chapter 19

Financial Management: Principles and Applications, 11e (Titman)

Financial Management: Principles and Applications, 11e (Titman)

Chapter 19 International Business Finance

19.1 Foreign Exchange Markets and Currency Exchange Rates

1) Trading in foreign exchange markets is dominated by:

A) Russian rubles, Indian rupees and Indonesian rupeas.

B) Spanish pesetas, German marks, French francs.

C) Chinese renminbis, Indian rupees and pesos of various Latin American countries.

D) U. S. dollars, the British pound, the euro and the yen.

Answer: D

Diff: 2

Topic: 19.1 Foreign Exchange Markets and Currency Exchange Rates

Keywords: foreign exchange markets

Principles: Principle 3: Cash Flows Are the Source of Value

2) Participants in foreign exchange trading include:

A) importers and exporters.

B) investors and portfolio managers.

C) currency traders.

D) all of the above.

Answer: D

Diff: 2




3) Suppose International Trading Enterprises purchased 25,000 kilograms of Belgian chocolate for a price of 100,000 euros. If the current exchange rate is .69368 euros to the U.S. dollar, what is the purchase price of the chocolate in dollars?

A) $14,416

B) $693,368

C) $69,368

D) $144,159

Answer: D

Diff: 2


Keywords: exchange rate


4) A spot transaction occurs when one currency is:

A) deposited in a foreign bank.

B) immediately exchanged for another currency.

C) exchanged for another currency at a specified price.

D) traded for another at an agreed-upon future price.

Answer: B

Diff: 2


Keywords: spot rates


5) Forward rates are quoted:

A) in direct form.

B) in indirect form.

C) at a premium or discount.


Answer: D

Diff: 2


Keywords: forward rates


6) If the quote for a forward exchange contract is greater than the computed price, the forward contract is:

A) overvalued.

B) undervalued.

C) a good buy.

D) at equilibrium.

Answer: A

Diff: 2




7) Buying and selling in more than one market to make a riskless profit is called:

A) profit maximization.

B) arbitrage.

C) international trading.

D) cannot be determined from the above information.

Answer: B

Diff: 2


Keywords: arbitrage


8) After the U.S. dollar, the most widely traded currency is:

A) the Saudi riyal.

B) the euro.

C) the Swiss franc.

D) the Canadian dollar.

Answer: B

Diff: 2




9) Which of the following statements about exchange rates is true?

A) Exchange rates are fixed by international agreements.

B) Exchange fluctuate between currencies but are fixed in terms of gold.

C) Exchange rates fluctuate constantly.

D) Are regulated by a special committee of the United Nations.

Answer: C

Diff: 2


Keywords: exchange rate risk


10) What keeps foreign exchange quotes in two different countries in line with each other?

A) Cross rates

B) Forward rates

C) Arbitrage

D) Spot rates

Answer: C

Diff: 2


Keywords: arbitrage


11) An attempt to profit by converting dollars to yen, yen to euros, and euros back to dollars would be an example of:

A) arbitrage.

B) speculation.

C) hedging.

D) intervention.

Answer: A

Diff: 2


Keywords: arbitrage


12) An investor purchased 200,000,000 Japanese yen at an exchange rate of 93 yen to the dollar. the yen cost her ________.

A) $18,600

B) $10,752.70

C) $21,505.30

D) $186,000

Answer: C

Diff: 2




13) An investor purchased 1,000,000 Canadian dollars at an exchange rate of 1.0309 Canadian dollars to the U.S. dollar. The Canadian dollars cost her ________.

A) $103,090

B) $970,026

C) $1,030,927

D) $97,000

Answer: B

Diff: 2




14) An investor purchased Canadian dollars at an exchange rate of $0.97 U.S. to 1 Canadian dollar. The Canadian dollars cost her $1,000,000 (U.S. dollars). How many Canadian dollars did she buy?

A) $103,090

B) $970,026

C) $1,030,927

D) $97,000

Answer: C

Diff: 2




15) Assume that an investor purchased 200,000,000 Japanese yen in New York at an exchange rate of 93 yen to the dollar and simultaneously sold the yen in Tokyo at an exchange rate of 91 Japanese yen to the dollar. Further assume that there was no cost associated with this transaction. What profit or loss did the investor make?

