Counterparty risk is greater for exchange-traded derivatives than for over-the-counter
derivatives.
Increasing the number of securities in a portfolio reduces the unsystematic risk but not
the systematic risk.
Many MNE s manage foreign exchange exposure centrally, thus gains or losses are
always matched with the country of origin.
Proactive financial strategies depend on discovering market imperfections.
Management often conducts hedging activities that benefit management at the expense
of the shareholders. The field of finance called agency theory frequently argues that
management is generally LESS risk averse than are shareholders.
Use of the International CAPM (ICAPM) assures that the WACC will be lower than if a
purely domestic market portfolio had been used in the estimation of the cost of equity.
In the mid 1980s the U.S. led the way to higher corporate income tax rates worldwide.
Today, most of the G7 nations have surpassed the U.S. and have higher corporate
income tax rates than the U.S.
According to the Boston Consulting Group gloabl challengers are companies based in
rapidly developing economies that are “shaking up” the established economic order.
If the same exchange rate were used to remeasure every line on a financial statement,
then there would be no imbalances from remeasuring.
For firms to raise capital in international markets, it is more important to adhere to
capital structure ratios similar to those found in the United States and United Kingdom
than to those in the firm’s home country.
Today it is widely assumed that there are NO LIMITS to financial globalization.
The actions of corporate insiders and the actions of rulers of sovereign states are both
agency costs that act as an impediment to the growth of globalization.
Eurocurrency markets serve two valuable purposes: 1) Eurocurrency deposits are an
efficient and convenient money market device for holding excess corporate liquidity;
and 2) the Eurocurrency market is a major source of short-term bank loans to finance
corporate working capital needs, including the financing of imports and exports.
When a currency is devalued the immediate impact may be an increase in a country’s
trade deficit. However, this situation tends to correct itself in 2 to 5 weeks.
The variability of a firm’s operating cash flows is probably reduced by international
diversification of its production, sourcing, and sales because exchange rate changes
under disequilibrium conditions are likely to increase the firm’s competitiveness in
some markets while reducing it in others.
The BOP must be in balance, but the current account need not be.
Hedging can be advantageous to shareholders because management is in a better
position than shareholders to recognize disequilibrium conditions and to take advantage
of single opportunities to enhance firm value through selective hedging.
The People’s Republic of China has two official currencies, the Chinese renminbi
(RMB) and the yuan (CNY).
Since March 1973, when exchange rates become more volatile and less predictable than
during the “fixed” exchange rate period, the nominal exchange rate index of the U.S.
dollar peaked in 2011.
Since in the U.S. the home currency is the dollar and the foreign currency is the euro, in
New York USD 1.2174 = EUR 1.00 would be a direct quote on the euro and an indirect
quote on the dollar.
Standard foreign currency options are priced around the forward rate.
China’s current political plan includes reducing their foreign exchange reserve balance
by allowing the yuan to float freely and by switching their goods balance from one of a
net surplus to a net deficit.
A firm entering into a currency or interest rate swap agreement holds no responsibility
for the timely servicing of its own debt obligations since that responsibility now is born
by the second party to the contract.
Remaining unhedged is NOT an option when dealing with foreign exchange transaction
exposure.
Traders by using the historical volatility assume that the immediate future will be the
same as the recent past, and the historical volatility will equal the forward-looking
volatility.
U.S. listings of publicly traded firms as a percentage of worldwide listings of such firms
INCREASED from 11% in 1996 to approximately 33% in 2010.
For purposes of international capital budgeting, it is NOT important to distinguish
between parent and total project cash flows.
An overdraft agreement allows a firm to overdraw its bank account up to the limit of its
credit line.
After being introduced in the 1980s, currency swaps have remained a relatively
insignificant financial derivative instrument.
If exchange rates were fixed, investors and traders would be relatively certain about the
current and near future exchange value of each currency.
As the general principle of comparative advantage is still valid, complete specializatoin
remains a realistic case.
For firms competing in a world characterized by oligopolistic competition, strategic
motives can be subdivided into proactive and defensive investments.
Since movements between exchanges typically are a zero sum within a country, and
spinouts and bulletin board movements are few in number, real growth in listings comes
from IPOs.
In the United States and most developed countries, the current account and the
combined financial/capital accounts tend to be inversely related in that when one is
positive, the other tends to be negative.
