F FIN 4604: Sample Questions III

1). Assume that the Swiss franc has an annual interest rate of 8% and is expected to depreciate by 6% against the dollar. From a U.S. perspective, the effective financing rate from borrowing francs is:

a) 8%b) 14.48%c) 2%d) 1.52%e) 14%

2). Assume that the U.S. interest rate is 11% while the interest rate on euros is 7%. If euros are borrowed by a U.S. firm, they would have to ________ against the dollar by _______ in order to have the same effective financing rate from borrowing dollars.a) Depreciate; 3.74%b) Appreciate; 3.74%c) Appreciate; 4.53%d) Depreciate; 4.53%

3). When a U.S. firm borrows a foreign currency and has no offsetting position in this currency, it will incur an effective financing rate that is always above the _______ if the currency ________.a) Foreign currency’s interest rate; appreciatesb) Foreign currency’s interest rate; depreciatesc) Domestic interest rate; depreciatesd) Domestic interest rate; appreciates

4). If a firm repeatedly borrows a portfolio of foreign currencies, the variability of the portfolio’s effective financing rate will be highest if the correlations between currencies in the portfolio are _______ and the individual variability of each currency is _________.a) High; lowb) High; highc) Low; lowd) Low; high

5). Assume the annual British interest rate is above the annual U.S. interest rate (iuk > ius). Also assume the pound’s forward rate of $1.75 equals the pound’s current spot rate. Given this information, interest rate parity ________ exist, and the U.S. firm _________ lock in a higher return by investing in pounds for one year.

a) Does; couldb) Does; could notc) Does not; could notd) Does not; could

6). A risk-averse firm would prefer to borrow _______ when the expected financing costs are similar in a foreign country as in the local country.

a) Locallyb) In the foreign countryc) Either a or bd) Part of the funds locally, and part from the foreign country

1

7). The effective financing rate is obtained by adjusting nominal financing rate for:a) Inflation over the period of concern.b) Spot exchange rate changes over the period of concern.c) A change in foreign interest rates over the period of concern.d) The forward Premium (discount) over the relevant period.

8). If interest rate parity holds and transaction costs are zero, foreign financing with a simultaneous forward purchase of the currency borrowed will result in an effective financing rate that is:

a) Less than the domestic interest rate.b) Greater than the domestic interest rate.c) Equal to the domestic interest rate.d) Greater than the domestic interest rate if the forward rate exhibits a premium and less than the

domestic interest rate if the forward rate exhibits a discount.

9). If interest rate parity holds, transactions costs are zero, and forward rate is an accurate predictor of the future spot rate, then the effective financing rate on a foreign currency would be:

a) Equal to the U.S. interest rate.b) Less than the U.S. interest rate.c) More than the U.S. interest rate.d) Less than the U.S. interest rate if the forward rate exhibited a discount and more than the U.S.

interest rate of the forward rate exhibited a premium.

10). Assume the U.S. one-year rate is 8%, and the British one-year interest rate is 6%. The one-year forward rate of the pound is $1.97. The spot rate of the pound at the beginning of the year is $1.95. By the end of the year, the pound’s spot rate is $2.05.Based on the information, what is the effective financing rate for a U.S. firm that takes out a one-year, uncovered British loan?a) 12.4%b) 7.1%c) 13.5%d) 10.3%e) 11.4%

11). Euro-notes are underwritten by:a) European Central Bank.b) Commercial banks.c) The International Monetary Fund.d) The Federal Reserve System.e) The World Bank

12). Assume U.S. interest rate is 7.5%, New Zealand rate is 6.5%, the spot rate of the NZ$ is $.52, and the one-year forward rate of NZ$ is $.50. At the end of the year, the spot rate of NZ$ is $.48. Compute effective financing rate for a U.S. firm that takes out a one-year, uncovered NZ$ loan?

a) –1.7%.b) 0.0%.c) 14.7%.d) 15.4%.e) 8.3%.

