INTERNATIONAL FINANCIAL MANAGEMENT 2021/2022

Question 1
A. What is Syndicated Eurocurrency Loan and how is it organized? Give an example
(5 Marks)
Answer
A. A Syndicated Eurocurrency Loan is a type of international loan provided by a
group of banks (the syndicate) in a currency other than the domestic currency of the
borrower. Eurocurrency refers to any currency deposited in a financial institution
outside its country of origin.
The organization involves a lead bank, known as the arranger, which structures the
loan, negotiates terms with the borrower, and then invites other banks to participate in
funding the loan. Each participating bank becomes a syndicate member and
contributes a portion of the loan amount.
For example, if a company in the United States wants to secure a Syndicated
Eurocurrency Loan, a lead bank may structure the loan in euros or another foreign
currency. It would then invite other banks, both domestic and international, to join the
syndicate. Each participating bank provides a portion of the loan, spreading the risk
and allowing the borrower access to a larger pool of funds.

Question
B. What are financial markets and what services do they provide?
Answer
Financial markets are platforms where individuals and entities trade financial assets.
They offer several services, including:
 Price Discovery: Financial markets determine the fair market value of assets
through the interaction of buyers and sellers, reflecting supply and demand.
 Liquidity: Markets provide a mechanism for buying or selling assets with
relative ease, ensuring that participants can convert their investments into cash.
 Capital Formation: Companies can raise capital by issuing stocks and bonds in
financial markets, enabling them to fund projects, expand operations, or
manage debt.
 Risk Management: Investors use financial markets to diversify their portfolios,
spreading risk across different assets, sectors, or regions.
 Efficient Allocation of Resources: Financial markets help allocate capital to its
most productive uses by directing funds to companies and projects with
promising growth prospects.

Question
C. What are the strategies for dealing with foreign exchange exposures? Give
examples where appropriate.
Answer
Managing foreign exchange exposures involves strategies to mitigate risks associated
with currency fluctuations. Some common strategies include:
 Forward Contracts:
  Example: A company can use a forward contract to lock in a future
exchange rate for a specified amount of currency, reducing uncertainty
in future transactions.
 Options Hedging:
 Example: By purchasing options, a business can secure the right (but not
the obligation) to exchange currency at a predetermined rate, providing
flexibility in volatile markets.
 Natural Hedging:
 Example: If a company has revenues and expenses in the same currency,
it naturally hedges against exchange rate fluctuations. For instance, a
multinational with euro-denominated sales and costs.
 Diversification:
 Example: Diversifying the geographic location of assets and liabilities
can help spread risk, reducing exposure to the currency of a specific
country.
 Netting:
 Example: A multinational company with subsidiaries in different
countries can offset payables in one currency against receivables in
another, reducing the need for external currency transactions.
 Leading and Lagging:
 Example: Timing payments and receipts strategically to take advantage
of favorable exchange rates (leading) or delaying transactions when
rates are unfavorable (lagging).
 Balance Sheet Hedging:
 Example: Adjusting the composition of assets and liabilities in different
currencies to create a natural hedge against currency risk.
 Currency Clauses:
 Example: Including specific clauses in contracts that allow for
adjustments in prices or payments based on exchange rate movements.
 Use of Currency Derivatives:
 Example: Utilizing currency futures or swaps to hedge against currency
risk by fixing exchange rates for future transactions.
 Risk-sharing Agreements:
 Example: Collaborating with business partners to share the risks
associated with currency fluctuations through mutually beneficial
agreements.
It's essential for businesses to carefully analyze their unique circumstances and risk
tolerance when choosing and combining these strategies.

Question 2
A. What is the international bond market?
Answer
The international bond market is a global platform where governments, corporations,
and other entities issue debt securities to raise capital. These debt instruments, known
as bonds, are essentially loans that investors provide to the issuers in exchange for
periodic interest payments and the return of the principal amount at maturity
Question
B. How do investors make money on the international bond markets.
Answer
Investors can make money on the international bond markets through interest income
and capital appreciation. When they purchase bonds, they receive periodic interest
payments (coupon payments) from the issuer. Additionally, if the bond's market value
increases, investors can sell it at a higher price than they paid, realizing a capital gain.
However, bond prices are influenced by interest rate changes, economic conditions,
and credit risk, so investors need to carefully assess these factors to make informed
investment decisions.0

Question
C. What is the difference between foreign bond and Eurobond.
Answer
A foreign bond is issued by a government or entity in a currency other than the one in
which the bond is sold, but it is typically issued in the country of the currency. For
example, if a Japanese government issues bonds denominated in US dollars, it's a
foreign bond.
On the other hand, a Eurobond is issued in a currency different from the one where it
is issued. It's not limited to European currencies despite the name. For instance, a
bond denominated in US dollars but issued in London would be considered a
Eurobond.
An example of a foreign bond could be the issuance of Japanese government bonds
denominated in euros. As for a Eurobond, an example is a US company issuing bonds
denominated in British pounds in the London market.

