OFFICE USE ONLY

Monash University
Semester Two Examination 2011
Faculty of Business and Economics
Department of Accounting and Finance

EXAM CODES: AFW2341

TITLE OF PAPER: INTERNATIONAL FINANCIAL MANAGEMENT
EXAM DURATION: 3 hours
READING TIME: 10 minutes

THIS PAPER IS FOR STUDENTS STUDYING AT: (office use only ‐ tick where applicable)
 Berwick  Clayton  Peninsula  Distance Education  Other (specify)
 Caulfield  Gippsland  Sunway  Open Learning

During an exam, you must not have in your possession, a book, notes, paper, calculator, pencil case,
mobile phone or any other material/item which has not been authorised for the exam or specifically
permitted as noted below. Any material or item on your desk, chair or person will be deemed to be in
your possession. You are reminded that possession of unauthorised materials in an exam is a
disciplinable offence under Monash Statute 4.1.

AUTHORISED MATERIALS

CALCULATORS  YES  NO
(If YES, only calculators with an 'approved for use' Faculty label are permitted)

OPEN BOOK  YES  NO

SPECIFICALLY PERMITTED ITEMS  YES  NO

if yes, items permitted are:

This paper consists of parts A and B and is printed on a total of ten (10) pages (including the Formula
Sheet on page 10).
Instructions are printed at the beginning of each part.

Students must earn a minimum of 50% (i.e. 50/100) in the final examination to be eligible for a pass in
this unit.

STUDENT ID: …………………………... DESK NUMBER: …………………….

PLEASE CHECK THE PAPER BEFORE COMMENCING. THIS IS A FINAL PAPER. THIS EXAMINATION
PAPER MUST BE INSERTED INTO THE ANSWER BOOK AT THE COMPLETION OF THE PAPER.
NO EXAMINATION PAPERS SHOULD BE REMOVED FROM THE EXAMINATION ROOM

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PART A: MULTIPLE CHOICE QUESTIONS (15  2 = 30 marks)

 Circle only one of (a), (b), (c), or (d) corresponding to the correct / best answer. There
is no penalty for incorrect answers.
 You must return this examination paper with your answer book/s at the end of the
examination.

1. A Japanese yen is worth $0.0080, and a Fijian dollar (F$) is worth $0.5900. What is the
worth of the yen in Fijian dollars?
(a) 73.75
(b) 0.014
(c) 1.69
(d) 125

2. Assume a Japanese firm invoices its 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

3. Andrea is a currency speculator who enjoys ‘betting’ on changes in the foreign

currency exchange market. Currently the spot price for the Japanese yen is
¥130.00/US$ and the six month forward rate is ¥129.00/US$. Andrea thinks the yen
will move to ¥125.00/US$ in the next six months. Interest rates are the same for both
currencies. To make profit from changing currency values, Andrea should:
(a) buy yen for dollars
(b) buy dollars for yens
(c) sell yen for dollars
(d) sell dollars for yens

4. A U.S. firm sells merchandise to a British company for £100,000 at a current exchange
rate of $1.75/£. If the exchange rate changes to $1.77/£ the U.S. firm will realise a
________ of ________.
(a) gain; $2000.
(b) loss; $2000.
(c) gain; £99,000.
(d) loss; £99,000.

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5. The buyer of a call option will have:

(a) A maximum loss equal to the premium paid.
(b) A gain equal to but opposite in sign to the writer of the option.
(c) An unlimited gain potential.
(d) All of the above.

6. 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 using covered interest arbitrage earn the same rate of return as
Americans who invest in the U.S.
(d) Americans who invest in the U.S. earn the same rate of return as Germans who
invest in Germany.

7. Which of the following factors is not expected to generally have a favourable impact
on the firm's cost of capital?
(a) Easy access to international capital markets.
(b) Volatile exchange rate fluctuations.
(c) High degree of international diversification.
(d) All of the above.

8. When the cost of equity capital is combined with after‐tax cost of debt according to
their weights, the result yields the:
(a) All‐equity beta.
(b) Cost of capital.
(c) Weighted average cost of capital.
(d) Target capital structure.

9. Assume the bid rate of a Singapore dollar is $0.40 while the ask rate is $0.41 at Bank
X. At the same time, the bid rate of a Singapore dollar is $0.42 while the ask rate is
$0.425 at Bank Z. Given this information, what would be your gain if you use
$1,000,000 and execute locational arbitrage?
(a) $24,390
(b) ‐$11,964
(c) $10,000
(d) $36,585

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10. Direct foreign investment would typically be welcomed if:

(a) The products to be produced are substitutes for other locally produced
products.
(b) People from the parent firm’s 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.

11. Assuming that cash flows are received evenly throughout the year, what is the pay‐
back period for a project with an initial outlay of $140,000 and cash flows of $40,000
per year for the next five years?
(a) 5 years
(b) 4 years
(c) 3.75 years
(d) 3.5 years

12. When evaluating international project cash flows, which of the following factors are
relevant?
(a) Future inflation.
(b) Blockage of funds.
(c) Remittance provisions.
(d) All of the above.

