were revised, upward for the value of the Hungarian forint and downward for the Japanese yen. The break-even salvage value for the project in Japan would now be _______ from the parent’s perspective.

A) negative B) higher than that for the Hungarian project C) lower than that for the Hungarian project D) the same as that for the Hungarian project E) A and C ANSWER: B 22. Exchange rates for purposes of multinational capital budgeting:

A) are very difficult to forecast. B) can be easily hedged with currency swaps. C) are unimportant, as they do not affect the cash flows of the multinational project. D) all of the above

ANSWER: A


23. A U.S.-based MNC has just established a subsidiary in Algeria. Shortly after the plant was built, the MNC determines that its exchange rate forecasts, which had previously indicated a slight appreciation in the Algerian dinar were probably false. Instead of a slight appreciation, the MNC now expects that the dinar will depreciate substantially due to political turmoil in Algeria. This new development would likely cause the MNC to __________ its estimate of the previously computed net present value. A) lower B) increase C) lower, but not necessarily if the MNC invests enough in Algeria to offset the decrease in NPV D) increase, but not necessarily if the MNC reduces its investment in Algeria by an offsetting

amount E) none of the above

ANSWER: A

The following information refers to questions 24 through 26. 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 $.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 $.13 $.14 $.12 $.15 24. What is the net present value of the Norwegian project?

A) -$803,848. B) $5,803,848. C) $1,048,829. D) none of the above

ANSWER: C

SOLUTION:

Year 0 Year 1 Year 2 Year 3 Year 4 Cash flow to parent -$5,000,000 $1,300,000 $2,100,000 $2,040,000 $3,000,000 PV of parent cash flow 1,150,442 1,644,608 1,413,822 1,839,956

Cumulative NPV -3,849,558 -2,204,950 -791,128 1,048,828


25. 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) 1,710,088 C) 1,040,000 D) none of the above

ANSWER: D

SOLUTION: Even if there is no salvage value, the NPV would still be positive, as shown below:

Year 0 Year 1 Year 2 Year 3 Year 4

Cash flow to parent -$5,000,000 $1,300,000 $2,100,000 $2,040,000 $1,800,000 PV of parent cash flow 1,150,442 1,644,608 1,413,822 1,103,974 Cumulative NPV -3,849,558 -2,204,950 -791,128 312,846 26. 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.

ANSWER: D

SOLUTION:

Year 0 Year 1 Year 2 Year 3 Year 4 Cash flow to parent -$5,000,000 $1,300,000 $2,100,000 $2,040,000 $3,000,000 PV of parent cash flow 1,120,690 1,560,642 1,306,942 1,656,873 Cumulative NPV -3,879,310 -2,318,668 -1,011,726 645,147

27. Petrus Company has a unique opportunity to invest in a two-year project in Australia. The 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 $.55 and $.60, respectively? A) $2,905,817. B) -$94,183. C) $916,128. D) none of the above

ANSWER: B


SOLUTION: Year 0 Year 1 Year 2

Cash flow to parent -$1,500,000 $550,000 $1,200,000 PV of parent cash flow 482,456 923,361 Cumulative NPV -1,017,544 -94,183 28. Which of the following is not a characteristic of a country to be considered within an MNC’s

international tax assessment? A) corporate income taxes. B) withholding taxes. C) provisions for carrybacks and carryforwards. D) tax treaties. E) all of the above are characteristics to be considered.

ANSWER: E

29. Like income tax treaties, ____________ help to avoid double taxation and stimulate direct foreign

investment. A) withholding taxes B) excise taxes C) tax credits D) carryforwards

ANSWER: C

30. If the parent’s government imposes a _______ tax rate on funds remitted from a foreign

subsidiary, a project is less likely to be feasible from the _________ point of view. A) high; subsidiary’s B) high; parent’s C) low; parent’s D) A and C E) none of the above

ANSWER: B

31. If a subsidiary project is assessed from the subsidiary’s perspective, then an expected appreciation

in the foreign currency will affect the feasibility of the project ________. A) positively B) negatively C) either positively or negatively, depending on the percentage appreciation D) none of the above

ANSWER: D


32. When a foreign subsidiary is not wholly owned by the parent and a foreign project is partially financed with retained earnings of the parent and of the subsidiary, then: A) the parent’s perspective should be used to evaluate a foreign project. B) the subsidiary’s perspective should be used to evaluate a foreign project. C) the foreign project should enhance the value of both the parent and the subsidiary. D) none of the above

ANSWER: C

33. The __________ is likely the major source of funds to support a particular project.

A) initial investment B) variable costs C) fixed costs D) none of the above

ANSWER: A

34. Because before-tax cash flows are necessary for an adequate capital budgeting analysis,

international tax effects need not be determined on a proposed foreign project. A) true. B) false.

ANSWER: B

35. The required rate of return of a project is _____________ the MNC’s cost of capital.

A) greater than B) less than C) the same as D) any of the above, depending on the specific project

ANSWER: D

36. An international project’s NPV is _________ related to the size of the initial investment and

_________ related to the project’s required rate of return. A) positively; positively B) positive; negatively C) negatively; positively D) negatively; negatively

ANSWER: D

37. An international project’s NPV is _________ related to consumer demand and _________ related

to the project’s salvage value. A) positively; positively B) positive; negatively C) negatively; positively D) negatively; negatively

ANSWER: A


38. Everything else being equal, the _________ the depreciation expense is in a given year, the ________ a foreign project’s NPV will be. A) higher; lower B) higher; higher C) lower; higher D) none of the above

ANSWER: B

39. A foreign project generates a negative cash flow in year 1 and positive cash flows in years 2

through 5. The NPV for this project will be higher if the foreign currency _________ in year 1 and _________ in years 2 though 5. A) depreciates; depreciates B) appreciates; appreciates C) depreciates; appreciates D) appreciates; depreciates

ANSWER: C

40. If an MNC sells a product in a foreign country and imports partially manufactured components

needed for production to that country from the U.S., then the local economy’s inflation will have: A) a more pronounced impact on revenues than on costs. B) a less pronounced impact on revenues than on costs. C) the same impact on revenues as on costs. D) none of the above ANSWER: A

41. When conducting a capital budgeting analysis and attempting to account for effects of exchange

rate movements for a foreign project, inflation __________ included explicitly in the cash flow analysis, and debt payments by the subsidiary _________ included explicitly in the cash flow analysis. A) should be; should be B) should definitely not be; should definitely not be C) should definitely not be; should be D) should be; should definitely not be

ANSWER: A

42. As the financing of a foreign project by the parent _______ relative to the financing provided by

the subsidiary, the parent’s exchange rate exposure _________. A) increases; decreases B) decreases; increases C) increases; increases D) none of the above

ANSWER: C


43. In conducting a multinational capital budgeting analysis, the subsidiary’s perspective should always be used. A) true. B) false.

ANSWER: B

44. The feasibility of a multinational project from the parent’s perspective is dependent not on the

subsidiary cash flows but on the cash flows that it ultimately receives. A) true. B) false.

ANSWER: A

45. The required rate of return used to discount the relevant cash flows from a foreign project may

differ from the MNC’s cost of capital because of that particular project’s risk. A) true. B) false.

ANSWER: A

46. In multinational capital budgeting, depreciation is treated as a cash outflow. A) true. B) false.

ANSWER: B

47. No matter what the probability distribution of future exchange rates is, as long as one out of

several scenarios results in a negative net present value (NPV), a project should not be accepted. A) true. B) false.

ANSWER: B

48. If a foreign project is financed with a subsidiary’s retained earnings, the subsidiary’s investment

could be viewed as an opportunity cost, since the funds could be remitted to the parent rather than invested in the foreign project. A) true. B) false.

ANSWER: A

49. If a host government restricts the remittances from a foreign subsidiary, a possible solution is to let

the subsidiary obtain partial financing for the project. A) true. B) false.

ANSWER: A

530

Chapter 15

Multinational Restructuring 1. Which of the following is not an example of multinational restructuring?

A) An MNC builds a new subsidiary in Malaysia. B) An MNC acquires a company in Germany. C) An MNC downsizes its operations in Hong Kong. D) An MNC shifts some production from its Swiss subsidiary to its Dutch subsidiary. E) All of the above are examples of multinational restructuring.

ANSWER: E

2. Which of the following is not an advantage of international acquisitions over the establishment of

a new subsidiary? A) The firm can immediately expand its international business. B) The firm benefits from existing customer relationships. C) International acquisitions are generally cheaper than the establishment of a new subsidiary. D) An international acquisition typically generates quicker and larger cash flows than the

establishment of a new subsidiary. E) All of the above are advantages of international acquisitions.

ANSWER: C 3. According to your text, many more international acquisitions are taking place in __________,

partially because of more uniform standards and the momentum for free enterprise. A) Europe B) Latin America C) Asia D) Africa E) none of the above

ANSWER: A

Chapter 15: Multinational Restructuring 531

4. Which of the following is not true regarding a target’s previous cash flows? A) They may serve as an initial base from which future cash flows may be estimated after

accounting for other factors. B) It may be easier to estimate the cash flows to be generated by a target than to estimate the cash

flows to be generated from a new foreign subsidiary. C) They are always good indicators of future cash flows. D) All of the above are true.

ANSWER: C

5. As far as the managerial talent of the target is concerned:

A) the manner in which the acquirer plans to deal with the managerial talent will affect the estimated cash flows to be generated by the target.

B) downsizing will reduce expenses and increase productivity and revenues. C) governments of some countries are likely to intervene and prevent the acquisition if

downsizing is anticipated. D) A and C only E) all of the above

ANSWER: D

6. Based on information in your text, the following factors should be considered in an international

acquisition, except: A) the target’s willingness to be acquired. B) the target’s previous acquisition history. C) the target’s previous cash flows. D) the target’s local economic conditions.

ANSWER: B

7. Which of the following tax-related factors need not be considered in assessing a foreign target? A) corporate tax rates in the host country. B) withholding tax rates in the host country. C) withholding tax rates in the home country. D) corporate tax rates in the home country. E) all of the above must be considered in assessing a foreign target.

ANSWER: C


The following information refers to questions 8 to 10. 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 firm 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 MYR15 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%. 8. Based on the information provided above, the net present value of the Malaysian target is

$_______ million. A) 155.9 B) 111.5 C) 138.0 D) 143.0 E) none of the above

ANSWER: B


SOLUTION: Valuation of Bulgarian Target Based on the Assumptions Provided

(numbers are in millions) Year 1 Year 2 Year 3 Revenue MYR300 MYR327 MYR356.4 Cost of Goods Sold MYR180 MYR196.2 MYR213.8 Gross Profit MYR120 MYR130.8 MYR142.6 Selling & Admin. Exp. MYR40 MYR40 MYR40 Depreciation MYR15 MYR15 MYR15 Earnings Before Taxes MYR65 MYR75.8 MYR87.6 Tax (30%) MYR19.5 MYR22.7 MYR26.3 Earnings After Taxes MYR45.5 MYR53.1 MYR61.3 +Depreciation MYR15 MYR15 MYR15 -Funds to Reinvest MYR9 MYR9 MYR9 Sale of Firm MYR500 Cash Flows in MYR MYR51.5 MYR59.1 MYR567.3 Exchange Rate of MYR $.23 $.23 $.23 Cash Flows in $ $11.8 $13.6 $130.5 PV (13% disc. rate) $10.4 $10.7 $90.4 Cumulative PV $10.4 $21.1 $111.5 The value of the Malaysian target based on the information provided is $111.5 million.

9. The Malaysian target’s value based on its stock price is $________ million. A) 1.4 B) 1,673.9 C) 111.5 D) 88.6 E) none of the above

ANSWER: D

SOLUTION: Since the Malaysian target has 11 million shares outstanding, each of which is worth MYR35 per share, its market value is 11,000,000 x 35 = MYR385 million x $.23 = $88.6 million.


10. 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

ANSWER: B

SOLUTION: Since your valuation of the target is $111.5 million and the market’s valuation of the target is $88.55 million, you should be willing to offer a maximum premium of $111.5/$88.55 - 1 = 25.9%.

11. Which of the following would probably not cause the stock price of a foreign target to decrease?

A) Its expected cash flows decline. B) General stock market conditions in the foreign country are deteriorating. C) Investors anticipate that the target will be acquired. D) All of the above will cause the target’s stock price to decrease.

ANSWER: C

12. Which of the following factors is least likely to cause the required rate of return to vary among

MNCs assessing the same foreign target? A) differences in the timing of remittances from the target to the parent. B) differences in the desired use of the target. C) differences in the local risk-free interest rate. D) differences in the ability to use financial leverage.