If a firm diversifies its financing sources, it will be pre-positioned to take advantage of
temporary deviations from the International Fisher Effect.
Affiliate firms are consolidated on the parent’s financial statements on a ________
basis.
A) pro rated
B) 50%
C) 75%
D) 100%
Which of the following is a reason why managers act to maximize shareholder wealth
in Anglo-American markets?
A) the use of stock options to align the goals of shareholders and managers
B) the market for corporate control that allows for outside takeover of the firm
C) performance based compensation for executive management
D) all of the above
If the European subsidiary of a U.S. firm has net exposed assets of €750,000, and the
euro drops in value from $1.30/euro to $1.20/€ the U.S. firm has a translation:
A) gain of $75,000.
B) loss of $75,000.
C) gain of $625,000.
D) loss of €576,923.
A foreign currency ________ gives the purchaser the right, not the obligation, to buy a
given amount of foreign exchange at a fixed price per unit for a specified period.
A) future
B) forward
C) option
D) swap
The greatest amount of foreign exchange trading takes place in the following three
cities:
A) New York, London, and Tokyo.
B) New York, Singapore, and Zurich.
C) London, Frankfurt, and Paris.
D) London, Tokyo, and Zurich.
The ________ approach states that the exchange rate is determined by the supply and
demand for national currency stocks, as well as the expected future levels and rates of
growth of monetary stock.
A) balance of payments
B) monetary
C) asset market
D) law of one price
Which of the following statements regarding currency futures contracts and forward
contracts is NOT true?
A) A futures contract is a standardized amount per currency whereas the forward
contact is for any size desired.
B) A futures contract is for a fixed maturity whereas the forward contract is for any
maturity you like up to one year.
C) Futures contracts trade on organized exchanges whereas forwards take place
between individuals and banks with other banks via telecom linkages.
D) All of the above are true.
Instruction 8.1:
For the following problem(s), consider these debt strategies being considered by a
corporate borrower. Each is intended to provide $1,000,000 in financing for a three-year
period.
∙ Strategy #1: Borrow $1,000,000 for three years at a fixed rate of interest of 7%.
∙ Strategy #2: Borrow $1,000,000 for three years at a floating rate of LIBOR + 2%, to
be reset annually. The current LIBOR rate is 3.50%
∙ Strategy #3: Borrow $1,000,000 for one year at a fixed rate, and then renew the credit
annually. The current one-year rate is 5%.
Refer to Instruction 8.1. After the fact, under which set of circumstances would you
prefer strategy #2? (Assume your firm is borrowing money.)
A) Your credit rating stayed the same and interest rates went up.
B) Your credit rating stayed the same and interest rates went down.
C) Your credit rating improved and interest rates went down.
D) Not enough information to make a judgment.
Central Valley Transit Inc. (CVT) has just signed a contract to purchase light rail cars
from a manufacturer in Germany for euro 3,000,000. The purchase was made in June
with payment due six months later in December. Because this is a sizable contract for
the firm and because the contract is in euros rather than dollars, CVT is considering
several hedging alternatives to reduce the exchange rate risk arising from the sale. To
help the firm make a hedging decision you have gathered the following information.
∙ The spot exchange rate is $1.250/euro
∙ The six month forward rate is $1.22/euro
∙ CVT’s cost of capital is 11%
∙ The Euro zone 6-month borrowing rate is 9% (or 4.5% for 6 months)
∙ The Euro zone 6-month lending rate is 7% (or 3.5% for 6 months)
∙ The U.S. 6-month borrowing rate is 8% (or 4% for 6 months)
∙ The U.S. 6-month lending rate is 6% (or 3% for 6 months)
∙ December call options for euro 750,000; strike price $1.28, premium price is 1.5%
∙ CVT’s forecast for 6-month spot rates is $1.27/euro
∙ The budget rate, or the highest acceptable purchase price for this project, is $3,900,000
or $1.30/euro
Refer to Instruction 10.1. CVT chooses to hedge its transaction exposure in the forward
market at the available forward rate. The required amount in dollars to pay off the
accounts payable in 6 months will be:
A) $3,000,000.
B) $3,660,000.
C) $3,750,000.
D) $3,810,000.