13. The capital structure of an MNC is composed of 60% equity and 40% debt. The firm’s
after‐tax cost of debt is 10 percent per annum and its cost of financing with equity is
15 percent per annum. The MNC has a corporate tax rate of 30 percent. What is this
firm’s weighted average cost of capital?
(a) 11.80% per annum.
(b) 12.50% per annum.
(c) 13.00% per annum.
(d) None of the above.

14. US Corporation invests 15 million South African rand at a nominal interest rate of
10% per annum. At the time the investment was made, the spot rate of the rand was
$0.205. If the spot rate of the rand at maturity of the investment is $0.203, what is the
effective yield for US Corporation from investing in rand?
(a) 11.08% per annum.
(b) 8.93% per annum.
(c) 10.00% per annum.
(d) None of the above.

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15. Assume an MNC establishes a subsidiary where it has no other existing business. The
present value of the parent’s cash flows expected from this subsidiary is more
sensitive to exchange rate movements when:
(a) The subsidiary finances the entire investment by local borrowing.
(b) The parent finances the entire investment.
(c) The subsidiary finances most of the investment by local borrowing.
(d) The parent finances half of the investment.

END OF PART A

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PART B: Answer any seven out of the following eight questions. All questions carry
equal marks. Total marks for part B: 7 × 10 = 70 marks

Question 1

Discuss two commonly held theories as to why firms are motivated to expand their
business internationally? In each case, provide an example to clarify the main idea of the
theory.
(10 marks)

Question 2

(a) Describe transaction exposure. What should a firm do if transaction exposure exists?
(5 marks)

(b) Discuss the ‘cost of hedging’ involved in using a forward contract and explain it by
using an example.
(5 marks)

Question 3

Identify and explain four main reasons due to which the cash flows of a foreign project (or
foreign subsidiary) may be different from the parent firm’s perspective.
(10 marks)

Question 4

(a) Discuss two basic types of taxation that governments levy on corporations within
their tax jurisdiction. (5 marks)

(b) Define capital structure. Identify two main components of capital and explain how
these components differ from each other. (5 marks)

Question 5

Micca Metals is a specialty Materials Company located in the U.S. The company specialises
in specific precious metals and materials that are used in a variety of pigment applications
in many other industries, including cosmetics, appliances, and a variety of high‐tensile
metal fabricating equipment. Micca just purchased a shipment of phosphates from Morocco
for 6,000,000 dirhams, payable in six months. Micca’s cost of capital is 14.00% per annum.
The following quotes are in the market:

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Question 5 (cont’d)

United States Morocco

Interest rate for borrowing 6.00% p.a. 8.00% p.a.
Interest rate for investing 5.00% p.a. 7.00% p.a.
Spot exchange rate US$1.00 = 10.00 dirhams
Six month forward rate US$1.00 = 10.40 dirhams

Options on Moroccan dirhams Call Option Put Option

Strike price $0.10 $0.10
Option premium $0.002 $0.003

Required:

Determine the U.S. dollar cost to Micca Metals in six months under each of the following
strategies:
(i) Micca chooses to buy the dirhams forward. (1.5 marks)
(ii) Micca chooses a money‐market hedge. (3.5 marks)
(iii) Micca chooses an options hedge. (2.5 marks)
(iv) Micca chooses to remain un‐hedged and the spot exchange rate on the due date
happens to be $1.00 = 10.20 dirhams. (1.5 marks)
(iv) Which one of the above four strategies is the best strategy for Micca and why?
(1 mark)

Note: Ignore the “carry forward” cost of the option in your calculation.

Question 6

(a) A corporate treasury with operations in Sydney simultaneously calls Westpac Bank in
Sydney and Barclays in London. The two banks give the following quotes at the same
time on the euro (€):

Westpac Sydney Barclays London

AUD1.1840 – 60/€ AUD1.1830 – 50/€

Assume the corporate treasury has AUD1,000,000 or its euro equivalent. Is it possible
to make an arbitrage profit with the two exchange rate quotes? Explain showing
calculations.
(5 marks)

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Question 6 (cont’d)

(b) You receive the following quotes for Swiss francs (SF) against the Australian dollar
(A$) for spot, one month forward, three months forward, and six months forward:

Quotations Values
Spot exchange rate:
Bid rate (SF/A$) 1.2575
Ask rate (SF/A$) 1.2585
One month forward margin 10 to 15 basis points
Three months forward margin 14 to 22 basis points
Six months forward margin 20 to 30 basis points

(i) Calculate the outright quotes for one, three and six months. (3 marks)

(ii) Comment on the future expectation of the A$ exchange rate against the SF as
reflected by the forward rates. (2 marks)