ANSWER: A

13. Which of the following types of international restructuring is probably the most difficult to value

by an MNC? A) international acquisition. B) newly privatized foreign business. C) international alliance. D) international divestiture.

ANSWER: B

14. A previously undertaken project in a foreign country may no longer be feasible because:

A) the MNC is unable to raise sufficient funds in order to undertake the project. B) the MNC’s cost of capital has decreased. C) the host government has increased its tax rates substantially. D) exchange rate projections changed from a depreciation to an appreciation of the foreign

currency.

ANSWER: C


15. An international alliance typically requires a __________ initial outlay than an international acquisition, and the cash flows to be received will typically be _________ than the cash flow resulting from an international acquisition. A) smaller; larger B) smaller; smaller C) larger; smaller D) larger; larger

ANSWER: B

16. Even if an existing business adds value to an MNC, it may be worthwhile to assess whether the

business would generate more value to the MNC if it was restructured. A) true. B) false.

ANSWER: A

17. At present, U.S. firms acquire more targets in the former Soviet Union than in any other country.

A) true. B) false.

ANSWER: B

18. The U.S. is one of the few countries with agencies that monitor mergers and acquisitions.

A) true. B) false.

ANSWER: B

19. Most countries discourage hostile takeovers.

A) true. B) false.

ANSWER: A

20. Since the cash flows generated by a foreign target will eventually be converted to the parent’s

currency, there is no need to consider the foreign exchange rate in the capital budgeting process. A) true. B) false.

ANSWER: B

21. From a foreign currency perspective, the ideal conditions would be a weak foreign currency at the time of acquisition and a strengthening of the foreign currency over time as funds are remitted back to the parent. A) true. B) false.

ANSWER: A


22. Premiums required to entice a target’s board of directors to approve an acquisition are usually between 1 and 3 percent of the target’s market price. A) true. B) false.

ANSWER: B

23. A foreign target’s expected future cash flows generally vary among different MNCs valuing the

target. A) true. B) false.

ANSWER: A

24. An acquirer based in a low-tax country may be able to generate higher cash flows from acquiring a

foreign target than an acquirer based in a high-tax country. A) true. B) false.

ANSWER: A

25. The value of an MNC (from the parent’s perspective) is independent of the MNC’s desired

scheduling of remitted funds from the target. A) true. B) false.

ANSWER: B

26. If potential acquirers are based in different countries, their required rates of return when

considering a specific target will only vary if the desired use of the target is different. A) true. B) false.

ANSWER: B

27. Acquirers may have different required rates of return because of differences in the ability to use financial leverage. A) true. B) false.

ANSWER: A

28. An international acquisition is different from the establishment of a new subsidiary in that the

MNC can immediately expand its international business since the target is already in place. A) true. B) false.

ANSWER: A


29. An MNC that plans to acquire a target would prefer to time its bid for the target when the local stock market prices are generally high. A) true. B) false.

ANSWER: B

30. Privatization involves the sale of previously government-owned businesses by the government.

A) true. B) false.

ANSWER: A

31. An MNC should periodically reassess its investments to determine whether to divest them.

A) true. B) false.

ANSWER: A

32. The initial outlay for a project in a foreign country may decline if property values in that country decline. A) true. B) false.

ANSWER: A

33. The valuation of newly privatized businesses is generally more difficult than the valuation of a

foreign target that has operated privately for several years. A) true. B) false.

ANSWER: A

34. Other things being equal, a foreign subsidiary in China would more likely be divested by the U.S.

parent if new information caused the parent to suddenly anticipate that: A) the Chinese yuan would depreciate in the future. B) the Chinese yuan would appreciate in the future. C) the Chinese yuan would remain somewhat stable in the future. D) none of the above; the value of the Chinese yuan has no impact on the feasibility of a

divestiture. ANSWER: A


35. Which of the following is not directly considered in the decision by a U.S.-based MNC to divest a subsidiary?

A) the required rate of return on the subsidiary. B) forecasted exchange rates of the subsidiary’s currency relative to the dollar. C) the initial outlay on the project. D) the possible selling price of the project. ANSWER: C 36. Regarding the valuation of privatized business in less developed countries, __________ can

normally be estimated with a high degree of accuracy. A) future cash flows B) future exchange rate movements C) the proper discount rate D) none of the above ANSWER: D 37. U.S. firms acquire more target firms in __________ than in any other country. A) Germany B) Mexico C) France D) United Kingdom ANSWER: D 38. Firms based in __________ tend to acquire more U.S. target firms than the other countries listed

here. A) Canada B) Japan C) Germany D) Mexico ANSWER: A 39. Even if an existing business adds value to the MNC, it may be worthwhile to assess whether the

business would generate more value to the MNC if it was restructured. A) true. B) false.

ANSWER: A


40. An MNC’s parent would consider investing in a target only if the estimated present value of the cash flows it would ultimately receive from the target over time ________ the initial outlay necessary to purchase the target. A) is less than B) is the same as C) is greater than D) none of the above

ANSWER: C 41. Which of the following is not a reason that the initial outlay for acquiring a firm in Asia was lower

as a result of the Asian crisis? A) Property values in Asia had declined. B) The parent’s currency (for parents in the United States of Europe) has less purchasing power

due to the weakening of the Asian currencies. C) Many firms in Asia were near bankruptcy and were unable to obtain necessary funding. D) The governments in Asian countries were more willing to allow foreign acquisitions of local

firms as a means of resolving the crisis. ANSWER: B 42. The adoption of the euro as the local currency by several European countries has ___________

capital budgeting analysis for an MNC that is comparing possible target firms in those countries. A) simplified B) complicated C) had no effect on D) none of the above

ANSWER: A 43. A target’s previous cash flows are typically an accurate indicator of future cash flows, especially

when the target’s cash flows would have to be converted into the acquirer’s home currency as they are remitted to the parent. A) true. B) false.

ANSWER: B 44. Potential targets in countries where economic conditions are ________ are more likely to

experience strong demand for their products in the future and may generate ________ cash flows. A) strong; lower B) weak; higher C) weak; lower D) strong; higher

ANSWER: D


45. When an MNC assesses targets among countries, it would prefer a country where the growth potential for its industry is ______ and the competition within the industry is ________. A) low; not excessive B) high; excessive C) high; not excessive D) low; excessive

ANSWER: C 46. An MNC that plans to acquire a target would prefer to make a bid at a time when the local stock

market prices are generally _______. Assume that economic conditions are held constant when completing this statement. A) low B) high C) volatile D) none of the above

ANSWER: A 47. If a target is privately held, general stock market conditions will not affect the amount that an

acquirer has to pay for a foreign target. A) true. B) false.

ANSWER: B 48. The earnings of a private European firm are €5 million, and the average P/E ratio of publicly

traded European firms in the same industry is 12. This firm is considering the possibility of going public in which it would issue one million shares. If the private firm has similar growth potential and other characteristics similar to other publicly traded firms in the industry, its value can be estimated as ______ million euros. A) 2.4 B) 60.0 C) 41.7 D) 12

ANSWER: B SOLUTION: Market valuation = €5 million x 12 = €60 million 49. If the foreign currency ___________ by the time the acquirer makes payment, the acquisition will

be more costly, and the cost of the acquisition changes __________ the change in the exchange rate. A) appreciates; by a lesser percentage then B) depreciates; in the same proportion as C) appreciates; in the same proportion as D) appreciates; by a greater percentage than

ANSWER: C


50. If an MNC targets a successful foreign company with plans to continue the target’s local business in a more efficient manner, the risk of the business will be relatively _______, and therefore the MNC’s required return from acquiring the target will be relatively _______. A) high; high B) high; low C) low; high D) low; low

ANSWER: D 51. Even after an MNC’s accept/reject decision of a foreign acquisition has been made, it should be

reassessed at various times. In fact, this analysis may indicate that a previously accepted project should be divested. A) true. B) false.

ANSWER: A

52. An international acquisition may be preferable to the establishment of a new subsidiary because

the firm can immediately expand its international business and benefit from existing customer relationships. A) true. B) false.

ANSWER: A

542

Chapter 16

Country Risk Analysis 1. A macro-assessment of country risk: A) is adjusted for the particular business of the firm involved. B) excludes all aspects relevant to a particular firm or project. C) A and B D) none of the above ANSWER: B 2. A micro-assessment of country risk: A) is adjusted for the particular business of the firm involved. B) excludes all aspects relevant to a particular firm or project. C) A and B D) none of the above ANSWER: A 3. The Delphi technique: A) is a method of purchasing information about inspections of the country being evaluated. B) requires the use of discriminant analysis to assess country risk. C) involves the collection of independent opinions on country risk. D) none of the above ANSWER: C 4. The checklist approach: A) requires several inspections of the country being evaluated. B) requires the use of discriminant analysis to assess country risk.

C) requires ratings and weights to be assigned to all factors relevant in assessing country risk. D) involves the collection of independent opinions on country risk. ANSWER: C

Chapter 16: Country Risk Analysis 543

5. The most important variable in determining a country’s degree of overall country risk: A) is political risk. B) is financial risk. C) is the probability of a host government takeover. D) may often vary with the country of concern. ANSWER: D 6. According to the text, country risk analysis has: A) almost always detected problems before they occur. B) been effectively used in place of capital budgeting to determine whether a project should be

accepted. C) been perfected as a result of the development of discriminant analysis. D) none of the above ANSWER: D 7. To best reduce exposure to a host government takeover, a subsidiary could: A) use a long-run profit perspective for business in that country. B) hire people from its own country if the host government does not cooperate. C) attempt to obtain supplies from its parent. D) borrow funds from its parent rather than from the host country’s creditors. ANSWER: C 8. Insurance purchased to cover the risk of expropriation __________, and will typically cover

__________. A) will be the same for all firms; only a portion of the firm’s total exposure. B) will be the same for all firms; all of the firm’s total exposure. C) will be dependent on the firm’s risk; all of the firm’s total exposure. D) will be dependent on the firm’s risk; only a portion of the firm’s total exposure. ANSWER: D 9. Country risk assessment should be used when: A) determining whether to establish a subsidiary in a foreign country. B) determining whether to continue business in a foreign country. C) A and B D) none of the above ANSWER: C


10. When determining whether a particular proposed project in a foreign country is feasible: A) a country risk rating can adequately substitute for a capital budgeting analysis. B) country risk analysis should be incorporated within the capital budgeting analysis. C) the effect of country risk on sales revenue is more important than the effect on cash flows. D) the project with the highest country risk rating (lowest country risk) should be accepted. E) B and D ANSWER: B 11. The primary purpose of country risk analysis when applied to capital budgeting is usually to: A) measure the effect of country risk on sales. B) measure the effect of country risk on cash flows. C) measure the effect of country risk on the consolidated balance sheet. D) measure the effect of country risk on the consolidated income statement. ANSWER: B 12. If a foreign country follows the “Purchase Homemade Products” philosophy, the least effective

strategy would be for a U.S. firm to: A) use a licensing arrangement with a local firm in that country. B) enter into a joint venture in that country. C) develop a subsidiary (under the U.S. name) that manufactures and sells products in that

country. D) develop a subsidiary (under the U.S. name) that manufactures products in that country and

exports them to border countries. ANSWER: C 13. An MNC considers direct foreign investment in Germany. It is mainly concerned with the

subsidiary’s ability to generate sufficient sales there. The country risk characteristic that would best address this concern is:

A) the host government’s tax rates charged on remitted earnings. B) the possibility of blocked funds. C) the state of the economy in Germany. D) the possibility of a withholding tax imposed by the German government. ANSWER: C 14. An MNC has a foreign manufacturing plant to capitalize on cheap production costs; the MNC

exports all the goods produced. It should be most concerned about the country’s: A) growth in gross national product. B) government policies designed to increase tariffs on imported goods. C) local consumer purchasing habits. D) government environmental regulations and taxes on the lease or purchase of a production site. ANSWER: D


15. A firm may incorporate a country risk rating into the capital budgeting analysis by: A) adjusting the NPV upward if the country risk rating has fallen (implying increased risk) below

a benchmark level. B) adjusting the discount rate upward as the country risk rating decreases (implying increased

risk). C) A and B

D) none of the above

ANSWER: B 16. According to the text, the most appropriate method of incorporating country risk into capital

budgeting analysis is to: A) compare each form of a country risk rating to a benchmark level. B) estimate the effect of each form of country risk on cash flows. C) estimate the effect of each form of country risk on the income statement and balance sheet. D) adjust the discount rate to reflect the level of country risk using the conventional adjustment

formula that is used by virtually all MNCs. ANSWER: B 17. The Multilateral Investment Guarantee Agency can provide MNCs implementing direct foreign

investment in less developed countries with: A) insurance that covers losses on multilateral netting procedures. B) exchange rate risk insurance. C) political risk insurance. D) guarantees that MNCs will receive the same taxation treatment by the host government as

local firms. E) guarantees of lines of credit provided by the World Bank if the MNC experiences liquidity

problems. ANSWER: C 18. Country risk analysis is important because it:

A) can be used by MNCs as a screening device to avoid countries with excessive risk. B) can be used by MNCs to monitor countries where the MNC is presently engaged in

international business. C) can be used to improve the analysis used to make long-term investing or financing decisions. D) all of the above

ANSWER: C

19. ______________ is(are) not a form of political risk.