A) ($43,010) loss

B) $47,272 profit

C) ($47,272) loss

D) $43,956 profit

Answer: B

Diff: 2


Keywords: arbitrage


16) Transactions carried out in the foreign exchange markets include:

A) spot transactions.

B) forward exchange contracts which allow the exchange of one currency for another today.

C) swaps.

D) both A and B.

Answer: D

Diff: 2




17) Assume that an investor owned 5,000 shares of Anheuser-Busch Corporation common stock prior to the acquisition by InBev of Belgium. At the time of the acquisition, the dollar was worth .77 euros. Further assume that the purchase price was equal to 54 euros per share. What was the sales price of Anheuser Busch common stock per share in U.S. dollars?

A) $41.58

B) $54

C) $77

D) $70.13

Answer: D

Diff: 2




18) One U.S. dollar buys 92.61 yen and 12.707 Mexican pesos. What is price of pesos in yen?

A) 7.2881

B) .1372

C) .0787

D) 1.0798

Answer: A

Diff: 2


Keywords: cross rate


19) Assume that an importer of wine were to purchase 5,000 cases of premium French Bordeaux for 700,000 euros. Further assume that the quoted exchange rates are as follows: spot rate = .70 euros to the U.S. dollar; 30-day forward rate = .705 euros to the U.S. dollar; and 90-day forward rate = .710 euros to the U.S. dollar. If the actual currency exchange rate at the time payment is due in 90 days is equal to the forward rate of .710 euros to the U.S. dollar, how much would the wine cost the importer in U.S. dollars if payment is made in 90 days? Round to the nearest dollar.

A) $704,225

B) $355,000

C) $497,000

D) $985,915

Answer: D

Diff: 2




20) You are leaving Mexico and have 3,000 pesos to change into dollars. The exchange rate is 10.2 pesos to the dollar. How many dollars will you receive?

A) You will receive 30,600 US$.

B) You will receive 294.12 US$.

C) You will lose money converting back into dollars.

D) This is not enough information to find the number of dollars.

Answer: B

Diff: 2




21) You are on your way to a beautiful Mexican resort. The current exchange rate is 12 pesos to the dollar. When you arrive, you convert 1,000 US$ for how many pesos?

A) 12,000 pesos

B) 1,200 pesos

C) 8,333 pesos

D) 83.33 pesos

Answer: A

Diff: 2




22) Assume that a buyer of Italian wine saw the following quotes: spot rate of .75 euros to the U.S. dollar; 30-day forward rate of .747 euros to the U.S. dollar; 90-day forward rate of .744 euros to the U.S. dollar. What does this information imply?

A) The forward euro is selling at a premium as compared with the spot euro.

B) The dollar is expected to maintain the same value in the near future relative to the euro.

C) The forward euro is selling at a discount as compared with the spot euro.

D) None of the above.

Answer: A

Diff: 2




Use the following information to answer the following question(s).

Below is an excerpt from Table 19.1, Foreign Exchange Ratrd (January 8, 2010) that appears in your text. (Sources The Wall Street Journal and Reuters)

U.S. $ equivalentCurrency per U.S. $

CountryMon. Mon.

India (Rupee)0.0219945.4752

Britain (Pound)1.6028.6239

30-day Forward1.6024.6241

90-day Forward1.6019.6243

180-day Forward1.6008.6247

Canada (Dollar)0.97001.0309

30-day Forward0.97001.0309

90-day Forward0.97001.0309

180-day Forward0.96981.30311

Switzerland franc0.97721.0233

30-day Forward0.97731.0232

90-day Forward0.97771.0228

180-day Forward0.97831.0222

23) To buy one Indian Rupee you would need:

A) 2.199 cents.

B) 45.4752 dollars.

C) 21.99 cents.

D) 4.54752 dollars.

Answer: A

Diff: 2




24) The number of pounds you can purchase per U.S. dollar is:

A) 1.6008.

B) 6.239.

C) 0.6239.

D) 1.6028.

Answer: C

Diff: 2




25) Assume that your firm must pay 10,000,000 rupees to an Indian firm. How much will you have to pay in U.S. dollars.

A) $2,199,000

B) $219,900

C) $454,752,000

D) $$454,752

Answer: B

Diff: 2




26) Assume that your firm must pay $4,000 to a Swiss firm. In Swiss francs Swiss firm will receive:

A) 3,908.80 Swiss francs.