________ risk is measured with beta.
A) Systematic
B) Unsystematic
C) International
D) Domestic
The process of acquiring an enterprise anywhere in the world has three common
elements EXCEPT:
A) identification and valuation of the target
B) execution of the acquisition offer and purchase—the tender
C) management of the post-acquisition transition
D) All of the above are common elements in acquiring an enterprise anywhere in the
world.
The authors refer to the practice of many Asian firms being largely controlled by
families of groups related to the governing body of the country as:
A) illegal.
B) insider trading.
C) cronyism.
D) not in my back yard.
One possible reason for a balance sheet hedge could be because the foreign subsidiary
is about to be liquidated, so that value of its Cumulative Translation Adjustment (CTA)
would be realized.
An agreement to exchange interest payments based on a fixed payment for those based
on a variable rate (or vice versa) is known as a/an:
A) forward rate agreement.
B) interest rate future.
C) interest rate swap.
D) none of the above
COVERED interest arbitrage (CIA), is where investors borrow in countries and
currencies exhibiting relatively low interest rates and convert the proceeds into
currencies that offer much higher interest rates. The transaction is “covered,” because
the investor does not sell the higher yielding currency proceeds forward.
Central Valley Transit Inc. (CVT) has just signed a contract to purchase light rail cars
from a manufacturer in Germany for euro 3,000,000. The purchase was made in June
with payment due six months later in December. Because this is a sizable contract for
the firm and because the contract is in euros rather than dollars, CVT is considering
several hedging alternatives to reduce the exchange rate risk arising from the sale. To
help the firm make a hedging decision you have gathered the following information.
∙ The spot exchange rate is $1.250/euro
∙ The six month forward rate is $1.22/euro
∙ CVT’s cost of capital is 11%
∙ The Euro zone 6-month borrowing rate is 9% (or 4.5% for 6 months)
∙ The Euro zone 6-month lending rate is 7% (or 3.5% for 6 months)
∙ The U.S. 6-month borrowing rate is 8% (or 4% for 6 months)
∙ The U.S. 6-month lending rate is 6% (or 3% for 6 months)
∙ December call options for euro 750,000; strike price $1.28, premium price is 1.5%
∙ CVT’s forecast for 6-month spot rates is $1.27/euro
∙ The budget rate, or the highest acceptable purchase price for this project, is $3,900,000
or $1.30/euro
Refer to Instruction 10.1. What is the cost of a call option hedge for CVT’s euro
receivable contract? (Note: Calculate the cost in future value dollars and assume the
firm’s cost of capital as the appropriate interest rate for calculating future values.)
A) $57,600
B) $59,904
C) $62,208
D) $63,936
The draft is the instrument normally used in international commerce to:
A) transfer product.
B) prove ownership.
C) transfer title.
D) initiate the sale.
When estimating a firm’s cost of equity capital using the CAPM, you need to estimate:
A) the risk-free rate of return.
B) the expected return on the market portfolio.
C) the firm’s beta.
D) all of the above
Which of the following is probably NOT an advantage of foreign exchange risk
management?
A) the reduction of the variability of cash flows due to domestic business cycles
B) increased availability of capital
C) reduced cost of capital
D) All of the above are potential advantages of foreign exchange risk management.
Which of the following is NOT true for the writer of a call option?
A) The maximum loss is unlimited.
B) The maximum gain is unlimited.
C) The gain or loss is equal to but of the opposite sign of the buyer of a call option.
D) All of the above are true.
The study of how shareholders can motivate management to accept the prescriptions of
the shareholder wealth maximization model is called:
A) market efficiency.
B) the SWM model.
C) agency theory.
D) the SCM model.
Instruction 18.1:
Use the information to answer the following question(s).