A) Exchange rate movements B) Attitude of consumers in the host country C) Actions of the host government D) Blockage of fund transfers E) All of the above are forms of political risk

ANSWER: A


20. Eurenasia is a country that has frequently been assigned low macro-assessment ratings of country risk in the recent past due to its tendency to war with neighboring nations. MNC A is considering the establishment of a subsidiary to manufacture personal computers, while MNC B is considering the establishment of a subsidiary to manufacture tanks. Which of the two MNCs is likely to be less affected by the low macro-assessment? A) MNC A. B) MNC B. C) both will be equally affected, since the macroassessment does not vary. D) none of the above

ANSWER: B

21. Which of the following is not a technique to assess country risk?

A) Gamma technique. B) Delphi technique. C) checklist approach. D) inspection visits.

ANSWER: A

22. The ______________ involves the collection of independent opinions on country risk without

group discussion by the assessors who provide these opinions. A) checklist approach B) discriminant analysis C) regression analysis D) Delphi technique

ANSWER: D

23. When quantifying country risk:

A) weights should be equally allocated among factors. B) weights should be assigned to the political and financial factors according to their perceived

importance. C) it is not generally necessary to construct separate ratings for political and financial risk since

these will be equally weighed in the final analysis. D) the derived factors will be identical for all MNCs conducting business in that country.

ANSWER: B

24. Which of the following is not a strategy that could be used by an MNC to reduce its exposure to a host government takeover? A) attempt to recover cash flows from a foreign investment as quickly as possible. B) rely on unique supplies and/or technology. C) hire local labor. D) borrow local funds. E) all of the above are strategies to reduce an MNC’s exposure to a host government takeover.

ANSWER: E


25. MNCs can purchase insurance to cover the risk of expropriation. Which of the following is not a source of this type of insurance? A) the World Bank. B) the Overseas Private Investment Corporation (OPIC). C) the International Monetary Fund (IMF). D) all of the above are sources for insurance against expropriation.

ANSWER: C

26. Which of the following is not a way in which country risk analysis can be used?

A) to monitor countries where an MNC is currently doing business. B) as a screening device to avoid conducting business in countries with excessive risk. C) to revise an MNC’s financing decisions. D) to determine the degree to which the MNC is exposed to exchange rate movements.

ANSWER: D

27. An MNC must assess country risk not only in countries where it currently does business but also

in those where it expects to export or establish subsidiaries. A) true. B) false. ANSWER: A

28. ___________ is not a political risk factor.

A) High interest rates in a foreign country B) Currency inconvertibility C) War D) Corruption

ANSWER: A

29. A mild form of political risk is a tendency of residents to purchase only:

A) imported products. B) locally produced products. C) products produced by MNCs. D) none of the above

ANSWER: B

30. To make an MNC’s operations coincide with its own goal, a host government could do all of the

following, except: A) require the use of local employees for managerial positions. B) require social facilities. C) subsidize the MNC. D) require environmental controls.

ANSWER: C


31. When a country’s currency is inconvertible, the earnings generated by a subsidiary in that country cannot be remitted to the parent through currency conversion. A) true. B) false. ANSWER: A

32. As a result of the 2003 war in Iraq, some MNCs feared that oil prices would ______ and that U.S.

inflation and interest rates would _______. A) rise; rise B) fall; fall C) rise; fall D) fall; rise

ANSWER: A

33. Higher interest rates in a foreign country tend to ________ the growth of an economy and

________ demand for the MNC’s product. A) increase; increase B) reduce; reduce C) increase; reduce D) reduce; increase

ANSWER: B 34. A __________ currency may ________ the volume of products imported by the country and

therefore reduce the country’s production and national income. A) weak; increase B) weak; reduce C) strong; increase D) strong; reduce

ANSWER: C

35. Risk assessors almost always arrive at the same opinion after completing a macroassessment of

country risk. A) true. B) false. ANSWER: B


36. _________ involve(s) the collection of independent opinions on country risk without group discussion by the assessors who provide these opinions. A) The checklist approach B) The Delphi technique C) Quantitative analysis D) Inspection visits

ANSWER: B

37. Perhaps the most appropriate method for incorporating forms of country risk in a capital budgeting analysis is to estimate how the _______ would be affected by each form of risk. A) discount rate B) cash flows C) opportunity cost D) none of the above

ANSWER: B

38. Since country risk is constantly changing and events in other parts of the world are largely

unpredictable, country risk analysis is not important for MNCs. A) true. B) false.

ANSWER: B

39. A blockage of fund transfers imposed by a host government usually forces a subsidiary to donate

the funds to the host government. A) true. B) false.

ANSWER: B

40. Higher interest rates tend to increase the growth of an economy and increase the demand for an

MNC’s products. A) true. B) false.

ANSWER: B

41. When using a checklist approach to assess country risk, factors should be converted to some

numerical forms and assigned equal weights. A) true. B) false.

ANSWER: B


42. Unlike project risk, country risk cannot be incorporated into the capital budgeting analysis of a proposed project by adjustment of the discount rate or by adjustment of the estimated cash flows. A) true. B) false.

ANSWER: B

43. After a project is accepted and implemented, country risk does not need to be monitored; since the

project is already established, no further changes can be made. A) true. B) false.

ANSWER: B

44. While an overall risk rating of a country can be useful, it cannot always detect upcoming crises.

A) true. B) false.

ANSWER: A

45. Country risk can affect an MNC’s cash flows but cannot affect its cost of capital.

A) true. B) false.

ANSWER: B

46. To reduce the exposure to a host government takeover, an MNC may attempt to recover cash

flows from the foreign project more quickly or hire local labor. A) true. B) false.

ANSWER: A

47. The degree to which foreign MNCs were affected by the Asian crisis suggests that country risk

analysts did not detect some of the potential problems in these countries. A) true. B) false.

ANSWER: A

48. A micro-assessment of country risk involves consideration of all variables that affect country risk

except for those unique to a particular firm or industry. A) true. B) false.

ANSWER: B


49. Delphi analysis examines the financial and political factors of various countries and attempts to identify which factors help to distinguish between tolerable-risk and intolerable-risk countries. A) true. B) false.

ANSWER: B

552

Chapter 17

Multinational Cost of Capital and Capital Structure 1. An argument for MNCs to have a debt-intensive capital structure is: A) they are well diversified. B) foreign government tax rules may change over time. C) exposure to exchange rate fluctuations. D) exposure to fund blockage. ANSWER: A 2. According to the text, there is evidence that the debt ratios (debt/capital) of MNCs based in: A) the U.S. tend to be generally higher than MNCs headquartered in Japan and Germany. B) the United Kingdom tend to be generally higher than MNCs headquartered in other non-U.S.

countries. C) the U.S. tend to be generally lower than MNCs headquartered in Japan and Germany. D) A and B ANSWER: C 3. According to the text, the cost of capital for an international project will: A) always be greater than the firm’s cost of capital. B) always be less than the firm’s cost of capital. C) always be the same as the firm’s cost of capital. D) none of the above ANSWER: D 4. Which of the following factors is not expected to generally have a favorable impact on the firm’s

cost of capital according to the text? A) easy access to international capital markets. B) high degree of international diversification. C) volatile exchange rate fluctuations. D) all of the above ANSWER: C

Chapter 17: Multinational Cost of Capital and Capital Structure 553

5. The capital asset pricing theory is based on the premise that: A) only unsystematic variability in cash flows is relevant. B) only systematic variability in cash flows is relevant. C) both systematic and unsystematic variability in cash flows are relevant. D) neither systematic nor unsystematic variability in cash flows is relevant. ANSWER: B 6. According to the text, MNCs: A) use only debt financing in foreign countries to support foreign subsidiaries. B) use only equity financing in foreign countries to support foreign subsidiaries. C) use only parent financing in foreign countries to support foreign subsidiaries. D) none of the above ANSWER: D 7. The term “global” target capital structure for an MNC represents the MNC’s capital structure:

A) in the U.S. B) relative to competitors across all countries. C) where it has its largest subsidiary. D) when consolidating all of its subsidiaries.

ANSWER: D 8. According to the text, an MNC’s “global” target capital structure is: A) always debt-intensive. B) always equity-intensive. C) sometimes different from an MNC’s “local” capital structures (at subsidiaries). D) none of the above ANSWER: C 9. One argument for why subsidiaries should be wholly-owned by the parent is that: A) the potential conflict of interests between the MNC’s managers and shareholders is avoided. B) the potential conflict of interests between the MNC’s majority shareholders and minority

shareholders is avoided. C) the potential conflict of interests between the MNC’s existing creditors is avoided. D) the potential conflict of interests between the MNC’s managers and creditors is avoided. ANSWER: B


10. One argument for why subsidiaries should be only partly-owned by the parent is: A) that the potential conflict of interests between the MNC’s managers and shareholders is

avoided. B) that the potential conflict of interests between the MNC’s majority shareholders and minority

shareholders is avoided. C) that the potential conflict of interests between the MNC’s existing creditors is avoided. D) to offer some protection against threats of any adverse actions by the host government. ANSWER: D 11. The cost of capital for MNCs based in the U.S. has been generally _______ than MNCs based in

Germany and _______ than MNCs based in Japan. A) lower; lower B) lower; higher C) higher; higher D) higher; lower ANSWER: C 12. Other things being equal, countries with relatively _______ populations and _______ inflation are

more likely to have a low cost of capital. A) young; high B) old; high C) old; low D) young; low ANSWER: C 13. Other things being equal, the financial leverage of MNCs will be higher if the governments of

their home countries are _______ likely to rescue them (in the event of failure), and if their home countries are _______ likely to experience a recession.

A) more; more B) less; more C) less; less D) more; less ANSWER: D 14. Based on the factors that influence a country’s cost of capital, the cost of capital in less developed

countries is likely to be _______ than that of the U.S. and _______ than that of Japan. A) higher; higher B) higher; lower C) lower; lower D) lower; higher ANSWER: A


15. According to the text: A) the cost of debt for each country is somewhat stable over time. B) the cost of debt for countries change over time, and these changes are negatively correlated. C) the cost of debt for countries change over time, and these changes are positively correlated. D) the cost of debt for countries change over time, and are not correlated. ANSWER: C 16. The term “local target capital structure” is used in the text to represent: A) the average capital structure of local firms where the MNC’s subsidiary is based. B) the average capital structure of local firms where the MNC’s parent is based. C) the desired capital structure of a subsidiary of a particular MNC. D) the desired capital structure of a particular MNC overall (including all subsidiaries). ANSWER: C 17. The term “global capital structure” is used in the text to represent: A) the average capital structure of all MNCs across countries. B) the average capital structure of all domestic firms across countries. C) the capital structure of a subsidiary of a particular MNC. D) the capital structure of a particular MNC overall (including all subsidiaries). ANSWER: D 18. An MNC may deviate from its target capital structure in each country where financing is obtained,

yet still achieve its target capital structure on a consolidated basis. A) true. B) false.

ANSWER: A

19. Assume that the risk-free interest rate in the U.S. is the same as that in Country M. Assume that

the government of Country M is more likely to rescue local firms that experience financial problems. Other things being equal, Country M’s firms are likely to use a _______ degree of financial leverage than U.S. firms. If a firm based in Country M had the same degree of financial leverage and the same operating characteristics as a U.S. firm, its cost of capital would be _______ than that of the U.S. firm.

A) higher; higher B) higher; lower C) lower; lower D) lower; higher ANSWER: B


20. When an MNC’s firm’s cost of capital rises, it would be _______ likely to divest an existing project, other things held constant.

A) more B) less C) neither; there is no effect D) neither; MNCs do not ever divest projects ANSWER: A 21. Which of the following is not a factor that favorably affects an MNC’s cost of capital, according

to your text? A) exchange rate risk. B) size. C) access to international capital markets. D) international diversification.

ANSWER: A

22. According to your text, which of the following is not a factor that affects an MNC’s cost of capital

unfavorably? A) exchange rate risk. B) country risk. C) political risk. D) size.

