OFFICE USE ONLY

Monash University
Semester One Examination 2014
Faculty of Business and Economics
Department of Banking and Finance

EXAM CODES: BFF2341

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  Malaysia  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 TEN (10) multiple choice questions and

EIGHT (8) questions printed on a total of ELEVEN (11) pages.
Students must attempt to answer ALL questions.

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 (10  2 = 20 marks)

Instructions: Encircle only one of a, b, c, or d corresponding to the correct/best answer.

There is no penalty for incorrect answers.

1. Agency costs faced by multinational corporations (MNCs) may be larger than those
faced by purely domestic firms because:
a. Monitoring of managers located in foreign countries is more difficult.
b. Foreign subsidiary managers raised in different cultures may not follow uniform
goals.
c. MNCs are relatively large.
d. All of the above.
e. a and b only.

2. Saller Limited has a subsidiary in Mexico. The expected cash flows in pesos to be
received in the future from this subsidiary have not changed since last month, but the
market value of Saller Limited has declined since last month. What could have caused
this decline in value?
a. A weaker Mexican economy.
b. Lower Mexican interest rates.
c. Depreciation of the Mexican peso.
d. Appreciation of the Mexican peso.

3. Assume the Canadian dollar is equal to US$0.88 and the Peruvian Sol is equal to
US$0.35. The value of the Peruvian Sol in Canadian dollars is:
a. About 0.3621 Canadian dollars.
b. About 0.3977 Canadian dollars.
c. About 2.36 Canadian dollars.
d. About 2.51 Canadian dollars.

4. Assume a Japanese firm invoices 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

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5. Assume that a bank's bid rate on Swiss francs is $0.45 and its ask rate is $0.47. Its bid‐
ask percentage spread is:
a. About 4.44%.
b. About 4.26%.
c. About 4.03%.
d. About 4.17%.

6. Assume that a speculator purchases a put option on British pounds with a strike price
of $1.50 for a premium of $0.05 per unit. A pound option represents 31,250 units.
Assume that at the time of the purchase, the spot rate of the pound is $1.51 and
continually rises to $1.62 by the expiration date. The highest net profit/loss possible
for the speculator based on the information above is:
a. $1,562.50.
b. ‐$1,562.50.
c. ‐$1,250.00.
d. ‐$625.00.

7. A U.S. corporation has purchased currency call options to hedge a 70,000 pound
payable. The premium is $0.02 and the exercise price of the option is $0.50. If the spot
rate at the time of maturity is $0.65, what is the total amount paid by the corporation
if it acts rationally?
a. $33,600.
b. $46,900.
c. $44,100.
d. $36,400.

8. Assume the bid rate of a New Zealand dollar is $0.33 while the ask rate is $0.335 at
Bank X. Assume the bid rate of the New Zealand dollar is $0.32 while the ask rate is
$0.325 at Bank Y. Given this information, what would be your gain if you use
$1,000,000 and execute locational arbitrage?
a. $15,385.
b. $15,625.
c. $22,136.
d. $31,250.

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9. 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 who invest in the U.S. earn the same rate of return as Germans who
invest in Germany.
d. a and b.
e. None of the above.

10. Points above the IRP line represent situations where:

a. Covered interest arbitrage is feasible from the perspective of domestic investors
and results in the same yield as investing domestically.
b. Covered interest arbitrage is feasible from the perspective of domestic investors
and results in a yield above what is possible domestically.
c. Covered interest arbitrage is feasible from the perspective of foreign investors
and results in a yield above what is possible in their local markets.
d. Covered interest arbitrage is not feasible for either domestic or foreign
investors.

(10 × 2 = 20 marks)

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PART B: QUESTIONS AND PROBLEMS (8  10 = 80 marks)

Instructions: Answer all questions. All questions carry equal marks

Question 1: International Business Environment

(a) Explain the prediction of the 'product life cycle theory’ in relation to cross‐border
expansion of a company’s business. (3 marks)

(b) Carlton & United Breweries, an Australian brewing company based in Abbotsford,
would like to expand into the Japanese market.
(i) List three business methods available to Carlton & United Breweries to gain
access to the Japanese market.
(ii) Identify the method with the lowest risk and the method with the highest risk,
and justify your answer.
(5 marks)

(c) Identify two global organisations and two regional organisations that facilitate
international trade and financial transactions. (2 marks)
[Total = 3 + 5 + 2 = 10 marks]

Question 2: Foreign Exchange Market

(a) Briefly explain the roles played by large commercial banks and foreign exchange
brokers in the foreign exchange market. (2 marks)

(b) Assume that a bank's bid quote for the Mexican peso is $0.126 and ask quote is
$0.129. What is the amount of pesos you need to have if you would like to purchase
$100,000?
(2 marks)
(c) Your company exports coal to a Chinese company. According to the agreement
between the two companies, the Chinese company sends a cheque denominated in
Yuan (Chinese currency) at the end of every quarter. You expect to receive the next
cheque in two months. The macro‐economic indicators predict that the rate of
inflation in China will rise substantially over the next two months while it remains
unchanged in Australia.
(i) Will the Chinese Yuan appreciate or depreciate against the Australian dollar
during the next two months?
(ii) How will the change in exchange rate affect the cash flows of your company?
(iii) Explain how you could use the forward market to hedge the foreign exchange
risk, if any.
(2 + 2 + 2 = 6 marks)

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[Total = 2 + 2 + 6 = 10 marks]
Question 3: Currency Derivatives

(a) Using a graph to illustrate, explain the pay‐off position of the seller of a currency put
option.
(4 marks)

(b) Assume that the following transactions are anticipated by the respective Australian
companies in coming months:
(i) Anslet Limited expects to export goods to a New Zealand company. The value of
the invoice will be NZ$ 250,000.
(ii) Corona Limited has a subsidiary in Indonesia. It expects to invest AU$500,000 in
a project launched by its Indonesian subsidiary.
(iii) Gangan Limited has borrowed Yuan 1,000,000 from a Chinese bank and the
annual instalment is due in three months.