2

13). A negative effective financing rate for a U.S. firm implies that the firm:a) Will incur a loss on the project financed with the funds.b) Paid more interest on the funds than what it would have paid if it had borrowed dollars.c) Will be unable to repay the loan.d) None of the above.e) Paid back an amount less than originally borrowed

14). A U.S. firm plans to borrow Swiss francs today for a one-year period. The Swiss interest rate is 9%. It uses today’s spot rate as a forecast for the franc’s spot rate in one year. The U.S. one-year interest rate is 10%. The expected effective financing rate on Swiss francs is:a) Equal to the U.S. interest rateb) Less than the U.S. interest rate, but more than the Swiss interest ratec) Equal to the Swiss interest rated) Less than the Swiss interest ratee) More than the U.S. interest rate

15). Assume Jelly Corporation, a U.S.-based MNC, obtains a one-year loan of 1,500,000 Malaysian Ringgit (MYR) at a nominal interest rate of 7%. At the time the loan is extended, the spot rate of the ringgit is $.25. If the spot rate of the ringgit in one year is $.28, the dollar amount initially obtained from the loan is $________, and $_________ are needed to repay the loan.a) 375,000; 449,400b) 449,400; 375,000c) 6,000,000; 5,375,143d) 5,357,142; 6,000,000

16). Morton Company obtains a one-year loan of 2,000,000 Sudanese Dinar (SD) at an interest rate of 6%. At the time the loan is extended, the spot rate of the dinar is $.005. If the spot rate of the dinar at maturity of the loan is $.0035, what is the effective financing rate for borrowing dinar?a) 37.8%b) 51.43%c) –25.8%d) –6%e) None of the above

17). ____________ are free of default risk.a) Euro notesb) Euro bondsc) Eurocommercial paperd) Eurocurrenciese) None of the above

3

** The following information refers to questions 18 and 19.

Assume a U.S.-based MNC is borrowing Romanian leu (ROL) at an interest rate of 8% for one year. Also assume that the spot rate of the leu is $.00012 and the one-year forward rate of the leu is $.00010. The expected spot rate of the leu one-year from now is $.00011.

18) What is the effective financing rate for the MNC assuming it borrows leu on a covered basis?a) 10%b) –10%c) –1%d) 1%e) None of the above

19) What is the effective financing rate for the MNC assuming it borrows leu on an uncovered basis?a) 10%b) –10%c) –1%d) 1%e) None of the above

20) Assume that interest rate parity holds between the U.S. and Cyprus. The U.S. one-year interest rate is 7% and the Cyprus one-year interest rate is 6%. What is the effective financing rate of a one-year loan denominated in Cyprus pounds assuming that a US MNC covers its exposure by purchasing pounds one year forward?a) 6%b) 7%c) 1%d) More information required to answer

** The following information refers to questions 21 and 22

Cameron Corporation would like to simultaneously borrow Japanese yen (¥) and Sudanese dinar (SDD) for a 6-month period. Cameron would like to determine the expected financing rate and the standard deviation of financing rate for a portfolio consisting of 30% yen and 70% dinar. Cameron has gathered the following information: Mean effective financing rate of Japanese yen or 6 months = 4% Mean effective financing rate o Sudanese dinar for 6 months = 1% Standard deviation for Japanese yen’s effective financing rate = .10 Standard deviation for Sudanese dinar’s effective financing rate = .20 Correlation coefficient of effective financing rates of these 2 currencies = .23

21) What is the expected financing rate for the portfolio contemplated by Cameron Corporation?a) 3.10%b) 1.90%c) 17.00%d) 13.00%e) None of the above

4

22) What is the expected standard deviation of financing rate for the portfolio contemplated by Cameron?

a) .0224b) .1498c) .0289d) .1700e) None of the above

23) A firm will likely benefit most from international diversification if:a) The correlations between country economies are highb) The correlations between country economies are lowc) Variability of economies are highd) Economies are integratede) Economies are segmentedf) Both b and e

24) Which of the following is a motivation for a firm to engage in international business?a) Exploit economies of scaleb) Exploit monopolistic advantagesc) Diversificationd) Internalizatione) All of the above

25) When evaluating international project cash flows, which of the following factors is relevant?a) Future inflationb) Blocked fundsc) Remittance provisionsd) Exchange rate dynamicse) All of the above

26) In multinational capital budgeting analysis, the following methods are used for adjusting risk assessment except:

a) Risk adjusted discount rateb) Sensitivity analysisc) Simulationd) Exchange rate forecasting

27) Which of the following is not a characteristic of a country to be considered within a MNC’s international tax assessment?

