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Supplemental Questions and Problems

1. Multinational Financial Management: An Overview


1. How does foreign competition limit the prices that domestic companies can charge and the
wages and benefits that workers can demand?
2. What political solutions can help companies and unions avoid the limitations imposed by
foreign competition?
3. Who pays for these political solutions? Explain.
2. International Financial Markets
1. Is a floating-rate system more inflationary than a fixed-rate system? Explain
2. Since 1979, the price of gold has fallen by more than 60%. What could explain such a steep
price decline? Consider the roles of inflation and new financial instruments such as swaps
and options that can provide lower-cost inflation hedges.
3. The experiences of fixed exchange-rate systems and target-zone arrangements have not been
entirely satisfactory.
a.
What lessons can economists draw from the breakdown of the Bretton Woods
system?
b.
What lessons can economists draw from the exchange rate experiences of the
European Monetary System?
3. Exchange Rate Determination
1. For each of the following six scenarios, say whether the value of the dollar will appreciate,
depreciate, or remain the same relative to the Japanese yen. Explain each answer. Assume
that exchange rates are free to vary and that other factors are held constant.
a. The growth rate of national income is higher in the U.S. than in Japan.
b. Inflation is higher in the U.S. than in Japan.
c. Prices in Japan and the U.S. are rising at the same rate.
d. Real interest rates are higher in the U.S. than in Japan
e. The U.S. imposes new restrictions on the ability of foreigners to buy American
companies and real estate.
f. U.S. wages rise relative to Japanese wages, while American productivity falls behind
Japanese productivity.
2. In the late 1980s, the Bank of Japan bought billions of dollars in the foreign exchange market
to prop up the dollars value against the yen. What were the likely consequences of this
foreign exchange market intervention for the Japanese economy?

3. Many Asian governments have attempted to promote their export competitiveness by holding
down the values of their currencies through foreign exchange market intervention.
a. What is the likely impact of this policy on Asian foreign exchange reserves? on Asian
inflation? on Asian export competitiveness? on Asian living standards?
b. Some Asian countries have attempted to sterilize their foreign exchange market
intervention by selling bonds. What are the likely consequences of sterilization on
interest rates? on exchange rates in the longer term? on export competitiveness?
4. Assume the Argentine peso spot rate is $.2759. The expected spot rate one year from now is
$.2968. What is the percent change?
5. You have the borrowing capacity of $500,000 or 5,000,000 Mexican pesos and the following
rates are available for the two currencies:
U.S.
Mexico
A.

Lending (investing) rate


5.2%
30.6%

Borrowing rate
6.1%
42.2%

You expect the peso to appreciate from its current spot rate of $.1002 to
$.1411 in 30 days. Estimate the profits that could be made from taking a speculative
position.

B.

You expect the peso to remain unchanged from its spot rate of $.1002 for
20 days.

C.

You expect the peso to depreciate from its spot rate of $.1002 to $.0517
in 15 days.

4. Foreign Exchange Market and Currency Derivatives


1. Suppose the quote on pounds is $1.624-31. If you converted $10,000 to pounds and then
back to dollars, how many dollars would you end up with?
2. Using current data, calculate the 30-day, 90-day, and 180-day forward premiums for the
Canadian dollar, the euro, and the Japanese yen.
5. Arbitrage, Parity Conditions, and Currency Forecasting
1. During 1988, the U.S. prime rate the rate of interest banks charge on loans to their best
customers stood at 9.5%. Japans prime rate, meanwhile, was about 3.5%. Pointing to that
discrepancy, a number of commentators argued that the cost of capital must come down for
U.S. business to remain competitive with Japanese companies. What additional information

would you need to properly assess this claim? Why might interest rates be lower in Japan
than in the U.S.?
2. One idea to curb potentially destabilizing international movements of capital has been
devised by James Tobin, a Nobel Prize-winning economist. He proposes putting a small tax
on foreign exchange transactions. He claims that his Tobin tax: would make short-term
speculation more costly wile having little effect on long-term investment.
A.
B.

Why would the Tobin tax have a disproportionate impact on short-term


investments?
Is the Tobin tax likely to accomplish its objective? Explain.

3. In July, the one-year interest rate is 12% on British pounds and 9% on U.S. dollars.
A.

If the currency exchange rate is $1.63, what is the expected future exchange rate
in one year?

B.

Suppose a change in expectations regarding future U.S. inflation causes the


expected future spot rate to decline to $1.52. What should happen to the U.S. interest
rate?

6. Foreign Exchange Exposures and Transaction Exposure


1.