Question 3
A. An American based importer of Italian bieycles owes in one year €150,000 to an
Italian supplier. The spot exchange rate is $1.50 = €1.00. The one-year interest rate in
Italy is ie = 5%.
i) What is the one year equivalent of the €150,000 debt?
ii) How can this payable transaction be hedged against transaction risk exposure?

Answer

i) To calculate the one-year equivalent of the €150,000 debt, you need to consider the
interest rate. The formula for the future value (FV) of money is:
FV=PV×(1+r)
FV = PV \times (1 + r)
FV=PV×(1+r)
Where:
FV
FV = Future Value
PV = Present Value (amount owed in euros)
r = Interest rate
In this case,
PV=€150,000 and r=5%
r = 5\%
r=5% or 0.05. Plugging in these values:
FV=€150,000(1+0.0)
FV = €150,000 \times (1 + 0.05)
FV=€150,000×(1+0.05)
Calculate
FV
FV to find the one-year equivalent of the debt.
ii) To hedge against transaction risk exposure, the American importer can enter into a
forward contract. A forward contract allows them to lock in the exchange rate for a
future date. In this scenario, the importer could enter into a one-year forward contract
to buy euros at a predetermined exchange rate.
This helps protect the importer from potential adverse exchange rate movements,
ensuring they know the exact amount of dollars needed to settle the debt in euros after
one year. Keep in mind that forward contracts involve some risks, and the chosen
exchange rate should be carefully considered based on market conditions and the
importer's risk tolerance.

INTERNATIONAL FINANCIAL MANAGEMENT 2022/2023

Q1.
A. What are Financial markets and what services do they provide?
Ans:
Financial markets are platforms or systems that facilitate the buying and selling of
financial instruments such as stocks, bonds, currencies, and commodities. These
markets play a crucial role in allocating capital, enabling price discovery, and
providing liquidity.
Financial markets offer several services:
 Capital Allocation: They help direct capital from savers (investors) to entities
in need of funds (companies, governments, etc.) for various projects and
activities.
 Price Discovery: Through the interaction of buyers and sellers, financial
markets determine the prices of financial instruments. This information is
crucial for investors, businesses, and policymakers.
 Liquidity: Markets provide a platform for buying or selling assets, ensuring that
investors can convert their holdings into cash relatively quickly.
 Risk Management: Participants use financial instruments like derivatives to
manage and hedge risks associated with price fluctuations, interest rates, and
other market variables.
 Facilitating Economic Growth: By providing a mechanism for raising capital,
financial markets contribute to economic growth by supporting businesses and
projects.
In summary, financial markets are vital for the efficient functioning of the economy,
facilitating investment, managing risks, and providing a mechanism for price
discovery and liquidity.

B. What are the strategies for dealing with foreign exchange exposures. Give
examples where appropriate
Answer:
Managing foreign exchange exposures involves various strategies to mitigate risks.
Here are some common approaches:
 Forward Contracts: Companies can use forward contracts to lock in a future
exchange rate. For instance, if a U.S. company expects to receive payment in
euros in three months, it can enter into a forward contract to sell euros at an
agreed-upon rate, providing protection against adverse currency movements.
 Options Contracts: Options give the holder the right but not the obligation to
buy or sell currency at a predetermined rate. A company might use options to
hedge against unfavorable currency movements while retaining the flexibility
to benefit from favorable ones.
 Natural Hedging: Aligning revenues and expenses in the same currency can act
as a natural hedge. For example, a U.S. company that exports goods to Europe
can match its euro-denominated revenues with expenses incurred in euros.
 Currency Diversification: Holding a diversified portfolio of currencies can help
offset losses in one currency with gains in another. This strategy is often used
by investors to spread risk.
 Netting: Companies with multiple currency exposures can net their positions to
reduce overall risk. By offsetting payables in one currency with receivables in
another, the net exposure is minimized.
 Leading and Lagging: Companies can strategically time their payments and
receipts. "Leading" involves accelerating collections or delaying payments
when a currency is expected to depreciate. "Lagging" is the opposite, delaying
collections or accelerating payments when a currency is expected to appreciate.
 Risk Sharing: Collaborating with partners or customers to share currency risk
can be an effective strategy. This could involve negotiating contract terms that
allocate currency risk between parties.
 Continuous Monitoring: Regularly monitoring currency markets and economic
conditions helps organizations stay informed about potential exposures. Being
proactive allows for timely adjustments to hedging strategies.
It's crucial for businesses to carefully assess their unique circumstances and risk
tolerance when selecting and implementing these strategies.