a) Corporate income taxesb) Withholding taxesc) Provisions for carry-backs and carry-forwardsd) Tax treatiese) All of the above are characteristics to be considered

28) An argument for MNCs to have a greater debt-intensive capital structure is:a) They are well diversifiedb) Foreign government tax rules may change over timec) Exposure to exchange rate fluctuationsd) Exposure to fund blockage

5

29) Which of the following factors is not expected to generally have a favorable impact on the firm’s cost of capital?

a) Easy access to international capital marketsb) High degree of international diversificationc) Volatile exchange rate changesd) All of the above

30) The capital asset pricing theory is based on the premise that:a) Only unsystematic variability in cash flows is relevantb) Only systematic variability in cash flows is relevantc) Both systematic and unsystematic variability in cash flows are relevantd) Neither systematic nor unsystematic variability is cash flows is relevant

31) Based on the factors that influence a country’s cost of capital, the cost of capital in less developed countries is likely to be ________ than that of the U.S. and _______ than that of Japan.

a) Higher; higherb) Higher; lowerc) Lower; lowerd) Lower; higher

32) The term “local target capital structure” is frequently used to represent:a) The average capital structure of local firms where the MNC’s subsidiary is basedb) The average capital structure of local firms where the MNC’s parent is basedc) The desired capital structure of a subsidiary of a particular MNCd) The desired capital structure of a particular MNC as an entity.

33) The term “global capitals structure” is used to represent:a) The average capital structure of all MNCs across countriesb) The average capital structure of all domestic firms across countriesc) The capital structure of a subsidiary of a particular MNCd) The capital structure of a particular MNC (including all subsidiaries)

34) The __________ an MNC, the _________ its cost of capital is likely to be.a) Larger; higherb) Larger; lowerc) Smaller; lowerd) Both a and c

35) MNC Corporation has a beta of 2.0. The risk-free rate of interest is 5%, and the return on an average stock is 13%. What is the required rate of return on MNC stock?

a) 21%b) 41%c) 16%d) 13%e) None of the above

36) Which of the following is not a reason that the cost of debt can vary across countries?a) Differences in the risk-free rateb) A high price/earnings multiplec) Differences in the risk premiumd) Differences in demographics

6

37) In general, MNCs would probably prefer to use __________ foreign debt when their foreign subsidiaries are subject to __________ local interest rates.

a) More; lowb) More; highc) Less; lowd) Both b and ce) None of the above

38) In general, MNCs would probably prefer to use __________ foreign debt when their foreign subsidiaries are subject to potentially __________ local currencies.

a) More; strongb) More; weakc) Less; strongd) Less; weake) Both b and c

39) A macro-assessment of country risk:a) Focuses on the particular business of the firm involvedb) Excludes all aspects relevant to a particular firm or projectc) Both a and bd) None of the above

40) A micro-assessment of country risk:a) Focuses on the particular business of the firm involvedb) Excludes all aspects relevant to a particular firm or projectc) Both a and bd) None of the above

41) The Delphi technique:a) Is a method of processing information about the country being evaluatedb) Requires the use of discriminant analysis to assess country riskc) Involves the collection of independent expert opinions on country riskd) None of the above

42) The most important variable in determining a country’s degree of overall country risk:a) Is political riskb) Is financial riskc) Is the probability of a host government takeoverd) May often vary with the country in question

43) The primary purpose of country risk analysis when applied to capital budgeting is usually tomeasure the effect of country risk on:a) Salesb) Cash flowsc) Consolidated balance sheetd) Consolidated income statement

44) A firm may incorporate a country risk rating into the capital budgeting analysis by:a) Adjusting the NPV upward if the country risk rating has fallen below a benchmark levelb) Adjusting the discount rate upward as the country risk rating decreases (implying increased risk)

c) Both a and bd) None of the above

7

45) Country risk analysis is important because it can be used by a MNC: a) As a screening device to avoid countries with prohibitive/excessive riskb) To monitor countries where the MNC is presently engaged in international businessc) To improve the analysis used to make long-term investing or financing decisionsd) To revise investment of financing decisions in the face of new risk profile.e) All of the above

46) ______________ is (are) not a form of political risk.a) Exchange rate movementsb) Attitude of consumers in the host countryc) Attitude of the host governmentd) Blockage of funds transferse) All of the above are forms of political risk