Walt Disney expects to receive a theatrical fee of 16,000,000 Mexican pesos in 90 days.
The current spot rate is $.1321 and the 90-day forward rate is $.1242.
A.
What is Disneys peso transaction exposure associated with this fee?
B.
If the spot rate expected in 90 days is $.1305, what is the expected
U.S. dollar value of the fee?
C.
What is the edged dollar value of the fee?

2.

An importer has a payment of 8,000,000 due in 90 days.


A.
If the 90-day pound forward rate is $1.4201, what is the hedged cost of
making that payment?
B.
If the spot rate expected in 90 days is $1.4050, what is the expected cost of
payment?
C.
What factor will influence the hedging decision?

3. An investment manager hedges a portfolio of Bunds (German government bonds) with a sixmonth forward contract. The current spot rate for the euro is $.6098, and the 180-day forward
rate is $.6211. At the end of the six-month period, the Bunds have risen in value by 3.75%
(in euro terms), and the spot rate is now $.6849. Assume a $100,000 investment.
A. If the Bunds earn interest at the annual rate of 5%, paid semiannually, what is the
investment managers total dollar return on the hedged Bunds?
B. What would the return on the Bunds have been without hedging?

4. Cooper Inc., a U.S. firm, has just invested 500,000 in a note that will come due in 90 days
and is yielding 9.5% annualized. The current spot value of the pound is $1.5612, and the 90day forward rate is $1.5467.
A.
What is the hedged dollar value of this note at maturity?
B.
What is the annualized dollar yield on the hedged note?
C.
Cooper anticipates that the value of the pound in 90 days will be
$1.5550. Should it hedge? Why or why not?
D.
Suppose that Cooper has a payable of 980,000 coming due in 180 days.
Should this affect its decision of whether to hedge its sterling note? How and why?
7. Economic Exposure
1. Chemex, a U.S. maker of specialty chemicals, exports 40% of its $600 million in annual
sales: 5% goes to Canada and 7% each to Japan, Britain, Germany, France, and Italy. It incurs
all its costs in U.S. dollars, while most of its export sales are priced in the local currency.
A. How is Chemex affected by exchange rate changes?
B. Distinguish between Chemexs transaction exposure and its economic exposure.
C. How can Chemex protect itself against transaction exposure?
D. What financial, marketing, and production techniques can Chemex use to protect itself
against economic exposure?
E. Can Chemex eliminate its economic exposure by hedging its position every time it makes
a foreign sale or by pricing all foreign sales in dollars? Why or why not?
9. Direct Foreign Investment
1. What could account for the fact that most European and Japanese automakers have design
studios in the U.S., and especially California?
2. In 1989, the British company Beecham Group merged with the U.S. company SmithKline
Beckman. What economic advantages might the two drug companies be expecting from their
marriage? More generally, what economic forces underlie the ongoing process of
consolidation and globalization in the world pharmaceutical industry?
3.

Germanys $28 billion electronics giant, Siemens AG, sells medical and
telecommunications equipment, power plants, automotive products, and computers. Siemens
has been operating in the U.S. since 1952, but its U.S. revenues account for only about 10%
of worldwide revenues. It intends to expand further in the U.S. market.
A.

B.

According to the head of its U.S. operation, The U.S. is a real testing ground. If
you make it here, you establish your credentials for the rest of the world. What does this
statement mean? How would you measure the benefits flowing from this rational for
investing in the U.S.?
What other advantages might Siemens realize from a larger American presence?

11. Country Risk Analysis

11.1

What obstacles do Third World countries such as Argentina, Brazil, and Ghana face in
becoming developed nations with strong economies?

11.2

What can we learn about economic development and political risk from the contrasting
experiences of East and West Germany, North and South Korea, and China and Taiwan,
Hong Kong, and Singapore?

12. Multinational Capital Structure


12.1

A firm with a corporate-wide debt-to-equity ratio of 0.5, and after-tax cost of debt of 7%,
and a cost of equity capital of 15% is interested in pursuing a foreign project. The debt
capacity of the project is the same as for the company as a whole, but its systematic risk
is such that the required return on equity is estimated to be about 12%. The after-tax cost
of debt is expected to remain at 7%. What is the projects weighted average cost of
capital? How does it compare with the parents WACC?

12.2

Suppose that a foreign project has a beta of 0.85, the risk-free return is 12%, and the
required return on the market is estimated at 19%. What is the cost of capital for the
project?

12.3

Although the one-year interest rate is 10% in the U.S., one-year, yen-denominated
corporate bonds in Japan yield only 5%.
A. Does this present a riskless opportunity to raise capital at low yen interest rates?
B. Suppose the current exchange rate is $.00714. What is the lowest future exchange rate
at which borrowing yen would be no more expensive than borrowing U.S. dollars?

