Lingnan University

FIN3352 International Financial Management

1st Term AY2022-23
1st Test (with Answers) September 30, 2022

Time Allowed: 90 Minutes

Answer ALL the Questions

Question 1
a. Why is it important to study international financial management? (5 marks)
b. How is international financial management different from domestic financial
management? (5 marks)

Answer:
a. We are now living in a world where all the major economic functions, such as
consumption, production, investment, and financing, are highly globalized. It is thus
essential for financial managers to fully understand vital international dimensions of
financial management.
b. There are three major dimensions that set apart international finance from domestic
finance. They are:

1. foreign exchange and political risks,

2. market imperfections, and

3. expanded opportunity set.

Question 2

a. You visit the foreign exchange trading room of a major bank in the US. A trader
asks for quotations of the British pound from various correspondents and hears the
following quotes:

From Bank A: 1.6580–85

From Bank B: 1.6582–87

What do they mean?

(4 marks)

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 b. The euro is quoted as US$/€ = 1.1420–1.1425, and the Canadian dollar is quoted as
C$/US$ = 1.3540– 1.3545. What is the implicit C$/€ quotation? (6 marks)

Answer:

a. These quotations mean that Bank A is willing to buy a pound for 1.6580 dollars
(bid rate) or to sell one for 1.6585 dollars (ask rate). Bank B's $/€ bid rate is
1.6582; its ask rate is 1.6587. That is, Bank B is willing to buy a pound for 1.6582
dollars or to sell one for 1.6587 dollars.

b. The C$/€ quotation is obtained as follows. In obtaining this quotation, we keep in

mind that C$/€ = C$/$ x $/€ and that the price for each transaction (bid or ask) is
the one that is more advantageous to the trader.
The C$/€ bid price is the number of Canadian dollars that a trader is willing to pay
for one euro. This transaction (buy euro-sell Canadian dollars) is equivalent to
selling Canadian dollars to buy dollars (at a bid rate of 1.3540) and then selling
those dollars to buy euros (at a bid rate of 1.1420).

Mathematically, the transaction is as follows:

(bid C$/$) × (bid $/€) = 1.3540 × 1.1420 = 1.54627.

The C$/€ ask price is the number of Canadian dollars that a trader is asking for
one euro. This transaction (sell euros-buy Canadian dollars) is equivalent to
buying Canadian dollars with dollars (at an ask rate of 1.3545) and simultaneously
purchasing these dollars against euros (at an ask rate of 1.1425). Mathematically,
this can be expressed as follows:

(ask C$/$) × (ask $/€) = 1.3545 × 1.1425 = 1.54752.

So the resulting quotation by the trader is: C$/€ = 1.54627 − 1.54752.

Question 3

You noticed that the exchange rate between the Korean won and the U.S. dollar has
changed considerably. The won/dollar exchange rate has moved from 800 won per
dollar to 1000 won per dollar.

(a) Has the Korean won appreciated or depreciated with respect to the dollar? By
what percentage? (5 marks)
(b) By what percentage has the value of the dollar changed with respect to the
won? (5 marks)

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Answer:

Question 4

a. What are some of the reasons central banks and treasuries enter the foreign exchange
markets, and in what important ways are they different from other foreign exchange
participants? (5 marks)
b. Fixed exchange rate regimes are sometimes implemented through a currency board
(Hong Kong SAR) or dollarization (Ecuador). What is the difference between the two
approaches? (5 marks)

Answer:

a. Central banks and treasuries enter the foreign exchange market to acquire/spend their
own foreign exchange reserves and to influence the price at which their own currency
is traded. Unlike other market participants, they are not profit-oriented. Instead, they
may willingly take a loss if they think it is in their best national interest.

b. In a currency board arrangement, the country issues its own currency but that
currency is backed 100% by foreign exchange holdings of a hard foreign currency—
usually the U.S. dollar. In dollarization, the country abolishes its own currency and
uses foreign currency, such as the U.S. dollar, for all domestic transactions.

Question 5

a. Why are foreign currency futures contracts more popular with individuals and banks
while foreign currency forwards is more popular with businesses? (6 marks)
b. 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? (4 marks)

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Answer:

a. Foreign currency futures are standardized contracts that lend themselves well to
speculation purposes but less so for hedging purposes. The standardized nature of the
futures contract makes it easy to trade futures and make bets about general changes in
the value of currencies. Forward contracts are better for hedging because they are
tailored to meet the client's specific needs, typically a business, and can be quite
useful in reducing exchange rate risk. Banks are involved in the foreign currency

b. ¥5,000,000 x $.0095/¥ = $47,500

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