47) You have an opportunity to invest in Australia at an interest rate of 8%. Moreover, you expect the Australian dollar (A$) to appreciate by 2%. Your effective return from this investment is:

a) 8.00%b) 6.00%c) 10.16%d) 5.88%e) None of the above

48) Consider an MNC that is exposed to the Taiwan dollar (TWD) and the Egyptian pound (EGP). 25% of the MNC’s funds are Taiwan dollars and 75% are pounds. The standard deviation of exchange movements is 7% for Taiwan dollars and 5% for pounds. The correlation coefficient between movements in the value of the Taiwan dollar and the pound is 0.7. Based on this information, the standard deviation of this two-currency portfolio is:

a) 5.13%b) 2.63%c) 4.33%d) 5.55%e) None of the above

49) Consider an MNC that is exposed to the Bulgarian lev (BGL) and the Romanian leu (ROL). 30% of the MNC’s funds are lev and 70% are leu. The standard deviation of exchange movements is 10% for lev and 15% for leu. The correlation coefficient between movements in the value of the lev and the leu is .85. Based on this information, the standard deviation of this two-currency portfolio is :

a) 17.28%b) 13.15%c) 14.50%d) 12.04%e) None of the above

50) A Japanese Tokyo-based MNC has a German subsidiary that annually remits €50 million to Japan. If the Euro _______ against the yen, the value of remitted funds _______

a) Appreciates; decreasesb) Depreciates; is unaffectedc) Appreciates; is unaffectedd) Depreciates; decreases

8

51. Which of the following U.S. industries would most likely take advantage of lower costs in some developing foreign countries?

a. Assembly line production.b. Specialized professional services.c. Nuclear missile planning.d. Planning for more sophisticated computer technology.

52. The term “privatization” is typically used to describe:

a. Firms that are purchased by their managers.b. Firms that are purchased by the government.c. Firms that are bought out by other firms.d. Government enterprises that are purchased by corporations and other investors.

53. In general, products and services are generally becoming ________ standardized across countries, which tends to _________ the globalization of business.

a. More; encourageb. More; discouragec. Less; discouraged. Less; encourage

54. ________ are most commonly classified as a Foreign Direct Investment (FDI).

a. Foreign acquisitionsb. Purchases of international stocksc. Licensing agreementsd. Exporting or importing transactionse. Strategic alliances

55. Which of the following is not an additional risk resulting from international business?

a. Exchange rate fluctuations.b. Political riskc. Interest rate risk.d. Exposure to foreign economies.

56. The __________ a project’s variability in cash flows, and the ___________ the correlation between the project’s cash flow and MNC’s cash flow, the lower the risk of the project to the MNC.

a. Higher; higherb. Higher; lowerc. Lower; lowerd. Lower; higher

9

57. Consider Firm “A” and Firm “B” that both produce the same product. Firm “A” would more likely have more stable cash flows if its percentage of foreign sales were ______ and the number of foreign countries it sold products to was _____.

a. Higher; largeb. Higher; smallc. Lower; smalld. Lower; large

58. When economic conditions of two countries are _______, then a firm would _______ its risk by operating in both counties instead of concentrating just in one.

a. Highly correlated; reduceb. Not highly correlated; not reducec. Not highly correlated; reduced. None of the above

59. In capital budgeting analysis, the use of a cumulative NPV is useful for:

a. Determining a probability distribution of NPVs.b. Determining the time required to achieve a positive NPV.c. Determining how the required rate of return changes over time.d. Determining how the cost of capital changes over timee. A and B

60. Other things being equal, firms from a particular home country will engage in more international acquisitions if they expect foreign currencies to ________ against their home currency, and if their cost of capital is relatively ________.

a. Appreciate; lowb. Appreciate; highc. Depreciate; highd. Depreciate; low

61. The impact of blocked funds on the net present value of a foreign project will be greater if interest rates are ___________ in the host country and there are _________ investment opportunities in the host country.

a. Very high; limitedb. Very low; limitedc. Very low; numerousd. Very high; numerous

62. An international project’s APV is ________ related to the size of the initial investment and

_________ related to the project’s required rate of return.

a. Positively; positivelyb. Positively; negativelyc. Negatively; positivelyd. Negatively; negatively