Question 7

(a) John purchased Canadian dollar call options for speculative purposes. If these options
are exercised, John will immediately sell the Canadian dollars in the spot
market. Each option was purchased for a premium of US$0.03 per unit, with an
exercise price of US$0.85. Determine John’s net gain or loss for C$100,000 call options
contract under the following spot rate scenarios:
(5 marks)
C$1.00 = US$0.77
C$1.00 = US$0.80
C$1.00 = US$0.84
C$1.00 = US$0.87
C$1.00 = US$0.92

(b) Ruth purchased Canadian dollar put options for speculative purposes. Each option
was purchased for a premium of US$0.04 per unit, with an exercise price of US$0.85.
Ruth will purchase the Canadian dollars just before it exercises the options (if it is
beneficial to exercise the options). Determine Ruth’s net gain or loss for C$100,000
put options contract under the following spot rate scenarios:
(5 marks)
C$1.00 = US$0.77
C$1.00 = US$0.80
C$1.00 = US$0.84
C$1.00 = US$0.87
C$1.00 = US$0.92

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Question 8

Over the last one year, the US dollar has appreciated by 20 per cent against the euro. One
year ago, the lending (or investment) and borrowing rates for these currencies were:

Currency Investment rate Borrowing rate

US dollar 5% per annum 6% per annum
Euro 7% per annum 8% per annum

(a) What was the effective cost of borrowing one million euro for a US firm over the last
one year? Assume that the US firm immediately converts the euros to US dollars and
repays the euro loan by using US dollars.
(5 marks)

(b) What was the effective rate of return earned by a French investor who invested
US$500,000 over the last one year? Assume that the French investor uses euros to
buy US dollars and converts the proceeds of investment back to euros.
(5 marks)

END OF PART B

END OF EXAMINATION PAPER

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FORMULA SHEET
Cross-rate between A$ and £ : S(A$/£) = S(A$/$) / S(£/$) = S($/£) / S($/A$ ) = S(A$/$)  S($/£)
Interest Rate Parity condition: (1 + i$) / (1 + i¥) = F / S
Forward premium/discount = (F - S) / S
Bid/ask spread = (ask rate – bid rate) / ask rate
Appreciation / depreciation of a currency: (e1 - e0)/e0 or (e0 - e1)/e1 or Δx + Δy + Δx × Δy = 0 .
Time value of an option = Option price - Intrinsic value of the option
Value of a currency call option at exercise = Max[S - E, 0]
Value of a currency put option at exercise = Max[E - S, 0]
Capital Asset Pricing Model: Ri = Rf + βi (Rm – Rf )
FV = CF × (1+k)n ; FV of ordinary annuity = CF × [(1+k)n – 1] / k
PV = CF / (1+k)n ; PV of ordinary annuity = CF × [1- (1+k)-n ] / k
PV of perpetuity = CF / k , provided k>0
NPV =  CFt / (1+k)t – I
IRR involves solving the equation:  CFt / (1+k)t – I = 0
Weighted Average Cost of Capital: K = We  Ke + Wd  (1-T)  Kd
Effective return (cost) from investing (borrowing) in a foreign currency:
(1 + Rd) = (1 + Rf) × (1 + Ef)

Future value of $1 at the end of n periods = (1+k)n

n \ k 1% 2% 3% 4% 5% 10% 15% 20% 25% 30%
1 1.0100 1.0200 1.0300 1.0400 1.0500 1.1000 1.1500 1.2000 1.2500 1.3000
2 1.0201 1.0404 1.0609 1.0816 1.1025 1.2100 1.3225 1.4400 1.5625 1.6900
3 1.0303 1.0612 1.0927 1.1249 1.1576 1.3310 1.5209 1.7280 1.9531 2.1970
4 1.0406 1.0824 1.1255 1.1699 1.2155 1.4641 1.7490 2.0736 2.4414 2.8561
5 1.0510 1.1041 1.1593 1.2167 1.2763 1.6105 2.0114 2.4883 3.0518 3.7129

Present value of $1 at the end of n periods = 1 / (1+k)n

n \ k 1% 2% 3% 4% 5% 10% 15% 20% 25% 30%
1 0.9901 0.9804 0.9709 0.9615 0.9524 0.9091 0.8696 0.8333 0.8000 0.7692
2 0.9803 0.9612 0.9426 0.9246 0.9070 0.8264 0.7561 0.6944 0.6400 0.5917
3 0.9706 0.9423 0.9151 0.8890 0.8638 0.7513 0.6575 0.5787 0.5120 0.4552
4 0.9610 0.9238 0.8885 0.8548 0.8227 0.6830 0.5718 0.4823 0.4096 0.3501
5 0.9515 0.9057 0.8626 0.8219 0.7835 0.6209 0.4972 0.4019 0.3277 0.2693
Note: PV or FV values for an ordinary annuity of $1 can be calculated by adding the
corresponding PV or FV factors respectively.

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