Select Technology and Business College

Department of Accounting and Finance

MSc in Accounting and Finance
International Business Finance
Case Analysis Assignment (20%)

International Business Finance

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Question No. 1
There are several methods by which firms can conduct international business. Mention and
describe at least four methods. Describe also direct foreign investment (DFI) by relating to
those methods.
Question No. 2
Several factors affect International Trade Flows. These factors include: i) Inflation, ii) National
income, iii) Tariff, iV) Subsidies for exporters, iV) Depreciation of currency. Show how each of
the above factors impact (increase or decrease or no impact) on imports, exports and current
account.
Question No. 3
There are several factors that affect Direct Foreign Investment (DFI). Mention at least three
factors and describe how each factor influence DFI.
Question No. 4
Exchange rate systems are classified into five categories according to the degree by which
government controls them. Mention and describe at least four exchange rate systems? Which
exchange rate system does Ethiopia follow currently?
Question No. 5
The strength of currency is a measure of the level of economic development of a country. Do you
agree? Explain by providing both theoretical and practical arguments.
Question No. 6
Why are firms motivated to expand their business internationally? We have three theories
explaining this. Please mention and describe these theories.

Question No. 7
Mr. Jackson resides in the United States of America while Mr. Daniel resides in the Great Britain
with $300,000 and £200,000, respectively. The current spot rate is as follows: £1=U.S.D 1.50.
British banks pay 4% per annum and U.S. banks pay 2% per annum. Assume the one year
forward rate is: £1=U.S.D 1.46. Assume further that there is no tax on interest for both countries.
Required:
A. Is covered interest arbitrage possible in the above scenario? Calculate the gain
from covered interest arbitrage, if any
B. Who will benefit from covered interest arbitrage? Explain
C. Calculate the equilibrium forward rate
D. What would happen to the value of British pound a year from now? Explain why?
(Provide theoretical explanations)
Question No. 8
Assume that the United States inflation rate is expected to be 2% over the next year,
while Ethiopian inflation rate is expected to be 7% over the next year. Assume the spot
rate is as follows: 1 U.S.D= 21 Birr
Required:

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 A. Assuming PPP, determine the percentage change in the value of Birr?
B. What is the forecasted value of Birr at the end of one year?
Question No. 9
CFO of Trident (U.S. firm) has just concluded a sale to Regency, a British firm, for £1,000,000.
The sale is made in March for settlement due in June (3 months).
Assumptions:

 Spot rate is $1.7640/£

 3-month forward rate is $1.7229/£
 UK 3 month investing rate is 8.0% p.a.
 US 3 month investing rate is 6.0% p.a.
 June put option in OTC market for £1,000,000; strike price $1.75/£; priced at
$0.0265/£
 June call option in OTC market for £1,000,000; strike price $1.77/£; priced at
$0.0265/£
 Trident can invest at the rates given above or borrow at 2% p.a. above those rates.
Trident’s cost of capital is 12%.
 Assume any new proceeds are invested in T-bills (not used to replace borrowings
nor invested in the firm’s tangible assets)
 Any new funds can be raised at the borrowing rate. Option premium is also
financed using borrowings.
 Trident’s foreign exchange advisory service forecasts future spot rate in 3 months
to be $1.7400/£
Required:
A. Calculate the amount of cash Trident will secure in each of the following
hedging strategies:
i. Forward market hedge
ii. Option market hedge
iii. Money market hedge
B. Compare the above three hedging alternatives and make a recommendation as
to which alternative Trident has to adopt.

Question No. 10
Assume that a bank has quoted the British pound (£) at $1.55, the Newzland dollar (NZ$)
at $ 0.55 and the cross exchange rate at 1£=NZ$ 3.15.
Required:
A. Determine the correct cross exchange rate.
B. If you have $ 10,000, how many U.S. dollars will you end up with in one
round trip triangular arbitrage?