10

63. An international project’s APV is __________ related to consumer demand and__________ related to the project’s salvage value.

a. Positively; positivelyb. Positively; negativelyc. Negatively; positivelyd. Negatively; negatively

64. As the financing of a foreign project by the parent _______ relative to the financing provided by

the subsidiary, the parent’s exchange rate exposure _______ a. Increases; decreasesb. Decreases; increasesc. Increases; increasesd. None of the above

65. One year ago John Doe invested in the stock of Lloyds, a U.K company. During the year, the

stock declined by 20% but the British pound appreciated by 10%. If John Doe sold the stock today his return would be ______.

a. 30% b. -10% c. -12% d. 32% e. None of the above.

66. When determining whether a particular proposed project in a foreign country is feasible:a. A country risk rating can adequately substitute for a capital budgeting analysis.b. Country risk analysis should be incorporated within the capital budgeting analysis.c. The effect of country risk on sales revenue is more important than the effect on cash flows.d. The project with the highest country risk rating (lowest country risk) should be accepted. e. B and D

67. The best course of action most likely to reduce political risk is for a MNC to:a. Avoid political risk all together.b. Make the cost of expropriation or confiscation prohibitive to the host country.c. Raise the benefit to the host country of the MNC’s operations in the country.d. Buy political risk insurance.

68. The following strategies may be employed to reduce exposure to country risk by MNCs except:

a. Short-term profit maximization.b. Protecting unique supplies/technology.c. Hiring local employees.d. Borrowing funds locally.e. Joining local political parties. f. Purchasing insurance.

11

69. __________ typically have maturities of less than one year.a. Eurobondsb. Euro-commercial paperc. Euronotesd. ADRs.e. Both b and c

70. MNCs can use short-term foreign financing to reduce their exposure to exchange rate fluctuations. For example, if an American-based MNC has _________ in Algerian dinars, it could borrow ____________, resulting in an offsetting effect.

a. Payables; dinarsb. Receivables; dinarsc. Payables; dollarsd. Receivables; dollars.

71. A parent’s perspective is appropriate in attempting to determine whether a project will enhance _____________.

a. Subsidiary earningsb. Subsidiary valuec. MNC earningsd. MNC valuee. None of the above

72. Which of the following is not an input required for a multinational capital budgeting analysis, given that it is conducted from the parent’s viewpoint?

a. Fund-transfer restrictionsb. Project lifetimec. Tax lawsd. Subsidiary’s management philosophye. Exchange rates

73. Which of the following is not a form of financial risk?a. Exchange rate movementsb. Inflation ratesc. Blockage of fund transfers d. All of the above are forms of financial risk.

74. _________ typically have maturities of one to six months; _________ typically have maturities of one to six months but can be tailored to the issuer’s preferences.

a. Eurobonds; Euronotesb. Euro-commercial paper; Euronotesc. Euronotes; euro-commercial paper d. Euro-commercial paper; Eurobonds

12

75. A _________ effective financing rate implies that as U.S. firm borrowing the foreign currency paid _________ in total loan repayment than the amount borrowed.

a. Negative; fewerb. Positive; morec. Negative; mored. Positive; fewere. Both a and b

76. The following are cost-related motives for Foreign Direct Investment except:a. Exploiting monopolistic advantages b. Fully benefiting from economies of scalec. Using foreign factors of productiond. Using foreign raw materials

77. _______ is not a revenue-related motive for Foreign Direct Investmenta. Attracting new sources of demandb. Fully benefiting from economies of scale c. Exploiting monopolistic advantagesd. Strategy of following the customer

78. The primary provider of political risk insurance to U.S. MNCs is the:a. Lloyd’s of Londonb. Liberty insurance Companyc. American International Groupd. Overseas Private Investment corporation e. Agency for international Development

79. Expropriation is most likely in the ______ sector of an economy.a. Constructionb. Agriculturec. Extractive d. Manufacturinge. Servicesf. All are equally likely

80. Assume that the euro is expected to appreciate by 4% annually against the U.S. dollar. If a U.S. company can borrow dollars for 9.3%, and is trying to minimize its expected financing cost, what is the highest interest rate it should be willing to pay to borrow euros?