12.4

Ford de Mexico can borrow pesos at 80% for one year. The peso exchange rate is
expected to move from $.0911 to $.0528 by years end. What is Fords expected after-tax
dollar cost of borrowing pesos for one year if the Mexican corporate tax rate is 53%?

13. Financing International Trade


13.1

Texas Computer (TC) recently has begun selling overseas. It currently has 30 foreign
orders outstanding, with the typical order averaging $2,500. TC is considering the
following three alternatives to protect itself against credit risk on these foreign sales:
Request a letter of credit from each customer. The cost to the customer would be $75
plus 0.25% of the invoice amount. To remain competitive, TC would have to absorb
the cost of the letter of credit.
Factor the receivables. The factor would charge a nonrecourse fee of 1.6%.
Buy FCIS insurance. The FCIA would charge a 1% insurance premium.
a. Which of these alternatives would you recommend to Texas Computers? Why?
b. Suppose that TCs average order size rose to $250,000. How would that affect your
decision?

13.2

L.A. Cellular has received an order for phone switches for Singapore. The switches will
be exported under the terms of a letter of credit issued by Sumitomo Bank on behalf of
Singapore Telecommunications. Under the terms of the L/C, the face value of the export
order, $12 million, will be paid six months after Sumitomo accepts a draft drawn by L.A.
Cellular. The current discount rate on six-month acceptances is 8.5% per annum, and the
acceptance fee is 1.25% per annum. In addition, there is a flat commission, equal to 0.5%
of the face amount of the accepted draft, which must be paid if it is sold.
a. How much cash will L.A. Cellular receive if it holds the acceptance until maturity?
b. How much cash will it receive if it sells the acceptance at once?
c. uppose L.A. Cellulars opportunity cost of funds is 8.75% per annum. If it wishes to
maximize the present value of its acceptance, should it discount the acceptance?

13.3

Suppose Minnesota Machines (MM) is trying to price an export order from Russia.
Payment is due nine months after shipping. Given the risks involved, MM would like to
factor its receivable without recourse. The factor will charge a monthly discount of 2%
plus a fee equal to 1.5% of the face value of the receivable for the nonrecourse financing.
a.
If Minnesota Machines desires revenue of $2.5 million from the sale, after paying
all factoring charges, what is the minimum acceptable price it should charge?
b.
Alternatively, CountyBank has offered to discount the receivable, but with
recourse, at an annual rate of 14% plus a 1% fee. What price will net MM the $2.5
million it desires to clear from the sale?
c.
On the basis of your answers to parts a and b, should Minnesota Machines
discount or factor its Russian receivables? MM is competing against Nippon
Machines for the order, so the higher MMs price, the lower the probability that its
bid will be accepted. What other considerations should influence MMs decision?
d.
What other alternatives might be available to MM to finance its sale to Russia?

14. Short-Term Financing


14.1

If Consolidate Corporation issues a Eurobond denominated in yen, the 7% interest rate on


the $1 million, one-year borrowing will be 2% less than rates in the U.S. However,
ConCorp would have to pay back the principal and interest in Japanese yen. Currently,
the exchange rate is $0.00546. By how much could the yen rise against the dollar before
the European bond would lose its advantage to ConCorp?

14.2

Ford can borrow dollars at 12% or pesos at 80% for one year. The peso:dollar exchange
rate is expected to move from $0.000303 to $0.000222 by years end.
a. What is the expected after-tax dollar cost of borrowing dollars for one year if the
Mexican corporate tax rate is 53%?
b. What is Fords expected after-tax dollar cost of borrowing pesos for one year?
c. At what end-of-year exchange rate will the after-tax peso cost of borrowing dollars
equal the after-tax peso cost of borrowing pesos?

14.3

The manager of an English subsidiary of a U.S. firm is trying to decide whether to


borrow, for one year, dollars at 7.8% or pounds sterling at 12%. If the current value of the

pound is $1.70, at what end-of-year exchange rate would the firm be indifferent now
between borrowing dollars and pounds?
14.4

Suppose that a firm located in Belgium can borrow dollars at 8% or Belgian francs at
14%. The U.S. tax rate is 30%.
a. If the Belgian franc is expected to depreciate from $0.01724 at the beginning of the
year to $0.01639 at the end of the year, what is the expected before-tax dollar cost of
the Belgian franc loan?
b. If the Belgian corporate tax rate is 42%, what is the expected after-tax dollar cost of
borrowing francs, assuming the same currency change scenario?
c. Given the expected exchange rate change, which currency yields the lower expected
after-tax dollar cost?