FIN350 QUESTIONS AND APPLICATIONS

1. Exchange Rate Systems Explain the exchange rate system that existed during the 1950s and 1960s. How did the Smithsonian Agreement in 1971 revise it? How does today’s exchange rate system differ?

6. Impact of Economic Conditions Assume that Switzerland has a very strong economy, putting upward pressure on both inflation and interest rates. Explain how these conditions could put pressure on the value of the Swiss franc, and determine whether the franc’s value will rise or fall.

1. Currency Futures Use the following information to determine the probability distribution of per unit gains from selling Mexican peso futures.

■  Spot rate of the peso is $0.10.

■  Price of peso futures is $0.102 per unit.

■  Your expectation of the peso spot rate at maturity of the futures contract is:

POSSIBLE OUTCOME FOR FUTURE  SPOT RATE	PROBABILITY
$0.090	10%
0.095	70
0.110	20

2. Currency Call Options Use the following information to determine the probability distribution of net gains per unit from purchasing a call option on British pounds.

■  Spot rate of the British pound is $1.45.

■  Premium on the British pound option is $0.04 per unit.

■  Exercise price of a British pound option is $1.46.

■  Your expectation of the British pound spot rate prior to the expiration of the option is:

POSSIBLE OUTCOME FOR FUTURE  SPOT RATE	PROBABILITY
$1.48	30%
1.49	40
1.52	30

4 .Covered Interest Arbitrage Assume the following information:

■ British pound spot rate = $1.58

■ British pound one-year forward rate = $1.58

■ British one-year interest rate = 11 percent

■ U.S. one-year interest rate = 9 percent

Explain how U.S. investors could use covered interest arbitrage to lock in a higher yield than 9 percent. What would be their yield? Explain how the spot and forward rates of the pound would change as covered interest arbitrage occurs.

Chapter 17: Questions and Applications 1, 2, 7, 11, and 13

1. Bank Balance Sheet Create a balance sheet for a typical bank, showing its main liabilities (sources of funds) and assets (uses of funds).

2. Bank Sources of Funds What are four major sources of funds for banks? What alternatives does a bank have if it needs temporary funds? What is the most common reason that banks issue bonds?

7. Borrowing from the Federal Reserve Describe the process of “borrowing at the Federal Reserve.” What rate is charged, and who sets it? Why do banks commonly borrow in the federal funds market rather than through the Federal Reserve?

11. Bank Capital Explain the dilemma faced by banks when determining the optimal amount of capital to hold. A bank’s capital is less than 10 percent of its assets. How do you think this percentage would com- pare to that of manufacturing corporations? How would you explain this difference?

13. Credit Crisis Explain how some mortgage operations by some commercial banks (along with other financial institutions) played a major role in instigating the credit crisis.

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RISK RESULTING FROM INTERNATIONAL BUSINESS

AUGUST 17, 2015 ADMIN

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Question 10

Risk Resulting from International Business This chapter concentrates on possible benefits to a firm that increases its international business.

1. What are some risks of international business that may not exist for local business?
2. What does this chapter reveal about the relation- ship between an MNC’s degree of international business and its risk?

Question 16

DFI Location Decision Decko Co. is a U.S. firm with a Chinese subsidiary that produces cell phones in China and sells them in Japan. This subsidiary pays its wages and its rent in Chinese yuan, which is stable relative to the dollar. The cell phones sold to Japan are denominated in Japanese yen. Assume that Decko Co. expects that the Chinese yuan will continue to stay stable against the dollar. The subsidiary’s main goal is to generate profits for itself and reinvest the profits. It does not plan to remit any funds to Decko, the U.S. parent.

1. Assume that the Japanese yen strengthens against the U.S. dollar over time. How would this be expected to affect the profitsearned by the Chinese subsidiary?
2. If Decko Co. had established its subsidiary in Tokyo, Japan, instead of in China, would the subsidiary’s profits be more exposed or less exposed to exchange rate risk?
3. Why do you think that Decko Co. established the subsidiary in China instead of Japan? Assume no major country risk barriers.
4. If the Chinese subsidiary needs to borrow money to finance its expansion and wants to reduce its exchange rate risk, should it borrow U.S. dollars, Chinese yuan, or Japanese yen?

Question 13

Capital Budgeting Example Brower, Inc., just constructed a manufacturing plant in Ghana. The construction cost 9 billion Ghanaian cedi. Brower intends to leave the plant open for 3 years. During the 3 years of operation, cedi cash flows are expected to be 3 billion cedi, 3 billion cedi, and 2 billion cedi, respectively. Operating cash flows will begin 1 year from today and are remitted back to the parent at the end of each year. At the end of the third year, Brower expects to sell the plant for 5 billion cedi. Brower has a required rate of return of 17 percent. It currently takes 8,700 cedi to buy 1 U.S. dollar, and the cedi is expected to depreciate by 5 percent per year.

1. Determine the NPV for this project. Should Brower build the plant?
2. How would your answer change if the value of the cedi was expected to remain unchanged from its cur- rent value of 8,700 cedi per U.S. dollar over the course of the 3 years? Should Brower construct the plant then?

Question 25

Capital Budgeting Analysis Zistine Co. considers a 1-year project in New Zealand so that it can capitalize on its technology. It is risk averse but is attracted to the project because of a government guarantee. The project will generate a guaranteed NZ$8 million in revenue, paid by the New Zealand government at the end of the year. The payment by the New Zealand government is also guaranteed by a credible U.S. bank. The cash flowsearned on the project will be converted to U.S. dollars and remitted to the parent in 1 year. The prevailing nominal 1-year interest rate in New Zealand is 5 percent, while the nominal 1-year interest rate in the United States is 9 percent. Zistine’s chief executive officer believes that the movement in the New Zealand dollar is highly uncertain over the next year, but his best guess is that the change in its value will be in accordance with the international Fisher effect (IFE). He also believes that interest rate parity holds. He provides this information to three recent finance graduates that he just hired as managers and asks them for their input.

1. The first manager states that due to the parity conditions, the feasibility of the project will be the same whether the cash flows are hedged with a forward contract or are not hedged. Is this manager correct? Explain.
2. The second manager states that the project should not be hedged. Based on the interest rates, the IFE suggests that Zistine Co. will benefit from the future exchange rate movements, so the project will generate a higher NPV if Zistine does not hedge. Is this manager correct? Explain.
3. The third manager states that the project should be hedged because the forward rate contains a premium and, therefore, the forward rate will generate more U.S. dollar cash flows than the expected amount of dollar cash flows if the firm remains unhedged. Is this man- ager correct? Explain.

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