a. 8.9%b. 7.2%c. 4.3%d. 5.1%e. None of the above

13

81. Assume that the euro is expected to depreciate 4% annually against the U.S. dollar. If a U.S. company can borrow dollars for 9.3%, and is trying to minimize its expected financing cost, what is the highest interest rate it should be willing to pay to borrow euros?

a. 5.09%b. 13.3%c. 13.85% d. 5.3%e. None of the above

82. A US investor purchased Canadian stocks at the beginning of the year in which the Canadian stock increased in valued by 18%. Assume that the exchange rate C$/US was 1.1255 at the beginning of the year and 1.2575 at the end of the year. What was the investor’s effective return?

a. 5.61% b. 31.84%c. 18%d. 11.73%e. None of the above

83. Obtain the effective return to a US investor who invests in the Indian SENSEX stock index during the year when the index gained 17.5 % but the rupee depreciated by 12% against the dollar.

a. 17.5 %b. 5.5%c. 12%d. 3.4% e. 31.6%

84. Compute the effective return to a US investor who purchased the FTSE Index during the year when the index gained 18 % and given the dollar price of the pound was $1.4565 at the beginning of the year and $1.4875 at the end of the year.

a. 20.51% b. 15.49%c. 18%d. 15.12%e. None of the above

14

PART B:1. Aviva (USA) is considering opening a factory in Hungary. The following data are given.

a) The initial investment is 2.5 billion Forint. (Ans. = $1.163m)b) Current exchange rate (forint/$) = 2150 [try F/$ = 227.15 or 208 F/S as of Dec 2010]. The spot rate is

expected to move according to the PPP between the U.S. and Hungary. U.S. and Hungarian inflation rates are expected to average 5 and 15 percent per year respectively over the investment period.

c) Remittable operating cash flows in local currency are estimated to be as follows:

t Cash flow (in millions)1 3002 3753 4504 6005 720

The applicable discount rate is 17% (Ans. = $515,053)d) Lost sales from existing operation will cost Aviva an average of $50,000 per year. The applicable

discount rate is 17% ( Ans. = - $159,967)e) The project will generate a net-of-tax depreciation allowance of $120,000 per year for five years

(Appropriate discount rate is 12%) (Ans. = $ 432,573)f) Extra tax benefits of $15,000 per year can be generated with an applicable discount rate of 15%.

(Ans. = $50,282)g) At the end of the five year project life the nominal salvage value (in local currency) is expected to be

20% of the original cost in local currency (appropriate discount rate is 18%). (Ans. = $64502)

Should Aviva build this factory? (Use APV as a decision rule). [Answer: - $260,401]

2. Aviva (USA) is considering opening a factory in Hungary. The following data are given.a) The initial investment is 1 billion Forint. (Ans. = $5m)b) Current exchange rate ($/Forint) = 0.005[try $/F = .004092]. The forint is expected to depreciate against

the dollar by10% per year over the investment period.c) Remittable operating cash flows in local currency are estimated to be as follows:

T Cash flow (in millions)1 3002 3753 4504 6005 720

The applicable discount rate is 15%. [Ans = $5,583,059]d) Lost sales from existing operating will cost Aviva an average of F30m per year. The applicable

discount rate is 10%.e) The project will generate a net-of-tax depreciation allowance of F65m per year for five years

(Appropriate discount rate is 10%).f) Extra tax benefits of F3.5m per year can be generated with an applicable discount rate of 10%.

(Answer for d+e+f = $548,641)g) At the end of the five year project life the nominal salvage value (in local currency) is expected to

be 15% of the original cost in local currency (appropriate discount rate is 15%). [ Ans = $220,183]

Should Aviva build this factory? (Use APV as a decision rule). [Answer: $1,351,884]

15

Typical Questions for problems 1 and 2.

Use the information provided above to answer the following questions. I) What is the value of the initial investment in dollar terms? II) What will be the applicable exchange rate at the end of year 5?III) What is the present value, in dollars, of the year 5 cash flow from operations?IV) Obtain the present value in dollars of the salvage described in the problem.

3. A-Z Corporation would like to borrow for 6 months in Yen and Euro. The following market information is available to the company.