ANSWER: D

23. The ____________ an MNC, the __________ its cost of capital is likely to be.

A) larger; higher B) larger; lower C) smaller; lower D) A and C

ANSWER: B

24. MNC Corporation has a beta of 2.0. The risk-free rate of interest is 5%, and the return on the stock

market overall is expected to be 13%. What is the required rate of return on MNC stock? A) 21%. B) 41%. C) 16%. D) 13%. E) none of the above

ANSWER: A SOLUTION: 5% + 2 (13% - 5%) = 21%.


25. Which of the following is not a reason the cost of debt can vary across countries? A) differences in the risk-free rate. B) a high price/earnings multiple. C) differences in the risk premium. D) differences in demographics.

ANSWER: B

26. In general, MNCs probably prefer to use ____________ foreign debt when their foreign

subsidiaries are subject to ___________ local interest rates. A) more; low B) more; high C) less; low D) B and C E) none of the above

ANSWER: A

27. In general, MNCs probably prefer to use ____________ foreign debt when their foreign

subsidiaries are subject to potentially ___________ local currencies. A) more; strong B) more; weak C) less; strong D) less; weak E) B and D ANSWER: B

28. A firm’s cost of ___________ reflects an opportunity cost: what the existing shareholders could

have earned if they had received the earnings as dividends and invested the funds themselves.. A) debt B) retained earnings C) new common equity D) none of the above

ANSWER: B

29. The ____________ the cost of capital, the ___________ will be a project’s net present value for a

project with a given set of expected cash flows. A) lower; higher B) higher; higher C) lower; lower D) none of the above

ANSWER: A


30. To the extent that individual economies are ______________ each other, net cash flows from a portfolio of subsidiaries should exhibit ________ variability, which may reduce the probability of bankruptcy. A) dependent on; less B) dependent on; more C) independent of; less D) independent of; more

ANSWER: C

31. In general, a firm __________ exposed to exchange rate fluctuations will usually have a

___________ distribution of possible cash flows in future periods. A) more; narrower B) less; wider C) more; wider D) none of the above

ANSWER: C

32. According to the CAPM, the required rate of return on stock is a positive function of all of the

following, except: A) the risk-free rate of interest. B) the market rate of return. C) the stock’s beta. D) the company’s earnings.

ANSWER: D

33. The lower a project’s beta, the _______ is the project’s _________ risk.

A) lower; systematic B) lower; unsystematic C) higher; systematic D) higher; unsystematic

ANSWER: A

34. Capital asset pricing theory suggests that _____________ risk of projects can be ignored and that

__________ is relevant. A) unsystematic; unsystematic B) unsystematic; systematic C) systematic; unsystematic D) systematic; systematic

ANSWER: B


35. Capital asset pricing theory would most likely suggest that the cost of capital is generally ________ for _________. A) higher; MNCs B) lower; domestic firms C) lower; MNCs D) none of the above

ANSWER: C

36. When assuming that financial markets are segments, it is acceptable to use the U.S. market when

measuring a U.S.-based MNC’s project’s beta. A) true. B) false.

ANSWER: A

37. Assume the following information for Pexi Co., a U.S.-based MNC that is considering obtaining

funding for a project in Germany:

U.S. risk-free rate = 4% German risk-free rate = 5% Risk premium on dollar-denominated debt provided by U.S. creditors = 3% Risk premium on euro-denominated debt provided by German creditors = 4% Beta of project = 1.2 Expected U.S. market return = 10% U.S. corporate tax rate = 30% German corporate tax rate = 40%

What is Pexi’s cost of dollar-denominated debt? A) 7.0%. B) 8.0%. C) 6.3%. D) 4.9%.

ANSWER: D SOLUTION: (4% + 3%) X (1 - .3) = 4.9%

38. Assume the following information for Pexi Co., a U.S.-based MNC that is considering obtaining

funding for a project in Germany:

U.S. risk-free rate = 4% German risk-free rate = 5% Risk premium on dollar-denominated debt provided by U.S. creditors = 3% Risk premium on euro-denominated debt provided by German creditors = 4% Beta of project = 1.2 Expected U.S. market return = 10% U.S. corporate tax rate = 30% German corporate tax rate = 40% What is Pexi’s cost of dollar-denominated equity?


A) 12.0%. B) 11.2%. C) 10.0%. D) 7.2%.

ANSWER: B SOLUTION: 4% + 1.2(10% - 4%) = 11.2%

39. When an MNC is considering financing a portion of a foreign project within the foreign country,

the best method to account for a foreign project’s risk is to: A) derive net present values based on the WACC. B) adjust the weighted average cost of capital for the risk differential. C) derive the net present value of the equity investment. D) none of the above

ANSWER: C

40. Normally, an MNC will issue stock in all of the countries where it does business.

A) true. B) false.

ANSWER: B

41. Generally speaking, an MNC’s size, its access to international capital markets, and international

diversification are unfavorable to an MNC’s cost of capital. A) true. B) false.

ANSWER: B

42. Country differences, such as differences in the risk-free interest rate and differences in risk

premiums across countries, can cause the cost of capital to vary across countries. A) true. B) false.

ANSWER: A

43. Because their economies have lower growth, the cost of debt in industrialized countries is much

higher than the cost of debt in many less developed countries. A) true. B) false.

ANSWER: B


44. In the United States, government rescues are not as common as in other countries, such as the United Kingdom. Therefore, the risk premium on a given level of debt would be higher for U.S. firms than for firms of the United Kingdom, everything else being equal. A) true. B) false.

ANSWER: A

45. Although an MNC can adjust either the discount rate or the cash flows to account for a project’s

risk, there is no perfect formula to adjust for a project’s unique risk. A) true. B) false.

ANSWER: A

46. Assume a subsidiary is forced to borrow in excess of the MNC’s optimal capital structure. Also

assume that the parent company reduces its debt financing by an offsetting amount. Under this scenario, the cost of capital for the MNC overall could not have changed. A) true. B) false.

ANSWER: B

47. Because increased external financing by a foreign subsidiary reduces the external financing

needed by the parent, such an action will not affect the overall MNC’s cost of capital. A) true. B) false.

ANSWER: B

48. Since the cost of funds can vary among markets, the MNC’s access to the international capital

markets may allow it to attract funds at a lower cost than that paid by domestic firms. A) true. B) false.

ANSWER: A

49. Capital asset pricing theory would most likely suggest that the MNC’s cost of capital is lower than

that of domestic firms. A) true. B) false.

ANSWER: A


50. If an MNC’s cash flows are more stable, it can probably handle more debt than an MNC with erratic cash flows. A) true. B) false.

ANSWER: A

563

Chapter 18

Long-Term Financing 1. Ideally, a firm desires to denominate bonds in a currency that: A) exhibits a low interest rate and is expected to appreciate. B) exhibits a low interest rate and is expected to depreciate. C) exhibits a high interest rate and is expected to depreciate. D) exhibits a high interest rate and is expected to appreciate. ANSWER: B 2. Eurobonds are often issued with a floating coupon rate that is tied to LIBOR.

A) true. B) false.

ANSWER: A

3. A U.S. firm could issue bonds denominated in euros and partially hedge against exchange rate risk

by: A) invoicing its exports in U.S. dollars. B) requesting that any imports ordered by the firm be invoiced in U.S. dollars. C) invoicing its exports in euros. D) requesting that any imports ordered by the firm be invoiced in the currency denominating the

bonds. ANSWER: C 4. Firm “X” conducts all business transactions in U.S. dollars. If it issues a currency cocktail bond, it

can: A) reduce exchange rate risk relative to issuing a bond denominated in U.S. dollars. B) reduce exchange rate risk relative to issuing a bond denominated in a single foreign currency. C) A and B D) none of the above ANSWER: B


5. Simulation is useful in the bond-denomination decision since it can: A) precisely compute the cost of financing with bonds denominated in a single foreign currency. B) precisely compute the cost of financing with bonds denominated in a portfolio of foreign

currencies. C) assess the probability that a bond denominated in a foreign currency will be less costly than a

bond denominated in the home currency. D) A and B ANSWER: C 6. An interest rate swap between two firms of different countries enables the exchange of

__________ for __________. A) fixed-rate payments; floating-rate payments B) stock; interest deductions on taxes C) interest payments on loans; ownership of debt of less developed countries D) interest payments on loans; stock ANSWER: A 7. If U.S. firms issue bonds in _______, the dollar outflows to cover fixed coupon payments increase

as the dollar _______. A) a foreign currency; weakens B) dollars; strengthens C) a foreign currency; strengthens D) dollars; weakens ANSWER: A 8. The yields offered on newly issued bonds denominated in dollars have: A) consistently increased over the last 10 years. B) consistently decreased over the last 10 years. C) remained stable. D) none of the above ANSWER: D 9. When ignoring exchange rate risk, bond yields: A) are the same for all currencies. B) are consistently higher for all non-U.S. bonds than U.S. bonds. C) are consistently lower for all non-U.S. bonds than U.S. bonds. D) none of the above ANSWER: D

Chapter 18: Long-Term Financing 565

10. A U.S. firm has received a large amount of cash inflows periodically in Swiss francs as a result of exporting goods to Switzerland. It has no other business outside the U.S. It could best reduce its exposure to exchange rate risk by:

A) issuing Swiss franc-denominated bonds. B) purchasing Swiss franc-denominated bonds. C) purchasing U.S. dollar-denominated bonds. D) issuing U.S. dollar-denominated bonds. ANSWER: A 11. A U.S. firm has a Canadian subsidiary that remits some of its earnings to the parent on an annual

basis. The firm has no other foreign business. The firm could best reduce its exposure to exchange rate risk by issuing bonds denominated in:

A) U.S. dollars. B) Canadian dollars. C) multiple currencies. D) a unit of account such as the SDR. ANSWER: B 12. If the currency denominating a foreign bond depreciates against the firm’s home currency, the

funds needed to make coupon payments will increase. A) true. B) false.

ANSWER: B

13. An interest rate swap is commonly used by an issuer of fixed-rate bonds to:

A) convert to floating-rate debt. B) hedge exchange rate risk. C) lock in the interest payments on debt. D) remove the default risk of its debt.

ANSWER: A 14. A currency swap between two firms of different countries enables the exchange of __________

for ___________ at periodic intervals. A) stock; one currency B) stock; a portfolio of foreign currencies C) one currency; stock options D) one currency; another currency ANSWER: D


15. Assume a U.S.-based subsidiary wants to raise $1,000,000 by issuing a bond denominated in Pakistani rupees (PKR). The current exchange rate of the rupee is $.02. Thus, the MNC needs ___________ rupees to obtain the $1,000,000 needed. A) 50,000,000 B) 20,000 C) 1,000,000 D) none of the above

ANSWER: A

SOLUTION: $1,000,000/$.02 = PKR50,000,000

16. An MNC issues ten-year bonds denominated in 500,000 Philippines pesos (PHP) at par. The

bonds have a coupon rate of 15%. If the peso remains stable at its current level of $.025 over the lifetime of the bonds and if the MNC holds the bonds until maturity, the financing cost to the MNC will be: A) 10.0%. B) 12.5%. C) 15.0%. D) none of the above

ANSWER: C

SOLUTION: Since the bonds are issued at par, and since the exchange rate remains stable over the life of the bonds and the bonds are held until maturity, the financing cost will be exactly the coupon rate of the bond.

17. Minnie Corp. has decided to issue three-year bonds denominated in 5,000,000 Slovakian koruna

(SKK) at par. The bonds have a coupon rate of 17%. If the koruna is expected to appreciate from its current level of $.03 to $.032, $.034, and $.035 in years 1, 2,and 3, respectively, what is the financing cost of these bonds? A) 17%. B) 23.18%. C) 22.36%. D) 23.39%.

ANSWER: D

SOLUTION:

Year 1

Year 2

Year 3 Annual Cost of

Financing Payments in Slovakian koruna 850,000 850,000 5,850,000 Forecasted exchange rate of koruna $.032 $.034 $.035 Payments in dollars $27,200 $28,900 $204,750 23.39%


18. In a(an) ___________ swap, two parties agree to exchange payments associated with bonds; in a(an) ____________ swap, two parties agree to periodically exchange foreign currencies. A) interest rate; currency B) currency; interest rate C) interest rate; interest rate D) currency; currency

ANSWER: A

19. Good Company prefers variable to fixed rate debt. Bad Company prefers fixed to variable rate

debt. Assume the following information for Good and Bad Companies:

Fixed Rate Bond Variable Rate Bond Good Company 10% LIBOR + 1% Bad Company 12% LIBOR + 1.5% Given this information:

A) an interest rate swap will probably not be advantageous to Good Company because it can issue both fixed and variable debt at more attractive rates than Bad Company.