B) 3,913 Swiss francs.

C) 39,088 Swiss francs.

D) 4,093.20 Swiss francs.

Answer: D

Diff: 2




27) The Swiss franc to British pound exchange rate is:

A) 1.64 Swiss francs to the pound.

B) 1.5663 Swiss francs to the pound.

C) .6097 Swiss francs to the pound.

D) .9772 Swiss francs to the pound.

Answer: A

Diff: 2




28) The British pound to Swiss franc exchange rate is:

A) 1.64 British pounds to the Swiss franc.

B) 1.5663 British pounds to the Swiss franc.

C) .6097 British pounds to the Swiss franc.

D) .9772 British pounds to the Swiss franc.

Answer: C

Diff: 2




29) The 90-day forward rate for Canadian dollars is:

A) 10.309.

B) 9.7000.

C) 0.9700.

D) 01.0309.

Answer: C

Diff: 2




30) Based on the forward rates in table 19.1, the British pound is expected to:

A) stay the same against the dollar.

B) weaken against the dollar.

C) fluctuate randomly against the dollar.

D) strengthen against the dollar.

Answer: D

Diff: 2




31) The following are the prices in the foreign exchange market between the U.S. dollar and a foreign currency (fc). Spot 0.6335US$/fc; three-month forward 0.6375US$/fc. What was the discount or premium on three-month forward for the foreign currency?

A) 0.63% premium

B) 0.40% premium

C) 0.63% discount

D) 0.40% discount

Answer: A

Diff: 2




32) Assume that a firm purchases foreign currency in order to complete the purchase of raw material from an overseas supplier. The currency is purchased today at an exchange rate that is good only for today. This transaction is referred to as a(n) ________ transaction.

A) forward

B) arbitrage

C) spot

D) hedge

Answer: C

Diff: 2




33) Forward exchange rates:

A) reduce uncertainty about future value of currencies.

B) are always slightly lower than the spot rate.

C) reflect expectations about the future value of currencies.

D) both A and C.

Answer: D

Diff: 2




34) A trader who simultaneously bought Swiss francs in New York for .9772 and sold them in Zurich for .9774 would be practicing:

A) simple arbitrage.

B) inside trading.

C) compound arbitrage.

D) parity exploitation.

Answer: A

Diff: 2


Keywords: arbitrage


35) A dealer in New York offers to buy U.K. pounds for $1.60 and sell them for $1.605. The different prices are due to:

A) arbitrage.

B) a tax on currency transactions.

C) the bid-ask spread.

D) supply and demand.

Answer: C

Diff: 2


Keywords: bid-ask


36) The exchange rate that represents the number of units of a home currency that is required to purchase one unit of a foreign currency is referred to as a(n) ________ quote.

A) forward

B) direct

C) market

D) indirect

E) arbitrage

Answer: B

Diff: 2


Keywords: direct, indirect quotes


37) The exchange rate that represents the number of units of a foreign currency that can be purchased with one unit of a home currency is referred to as a(n) ________ quote.

A) forward

B) direct

C) market

D) indirect

Answer: D

Diff: 2




38) A foreign exchange dealer in New York posts an ask price of .02201 for Indian rupees and a bid price of .02197. What is the dealer's profit on the simultaneous purchase and sale of 1 million rupees?

A) $40 profit

B) ($40 )loss

C) $400 profit

D) ($4) loss

Answer: A

Diff: 2


Keywords: bid-ask


39) The international currency system that presently exists is best described as a ________ rate currency system.

A) parity

B) fixed

C) multinational

D) floating

Answer: D

Diff: 2




40) A cross rate is the computation of an exchange rate for a currency from the exchange rates of two other countries.

Answer: TRUE

Diff: 2




41) The asked rate is the price a customer will receive from a foreign currency trader when selling a foreign currency.

Answer: FALSE

Diff: 2


Keywords: bid-ask


42) The foreign exchange market is similar in form to the New York Stock Exchange.

Answer: FALSE

Diff: 2




43) Arbitrage eliminates forward discounts and premiums across the markets of a single currency.

Answer: FALSE

Diff: 2


Keywords: arbitrage


44) Arbitrage is the process of buying and selling in one market in order to make a riskless profit.

Answer: TRUE

Diff: 2


Keywords: arbitrage


45) The efficiency of foreign currency markets is ensured, in large measure, by the process of arbitrageurs.

