978-0134083285 Chapter 16 Part 3

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6) The law of one price suggests that all of the following will have the same price in different countries

EXCEPT

A) oil.

B) grain.

C) fresh vegetables.

D) silver.

Keywords: Law of One Price, Purchasing Power Parity Theory

Learning Obj.: L.O. 16.4

AACSB: Reflective Thinking

7) A corporate investment manager needs to invest $1,000,000 for the next 6 months. The current nominal

rate of interest in the United States is 5%, while the nominal rate of interest in Argentina is 8%. Which of

the following statements is MOST correct?

A) The manager should invest the funds in Argentina and make an extra $30,000 for the year.

B) The manager may decide to invest the funds in the United States due to the international Fisher effect,

which suggests inflation in Argentina may make the extra interest income worth less in one year.

C) The manager is indifferent between investing the funds in the United States or Argentina because real

returns will always be the same in the end.

D) The manager cannot invest in Argentina because his company is investing dollars.

Keywords: International Fisher Effect

Learning Obj.: L.O. 16.4

AACSB: Reflective Thinking

8) Exchange rate changes tend to reflect international differences in inflation rates. What is the name of

this theory?

A) the purchasing power parity theory

B) the IMF effect

C) interest rate parity theory

D) the law of one price

Keywords: Purchasing Power Parity Theory

Learning Obj.: L.O. 16.4

AACSB: Reflective Thinking

9) Which of the following parity conditions is (are) correct?

A) The interest-rate parity theory states that the forward premium/discount should be equal and opposite

in size to the national interest rate differential.

B) The purchasing-power parity theory states that in the long run exchange rate changes tend to reflect

international differences in inflation rates.

C) The international Fisher effect states that national interest rate differentials are the result of inflation

differentials.

D) All of the above are correct.

Keywords: Interest Rate Parity, Purchasing Power Parity, International Fisher Effect

Learning Obj.: L.O. 16.4

AACSB: Reflective Thinking

10) What does the law of one price say?

Keywords: Purchasing Power Parity Theory, Law of One Price

Learning Obj.: L.O. 16.4

AACSB: Reflective Thinking

Learning Objective 16.5

1) Exchange rate risk is the risk that exchange rates will be lower in the future than they are today.

Keywords: Exchange Rate Risk

Learning Obj.: L.O. 16.5

AACSB: Reflective Thinking

2) Exchange rate risk exists for a party to a contract if the contract is denominated in a foreign currency.

Keywords: Exchange Rate Risk

Learning Obj.: L.O. 16.5

AACSB: Reflective Thinking

3) Exchange-rate risk arises from the fact that the spot exchange rate on a future date is unknown today.

Keywords: Exchange Rate Risk

Learning Obj.: L.O. 16.5

AACSB: Reflective Thinking

4) Exchange rate risk exists in International Trade Contracts, Foreign Portfolio Investments, and in Direct

Foreign Investments.

Keywords: Exchange Rate Risk

Learning Obj.: L.O. 16.5

AACSB: Reflective Thinking

5) With international investing, unlike domestic investing, exchange rate risk could cause a marginally-

positive–NPV project to be rejected due to the additional risk.

Keywords: Exchange Rate Risk

Learning Obj.: L.O. 16.5

AACSB: Reflective Thinking

6) In an international trade contract involving one buyer and one seller, both parties may be exposed to

exchange rate risk if the contract is denominated in a third currency.

Keywords: International Trade Contract, Exchange Rate Risk

Learning Obj.: L.O. 16.5

AACSB: Analytical Thinking

7) Exchange rate fluctuations do not increase the riskiness of foreign portfolio investments because

changes in exchange rates are compensated for by changes in interest rates and investment returns.

Keywords: Exchange Rate Risk, Foreign Portfolio Investments

Learning Obj.: L.O. 16.5

AACSB: Analytical Thinking

8) Only purely domestic firms that buy all of their inputs and sell all of their outputs in their home

countries are unaffected by events in international financial markets.

Keywords: Purely Domestic Firms, International Financial Markets

Learning Obj.: L.O. 16.5

AACSB: Reflective Thinking

9) An American manufacturer with its corporate headquarters in New York City is purchasing goods

from a French supplier. Which of the following statements is true regarding the exchange rate risk for this

contract?

A) The American company will bear all of the exchange rate risk if the contract is denominated in dollars.

B) The French company will bear all of the exchange rate risk if the contract is denominated in dollars.

C) Both companies could bear exchange rate risk if the contract is denominated in British pounds.

D) Both B and C are correct.

Keywords: Exchange Rate Risk

Learning Obj.: L.O. 16.5

AACSB: Reflective Thinking

10) Exchange rate risk is highest for companies with

A) international trade contracts denominated in the foreign currency.

B) investment portfolios that contain foreign securities.

C) direct foreign investments in foreign subsidiaries.

D) international trade contracts denominated in the domestic currency.

Keywords: Exchange Rate Risk, Direct Foreign Investment

Learning Obj.: L.O. 16.5

AACSB: Reflective Thinking

11) A U.S.-based multinational corporation (MNC) currently has an investment portfolio that includes

Japanese securities valued at 10,000,000 yen. The company also owes its Japanese suppliers 12,000,000

yen. Which of the following statements is MOST correct?