B) an interest rate swap attractive to both parties could result if Good Company agreed to provide Bad Company with variable rate payments at LIBOR + 1% in exchange for fixed rate payments of 10.5%.

C) an interest rate swap attractive to both parties could result if Bad Company agreed to provide Good Company with variable rate payments at LIBOR + 1% in exchange for fixed rate payments of 10.5%.

D) none of the above ANSWER: B 20. _____________ are beneficial because they may reduce transaction costs. However, MNCs may

not be able to obtain all the funds that they need. A) Private placements B) Domestic equity offerings C) Global equity offerings D) Global debt offerings

ANSWER: A 21. Most MNCs obtain equity funding:

A) in foreign countries. B) in their home country. C) through global offerings. D) through private placements.

ANSWER: B


22. Some firms may be uncomfortable issuing bonds denominated in foreign currencies because exchange rates are __________ difficult to predict over ________ time horizons. A) less; long B) more; short C) more; long D) none of the above

ANSWER: C 23. If the foreign currency that was borrowed appreciates over time, an MNC will need fewer funds

to cover the coupon or principal payments. [Assume the MNC has no other cash flows in that currency.] A) true. B) false.

ANSWER: B 24. U.S.-based MNCs whose foreign subsidiary generates large earnings may be able to offset

exposure to exchange rate risk by issuing bonds denominated in the subsidiary’s local currency. A) true. B) false.

ANSWER: A 25. Countries where bond yields are ________ tend to have a _______ risk-free interest rate.

A) low; high B) high; low C) high; high D) none of the above ANSWER: C

26. MNCs can use __________ to reduce exchange rate risk. This occurs when two parties provide

simultaneous loans with an agreement to repay at a specified point in the future. A) forward contracts B) currency swaps C) parallel loans D) none of the above

ANSWER: C 27. The United States typically has a(n) ___________-sloping yield curve, which means that the

annualized yields are ________ for short-term debt than for long-term debt. A) downward; higher B) downward; lower C) upward; higher D) upward; lower

ANSWER: D


28. When financing international operations, MNCs typically will not use a maturity that _________ the expected life of the business in that country. A) is less than B) exceeds C) is the same as D) none of the above

ANSWER: B 29. When an MNC financesin a currency that matches its cash inflows using a relatively _______

maturity, the MNC is exposed to __________ risk. A) short; interest rate B) long; interest rate C) short; exchange rate D) none of the above

ANSWER: B 30. Some MNCs use a country’s yield curve to compare annualized rates among debt maturities, so

that they can choose a maturity that has a relatively low rate. A) true. B) false.

ANSWER: A 31. As a ________ to an interest rate swap, a financial institution simply arranges a swap between two

parties. A) ultraparty B) broker C) counterparty D) none of the above

ANSWER: B 32. In general, the _________ rate payer in a plain vanilla swap believes interest rates are going to

_______. A) fixed; decline B) floating; decline C) floating; increase D) none of the above

ANSWER: B


33. In a(n) ___________ swap, the fixed rate payer has the right to terminate the swap. A) callable B) putable C) amortizing D) zero-coupon

ANSWER: A 34. In a(n) _________ swap, the notional value is increased over time.

A) amortizing B) basis C) zero-coupon D) accretion

ANSWER: D 35. A ___________ gives its owner the right to enter into a swap.

A) basis swap B) swaption C) callable swap D) putable swap

ANSWER: B 36. Because bonds denominated in foreign currencies rarely have lower yields, U.S. corporations

rarely consider issuing bonds denominated in those currencies. A) true. B) false.

ANSWER: B

37. The actual financing cost of a U.S. corporation issuing a bond denominated in euros is affected by

the euro’s value relative to the U.S. dollar during the financing period. A) true. B) false.

ANSWER: A

38. A floating coupon rate can be an advantage to the bond issuer during periods of increasing interest

rates. A) true. B) false.

ANSWER: B


39. An MNC issuing pound-denominated bonds may be completely insulated from exchange rate risk associated with the bond if its foreign subsidiary makes the coupon and principal payments of the bond with its pound receivables. A) true. B) false.

ANSWER: A

40. If an MNC uses a long-term forward contract to hedge the exchange rate risk associated with a

bond denominated in euros, it would sell euros forward. A) true. B) false.

ANSWER: B

41. Currency swaps, whereby two parties exchange currencies at a specified point in time for a

specified price, are often used by MNCs to hedge against interest rate risk. A) true. B) false.

ANSWER: B

42. Two limitations of interest rate swaps are that there is a cost of time and resources associated with

searching for a suitable partner and that there is a risk to each swap participant that the counterparticipant could default on his payments. A) true. B) false.

ANSWER: A

43. Many MNCs simultaneously swap interest payments and currencies.

A) true. B) false.

ANSWER: A

44. A back-to-back (also called parallel) loan represents simultaneous loans provided by two parties

with an agreement to repay at a specified point in the future. A) true. B) false.

ANSWER: A

45. Since yield curves are identical across countries, MNCs rarely consider them when deciding on

the maturity of bonds denominated in a foreign currency. A) true. B) false.

ANSWER: B

572

Chapter 19

Financing International Trade 1. Which of the following is a reason why commercial banks can facilitate international trade? A) The exporter may not wish to accept credit risk of the importer. B) The government may impose exchange contracts that prevent payment by the importer to the

exporter. C) The exporter may need financing until payment for the goods is received. D) All of the above ANSWER: D 2. Consider an exporter that sells its accounts receivables off to another firm that becomes

responsible for obtaining cash from the various importers. This reflects: A) accounts receivable financing. B) consignment. C) factoring. D) a letter of credit. ANSWER: C 3. Consider a bank that acknowledges that it will make payments on behalf of a beer importer after

the beer is delivered to the importer. This reflects: A) accounts receivable financing. B) forfaiting. C) factoring. D) a letter of credit. ANSWER: D 4. Consider an importer that issues a promissory note to pay for the imported capital goods over a

period of five years. The notes are extended to an exporter who sells them at a discount to a bank. This reflects:

A) accounts receivable financing. B) forfaiting. C) factoring. D) a letter of credit. ANSWER: B

Chapter 19: Financing International Trade 573

5. Consider an exporter that is willing to send goods to the importer without a guaranteed payment by the bank. The bank provides a loan to the exporter that is backed by the value of the exported goods. This reflects:

A) accounts receivable financing. B) forfaiting. C) factoring. D) a letter of credit. ANSWER: A 6. The all-in-rate a bank charges its customer(s) for accepting drafts includes both the discount rate

and the acceptance commission. A) true. B) false.

ANSWER: A

7. MNCs can use _________ to sell their existing accounts receivable as a means of obtaining cash. A) factoring

B) a bill of lading C) a banker’s acceptance D) a letter of credit

ANSWER: A 8. __________ was established in 1934 with the intention to facilitate Soviet-American trade.

A) Domestic International Sales Corporation (DISC) B) Private Export Funding Corporation (PEFCO) C) Export-Import Bank D) Foreign Credit Insurance Association (FCIA) ANSWER: C 9. A __________ provides a summary of freight charges and conveys title to the merchandise. A) letter of credit B) banker’s acceptance C) bill of lading D) bill of exchange ANSWER: C


10. According to the text, international trade activity has generally __________ over time. This should cause the popularity of trade finance techniques to ___________ over time.

A) increased; increase B) increased; decrease C) decreased; increase D) decreased; decrease ANSWER: A 11. Which of the following payment terms provides the supplier with the greatest degree of

protection? A) letters of credit. B) consignment. C) prepayment. D) drafts (sight/time). ANSWER: C 12. With _______, the exporter ships the goods to the importer while still retaining actual title to the

merchandise. A) a letter of credit arrangement B) an open account arrangement C) a draft arrangement D) a consignment arrangement ANSWER: D 13. With _______, a bank purchases a receivable without recourse to the exporter. A) accounts receivable financing B) factoring C) a banker’s acceptance D) a letter of credit ANSWER: B 14. In _______, a bank arranges to fund a loan to pay the exporter instead of charging the importer’s

account immediately. A) refinancing of a sight letter of credit B) a banker’s acceptance C) a short-term bank loan D) accounts receivable financing ANSWER: A


15. A bill of exchange requesting the bank to pay the face amount upon presentation of documents is a:

A) banker’s acceptance. B) time draft. C) letter of credit. D) sight draft. ANSWER: D 16. A bill of exchange requesting the bank to pay the face amount at a future date is a: A) banker’s acceptance. B) time draft. C) letter of credit. D) sight draft. ANSWER: B 17. An exchange of goods between two parties under two distinct contracts expressed in monetary

terms is: A) compensation. B) counterpurchase. C) factoring. D) accounts receivable financing. ANSWER: B 18. Which of the following is not a program of the Export-Import Bank of the U.S.? A) working capital guarantee program. B) project finance loan program. C) direct loan program. D) the foreign sales corporation program. ANSWER: D 19. Who bears the payment risk in a letter of credit? A) the exporter. B) the importer. C) the issuing bank. D) both the exporter and importer. ANSWER: C


20. Countertrade represents foreign trade: A) restrictions imposed by the government on imports from another country. B) restrictions imposed by the government on exports sent from the country. C) transactions that force the sales of goods of one country to be linked to the purchase or

exchange of goods from the country. D) financing provided to an exporter in exchange for goods provided to the creditor by the

exporter. ANSWER: C 21. All types of foreign trade transactions in which the sale of goods to one country is linked to the

purchase or exchange of goods from that same country are called countertrade. A) true. B) false.

ANSWER: A

22. The exchange of goods between two parties without the use of any currency as a medium of

exchange is called factoring. A) true. B) false.

ANSWER: B

23. A draft drawn on and accepted by a bank is called a banker’s acceptance.

A) true. B) false.

ANSWER: A 24. The Direct Loan Program is administered by the: A) Private Export Funding Corporation (PEFCO). B) Overseas Private Investment Corporation (OPIC). C) Ex-Imbank. D) Foreign Credit Insurance Association (FCIA). ANSWER: C 25. The Working Capital Guarantee Program is administered by the: A) Private Export Funding Corporation (PEFCO). B) Overseas Private Investment Corporation (OPIC). C) Ex-Imbank. D) Foreign Credit Insurance Association (FCIA). ANSWER: C


26. Which of the following is not a payment method used for international trade? A) consignment. B) open account. C) factoring. D) draft. E) letter of credit.

ANSWER: C

27. Under a letter of credit arrangement, the bank issuing the letter of credit is known as the ________

bank, the correspondent bank in the beneficiary’s country to which the issuing bank sends the letter of credit is known as the _______ bank, and the bank that agrees to examine documents under the letter of credit and pay the beneficiary is called the ________ bank. A) issuing; negotiating; advising B) issuing; advising; negotiating C) advising; issuing; negotiating D) negotiating; issuing; advising E) advising; negotiating; issuing

ANSWER: B

28. A _____________ letter of credit is not a trade-related letter of credit.

A) commercial B) import/export C) revocable D) irrevocable E) all of the above are trade-related letters of credit

ANSWER: E

29. Which of the following is not true regarding letters of credit?

A) They are issued by banks on behalf of the importer promising to pay the exporter. B) A revocable letter of credit can be cancelled or revoked at any time without prior notification

to the beneficiary. C) They guarantee that the goods shipped are the goods purchased. D) All of the above are true.

ANSWER: C

30. A banker’s acceptance is a draft drawn on and accepted by a(an) __________.

A) bank B) importer C) exporter D) none of the above

ANSWER: A


31. Which of the following is not true regarding a banker’s acceptance? A) It can be beneficial to the exporter, as he does not have to worry about the credit risk of the

importer. B) It can be beneficial to the importer, as he may have greater access to foreign markets when

purchasing supplies. C) It can be beneficial to the bank accepting the draft in that it earns a commission for creating an

acceptance. D) It is a sight draft. E) All of the above are true.

ANSWER: D

32. ___________ is not a type of program offered by Ex-Imbank.