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 C. How much is the gain from triangular arbitrage?
Question No. 11
Assume that the Mexican peso exhibits a six month interest rate of 6 percent, while the
U.S. dollar exhibits a six month interest rate of 5 percent. Assume further that the peso’s
spot rate is $0.10.
Required:
A. Determine forward premium or discount.
B. Determine the forward rate.
C. If the actual forward rate in the open market is $0.08, will covered interest
arbitrage be possible? If yes by which investors (local or foreign)?
Assume no market imperfections.

Question No. 12
XYZ Company plans to determine how changes in British and U.S. interest rates will affect the
value of British pound. The control variables are relative inflation rates and relative income
growth.

Required:

a) Describe a regression model that could be used to achieve the stated objective. Also
explain the expected sign of the regression coefficient
b) If XYZ Company thought that the existence of a quota in particular historical periods
may have affected exchange rates, how might this be accounted for in the regression
model?

Question No. 13
Blue Demon Bank expects that the Chinese currency (the yuan) will depreciate against the dollar
from its spot rate of $0.15 to $0.14 in 30 days. The following interbank lending and borrowing
rates exist:

Lending Rate Borrowing Rate

U.S. dollar 8.0% 8.3%
Chinese yuan 8.5% 8.7%

Assume that Blue Demon Bank has a borrowing capacity of either $10 million or 70
million yuan in the interbank market, depending on which currency it wants to borrow.
a) How could Blue Demon Bank attempt to capitalize on its expectations without
using deposited funds? Estimate the profits that could be generated from this
strategy.

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 b) Assume all the preceding information, with this exception: Blue Demon Bank
expects the yuan to appreciate from its present spot rate of $0.15 to $0.17 in
30 days. How could it attempt to capitalize on its expectations without using
deposited funds? ? Estimate the profits that could be generated from this
strategy.

Question No. 14
Gandor Co. is a U.S. firm that is considering a joint venture with a Chinese firm to
produce and sell videocassettes. Gandor will invest $12million in this project, which will
help to finance the Chinese firm’s production. For each of the first three years, 50 percent
of the total profits will be distributed to the Chinese firm, while the remaining 50 percent
will be converted to dollars to be sent to the United States. The Chinese government is
expected to impose a 20 percent income tax on the profits earned by Gandor. The
Chinese government has guaranteed that the after tax profits (denominated in yuan, the
Chinese currency) can be converted to U.S. dollars at an exchange rate of $0.20 per yuan
and sent to Gandor Co. each year. At the current time, there is no withholding tax
imposed on profits to be sent to the United States as a result of joint ventures in China.
Assume that even after considering the taxes paid in China, there is an additional 10
percent tax imposed by the U.S. government on profits received by Gandor Co. After the
first three years, all profits earned are allocated to the Chinese firm. The expected total
profits resulting from the joint venture per year are as follows:
End Total Profits From Joint Venture (in
of yuan)
Year
1 60 million
2 80 million
3 100 million

Gandor’s average cost of debt is 13.8 percent before taxes. Its average cost of equity is 18
percent. Assume that the corporate income tax rate imposed on Gandor is normally 30
percent. Gandor uses a capital structure composed of 60 percent debt and 40 percent
equity. Gandor automatically adds 4 percentage points to its cost of capital when deriving
its required rate of return on international joint ventures. While this project has particular
forms of country risk that are unique, Gandor plans to account for these forms of risk
within its estimation of cash flows.

There are two forms of country risk that concern Gandor. First, there is the risk that the
Chinese government will increase the corporate income tax rate from 20 percent to 40
percent (20 percent probability). If this occurs, additional tax credits will be allowed,