Mean effective 6-month rate on Yen = 4 %Mean effective 6- month rate on Euro = 10%Std. Dev for Yen effective rate = 0.10Std. Dev for Euro effective rate = 0.25Correlation of Yen and Euro effective rates = 0.35

a) What is the expected effective financing rate and the Std. Dev of effective financing if the portfolio contemplated by A-Z Corp consists of 35% Yen and 65% Euro? [ Rip = 7.9%; σi p = 17.78% ]

b) Assume now that the Yen and the Euro are perfectly negatively correlated. Compute the relevant weights for the Yen and the Euro to construct a portfolio with zero risk and obtain the resultant effective financing rate. [w1 = 5/7; w2 = 2/7; Ri p = 5.71%]

4. The following are expected returns and risks of US and UK assets. US UK Expected return 10% 14% Risk 15% 20% (i) ρ = 1 (ii) ρ = -1 (iii) ρ = .35 (iv) ρ = - .55 a) Compute the expected return and risk of a portfolio made up of the following proportions of US and UK assets: US: 80%, 60%, 45%, 25%, 15%

UK: 20%, 40%, 55%, 75%, 85% (try for 4 values of ρ; 5 combinations of US and UK)

b) For the case of ρ = -1, compute the relevant weights for US and UK to construct a portfolio with zero risk and calculate the expected return on such a portfolio. [w1 = 57.14%; w2 = 42.86%] [Rip = 11.71%]

5. Assume that it is now January 2010. AZDT Inc. (US) expects to receive cash dividends from a joint venture in India over the next five years. The first dividend of Rs 2 million will be paid in December 2010. The dividend is then expected to grow at an annual rate of 10% over the following four years. The current exchange rate (Rs/$) is 45 and AZDT’s average weighted cost of capital is 10%.

a. Compute the dollar present value of the expected rupee dividend stream if the dollar is expected to depreciate by 5% per year against the rupee over the investment period.

b. Obtain the dollar present value of the expected rupee dividend stream if the rupee is expected to depreciate by 10% per year against the dollar over the investment period

c. What is the dollar present value of the expected rupee dividend stream if the exchange rate remains constant over the investment period?

a) Ans = $236, 251 b) Ans = $148,919 c) Ans = $202,020

16

Answers to Sample Multiple Choice Questions III

Answers to Sample Multiple Choice Questions III

1) D

2) B

3) A

4) B

5) D

6) A

7) B

8) C

9) A

10) E

% change in pound = $2.05 - $1.95 ≈ 5.1% $1.95

Effective financing rate = (1 + 6%)(1 + 5.1%) – 1 = 11.4%11) B

12) A % change in NZ$ = $.48 - $.52 ≈ -7.7%

$.52 Effective financing rate = (1+ 6.5%)(1 -7.7%)) – 1 ≈ -1.7%

13) E

14) C

15) A

MYR 1,500,000 x $.25 = $375,000 (MYR 1,500,000 x 1.07) x $.28 = $449,400

16) C

[(1.06) x (.0035/.005 – 1)] – 1 = -25.8%

17) E

18) B

[(1.08) x (1+(F-S)/S ] – 1

= [(1.08) x (1+(.00010-.00012)/.00012]-1 = -10.00%

19) C

[(1.08) x (1+(St-So)/So] - 1

= [(1.08) x (1+(.00011-.00012)/.00012] – 1 = -1.00%

20) B

When IRP holds, the foreign financing cost

(when covering with a forward hedge) is

approximately equal to the domestic financing

21) B Cost = (.3)(.04) + (.7)(.01) = 1.90%

22) B

{(.3)2 (.1)2 + (.7)2 (.2)2 + 2(.3)(.7)(.1)(.2)(.23)}1/2

=.1498

23) F

24) E 59) B

25) E 60) A

26) D 61) B

27) E 62) D

28) A 63) A

29) C 64) C

30) B 65) C

31) A 66) B

32) C 67) B

33) D 68) E

34) B 69) E

35) A 70) B

36) B 71) D

37) A 72) D

38) E 73) C

39) B 74) C

40) A 75) E

41) C 76) A

42) D 77) B

43) B 78) D

44) B 79) C

17

45) E 80) D

46) A

47) C

48) A

49) B

50) D

51) A

52) D

53) A

54) A

55) C

56) C

57) A

58) C Revised 11/2010

18