Q2.
A. What is the international bond market?

B. What is the difference between foreign bond and Eurobond? Give examples

Answer:
A. The international bond market refers to the global marketplace where bonds are
bought and sold. It involves the issuance and trading of debt securities issued by
various entities, including governments, corporations, and other institutions.

B. The main difference between a foreign bond and a Eurobond lies in the currency of
denomination and the location of issuance. A foreign bond is issued in a specific
foreign country's currency and subject to its regulations. In contrast, a Eurobond is
issued in a currency different from the country where it is placed, often in a currency
widely accepted globally, such as the Euro. Example of a foreign bond: If a US
company issues bonds in Japan in Japanese Yen. Example of a Eurobond: If a Chinese
company issues bonds in US dollars in the international market.

Q3.
A. An American based importer of Italian bicycles owes in one year E150,000 to an
Italian supplier. The spotexchange rate is $1.50= €1.00. The onc-year interes rate in
fraly 15 1e - 5%.
b What is the one year equivalent of the €150,000 debt? it How can this payable
transaction be hedged against transaction risk exposure?

Answer:
i. To calculate the one-year equivalent of the €150,000 debt, you need to consider the
interest rate in Italy. The formula for calculating the one-year equivalent is:
One-year equivalent
=
Original amount ×(1+Interest rate)text{One-year equivalent} = \text{Original
amount} \times (1 + \text{Interest rate})One
year equivalent=Original amount×(1+Interest rate)
In this case:
One-year equivalent=€150,000×(1+(−0.05))
\text{One-year equivalent} = €150,000 \times (1 + (-0.05))
One-year equivalent=€150,000×(1+(−0.05))
Calculate this to find the one-year equivalent.

ii. To hedge against transaction risk exposure, the American importer can use a
forward contract. In a forward contract, the importer would agree with a financial
institution to exchange a specific amount of dollars for euros at a future date at a
predetermined exchange rate. This helps mitigate the risk of exchange rate
fluctuations, providing more certainty in the cost of the transaction.

B. United States. Multinational Company is considering a European investment

opportunity. The Expected after-tax cash flows are as follows: Year 0 €600, Year 1
€200, Year €500, Year 3 €300. The
inflation rate in the euro zone is inf€= 3%, the inflation rate in the US is inf$= 6%,
and the business risk
exchange rate is So ($/€) = $1.25/€.
of the investment would lead an unlevered U.S.-based firm to demand a return of r -
15%. The current I this a good investment from the perspective of the U.S.
Multinational Parent Company?
Answer:

rate
) rate
)
\text{One-year equivalent} = \text{Original debt} \times (1 + \text{Interest rate})
One-year equivalent=Original debt×(1+Interest rate)
One-year equivalent
=
€
150
,
000
×
(
1
+
0.015
)
\text{One-year equivalent} = €150,000 \times (1 + 0.015)
One-year equivalent=€150,000×(1+0.015)
Calculate this to find the equivalent in dollars.
b. To hedge against transaction risk exposure, the importer can use a forward contract.
By entering into a forward contract to buy euros at a predetermined exchange rate, the
importer can lock in a future rate, mitigating the impact of potential exchange rate
fluctuations. This provides certainty about the future cost of euros, helping to manage
the risk associated with currency exchange rate movements.
\text{One-year equivalent} = \text{Original debt} \times (1 + \text{Interest rate})
One-year equivalent=Original debt×(1+Interest rate)
One-year equivalent
=
€
150
,
000
×
(
1
+
0.015
)
\text{One-year equivalent} = €150,000 \times (1 + 0.015)
One-year equivalent=€150,000×(1+0.015)
Calculate this to find the equivalent in dollars.
b. To hedge against transaction risk exposure, the importer can use a forward contract.
By entering into a forward contract to buy euros at a predetermined exchange rate, the
importer can lock in a future rate, mitigating the impact of potential exchange rate
fluctuations. This provides certainty about the future cost of euros, helping to manage
the risk associated with currency exchange rate movements.