7) The spot exchange rate in New York is 1.600 dollars per British pound. The 360-day forward
exchange rate is 1.680 dollars per pound. The one-year interest rate in Great Britain is 2% while
the one-year interest rate in the United States is 4%.
a. If the interest rate in Great Britain remains at 2%, what should the interest rate be in the
United States according to the interest rate parity theory?
b. An American investor with $40,000 decides to take advantage of the differences in rates.
Ignoring transaction costs, how can the American investor exploit the disequilibrium? Compare
the amount of money the investor will have at the end of the year if he or she invests in one-year
U.S. securities versus one-year British securities.
17.4 Learning Objective 4
1) Purchasing power parity suggests that interest rates in different countries will adjust so that
each currency will have the same purchasing power.
2) Argentina experienced a period of extremely high inflation relative to its trading partners and
Argentina’s currency decreased in value. This is an example of purchasing power parity theory.
3) Exceptions to purchase power parity exist if arbitrage opportunities are limited by
characteristics such as perishability or high transportation costs.
4) Suppose the current spot rate in New York is .0107 dollars per yen. Inflation for the coming
year in the United States is expected to be 5%, while inflation for the coming year is Japan is
expected to be only 2%. Using the purchasing power parity theory, what is the expected spot rate
at the end of the year should be
A) .0110147 dollars per yen.
B) .0108159 dollars per yen.
C) .0138373 dollars per yen.
D) .0107988 dollars per yen.
5) A bottle of French wine costs $25 euros in Paris. According to the purchasing power parity
theory, what would the bottle sell for in New York if it costs the New York company $2 per
bottle to transport the wine to the United States? Assume the exchange rate is $1.50 per euro.
A) $40.50
B) $28.50
C) $27.00
D) $39.50
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.
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
Brazil is 8%. Which of the following statements is most correct?
A) The manager should invest the funds in Brazil 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 Brazil 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 Brazil because
real returns will always be the same in the end.
D) The manager cannot invest in Brazil because his company is investing dollars.
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
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.
17.5 Learning Objective 5
1) Exchange rate fluctuations increase the variability of returns for investment portfolios that
include foreign securities.
2) A U.S.-based multinational corporation with 200,000,000 yen of net exposed assets in Japan
will realize exchange rate gains if the yen appreciates in value relative to the dollar.
3) The objective of a prudent financial manager is to eliminate all foreign exchange risk.
4) A multinational with a large number of receivables runs the risk of transaction exposure.
5) Translation exposure can be reduced by the use of a money-market hedge or a forward-market
hedge.
6) All of the following exchange rate exposures involve direct cash flow effects except:
A) net exposed assets.
B) transactions exposure.
C) economic exposure.
D) translation exposure.
7) A U.S. Company has a 20,000 euro loan in Germany that must be paid in 30 days. Assume the
30-day money market rates in the U.S. and France are both 3% for lending and 4% for
borrowing. The current exchange rate is 1.55 dollars per euro. If the company wants to complete
a money-market hedge, then the company will
A) sell euros on the spot market and invest the dollars in the U.S. money market.
B) buy euros on the spot market and invest the euros in the German money market.
C) buy dollars on the spot market and invest them in the German money market.
D) buy dollars on the spot market and invest them in the U.S. money market.
8) A U.S. Company has a 40,000 euro loan in Germany that must be paid in 30 days. Assume the
30-day money market rates in the U.S. and Germany are both 2% for lending and 3.5% for
borrowing. The current exchange rate is 1.55 dollars per euro. If the company wants to complete
a money-market hedge, how many euros will be invested in the German money market?
A) 25,806.45
B) 38,647.34
C) 39,215.69
D) 44,245.01
9) A U.S. Company has a 40,000 euro loan in Germany that must be paid in 30 days. Assume the
30-day money market rates in the U.S. and Germany are both 2% for lending and 3.5% for
borrowing. The current exchange rate is 1.55 dollars per euro. If the company wants to complete
a money-market hedge, how many dollars will be needed to purchase euros in the spot market?
A) $36,213.60
B) $40,000.00
C) $59,903.38
D) $60,784.32
10) Elimination of all foreign exchange risk
A) should be the objective of a prudent financial manager.