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resulting in no U.S. taxes on the profits from this joint venture. Second, there is the risk
that the Chinese government will impose a withholding tax of 10 percent on the profits
that were to be sent to the United States (20 percent probability). In this case, additional
tax credits will not be allowed, and Gandor will still be subject to a 10 percent U.S. tax
on profits received from China. Assume that the two types of country risk are mutually
exclusive. That is, the Chinese government will only adjust one of its tax guidelines (the
income tax or withholding tax),if any.
Required:
A. Determine Gandor’s cost of capital. Also, determine Gandor’s required rate of
return for the joint venture in China.
B. Determine Gandor’s net present values for the joint venture for the three
scenarios:
Scenario 1. Based on original assumptions.
Scenario 2. Based on an increase in the corporate income tax by the Chinese
government.
Scenario 3. Based on the imposition of a withholding tax by the Chinese
government.
C. Determine the estimated NPV for Gandor’s joint venture
D. Would you recommend that Gandor participate in the joint venture? Explain
E. What do you think would be the key underlying factor that would have the most
influence on the profits earned in China as a result of the joint venture?
F. Is there any reason for Gandor to revise the composition of its capital (debt and
equity) obtained from the United states when financing joint ventures like this?

Question No. 15
Mr. Daniel resides in the United States of America and currently he is contemplating in
which country bank to deposit his wealth of $100,000. For this purpose, he is considering
three alternative countries-Ethiopia, Great Britain, and U.S.A. The current spot rate is as
follows: U.S.D. 1=Br.20 and £1=U.S.D.1.5. Banks in Ethiopia are expected to pay an
interest rate of 5% per annum, British banks pay 3% per annum and U.S. banks pay 2%
per annum. The inflation rate per annum for Ethiopia, Britain and United States is
expected to be 10%, 7% and 6% respectively. Assume interest rates and inflation rates
will be constant every year throughout the next five years. Use purchasing power parity
(PPP) to forecast exchange rates five years from now. Assume further that there is no tax
on interest for all the three countries. Mr. Daniel has a five year investment horizon.
Required:

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 1. During the five year investment horizon, how much U.S. dollar will Mr. Daniel
obtain if he deposits in Ethiopia? Great Britain? United States?
2. Which country do you recommend for Mr. Daniel to deposit his money?
Question No. 16

Assume the following information:

Spot rate of Canadian dollar =$0.80
90-day forward rate of Canadian dollar =$0.79
90-day Canadian interest rate = 4%
90-day U.S. interest rate =2.5%

Given this information, what will be the yield (percentage return) to a U.S. investor who
used covered interest arbitrage? (Assume the investor invests $1,000,000.)

Question No. 17
In forecasting foreign exchange rates, experts may use fundamental forecasting
techniques. What is a fundamental forecasting technique? Discuss by using an
illustration.

Question No. 1 8
Mr. Solomon resides in the United States of America and currently he is contemplating in
which country bank to deposit his wealth of $200,000. For this purpose, he is considering
two alternative countries-Great Britain and U.S.A. The current spot rate is as follows:
£1=U.S.D 1.5. British banks pay 2% per annum and U.S. banks pay 1% per annum.
Assume interest rates will be constant every year throughout the next five years. Assume
the five year forward rate is: £1=U.S.D 1.45. Assume further that there is no tax on
interest for both countries. Mr. Solomon has a five year investment horizon and engages
forward contract if he has to invest in Britain.
Required:
1. During the five year investment horizon, how much U.S. dollar will Mr. Solomon
obtain if he deposits in Great Britain? United States?
2. Which country do you recommend for Mr. Solomon to deposit his money?
3. Is covered interest arbitrage possible in the above scenario? Calculate the gain
from covered interest arbitrage, if any
Question No. 19

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Assume that the United States inflation rate is expected to be 1% over the next year,
while Ethiopian inflation rate is expected to be 6% over the next year. Assume the spot
rate is as follows: 1 U.S.D= 20 Birr
Required:
1. Assuming PPP, determine the percentage change in the value of Birr?
2. What is the forecasted value of Birr at the end of one year?
Question No. 20
Assume that a bank has quoted the British pound (£) at $1.50, the Newzland dollar (NZ$)
at $ 0.50 and the cross exchange rate at 1£=NZ$ 2.95.
Required:
1. Determine the correct cross exchange rate.
2. If you have $ 10,000, how many U.S. dollars will you end up with in one
round trip triangular arbitrage?
3. How much is the gain from triangular arbitrage?