Answer: TRUE

Diff: 2


Keywords: arbitrage


46) A direct quote in Bombay tells one how many British pounds can buy one Indian rupee.

Answer: FALSE

Diff: 2




47) The bid rate (also called the offer rate) is the number of units of home currency paid to a customer in exchange for their foreign currency.

Answer: FALSE

Diff: 2


Keywords: bid-ask


48) The foreign exchange market provides a physical entity that transfers the purchasing power from one currency to another.

Answer: FALSE

Diff: 2




49) Foreign exchange transactions carried out in the spot market entails an agreement today to deliver a specific number of units of currency on a future date in return for a specified number of units of another currency.

Answer: FALSE

Diff: 2




50) Transactions carried out in the foreign exchange markets can include direct or indirect exchange rate quotes.

Answer: TRUE

Diff: 2




51) Spot transactions are made immediately in the market place at the market price.

Answer: TRUE

Diff: 2




52) Spot exchange markets are efficient due to arbitrage forces.

Answer: TRUE

Diff: 2




53) When banks transact in foreign currencies, the direct bid quote is greater than the direct asked quote.

Answer: FALSE

Diff: 2


Keywords: bid-ask


54) The forward rate is the same as the spot rate that will prevail in the future.

Answer: FALSE

Diff: 2




55) The major advantage of the forward market is risk reduction.

Answer: TRUE

Diff: 2




56) Spot exchange markets have the potential for arbitrage opportunities for a long period of time.

Answer: FALSE

Diff: 2




57) The difference between the asked price and the bid price is known as the spread.

Answer: TRUE

Diff: 2


Keywords: bid-ask


58) A narrow spread indicates efficiency in the spot exchange market.

Answer: TRUE

Diff: 2


Keywords: bid-ask


59) Forward contracts are usually quoted for periods greater than one year.

Answer: FALSE

Diff: 2




60) Forward rates, like spot rates, are quoted in both direct and indirect form.

Answer: TRUE

Diff: 2




61) Forward contracts benefit only the customer due to a reduction in uncertainty.

Answer: FALSE

Diff: 2




62) What is the role of arbitrage in the foreign exchange markets?

Answer: Foreign exchange quotes should be consistent with each other so that the exchange rates in all markets will be the same. If a currency could be purchased for one price in, for example, Paris and sold at a higher price in another market, say New York, then arbitrageurs would buy aggressively in Paris, increasing demand, and sell in New York, increasing supply. The increased buying activity in one market and selling activity in the other would soon eliminate the price differential.

Diff: 2


Keywords: arbitrage


63) A dealer in London posts an ask rate of .6238 and a bid rate of .6237. How much, in U.K. pounds, would it cost to purchase $100,000. For how much in pounds could you sell $100,000?

Answer: $100,000 could be purchased for 62,380 British pounds and sold for 62,370 British pounds.

Diff: 2




64) What is the difference between forward rates and spot rates? What is the purpose of forward contracts?

Answer: The spot rate for a currency is the price that is paid for immediate delivery "on the spot." Forward rates are the prices paid for currency that is to be delivered at some point in the future, such as 30, 60 or 90 days. Forward transactions are useful for importers and exporters because they allow buyers and sellers to fix the value of payments in advance, in their own currencies.

Diff: 2




65) What is the difference between and "ask" quote and a "bid" quote.

Answer: Currency traders make a small (in percentage terms) profit by purchasing at a slightly lower price, the "bid" rate and selling at a slightly higher price, the "ask" rate.

Diff: 2


Keywords: bid-ask


66) As of January 8, 2010, the spot rate for Swiss francs was .9772. The 180 day forward rate was .9783. Compute the annualized percentage rate premium or discount for Swiss francs.

Answer: (.9783 - .9772)/.9772 365/180 = .002283. The annualized premium is 0.2283%.

Diff: 2




67) One U.S. dollar buys 12.706 Mexican pesos and .6936 euros. What is the peso/euro exchange rate.

Answer: 12.706/1 1/.6936 = 18.319 pesos per euro.

Diff: 2




19.2 Interest Rate and Purchasing-Power Parity

1) A theory that relates the ratios of spot and forward exchange to differences in interest rates in two countries or currency zones is known as:

A) interest rate parity.

B) purchasing power parity.

C) market efficiency.