A) Guarantees B) Loans C) Currency swap insurance D) Bank insurance

ANSWER: C

33. As part of Ex-Imbank’s export credit insurance programs, a(an) ____________ policy is generally

issued to an administrator, such as a bank, trading company, insurance broker, or government agency, who then administers the policy for multiple exporters. A) multiple-buyer B) single-buyer C) small business D) umbrella

ANSWER: D

34. The ____________________ is a private corporation owned by a consortium of commercial banks

and industrial companies, but the ______________ is a self-sustaining government agency. A) Overseas Private Investment Corporation (OPIC); Private Export Funding Corporation

(PEFCO) B) Private Export Funding Corporation (PEFCO); Overseas Private Investment Corporation

(OPIC) C) Private Export Funding Corporation (PEFCO); Ex-Imbank D) Overseas Private Investment Corporation (OPIC); Ex-Imbank

ANSWER: B

35. The risk to the exporter is highest with the __________ method.

A) prepayment B) letter of credit C) consignment D) open account

ANSWER: D


36. A(n) ___________ is an unconditional promise drawn by one party, instructing the buyer to pay the face amount upon presentation. A) draft B) bill of lading C) trade acceptance D) letter of credit

ANSWER: A

37. Under a _____________ arrangement, the exporter ships the goods to the importer while still

retaining actual title to the merchandise. A) draft B) consignment C) prepayment D) open account

ANSWER: B

38. In ___________, the exporter sells accounts receivable without recourse.

A) accounts receivable financing B) factoring C) working capital financing D) countertrade

ANSWER: B

39. An irrevocable L/C obligates the issuing bank to honor all drawings presented in conformity with

the terms of the L/C. A) true. B) false.

ANSWER: A

40. _______________ promises to pay the beneficiary if they buyer fails to pay as agreed.

A) A standby L/C B) A transferable L/C C) Assignment of proceeds D) None of the above

ANSWER: A

41. The interest rate the bank charges the customer in a banker’s acceptance is referred to as the all-in

rate; it entirely consists of the acceptance commission. A) true. B) false.

ANSWER: B


42. ___________ refers to the purchase of financial obligations, such as bills of exchange or promissory notes, without recourse to the original holder, usually the exporter. A) Factoring B) Accounts receivable financing C) Forfaiting D) None of the above

ANSWER: C

43. The term counterpurchase denotes the exchange of goods between two parties under two distinct

contracts expressed in monetary terms. A) true. B) false.

ANSWER: A

44. The Working Capital Guarantee Program and the Medium-term Guarantee Program are offered by

the: A) Export-Import Bank of the United States B) Private Export Funding Corporation C) Overseas Private Investment Corporation D) none of the above

ANSWER: A

45. The ______________ is a self-sustaining federal agency responsible for insuring direct U.S.

investments in foreign countries against the risk of currency inconvertibility, expropriation, and other political risks. A) Export-Import Bank of the United States B) Private Export Funding Corporation C) Overseas Private Investment Corporation D) none of the above

ANSWER: C

46. Under a letter of credit, the exporter will not ship the goods until the buyer has remitted payment

to the exporter. A) true. B) false.

ANSWER: B

47. In an open account transaction, the exporter ships the goods to the importer but retains title to the

goods until they have been sold. A) true. B) false.

ANSWER: B


48. When using factoring to finance international trade, a bank will provide a loan to the exporter secured by an assignment of the account receivable. A) true. B) false.

ANSWER: B

49. From a bank’s viewpoint, issuing a letter of credit is analogous to making a loan as far as risk is

concerned. A) true. B) false.

ANSWER: A

50. There is an active secondary market for banker’s acceptances.

A) true. B) false.

ANSWER: A

51. The commission earned by the bank for accepting a draft is reflected in the all-in-rate.

A) true. B) false.

ANSWER: A

52. The Working Capital Guarantee Program of the Private Export Funding Corporation (PEFCO)

encourages commercial banks to extend short-term export financing to eligible exporters by providing a comprehensive guarantee that covers 100 percent of the loan’s principal and interest. A) true. B) false.

ANSWER: B

53. The objectives of the Export-Import Bank of the United States include the assumption of

underlying credit risk and country risk to encourage private lenders to finance export trade and the provision of direct loans to foreign buyers when private lenders are unwilling to do so. A) true. B) false.

ANSWER: A

54. The Overseas Private Investment Corporation (OPIC) is owned by a consortium of commercial

banks and industrial companies; it cooperates closely with the Export-Import Bank. A) true. B) false.

ANSWER: B


55. Under prepayment, the exporter will not ship the goods until the buyer has remitted payment to the exporter. A) true. B) false.

ANSWER: A

56. A letter of credit does not guarantee that the goods purchased will be those invoiced and shipped.

A) true. B) false.

ANSWER: A

57. If shipment is made under a forfaiting draft, the exporter is paid once shipment has been made and the draft is presented to the buyer for payments. A) true. B) false.

ANSWER: B

58. In a countertrade transaction, banks on both ends act as intermediaries in the processing of

shipping documents and the collection of payment. A) true. B) false.

ANSWER: B

59. Under a countertrade arrangement, the exporter ships the goods to the importer while retaining

title to the merchandise until it is sold. A) true. B) false.

ANSWER: B

60. The sale of accounts receivable to a third party for a discount is called factoring.

A) true. B) false.

ANSWER: A

583

Chapter 20

Short-Term Financing 1. MNCs may be able to lock in a lower cost from financing in a low interest rate foreign currency if

they: A) have future cash inflows in that foreign currency. B) have future cash outflows in that foreign currency. C) have offsetting future cash inflows and outflows in that foreign currency. D) have no other cash flows in that foreign currency. ANSWER: A 2. Assume that the Swiss franc has an annual interest rate of 8% and is expected to depreciate by 6%

against the dollar. From a U.S. perspective, the effective financing rate from borrowing francs is: A) 8%. B) 14.48%. C) 2%. D) 1.52%. ANSWER: D SOLUTION: (1 + 8%)[1 + (-6%)] - 1 = 1.52%. 3. Assume that the U.S. interest rate is 11% while the interest rate on euro is 7%. If euros are

borrowed by a U.S. firm, they would have to _________ against the dollar by __________ in order to have the same effective financing rate from borrowing dollars.

A) depreciate; about 3.74% B) appreciate; about 3.74% C) appreciate; about 4.53% D) depreciate; about 4.53% ANSWER: B SOLUTION: (1.11/1.07) – 1 = 3.74%. Euros have to appreciate since borrowing in euros is

currently cheaper.


4. When a U.S. firm borrows a foreign currency and has no offsetting position in this currency, it will incur an effective financing rate that is always above the __________ if the currency __________.

A) foreign currency’s interest rate; appreciates B) foreign currency’s interest rate; depreciates C) domestic interest rate; depreciates D) domestic interest rate; appreciates ANSWER: A 5. A firm without any exposure to foreign exchange rates would likely increase this exposure the

most by: A) borrowing domestically. B) borrowing a portfolio of foreign currencies that are not highly correlated. C) borrowing a portfolio of foreign currencies that are highly correlated. D) borrowing two foreign currencies that are negatively correlated. ANSWER: C 6. If a firm repeatedly borrows a foreign currency portfolio, the variability of the portfolio’s effective

financing rate will be highest if the correlations between currencies in the portfolio are __________ and the individual variability of each currency is _________.

A) high; low B) high; high C) low; low D) low; high ANSWER: B 7. Assume the annual British interest rate is above the annual U.S. interest rate. Also assume the

pound’s forward rate of $1.75 equals the pound’s spot rate. Given this information, interest rate parity __________ exist, and the U.S. firm __________ lock in a lower financing cost by borrowing pounds for one year.

A) does; could B) does; could not C) does not; could not D) does not; could ANSWER: C 8. A risk-averse firm would prefer to borrow __________ when the expected financing costs are

similar in a foreign country as in the local country. A) locally B) in the foreign country C) either A or B D) part of the funds locally, and part from the foreign country ANSWER: A

Chapter 20: Short-Term Financing 585

9. A firm forecasts the euro’s value as follows for the next year: Possible Percentage Change Probability -2% 10% 3% 50% 6% 40% The annual interest rate on euro is 7%. The expected value of the effective financing rate from a

U.S. firm’s perspective is about: A) 8.436%. B) 10.959%. C) 11.112%. D) 11.541%. ANSWER: B SOLUTION: Computation of Effective Financing Rate Probability Expected Value (1.07)(.98) – 1 = 4.86% 10% .486% (1.07)(1.03) – 1 =10.21% 50% 5.105% (1.07)(1.06) –1 =13.42% 40% 5.368% 10.959% 10. The effective financing rate: A) adjusts the nominal interest rate for inflation over the period of concern. B) adjusts the nominal interest rate for the change in the spot exchange rate over the period of

concern. C) adjusts the nominal rate for a change in foreign interest rates over the period of concern.

D) adjusts the nominal rate for the forward discount (or premium) over the period of concern. ANSWER: B 11. If interest rate parity exists and transactions costs are zero, foreign financing with a simultaneous

forward purchase of the currency borrowed will result in an effective financing rate that is: A) less than the domestic interest rate. B) greater than the domestic interest rate. C) equal to the domestic interest rate. D) greater than the domestic interest rate if the forward rate exhibits a premium and less than the

domestic interest rate if the forward rate exhibits a discount. ANSWER: C


12. If interest rate parity exists, transactions costs are zero, and the forward rate is an accurate predictor of the future spot rate, then the effective financing rate on a foreign currency:

A) would be equal to the U.S. interest rate. B) would be less than the U.S. interest rate. C) would be more than the U.S. financing rate. D) would be less than the U.S. interest rate if the forward rate exhibited a discount and more than

the U.S. interest rate of the forward rate exhibited a premium. ANSWER: A 13. Assume that interest rate parity exists, and there are zero transactions costs. If the forward rate

consistently underestimates the future spot rate, then: A) on average, the foreign effective financing rate is greater than the domestic interest rate. B) on average, the foreign effective financing rate is less than the domestic rate. C) the foreign effective financing rate exceeds the U.S. interest rate when its forward rate exhibits

a discount and is less than the U.S. interest rate when its forward rate exhibits a premium. D) the foreign effective financing rate is less than the U.S. interest rate when its forward rate

exhibits a discount and exceeds the U.S. interest rate when its forward rate exhibits a discount. ANSWER: A 14. Assume the U.S. one-year interest rate is 8%, and the British one-year interest rate is 6%. The

one-year forward rate of the pound is $1.97. The spot rate of the pound at the beginning of the year is $1.95. By the end of the year, the pound’s spot rate is $2.05. Based on the information, what is the effective financing rate for a U.S. firm that takes out a one-year, uncovered British loan?

A) about 12.4%. B) about 7.1%. C) about 13.5%. D) about 10.3%. E) about 11.3%. ANSWER: E SOLUTION: % change in pound = $2.05 - $1.95 = about 5.1% $1.95 Effective financing rate = (1 + 6%)(1 + 5.1%) - 1 = 11.4%


15. The variance in financing costs over time is _______ for foreign financing than domestic financing. The variance when financing with foreign currencies is lower when those currencies exhibit _______ correlations, assuming the firm has no other business in those currencies.

A) lower; low B) lower; high C) higher; high D) higher; low ANSWER: D 16. Euronotes are underwritten by: A) European central banks. B) commercial banks. C) the International Monetary Fund. D) the Federal Reserve System. ANSWER: B 17. Assume the U.S. interest rate is 7.5%, the New Zealand interest rate is 6.5%, the spot rate of the

NZ$ is $.52, and the one-year forward rate of the NZ$ is $.50. At the end of the year, the spot rate is $.48. Based on this information, what is the effective financing rate for a U.S. firm that takes out a one-year, uncovered NZ$ loan?

A) about -1.7%. B) about 0.0%. C) about 14.7%. D) about 15.4%. E) about 8.3%. ANSWER: A SOLUTION: % change in NZ$ = $.48 - $.52 = about -7.7% $.52 Effective financing rate = (1 + 6.5%)[1 + (-7.7%)] –1 = about -1.7% 18. A negative effective financing rate for a U.S. firm implies that the firm: A) will incur a loss on the project financed with the funds. B) paid more interest on the funds than what it would have paid if it had borrowed dollars. C) will be unable to repay the loan. D) none of the above ANSWER: D


19. A U.S. firm plans to borrow Swiss francs today for a one-year period. The Swiss interest rate is 9%. It uses today’s spot rate as a forecast for the franc’s spot rate in one year. The U.S. one-year interest rate is 10%. The expected effective financing rate on Swiss francs is:

A) equal to the U.S. interest rate. B) less than the U.S. interest rate, but more than the Swiss interest rate. C) equal to the Swiss interest rate. D) less than the Swiss interest rate. E) more than the U.S. interest rate. ANSWER: C 20. Assume that interest rates of most industrialized countries are similar to the U.S. interest rate. In

the last few months, the currencies of all industrialized countries weakened substantially against the U.S. dollar. If non-U.S. firms based in these countries financed with U.S. dollars during this period (even when they had no receivables in dollars), their effective financing rate would have been:

A) negative. B) zero. C) positive, but lower than the interest rate of their respective countries. D) higher than the interest rate of their respective countries. ANSWER: D 21. ___________ typically have maturities of less than one year.