A) The MNC is not exposed to exchange rate risk because it holds both assets and liabilities denominated

in yen.

B) The MNC will be exposed to exchange rate losses if the yen declines in value relative to the dollar.

C) The MNC will be exposed to exchange rate losses if the yen increases in value relative to the dollar.

D) The MNC can avoid exchange rate risk by paying its Japanese liabilities with dollars.

Keywords: Exchange Rate Risk, Net Exposed Position

Learning Obj.: L.O. 16.5

AACSB: Reflective Thinking

12) A U.S.-based multinational corporation has 100% owned subsidiary in Argentina. The subsidiary

operates only domestically, that is, all transactions occur within Argentina. Therefore, the U.S.

multinational corporation

A) is exposed to translation risk only.

B) is not exposed to exchange rate risk because the subsidiary operates 100% domestically.

C) is exposed to both translation exposure and economic exposure.

D) is most concerned with transactions exposure.

Keywords: Translation Exposure, Economic Exposure, Multinational Corporation, Exchange Rate Risk

Learning Obj.: L.O. 16.5

AACSB: Analytical Thinking

13) 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) has been reduced by the adoption of floating exchange rates.

Keywords: Exchange Rate Risk

Learning Obj.: L.O. 16.5

AACSB: Reflective Thinking

14) 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.

D) all of the above

Keywords: Exchange Rate Risk

Learning Obj.: L.O. 16.5

AACSB: Reflective Thinking

15) Suppose a U.S. importer purchases an Italian product today but will not pay for it for 90 days. The

cost of the product today is 85,000 euros. The spot exchange rate today is .7559 euros per dollar. How

much is the cost today in dollars?

A) $58,062

B) $56,153

C) $65,683

D) $64,252

Keywords: International Trade Contract, Exchange Rate Risk

Learning Obj.: L.O. 16.5

AACSB: Analytical Thinking

16) Suppose a U.S. importer purchases an Italian product today but will not pay for it for 90 days. The

cost of the product today is 30,000 euros. The spot exchange rate today is .6233 euros per dollar. If the

U.S. importer does not hedge the position, which of the following spot exchange rates in 90 days will

yield the highest returns?

A) 0.6833 euros per dollar

B) 0.6499 euros per dollar

C) $1.4844 per euro

D) $1.5387 per euro

Keywords: International Trade Contract, Exchange Rate Risk

Learning Obj.: L.O. 16.5

AACSB: Analytical Thinking

17) Suppose a U.S. importer purchases an Italian product today but will not pay for it for 90 days. The

cost of the product today is 35,000 euros. The spot exchange rate today is .6233 euros per dollar. The

importer creates a forward-market hedge. The 90-day forward rate is .6100 euros per dollar. The amount

the U.S. importer will pay in 90 days is

A) $56,153.

B) $57,377.

C) $55,683.

D) $56,667.

Keywords: International Trade Contract, Exchange Rate Risk

Learning Obj.: L.O. 16.5

AACSB: Analytical Thinking

18) In addition to those risks faced by domestic corporations, multinational corporations face

A) political risk.

B) exchange risk.

C) Both A and B are correct.

D) All domestic and multinational corporations face similar risk profiles.

Keywords: Political Risk, Exchange Risk, Multinational Corporation

Learning Obj.: L.O. 16.5

AACSB: Reflective Thinking

19) Strategies to counter exchange rate risk include all of the following EXCEPT

A) futures contracts.

B) spot-market hedges.

C) forward–market hedges.

D) money-market hedges.

Keywords: Exchange Rate Risk, Futures Contracts, Forward-market Hedges, Money-market Hedges

Learning Obj.: L.O. 16.5

AACSB: Reflective Thinking

20) 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.

D) maintaining the domestic cost of capital.

Keywords: Direct Foreign Investment

Learning Obj.: L.O. 16.5

AACSB: Reflective Thinking

21) All of the following are examples of political risk for a U.S. company investing in a foreign country

EXCEPT

A) expropriation of plant and equipment.

B) the problem of blocked funds.

C) substantial changes in foreign country tax laws.

D) government requirements that ownership must be limited to U.S. citizens.

Keywords: Direct Foreign Investment

Learning Obj.: L.O. 16.5

AACSB: Reflective Thinking

22) What is direct foreign investment? What are the additional risks that a multinational corporation must

consider before undertaking direct investment in a foreign country?

Keywords: Direct Foreign Investment, Political Risk Exchange Rate Risk

Learning Obj.: L.O. 16.5

AACSB: Reflective Thinking

23) Define the types of risk that are commonly referred to as political risk, and give some examples of

them.

Keywords: Political Risk, Exchange Risk, Multinational Corporation

Learning Obj.: L.O. 16.5

AACSB: Reflective Thinking

24) What is exchange rate risk? Why would a multinational firm be concerned about it?

Keywords: Exchange Rate Risk

Learning Obj.: L.O. 16.5

AACSB: Reflective Thinking