D) forward/spot equivalence hypothesis.

Answer: A

Diff: 2

Topic: 19.2 Interest Rate and Purchasing-Power Parity

Keywords: interest rate parity


2) The interplay between interest rate differentials and exchange rates such that both adjust until the foreign exchange market and the money market reach equilibrium is called the:

A) purchasing power parity theory.

B) balance of payments quantum theory.

C) interest rate parity theory.

D) arbitrage markets theory.

Answer: C

Diff: 2




3) Which of the following statements is true?

A) The forward rate is the same as the spot rate that will prevail in the future.

B) Only the forward rate is known.

C) An indirect quote is the exchange rate that indicates the number of units of the home currency required to buy one unit of foreign currency.

D) Both B and C.

Answer: B

Diff: 2




4) The purchasing power parity theory is least likely to apply to the price of:

A) oral surgery.

B) smart phones.

C) crude oil.

D) cane sugar.

Answer: A

Diff: 2


Keywords: purchasing power parity


5) The 1 year interest rate in the U.S. is 1%. The spot exchange rate for yen is 92.61 to the dollar. The 6 months forward rate is 92.57 to the dollar. These prices indicate that interest rates in Japan, on an annualized basis, are about:

A) .08% lower.

B) .08% higher.

C) .04% higher.

D) .8% lower.

Answer: B

Diff: 2




6) The 1 year interest rate in the U.S. is 2%. The spot exchange rate for Canadian dollars .97 to the U.S.dollar. The 6 months forward rate is .9698 to the U.S. dollar. These prices indicate that interest rates in Canada, on an annualized basis, are about:

A) .08% lower.

B) .08% higher.

C) .04% higher.

D) .8% lower.

Answer: C

Diff: 2




7) The spot exchange rate for Canadian dollars is .97 to the U.S.dollar. The 6 months forward rate is .9698 to the U.S. dollar. The interest rate in Canada (annual) is 2.04%. What is the U. S. Interest rate?

A) 2.02%

B) 4.04%

C) 1.08%

D) .9982%

Answer: A

Diff: 2




8) A barrel of oil currently costs $85 in U.S. dollars. The current exchange rate is $1.40 U. S. to the euro. If purchasing power parity prevails what is the price of a barrel of oil in euros?

A) 71.43 euros

B) 140 euros

C) 119 euros

D) 60.71 euros

Answer: D

Diff: 2




9) 10,000 bushels of corn currently sells in the U. S. for $57,300. The current exchange rate is 45.5 rupees to the dollar. If purchasing power parity prevails, what is the price of 10,000 bushels of corn in rupees?

A) 2,607,150 rupees

B) 12,593.34 rupees

C) 45,500 rupees

D) 260,715 rupees

Answer: A

Diff: 2




10) The current spot exchange rate between the Japanese yen and the U.S. dollar is 92.61 Y/US$. The yen is expected to appreciate by 4% against the dollar over the next year. What do you expect the spot exchange rate between the yen and the dollar to be one year from now?

A) 92.61 Y/US$

B) 98.18 Y/US$

C) 89.05 Y/US$

D) 103.08 Y/US$

Answer: C

Diff: 2




11) According to the domestic Fisher effect, if the inflation rate is 3% and the real rate of interest is 2%, the nominal rate of interest will be:

A) 5.06%.

B) 5.00%.

C) 6%.

D) 8.15%.

Answer: A

Diff: 2




12) According to the domestic Fisher effect, if the inflation rate is 5%, and the nominal rate of interest is 7%, the real rate of interest is:

A) 2.00%.

B) 1.904%.

C) 4.65%.

D) 0.5252%.

Answer: B

Diff: 2




13) According to the international Fisher effect, if the nominal interest rate in Russia is 9.5% and the inflation rate is 8%, the real rate of interest is approximately:

A) 18.26%.

B) 6.5%.

C) 1.5%.

D) -1.5%.

Answer: C

Diff: 2




14) The nominal rate of interest in Russia is 9.5% and the inflation rate is 8%. The nominal rate of interest in Spain is 3% and the inflation rate is 1%. Which country has the higher real rate of interest?

A) Russia

B) Spain

C) There is no difference.

D) There is not enough information

Answer: B

Diff: 2




15) The nominal rate of interest in Russia is 9.5% and the inflation rate is 8%. The nominal rate of interest in Canada is 2.5% and the inflation rate is zero. We would expect:

A) the ruble to strengthen against the dollar.