A) Eurobonds B) Euro-commercial paper C) Euronotes D) ADRs

ANSWER: B

22. MNCs can use short-term foreign financing to reduce their exposure to exchange rate fluctuations.

For example, if an American-based MNC has ____________ in Algerian dinars, it could borrow ___________, resulting in an offsetting effect. A) payables; dinars B) receivables; dinars C) payables; dollars D) receivables; dollars

ANSWER: B


23. Assume Jelly Corporation, a U.S.-based MNC, obtains a one-year loan of 1,500,000 Malaysian ringgit (MYR) at a nominal interest rate of 7%. At the time the loan is extended, the spot rate of the ringgit is $.25. If the spot rate of the ringgit in one year is $.28, the dollar amount initially obtained from the loan is $__________, and $___________ are needed to repay the loan. A) 375,000; 449,400 B) 449,400; 375,000 C) 6,000,000; 5,357,143 D) 5,357,143; 6,000,000

ANSWER: A

SOLUTION: MYR1,500,000 x $.25 = $375,000 (MYR1,500,000 x 1.07) x $.28 = $449,400

24. Morton Company obtains a one-year loan of 2,000,000 Sudanese dinar (SDD) at an interest rate of

6%. At the time the loan is extended, the spot rate of the dinar is $.005. If the spot rate of the dinar at maturity of the loan is $.0035, what is the effective financing rate of borrowing dinar? A) 37.8%. B) 51.43%. C) -25.8%. D) -6%. E) none of the above

ANSWER: C

SOLUTION: Depreciation of dinar: $.0035/$.005 – 1 = -30%

Effective financing rate: (1.06) x [1 + (-30%)] – 1 = -25.80%. 25. ____________ are free of default risk.

A) Euronotes B) Eurobonds C) Euro-commercial paper D) None of the above

ANSWER: D


26. Assume a U.S.-based MNC is borrowing Romanian leu (ROL) at an interest rate of 8% for one year. Also assume that the spot rate of the leu is $.00012 and the one-year forward rate of the leu is $.00010. The expected spot rate of the leu one-year from now is $.00011. What is the effective financing rate for the MNC assuming it borrows leu on a covered basis? A) 10%. B) -10%. C) -1%. D) 1%. E) none of the above

ANSWER: B SOLUTION: Forward disount: .00010/.00012 – 1 = -16.67%

Effective financing rate: (1.08) x [1 + (-16.67%)] –1 = -10.00%. 27. Assume a U.S.-based MNC is borrowing Romanian leu (ROL) at an interest rate of 8% for one

year. Also assume that the spot rate of the leu is $.00012 and the one-year forward rate of the leu is $.00010. The expected spot rate of the leu one-year from now is $.00011. What is the effective financing rate for the MNC assuming it borrows leu on an uncovered basis? A) about 10%. B) about -10%. C) about -1%. D) about –2%. E) none of the above

ANSWER: D

SOLUTION: Depreciation of leu: .00010/.00011 – 1 = -9.09%

Effective financing rate: (1.08) x [1 + (-9.09%)] – 1 = -1.82%. 28. Assume that interest rate parity holds between the U.S. and Cyprus. The U.S. one-year interest rate

is 7% and the Cyprus one-year interest rate is 6%. What is the approximate effective financing rate of a one-year loan denominated in Cyprus pounds assuming that the MNC covered its exposure by purchasing pounds one year forward? A) 6%. B) 7%. C) 1%. D) cannot answer without more information

ANSWER: B

SOLUTION: When interest rate parity holds, the foreign financing cost (when covering with a forward hedge) is approximately equal to the domestic financing cost.


29. Maston Corporation has forecasted the value of the Russian ruble as follows for the next year:

Percentage Change Probability of Occurrence -5% 20% -3% 50% 1% 30%

If the Russian interest rate is 30%, the expected cost of financing a one-year loan in rubles is: A) 27.14%. B) 32.86%. C) 26.10%. D) none of the above

ANSWER: A SOLUTION: Computation of Effective Financing Rate Probability Expected Value (1.30)(.95) - 1 = 23.50% 20% 4.70%

(1.30)(.97) - 1 = 26.10% 50% 13.05% (1.30)(1.01) - 1 = 31.30% 30% 9.39%

27.14% The following information refers to questions 30 and 31. To benefit from the low correlation between the Canadian dollar (C$) and the Japanese yen (¥), Martha Corporation decides to borrow 50% of funds needed in Canadian dollars and the remainder in yen. The domestic financing rate for a one-year loan is 7%. The Canadian one-year interest rate is 6% and the Japanese one-year interest rate is 10%. Martha has determined the following possible percentage changes in the two individual currencies as follows: Currency Percentage Change Probability Canadian dollar 2.0% 30% Canadian dollar 4.0% 70% Japanese yen -3.0% 60% Japanese yen 1.0% 40% 30. What is the expected effective financing rate of the portfolio Martha is contemplating (assume the

two currencies move independently from one another)? A) 9.03%. B) 7.00%. C) 10.00%. D) 7.59%. E) none of the above

ANSWER: A


SOLUTION: Step 1. Determine effective financing rate for each currency under each possible scenario.

Currency

Percentage Change

Probability

Effective Rate

Canadian dollar 2.0% 30% (1.06)(1.02) - 1 = 8.12% Canadian dollar 4.0% 70% (1.06)(1.04) - 1 = 10.24% Japanese yen -3.0% 60% (1.10)( .97) - 1 = 6.70% Japanese yen 1.0% 40% (1.10)(1.01) - 1 = 11.10%

Step 2. Determine joint probabilities and effective financing rate of portfolio for each scenario.

Canadian Dollar

Japanese Yen

Joint Probability

Portfolio Effective Rate

8.12% 6.70% (.3)(.6) = .18 (.5)(8.12%) + (.5)(6.70%) = 7.41% 8.12% 11.10% (.3)(.4) = .12 (.5)(8.12%) + (.5)(11.10%) = 9.61% 10.24% 6.70% (.7)(.6) = .42 (.5)(10.24%) + (.5)(6.70%) = 8.47% 10.24% 11.10% (.7)(.4) = .28

1.00 (.5)(10.24%) + (.5)(11.10%) = 10.67%

Step 3. Determine effective financing rate of portfolio.

(.18)(7.41%) + (.12)(9.61%) + (.42)(8.47%) + (.28)(10.67%) = 9.03% 31. What is the probability that the financing rate of the two-currency portfolio is less than the

domestic financing rate? A) 12%. B) 30%. C) 100%. D) 0%. E) none of the above

ANSWER: D

SOLUTION: Since the domestic financing rate is 7%, the table above shows that there is no possibility that foreign financing with the portfolio of currencies is cheaper than domestic financing.


The following information refers to questions 32 and 33. Cameron Corporation would like to simultaneously borrow Japanese yen (¥) and Sudanese dinar (SDD) for a six-month period. Cameron would like to determine the expected financing rate and the variance of a portfolio consisting of 30% yen and 70% dinar. Cameron has gathered the following information: Mean effective financing rate of Japanese yen for six months 4% Mean effective financing rate of Sudanese dinar for six months 1% Standard deviation of Japanese yen’s effective financing rate .10 Standard deviation of Sudanese dinar’s effective financing rate .20 Correlation coefficient of effective financing rates of these two currencies .23 32. What is the expected financing rate of the portfolio contemplated by Cameron Corporation?

A) 3.10%. B) 1.90%. C) 17.00%. D) 13.00%. E) none of the above

ANSWER: B SOLUTION: (.3)(4%) + (.7)(1%) = 1.90%. 33. What is the expected standard deviation of the portfolio contemplated by Cameron?

A) 2.24%. B) 14.98%. C) 2.89%. D) 17.00%. E) none of the above

ANSWER: B

SOLUTION: %98.14)23)(.2)(.1)(.7)(.3(.2)2(.)7(.)1(.)3(. 2222 =++ 34. If interest rate parity exists, financing with a foreign currency may still be feasible, but it would

have to be conducted on an uncovered basis (i.e., without use of a forward hedge). A) true. B) false.

ANSWER: A

35. Firms that believe the forward rate is an unbiased predictor of the future spot rate will prefer

borrowing the foreign currency. A) true. B) false. ANSWER: B


36. Euronotes are unsecured debt securities whose interest rate is based on the London Interbank Offer Rate (LIBOR) with typical maturities of one, three, and six months. A) true. B) false.

ANSWER: A

37. One reason an MNC may consider foreign financing is that the proceeds could be used to offset a foreign net payables position. A) true. B) false.

ANSWER: B

38. A negative effective financing rate implies that the U.S. firm actually paid fewer dollars in total

loan repayment than the number of dollars borrowed. A) true. B) false.

ANSWER: A

39. If all currencies in a financing portfolio are not correlated with each other, financing with such a

portfolio would not be very different from financing with a single foreign currency. A) true. B) false.

ANSWER: B

40. The interest rate of euronotes is based on the T-bill rate.

A) true. B) false.

ANSWER: B

41. Countries with a _______ rate of inflation tend to have a ______ interest rate.

A) high; low B) low; high C) high; high D) A and B are correct

ANSWER: C


42. Kushter Inc. would like to finance in euros. European interest rates are currently 4%, and the euro is expected to depreciate by 2% over the next year. What is Kushter’s effective financing rate next year? A) 1.92% B) 2.00% C) 6.08% D) none of the above ANSWER: A SOLUTION: (1.04)(.98) – 1 = 1.92%

43. A negative effective financing rate indicates that an MNC:

A) paid only a small amount in interested over and above the amount borrowed. B) has been negatively affected by a large appreciation of the foreign currency. C) actually paid fewer dollars to repay the loan than it borrowed. D) would have been better off borrowing in the U.S.

ANSWER: C

44. If interest rate parity exists, the attempt to finance with a foreign currency while covering the

position to avoid exchang rate risk will result in an effective financing rate that is _________ the domestic interest rate. A) lower than B) greater than C) similar to D) none of the above

ANSWER: C

45. If interest rate parity exists, and the forward rate is an accurate estimator of the future spot rate, the

foreign financing rate will be ____________ the home financing rate. A) lower than B) greater than C) similar to D) none of the above ANSWER: C


46. Assume the U.S. financing rate is 10 percent and that the financing rate in Germany is 9 percent. An MNC would be indifferent between financing in dollars and financing in euros next year if the euro is expected to ___________. A) appreciate by 0.92%. B) depreciate by 0.92%. C) appreciate by 1.00%. D) depreciate by 1.00%.

ANSWER: A

SOLUTION: 1.10/1.09 – 1 = 0.92%

47. Foreign financing costs in a single foreign currency ____________ financing costs in dollars, and

the variance of foreign financing costs over time is ___________ than the variance of financing in dollars. A) are higher than; higher than B) can be lower or higher than; higher than C) can be lower or higher than; lower than D) are lower than; higher than

ANSWER: B

48. The degree of volatility of financing with a currency portfolio depends on only the standard

deviations of effective financing rates of the individual currencies within the portfolio. A) true. B) false.

ANSWER: B

597

Chapter 21

International Cash Management 1. The Mexican one-year interest rate is 27 percent, while the U.S. one-year interest rate is 9

percent. If a U.S. firm creates a one-year deposit in Mexico, the Mexican peso would have to _______ against the U.S. dollar by _______ in order to make that investment have an effective yield that is achievable in the U.S.

A) appreciate; 18% B) depreciate; 36% C) depreciate; 14% D) appreciate; 14% E) depreciate; 8.5% ANSWER: C SOLUTION: 1.09/1.27 – 1 = -14.2% 2. Assume that Subsidiaries “X” and “Y” often trade with each other. Assume that Subsidiary “X”

has excess cash while Subsidiary “Y” is short on cash. How can Subsidiary “X” help out Subsidiary “Y”?