B) should be analyzed on a cost-benefit basis.
C) both A and B.
D) neither A nor B.
11) Billings, Inc., a U.S.-based multinational, has just sold equipment to a French company for
$1 million. The French company will pay for the order in 60 days. Billings is now exposed to
which kind of risk
A) hedging risk.
B) transaction risk.
C) business risk.
D) forward exchange risk.
12) Translation exposure is typically dealt with in the following manner
A) money-market hedge.
B) forward-market hedge.
C) currency-futures contract.
D) no hedging is done since any losses are paper losses only.
13) Firms generally do not hedge against which type of exposure
A) transaction.
B) translation.
C) economic.
D) financial.
14) If the exposed position in a foreign currency is offset by borrowing or lending, it is referred
to as a
A) forward-market hedge.
B) spot hedge.
C) money-market hedge.
D) interest-rate hedge.
15) Which of the following refers to the overall impact of exchange rate changes on the value of
a firm?
A) transaction exposure
B) economic exposure
C) translation exposure
D) interest rate parity exposure
16) If a firm had plant and equipment expropriated without compensation, this would be referred
to as
A) financial risk.
B) business risk.
C) political risk.
D) exchange rate risk.
17) A foreign currency option differs from a forward exchange contract is all of the following
ways except:
A) it is used to hedge for foreign exchange risk.
B) it permits delivery of the currency anytime before maturity.
C) it is traded in standard amounts.
D) it is traded with standard maturity dates.
17.6 Learning Objective 6
1) If a foreign currency is expected to depreciate with respect to the home currency, the holder of
a net liability in foreign currency will profit.
2) A company holding a net asset position in a depreciating currency should lead, and a company
holding a net asset position in an appreciating currency should lag.
3) The objective of hedging strategy is to have a zero net asset position in a foreign currency.
4) A multinational corporation can move funds from a subsidiary in one country to a subsidiary
in another country so foreign exchange exposure and the tax liability of the multinational
corporation as a whole are minimized.
5) A multinational corporation is involved in a country whose currency is likely to decline in
value. The corporation should
A) lead if the corporation has a net liability (short) position.
B) lag if the corporation has a net asset (long) position.
C) lead regardless of whether the corporation has a net asset or net liability position.
D) lag if the corporation has a net liability (short) position.
6) The transfer of funds among subsidiaries and the parent company of a multinational
corporation is achieved by which of the following methods?
A) money-market hedge
B) royalties
C) forward-market hedge
D) leading and lagging
7) The rate that a subsidiary or parent of the MNC charges other divisions of the firm for its
products is called
A) a forward price.
B) an intrafirm transaction rate.
C) a transfer price.
D) an exchange rate.
8) Leading and lagging
A) are important risk-reduction techniques.
B) are useful when hedging is not available.
C) can be successfully applied for an MNC.
D) all of the above.
17.7 Learning Objective 7
1) 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.
2) The cost of debt used in the international investment decision is the lesser of the parent’s or
the subsidiary’s cost of debt.
3) A major source of long-term capital overseas is in the Eurocurrency market.
4) A currency swap is the exchange of principal and interest in one currency for the same in
another currency for an agreed period of time.
5) Which of the following is a reason for international investment?
A) to reduce portfolio risk
B) to increase P/E ratio
C) to gain an advantage in a foreign country
D) to gain access to foreign currency
6) 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.
7) 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.
17.8 Learning Objective 8
1) Exchange rate risk is the risk that exchange rates will be lower in the future than they are
today.
2) Exchange rate risk exists for a party to a contract if the contract is denominated in a foreign
currency.
3) Exchange-rate risk arises from the fact that the spot exchange rate on a future date is unknown
today.
4) Exchange rate risk exists in International Trade Contracts, Foreign Portfolio Investments, and
in Direct Foreign Investments.
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.
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.
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.
8) 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.
9) 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.
10) 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.
11) 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.
12) 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.
13) 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.
14) 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. How much is the cost today in dollars?
A) $58,062
B) $56,153
C) $65,683
D) $64,255
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 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
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 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.
17) 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.
18) 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.
19) What is direct foreign investment? What are the additional risks that a multinational
corporation must consider before undertaking direct investment in a foreign country?