B) the exchange rate between the Canadian dollar and the ruble to stay the same because of interest rate parity.

C) the exchange rate between the Canadian dollar and the ruble to stay the same because of purchasing price parity.

D) the Canadian dollar to strengthen against the ruble.

Answer: D

Diff: 2




16) Which of the following statements is true?

A) Interest rate parity indicates that the forward premium or discount should be greater than the differences in the national interest rates for securities of the same maturity.

B) Purchasing power parity indicates that, in the long run, exchange rates adjust to reflect international differences in inflation so that the purchasing power of each currency tends to remain the same.

C) The International Fisher Effect indicates that the nominal interest rate should be the same all over the world at all times if the market is efficient.

D) Both B and C.

Answer: B

Diff: 2




17) Which of the following is a conceptual method for keeping the foreign currency market in equilibrium?

A) The purchasing power parity mechanisms

B) The balance of trade mechanisms

C) Government intervention through central banks

D) The interest rate parity mechanisms

Answer: D

Diff: 2




18) Assume that a Toyota sold for 1,476,000 yen in 1990. If the price for this automobile was $8,200 in 1985, and the car still sells for the same amount of yen today, but the current exchange rate is 90 yen per dollar, what is the car selling for today in U.S. dollars?

A) $ 14,760

B) $16,400

C) $18,204

D) $12,062

Answer: B

Diff: 2




19) If a currency's forward price in U. S. dollars is higher than the spot price, interest rates are higher in the foreign country than they are in the U.S.

Answer: FALSE

Diff: 2




20) If a currency's forward price in U. S. dollars is lower than the spot price, interest rates are higher in the foreign country than they are in the U.S.

Answer: TRUE

Diff: 2




21) Purchasing price parity is more likely to be the case for common commodities than for personal services.

Answer: TRUE

Diff: 2




22) If a country is has high interest rates because of inflation, the forward price of its currency will be higher than the spot price.

Answer: FALSE

Diff: 2




23) Prices differences of identical items in different currencies can best be explained by the international Fisher effect.

Answer: FALSE

Diff: 2


Keywords: international Fisher effect


24) The forward price of currencies can be either higher, lower or even the same as the spot price.

Answer: TRUE

Diff: 2




25) The price of a Big Mac is more or less the same everywhere in the world.

Answer: FALSE

Diff: 2




26) What is meant by interest rate parity?

Answer: Interest rate parity is the theory that explains the differences between spot rates and forward rates by relating them to differing interest rates in the two countries. Interest rate parity can be expressed by the following identity: Difference in interest rates=ratio of the forward and the spot rates.

Diff: 2




27) Assume that the interest rate in India is 10% while in Europe it is 3% and that the exchange rate is 65.50 rupees to the euro. What would we expect the 6 month exchange rate to be?

Answer: The higher interest rate in India implies that the the rupee will weaken against the euro. Specifically, (1 + .03/2)/(1 + .10/2)=Forward Exchange Rate/65.50 so the 6 month forward exchange rate should be 67.76 rupees to the euro.

Diff: 2




28) What is the law of one price? How does it apply to foreign exchange rates?

Answer: The law of one price states that under certain conditions, the same item should sell for the equivalent price in different currencies. It should not be possible to make a profit by buying a barrel of oil in dollars and simultaneously selling it in euros or yen, or the reverse.

Diff: 2




29) Jean-Marc lives in Besanon, a French city near the Swiss border. The exchange rate is 1.47 Swiss francs to the euro. If Jean-Marc's shopping cart of groceries typically costs him 80 euros, what should it cost him if he drives across the border to Switzerland? Do you think that purchase price parity would apply in this situation?

Answer: If purchase price parity applies, Jean-Marc's groceries should cost him approximately 80 x 1.47 =118 Swiss francs. Although some items might be priced differently because of taxes or brand preferences, it is unlikely that a grocery cart of diverse items would be priced very differently when it is easily possible for customers to drive from one location to the other. If groceries were significantly less expensive on one or the other side of the border, local merchants in the more expensive country would be unable to compete or survive.

Diff: 2




19.3 Capital Budgeting for Direct Foreign Investment

1) Which of the following international business activities constitutes a foreign direct investment? All firms mentioned are U.S. based.