Note: Assume that these are the only foreign transactions anticipated by these
companies.

Place an ‘X’ in the table below to identify all the possible ways to hedge the foreign
exchange risk associated with each of the above transactions.

Forward Contract Futures Contract Options Contract

Transaction Forward Forward Buy Sell Purchase Purchase
Purchase Sale Futures Futures Calls Puts
(i)

(ii)

(iii)

(6 marks)

[Total = 4 + 6 = 10 marks]

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Question 4: International Arbitrage and Interest Rate Parity

(a) Explain the concept of triangular arbitrage. (2 marks)

(b) National Bank quotes the following for the British pound and the New Zealand dollar:

Quoted Bid Quoted Ask

Price Price
Value of a British pound (£) in $ $1.61 $1.62
Value of a New Zealand dollar (NZ$) in $ $0.55 $0.56
Value of a British pound in New Zealand dollars NZ$2.95 NZ$2.96

Assume you have $10,000 to conduct triangular arbitrage. What is your profit from
implementing this strategy?
(5 marks)

(c) Assume the following information:

You have $400,000 to invest:
Current spot rate of Sudanese dinar = $0.00570
90‐day forward rate of the dinar = $0.00569
90‐day interest rate in Australia = 4.0% per annum
90‐day interest rate in Sudan = 4.2% per annum

If you conduct covered interest arbitrage, what amount will you have after 90 days?
(3 marks)

[Total = 2 + 5 + 3 = 10 marks]

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Question 5: Transaction Exposure/Capital Structure

(a) Cranbourne Limited imports leisure products from the UK and distributes them in
Australia. It pays monthly invoices with a one month lag and the next payment of
£200,000 is due in one month’s time. The current spot rate of the British pound is
AU$1.80.

In the past, the company has used the spot rate to settle its payables. However, their
new finance manager believes that the company should use currency options to hedge
any foreign exchange risk associated with future payments. She has developed the
following probability distribution of the future spot rate in one month:

Spot rate in one month Probability

$1.75 0.30
$1.85 0.40
$1.90 0.30

One‐year call options on British pounds are available with an exercise price of $1.82
and a premium of $0.03 per unit.

Given this information, determine whether Cranbourne Limited should use currency
options to hedge foreign exchange risk or remain unhedged.
(6 marks)

(b) ‘The factors affecting the cost of capital of an MNC can be different from those
affecting the cost of capital of a domestic firm.’

Identify the factors that specifically influence the cost of capital of an MNC and explain
their influence on the cost of capital of an MNC.
(4 marks)

[Total = 6 + 4 = 10 marks]

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Question 6: Foreign direct investment and political risk

(a) Explain the terms “Greenfield Investment” and “Cross‐Border Acquisitions” in relation
to Foreign Direct Investment. What differences do they have?
(3 marks)

(b) Discuss revenue related and cost related motives for Foreign Direct Investment.
(3 marks)

(c) Explain, with a diagram of an efficient frontier, how an MNC can achieve more
desirable risk and return characteristics by diversifying among products and
geographic markets.
(3 marks)
[Total = 3 + 4 + 3 = 10 marks]

Question 7: International taxation and cash management

(a) Explain how the leading and lagging techniques help an MNC in its international cash
management.
(3 marks)

(b) Explain the term ‘Double Taxation Arrangements (DTA)’ in relation to international
businesses.
(2 marks)

(c) Texas Limited plans to invest its excess cash in Mexican pesos for one year. The one
year Mexican interest rate is 18%. The probability of the peso’s percentage change in
value during the next year is shown below:

Possible Rate of Change in the Mexican

Peso over the life of the investment Probability of occurrence
‐10% 30%
‐5% 50%
0% 20%

(i) What is the expected value of the effective yield of the peso based on this
information?
(ii) If the one year Australian interest rate is 7%, what is the probability that a one
year investment in pesos will generate a lower effective yield than could be
generated if Texas Limited simply invested domestically?
(5 marks)
[Total = 3 + 2 + 5 = 10 marks]

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Question 8: International Capital Budgeting

Alpha Industries, a parent company based in Australia, has planned to expand its business
in Thailand by investing in a new project. The following information has been gathered to
assess this project:
 The initial investment required is Thai Baht (THB) 30 million. This investment outlay
will be depreciated on a straight line basis over its useful life.
 The project will be terminated at the end of Year 3 when the subsidiary will be sold.
 The Thailand government charges a corporate tax of 30% on profit. In addition, it will
impose a tax of 10% on all profit remitted by the subsidiary to the parent.
 All cash flows received by the subsidiary are sent to the parent at the end of each year.
 In three years’ time, the subsidiary is to be sold for THB 15 million. Assume that this
amount is not subject to any tax.
 Alpha Industries requires a 20% per annum rate of return on this project.
 You have been given the following additional information:

Year Exchange rate Product cost and revenue information

Variable costs Other cash
THB/A$ Price per unit Sales (No. per unit expenses
(forecast) (THB) of units) (THB) (THB)
0 30.20
1 30.24 120.0 250,000 75.0 2,250,000
2 30.56 125.0 350,000 80.0 3,000,000
3 30.77 130.0 300,000 84.0 4,500,000

Required:

Calculate the net present value (NPV) of the project and determine whether Alpha
Industries should undertake this project.
[Total = 10 marks]

END OF EXAMINATION

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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

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