A) “X” should lag its payments sent to “Y” to pay for imports from “Y.” B) “X” should request that “Y” lead its payments to be sent for goods that “Y” sent to “X.” C) A and B D) None of the above ANSWER: D 3. Netting can achieve all but one of the following: A) Cross border transactions between subsidiaries are reduced. B) Transactions costs are reduced. C) Currency conversion costs are reduced. D) Transaction exposure is eliminated. ANSWER: D


4. Which of the following is true? A) Some countries may prohibit netting. B) Some countries may prohibit forms of leading and lagging. C) A and B D) None of the above ANSWER: C 5. According to the text: A) banks in most non-U.S. countries are as capable as the U.S. in facilitating cash transfers and

most other cash management operations for MNCs. B) banks in most non-U.S. countries are more advanced than the U.S. in facilitating cash transfers

for MNCs. C) an MNC with subsidiaries in several different countries has no problems in coordinating its

cash transfers since a uniform global banking system exists. D) none of the above ANSWER: D 6. In what is known as dynamic hedging, banks periodically hedge those currencies expected to

move unfavorably and remove currencies that are expected to move favorably. A) true. B) false. ANSWER: B

7. Assume the U.S. one-year interest rate is 11% and the French one-year interest rate is 18%. The

break-even level of depreciation in the euro at which the U.S. and French investments would exhibit the same return to a U.S. investor is:

A) about 5.1%. B) about 6.8%. C) about 6.3%. D) about 5.9%. ANSWER: D SOLUTION: 1.11/1.18 – 1 = -5.9% 8. Assume that a U.S. investor invests in a British CD offering a six-month interest rate of 5%. Over

this six-month period, the pound depreciates by 9%. The effective yield on the British CD for the U.S. investor is:

A) 14.45%. B) -4.45%. C) 14.00%. D) -4.00%. ANSWER: B SOLUTION: (1 + 6%)[1 + (-9%)] – 1 = -4.45%

Chapter 21: International Cash Management 599

9. Assume that there are several foreign currencies that exhibit a higher interest rate than the U.S. interest rate. The U.S. firm has a higher probability of generating a higher effective yield on a portfolio of currencies (relative to the domestic yield) if:

A) the foreign currency movements against the U.S. dollar are highly correlated. B) the foreign currency movements against the U.S. dollar are perfectly positively correlated. C) the foreign currency movements against the U.S. dollar exhibit low correlations. D) none of the answers above would have any impact on the probability of a foreign cash

investment generating a higher effective yield than a U.S. investment. ANSWER: C 10. If the international Fisher effect (IFE) exists, then a U.S. firm that has access to banks offering

high interest rates in deposits denominated in foreign currencies should: A) invest in the foreign deposits since they will, on average, generate higher effective yields than

a U.S. deposit. B) invest in the U.S. deposits since they will, on average, generate higher effective yields than a

foreign deposit. C) invest in the U.S. deposits since they will, on average, generate similar effective yields as a

foreign deposit. D) invest in the foreign deposits since they will, on average, generate similar effective yields as a

U.S. deposit. ANSWER: C 11. The most useful measure of an MNC’s liquidity is its: A) cash balance. B) amount of securities held as investments. C) political risk rating. D) potential access to funds. ANSWER: D 12. Generally, if interest rate parity holds and the forward rate is an unbiased predictor of the future

spot rate, then the international Fisher effect will also hold. A) true. B) false.

ANSWER: A

13. According to the international Fisher effect: A) exchange rates adjust to compensate for income differentials between countries. B) interest rates adjust to compensate for income differentials between countries. C) exchange rates adjust to compensate for interest rate differentials between countries. D) exchange rates adjust to compensate for risk differentials between countries. ANSWER: C


14. The international Fisher effect suggests that: A) the effective yield on short-term foreign securities should, on average, equal the yield on

short-term domestic securities. B) the effective yield on short-term securities of high inflation countries is greater than the yield

on short-term domestic securities. C) if domestic income grows faster than foreign income, the effective yield on short-term foreign

securities is higher than short-term domestic securities. D) if foreign tax rates equal domestic tax rates, the exchange rates of different currencies will

change by the same degree. ANSWER: A 15. If a foreign currency consistently depreciated against the dollar over several periods and had lower

interest rates at the beginning of those periods than the U.S. interest rates, then: A) U.S. firms could have achieved a higher effective yield on foreign deposits than on U.S.

deposits during those periods. B) the international Fisher effect is supported by the results. C) A and B D) none of the above ANSWER: D 16. In a bilateral netting system, transactions between the parent and a subsidiary or between two

subsidiaries are consolidated over a specific period of time. A) true. B) false.

ANSWER: A

17. A common purpose of inter-subsidiary leading or lagging strategies is to: A) allow subsidiaries with excess funds to provide financing to subsidiaries with deficient funds. B) assure that the inventory levels at subsidiaries are maintained within tolerable ranges. C) change the prices a high-tax rate subsidiary charges a low-tax rate subsidiary. D) measure the performance of subsidiaries according to how quickly subsidiaries remit dividend

payments to the parent. ANSWER: A


18. Assume that a U.S. firm considers investing in British one-year Treasury securities. The interest rate on these securities is 12%, while the interest rate on the same securities in the U.S. is 10%. The firm believes that today’s spot rate is an appropriate forecast for the spot rate of the pound in one year. Based on this information, the effective yield on British securities from the U.S. firm’s perspective is:

A) equal to the U.S. interest rate. B) equal to the British interest rate. C) lower than the U.S. interest rate. D) higher than the British interest rate. E) lower than the British interest rate, but higher than the U.S. interest rate. ANSWER: B 19. Assume that in recent months, most currencies of industrialized countries depreciated substantially

against the dollar. Assume that their interest rates were similar to the U.S. interest rate. If non-U.S. firms invested in U.S. Treasury securities during this period, their effective yield would have been:

A) negative. B) zero. C) positive, but less than the interest rate of their respective countries. D) more than the interest rate of their respective countries. ANSWER: D 20. According to _______, the effective yield earned by U.S. investors will be the same as the

effective yield earned by non-U.S. investors in any given period. A) interest rate parity (IRP) B) the international Fisher effect (IFE) C) purchasing power parity (PPP) D) none of the above ANSWER: D 21. Assume Costner Corporation, a U.S.-based MNC, invests 2,500,000 Zambian kwacha (ZMK) for

a one-year period at a nominal interest rate of 9%. At the time the loan is extended, the spot rate of the kwacha is $.00060. If the spot rate of the kwacha in one year is $.00056, the dollar amount initially invested in Zambia is $__________, and $___________ are paid out after one year. A) 1,500; 1,526 B) 1,526; 1,500 C) 1,500; 1,400 D) 1,400; 1,500

ANSWER: A SOLUTION: ZMK2,500,000 x $.0006 = $1,500 (ZMK2,500,000 x 1.09) x $.00056 = $1,526


22. Bullock Corporation invests 1,500,000 South African rand at a nominal interest rate of 10%. At the time the investment is made, the spot rate of the rand is $.205. If the spot rate of the rand at maturity of the investment is $.203, what is the effective yield of investing in rand? A) 11.08%. B) 8.92%. C) 10.00%. D) none of the above

ANSWER: B

SOLUTION: Depreciation of rand: .203/.205 –1 = -.98% Effective yield: (1 + 10%) + [1 + (-.98%)] – 1 = 8.92%. 23. Assume that interest rate parity holds. The U.S. one-year interest rate is 10% and the Australian

one-year interest rate is 8%. What will the approximate effective yield be for an Australian citizen of a one-year deposit denominated in U.S. dollars? Assume the deposit is covered by a forward sale of dollars. A) 10%. B) 8%. C) 2%. D) cannot answer without more information

ANSWER: B

SOLUTION: If interest rate parity holds, the Australian citizen will be able to earn approximately his or her domestic interest rate.

24. Assume that you forecast the value of the euro as follows for the next year:

Percentage Change Probability of Occurrence -2% 30% 3% 40% 5% 30%

If the interest rate on the euro is 12%, the expected effective yield from a euro-denominated deposit is: A) 15.36%. B) 15.70%. C) 12.00%. D) 14.35%. E) none of the above

ANSWER: D


SOLUTION: Computation of

Effective Financing Rate Probability Expected Value (1.12)(.98) - 1 = 9.76% 30% 2.93% (1.12)(1.03) - 1 = 15.36% 40% 6.14% (1.12)(1.05) - 1 = 17.60% 30% 5.28%

14.35% The following information refers to questions 25 and 26. To benefit from the low correlation between the Trinidad dollar and the Japanese yen (¥), Sciorra Corporation decides to invest 50% of total funds invested in Trinidad dollars and the remainder in yen. The domestic yield on a one-year deposit is 8%. The Trinidad one-year interest rate is 10% and the Japanese one-year interest rate is 7%. Sciorra has determined the following possible percentage changes in the two individual currencies as follows: Currency Percentage Change Probability Trinidad dollar -1.0% 35% Trinidad dollar 2.0% 65% Japanese yen -2.0% 45% Japanese yen 1.0% 55% 25. What is the expected effective yield of the portfolio Sciorra is contemplating (assume the two

currencies move independently from one another)? A) 6.47%. B) 8.84%. C) 8.50%. D) none of the above

ANSWER: B SOLUTION: Step 1. Determine effective yield for each currency under each possible scenario.

Currency

Percentage Change

Probability

Effective Yield

Trinidad dollars -1.0% 35% (1.10)( .99) - 1 = 8.90% Trinidad dollars 2.0% 65% (1.10)(1.02) - 1 = 12.20% Japanese yen -2.0% 45% (1.07)( .98) - 1 = 4.86% Japanese yen 1.0% 55% (1.07)(1.01) - 1 = 8.07%


Step 2. Determine joint probabilities and effective yield of portfolio for each scenario.

Trinidad Dollar

Japanese Yen

Joint Probability

Portfolio Effective Rate

8.90% 4.86% (.35)(.45) = .1575 (.5)(8.90%) + (.5)(4.86%) = 6.88% 8.90% 8.07% (.35)(.55) = .1925 (.5)(8.90%) + (.5)(8.07%) = 8.49% 12.20% 4.86% (.65)(.45) = .2925 (.5)(12.20%) + (.5)(4.86%) = 8.53% 12.20% 8.07% (.65)(.55) = .3575

1.0000 (.5)(12.20%) + (.5)(8.07%) = 10.14%

Step 3. Determine effective yield of portfolio.

(.1575)(6.88%)+(.1925)(8.49%)+(.2925)(8.53%)+(.3575)(10.14%)=8.84% 26. What is the probability that the yield of the two-currency portfolio is less than the domestic yield?

A) .1575. B) .35. C) .6425. D) 1. E) none of the above

ANSWER: A

SOLUTION: Since the domestic financing rate is 8%, the table above shows that there is a .1575 chance that foreign investment with the portfolio of currencies will yield a higher rate than investing domestically.

The following information refers to questions 27 and 28. Moore Corporation would like to simultaneously invest in Malaysian ringgit (MYR) and Romanian leu (ROL) for a three-month period. Moore would like to determine the expected yield and the variance of a portfolio consisting of 40% ringgit and 60% leu. Moore has identified the following information: Mean effective financing rate of Malaysian ringgit for three months 3% Mean effective financing rate of Romanian leu for three months 2% Standard deviation of Malaysian ringgit’s effective financing rate .15 Standard deviation of Romanian leu’s effective financing rate .07 Correlation coefficient of effective financing rates of these two currencies .19


27. What is the expected effective yield of the portfolio contemplated by Moore Corporation? A) 2.50%. B) 2.60%. C) 2.40%. D) none of the above

ANSWER: C SOLUTION: (.4)(3%) + (.6)(2%) = 2.40%. 28. What is the standard deviation of the portfolio contemplated by Moore Corporation?

A) .624%. B) 7.950%. C) 1.040%. D) 10.200%. E) none of the above

ANSWER: B

SOLUTION: %95.7)19)(.07)(.15)(.6)(.4(.2)07(.)6(.)15(.)4(. 2222 =++ 29. Lockboxes are post office box numbers assigned to employees for picking up their paychecks.


30. Preauthorized payment is an arrangement that allows a corporation to charge a customer’s bank account up to some limit. A) true. B) false.

ANSWER: A

31. Although netting typically increases the need for foreign exchange conversion, it generally

reduces the number of cross border transactions between subsidiaries. A) true. B) false.

ANSWER: B

32. Leading refers to the payment of supplies earlier than necessary; lagging refers to the payment of

supplies later than allowed. A) true. B) false.

ANSWER: A


33. Since exchange rate forecasts are not always accurate, a probability distribution of possible exchange rates may be preferable to a single point estimate. A) true. B) false.

ANSWER: A

34. When investing in a portfolio of foreign currencies, the currencies represented within the portfolio

are ideally highly positively correlated. A) true. B) false.

ANSWER: B

35. A subsidiary will normally have a more difficult time forecasting future outflow payments if its purchases are international rather than domestic. A) true. B) false.

ANSWER: A

36. To _________________, MNCs can use preauthorized payments.

A) accelerate cash inflows B) minimize currency conversion costs C) manage blocked funds D) manage intersubsidiary cash transfers

ANSWER: A

37. ___________________ may complicate cash flow optimization.

A) The use of a zero-balance account B) Government restrictions C) Leading and lagging D) None of the above

ANSWER: B

38. MNCs often use ____________ to invest excess cash while retaining liquidity.

A) international bond markets B) international equity markets C) international money markets D) the market for acquisitions

ANSWER: C

39. Centralized cash management is more complicated when the MNC uses multiple currencies.

A) true. B) false.

ANSWER: A

multinational financial management: an...

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