A) Yanqui Spirits imports a 1000 cases of rum from the Dominican Republic.

B) WMT Inc. opens a big-box retail facility in Nicaragua.

C) Condor University runs training sessions for Indonesian civil servants on its California Campus.

D) Merkizer Pharmaceuticals licenses an Indian company to manufacture a drug under its patents.

Answer: B

Diff: 2

Topic: 19.3 Capital Budgeting for Direct Foreign Investment

Keywords: direct foreign investment


2) One reason for international investment is that:

A) the economies of many countries are growing faster than the U.S.

B) price-earnings (P/E) ratios are higher in foreign countries.

C) doing business in foreign countries is simpler than in the U. S.

D) raw materials are typically cheaper in other countries than in the U. S.

Answer: A

Diff: 2




3) In 2010, the U. S. A. comprised ________ of the world's stock market capitalization.

A) 20%

B) just under 50%

C) 75%

D) 90%

Answer: B

Diff: 2


Keywords: multinational corporation


4) The spot exchange rate for the Thai bhat is 33.135 bhat to the dollar. The 1 year forward rate is 34.175. Ramo Corp. has undertaken a capital project in Bangkok that is expected to produce a cash flow of 17,087,500 bhat at the end of the first year. The company will discount cash flows at a rate of 14%. What is the present value of the first year cash flow in U.S. dollars.

A) $14,989,035

B) $500,000

C) $438,596

D) $452,363

Answer: C

Diff: 2




5) The spot exchange rate for the Thai bhat is 33.135 bhat to the dollar or .00318 dollar to the bhat. For capital budgeting purposes, Ramo Corp needs to estimate the exchange rate 5 years from now. The U.S. interest rate is 4%; the interest rate in Thailand is 8%. The estimated 5 year forward rate is:

A) 27.44 bhat to the dollar.

B) 40.02 bhat to the dollar.

C) 31.90 bhat to the dollar.

D) 34.41 bhat to the dollar.

Answer: B

Diff: 2




6) RAH Inc., a U.S. corporation is evaluating a proposal to construct and lease an office building in Kiev. RAH's weighted average cost of capital is 11%. The risk free rate in the U.S. is 3.75%. RAH believes that conditions in Kiev warrant a required rate of return that is 12% above the risk-free rate. Cash flows from the hotel project should be discounted at:

A) 23%.

B) 14.75%.

C) 15.75%.

D) 12%.

Answer: C

Diff: 2




7) Some complexities of conducting international business include:

A) multiple currencies.

B) differing legal requirements.

C) restrictions on repatriating earnings.


Answer: D

Diff: 2


Keywords: political risk


8) When multinational companies evaluate capital investments in foreign countries, they discount:

A) pre-tax earnings of the foreign subsidiary.

B) foreign earnings at home country discount rates.

C) only earnings that are expected to be transferred back to the parent company.

D) all cash flows in the foreign currency at the host country discount rates.

Answer: C

Diff: 2




9) Exchange rate risk:

A) arises from the fact that the spot exchange rate on a future date is a random variable.

B) applies only to certain types of international businesses.

C) has been phased out due to recent international legislation.

D) is not a significant factor in foreign investment decisions.

Answer: A

Diff: 2




10) Exchange rate risk:

A) exists when the contract is written in terms of the foreign currency.

B) exists also in direct foreign investments and foreign portfolio investments.

C) does not exist if the international trade contract is written in terms of the domestic currency.


Answer: D

Diff: 2




11) Risks of foreign direct investment potentially include:

A) exchange rate fluctuations.

B) political instability.

C) competition from foreign competitors.


Answer: D

Diff: 2




12) An important (additional) consideration for a direct foreign investment is:

A) political risk.

B) maximizing the firm's profits.

C) attaining a high international P/E ratio.


Answer: A

Diff: 2




13) If the net present value of a direct foreign investment is negative, the multinational firm should:

A) reject any proposals.

B) consider establishing a sales office.

C) consider licensing.

D) both A and C.

Answer: C

Diff: 2




14) Foreign countries claim that multinational corporations:

A) cause stability in their currencies in foreign exchange markets.

B) exploit local labor with low wages.

C) have no political or cultural loyalty.

D) both B and C.

Answer: D

Diff: 2




15) Capital markets in foreign countries:

A) offer lower returns than those obtainable in the domestic capital markets.