The Velo Rapid Revolutions Inc., a company that produces bicycles, elliptical trainers,
scooters and other wheeled non-motorized recreational equipment is considering an
expansion of their product line to Europe. The expansion would require a purchase of
equipment with a price of euro 1,200,000 and additional installation of euro 300,000
(assume that the installation costs cannot be expensed, but rather, must be depreciated
over the life of the asset). Because this would be a new product, they will not be
replacing existing equipment. The new product line is expected to increase revenues by
euro 600,000 per year over current levels for the next 5 years, however; expenses will
also increase by euro 200,000 per year. (Note: Assume the after-tax operating cash
flows in years 1-5 are equal, and that the terminal value of the project in year 5 may
change total after-tax cash flows for that year.) The equipment is multipurpose and the
firm anticipates that they will sell it at the end of the five years for euro 500,000. The
firm’s required rate of return is 12% and they are in the 40% tax bracket. Depreciation is
straight-line to a value of euro 0 over the 5-year life of the equipment, and the initial
investment (at year 0) also requires an increase in NWC of euro 100,000 (to be
recovered at the sale of the equipment at the end of five years). The current spot rate is
$0.95/euro , and the expected inflation rate in the U.S. is 4% per year and 3% per year
in Europe.
Refer to Instruction 18.1. What is the initial investment for the Velo Rapid Revolutions
project?
A) $1,500,000
B) €1,600,000
C) $1,600,000
D) €1,500,000
The price of a Big Mac in the U.S. is $3.41 and the price in Mexico is Peso 29.0. What
is the implied PPP of the Peso per dollar?
A) Peso 8.50/$1
B) Peso 10.8/$1
C) Peso 11.76/$1
D) None of the above
Most financial theorists believe that the optimal capital structure is a ________ with a
debt to total value ratio somewhere around ________.
A) point; 50%
B) point; 25%
C) range; 30%-60%
D) range; 10%-40%
Under the U.S. method of translation procedures, if the financial statements of the
foreign subsidiary of a U.S. company are maintained in U.S. dollars:
A) translation is accomplished through the current rate method.
B) translation is accomplished through the temporal method.
C) translation is not required.
D) the translation method to be used is not obvious.
Which of the following is NOT a reason why capital budgeting for a foreign project is
more complex than for a domestic project?
A) Parent cash flows must be distinguished from project cash flows.
B) Parent firms must specifically recognize remittance of funds due to differing rules
and regulations concerning remittance of cash flows, taxes, and local norms.
C) Differing rates of inflation exist between the foreign and domestic economies.
D) All of the above add complexity to the international capital budgeting process.
Peter Simpson thinks that the U.K. pound will cost $1.43/£ in six months. A 6-month
currency futures contract is available today at a rate of $1.44/£. If Peter was to
speculate in the currency futures market, and his expectations are correct, which of the
following strategies would earn him a profit?
A) Sell a pound currency futures contract.
B) Buy a pound currency futures contract.
C) Sell pounds today.
D) Sell pounds in six months.
If the European subsidiary of a U.S. firm has net exposed assets of €200,000, and the
euro increases in value from $1.22/€ to $1.26/€ the U.S. firm has a translation:
A) gain of $8,000.
B) loss of $8,000.
C) gain of $252,000.
D) loss of €252,000.
Privatization is a term used to describe:
A) firms that are purchased by the government.
B) government operations that are purchased by corporations and other investors.
C) firms that do not use publicly available debt.
D) non-public meetings held by members of interlocking directorates.
Recently the British Pound suffered an unexpected depreciation in value. Which of the
following actions being considered by Coventry Furniture of London, a purely domestic
furniture manufacturer and retailer, would be considered a highly unlikely response to
the depreciation of the pound?
A) Coventry might choose to maintain its domestic sales prices constant in pound
terms.
B) Coventry might try to raise domestic prices because competing imports are now
priced higher in England.
C) Coventry might try to lower domestic prices because competing imports are now
priced higher in England.
D) none of the above
PolyProduction Inc. has two classes of common stock. Class A has 5 million shares
with 10 votes per share. Class B has 5 million shares with 1 vote per share. If the
dividends per share are equal for both class A and B stock, then Class A shareholders
have ________ of the votes and ________ of the dividends.
A) 90.91%; 90.91%
B) 90.91%; 50.00%
C) 50.00%; 50.00%
D) 83.33%; 33.33%
A call option whose exercise price exceeds the spot price is said to be:
A) in-the-money.
B) at-the-money.
C) out-of-the-money.
D) over-the-spot.
The current U.S. dollar-yen spot rate is 125¥/$. If the 90-day forward exchange rate is
127 ¥/$ then the yen is selling at a per annum ________ of ________.
A) premium; 1.57%
B) premium; 6.30%
C) discount; 1.57%
D) discount; 6.30%