B) provide international diversification.

C) in general are becoming less integrated due to the widespread availability of interest rate and currency swaps.

D) increase portfolio betas.

Answer: B

Diff: 2




16) Expropriation of plant and equipment without compensation is an example of financial risk from direct foreign investments.

Answer: FALSE

Diff: 2




17) Economic exposure refers to the overall impact of exchange rate changes on the value of the firm.

Answer: TRUE

Diff: 2




18) The cost of debt used in the international investment decision is the lesser of the parent's or the subsidiary's cost of debt.

Answer: FALSE

Diff: 2




19) Because a large part of a subsidiary's equity funds comes from the parent, the subsidiary should use the same cost of equity as the parent.

Answer: FALSE

Diff: 2




20) Millheim Electronics is an American firm operating in India, whose government refuses to allow Millheim to send its earnings out of the country. This is an example of repatriation of profits.

Answer: FALSE

Diff: 2




21) Multinational corporations can have lower cost of capital and more continuous access to external finance compared to a domestic firm.

Answer: TRUE

Diff: 2




22) The relevant sources of risk for direct foreign investment capital budgeting decisions are the same as those faced when making domestic capital budgeting decisions.

Answer: FALSE

Diff: 2




23) The interest rate in the U.S. is 4%, in Switzerland it is 3%. The spot rate is 1.0232 USD to the Swiss franc. A U.S. based hotel chain needs to project forward exchange rates for the next five years. Complete the table below.

Year Spot Ratex rate differentialForward Rate

0

1

2

3

4

5

Answer: The interest rate in the U.S. is 4%, in Switzerland it is 3%. The spot rate is .9700 Swiss francs to the dollar. A U.S. based hotel chain needs to project forward exchange rates for the next five years. Complete the table below.

Year Spot Ratex rate differentialForward Rate

0 $0.9700/SF1$0 .9700/SF

1 $0.9700/SF1.00977$0.9794/SF

2 $0.9700/SF(1.00977)2$0.9890/SF

3 $0.9700/SF(1.00977)3$0.9987/SF

4 $0.9700/SF(1.00977)4$1.0085/SF

5 $0.9700/SF(1.00977)5$1.01832/SF

Diff: 2




24) The spot exchange rate for the Thai bhat is 33.135 bhat to the dollar. The Host Hotel Company will be able to repatriate profits from its luxury resort hotel in Phuket in 5 years. It has estimated the 5 year forward rate at 38 bhat to the dollar. The risk-free rate in the U.S. is 4% and Host uses an 11 % risk premium for investments of this type. If the expected accumulated profits after 5 years are 100 million bhat, what is their present value in U.S. dollars.

Answer: Present value in bhats is 100,000,000/(1 + .04 + .11)5=49,717,674. Dividing the PV in bhats by the forward price of 38 bhats to the dollar, we obtain $1,308,360.

Diff: 2




25) What are some of the potential risks, other than exchange rate risk, that need to be considered in foreign direct investment decisions.

Answer: Business risks involve issues such as product acceptance in foreign markets, competitive practices, legal protections for physical and intellectual property and the like. Financial risk could arise from the way in which the investment is financed. Political risk involves possible expropriation of property, locked up funds that cannot be converted into parent company currency, price controls, unexpected changes in tax rates, restrictive employment policies and the like. Unfortunately, these risks tend to be greater in the areas of greatest opportunity.

Diff: 2




26) Briefly discuss the factors that multinational firms consider in arriving at capital structure decisions.

Answer: Multinational firms should consider several factors in arriving at capital structure decisions. First, firms should consider how the capital structure of its local affiliates is influenced by the local norms of the industry and in that country. It is noted that norms will vary from country to country. Second, the local affiliate capital structure needs to reflect corporate attitudes toward exchange rate and political risk in that country. These risks would normally lead to higher levels of debt and other local capital. Third, the capital structure of the local affiliate must reflect home country requirements with regard to the company's consolidated capital structure. Last, the optimal capital structure should reflect wider access to financial markets as well as the ability to diversify economic and political risks.

Diff: 2




1Copyright 2011 Pearson Education, Inc.

chapter 19

Documents

foreign exchange trading

exchange rate principles

forward exchange contract

current exchange rate

d diff

forward rates principles

b diff

spot rates principles