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Indicate whether the statement is true or false.
1. To avoid exchange rate risk when borrowing a foreign currency, an MNC could hedge its position by using interest rate
swaps.
a.
True
b.
False
2. When an MNC borrows in two foreign currencies with lower interest rates than the U.S. rate, the portfolio will have a
higher effective financing rate than a loan in U.S. dollars if both currencies depreciate simultaneously against the dollar.
a.
True
b.
False
3. If movements of two currencies with low interest rates are highly negatively correlated, then financing in a portfolio of
currencies would not be very beneficial. That is, financing with such a portfolio would not be very different from
financing with a single foreign currency.
a.
True
b.
False
4. A negative effective financing rate implies that the U.S. firm actually paid less to repay the loan than it borrowed.
a.
True
b.
False
5. The interest rate of Euronotes is based on the T-bill rate.
a.
True
b.
False
6. One reason an MNC may consider foreign financing is that the proceeds could be used to offset a foreign net payables
position.
a.
True
b.
False
7. If interest rate parity exists, financing with a foreign currency may still be feasible, but it would have to be conducted
on an uncovered basis (i.e., without use of a forward hedge).
a.
True
b.
False
8. Euronotes are unsecured debt securities whose interest rate is based on the London Interbank Offer Rate (LIBOR) with
typical maturities of one, three, and six months.
a.
True
b.
False
9. A large firm may finance in a foreign currency to offset a net payable position in that foreign country.
a.
True
b.
False
10. If all currencies in a financing portfolio are not correlated with each other, financing with such a portfolio would not
be very different from financing with a single foreign currency.
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a.
True
b.
False
11. When a U.S. firm borrows a foreign currency that is at a fixed exchange rate and has the same interest rate as the U.S.
interest rate, the effective financing rate should be the same as if it borrowed dollars.
a.
True
b.
False
12. Firms that believe the forward rate is an unbiased predictor of the future spot rate will prefer borrowing the foreign
currency.
a.
True
b.
False
13. An MNC’s parent or subsidiary in need for funds commonly determines whether there are any available internal funds
before searching for outside funding.
a.
True
b.
False
Indicate the answer choice that best completes the statement or answers the question.
14. Assume that the U.S. interest rate is 11 percent while the interest rate on the euro is 7 percent. If a U.S. firm borrows
euros, the euro would have to ____ against the dollar by ____ in order to have the same effective financing rate as
borrowing dollars.
a.
depreciate; about 3.74 percent
b.
appreciate; about 3.74 percent
c.
appreciate; about 4.53 percent
d.
depreciate; about 4.53 percent
15. A firm forecasts the euro’s value as follows for the next year:
Possible
Percentage Change
Probability
−2%
10%
3%
50%
6%
40%
The annual interest rate on the euro is 7 percent. The expected value of the effective financing rate from a U.S. firm’s
perspective is about:
a.
8.436 percent.
b.
10.959 percent.
c.
11.112 percent.
d.
11.541 percent.
16. Which of the following statements is false?
a.
If interest rate parity holds, foreign financing and a simultaneous hedge of that position in the forward market
will result in financing costs similar to those in domestic financing.
b.
If interest rate parity holds, and the forward rate is an accurate forecast of the future spot rate, uncovered
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foreign financing will result in financing costs similar to those in domestic financing.
c.
If interest rate parity holds, and the forward rate is expected to overestimate the future spot rate, uncovered
foreign financing is expected to result in lower financing costs than those in domestic financing.
d.
If interest rate parity holds, and the forward rate is expected to underestimate the future spot rate, uncovered
foreign financing is expected to result in lower financing costs than those in domestic financing.
17. If interest rate parity exists, and the forward rate is an accurate estimator of the future spot rate, the foreign financing
rate will be ____ the home financing rate.
a.
lower than
b.
greater than
c.
similar to
d.
None of these are correct.
18. Assume the U.S. one-year interest rate is 8 percent, and the British one-year interest rate is 6 percent. 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.
about 12.4 percent
b.
about 7.1 percent
c.
about 13.5 percent
d.
about 10.3 percent
e.
about 11.4 percent
19. Morton Company obtains a one-year loan of 2,000,000 Japanese yen at an interest rate of 6 percent. At the time the
loan is extended, the spot rate of the yen is $.005. If the spot rate of the yen at maturity of the loan is $.0035, what is the
effective financing rate of borrowing yen?
a.
37.8 percent
b.
51.43 percent
c.
−25.8 percent
d.
−6 percent
e.
None of these are correct.
20. If a U.S. firm needs dollars but borrows a foreign currency portfolio, the uncertainty of the portfolio’s effective
financing rate will be highest if the correlations between currencies in the portfolio are ____ and the individual volatility
of each currency is ____.
a.
high; low
b.
high; high
c.
low; low
d.
low; high
21. If interest rate parity does not hold and the forward premium exceeds the interest rate differential, foreign financing
with a simultaneous forward purchase of the currency borrowed will result in an effective financing rate that is:
a.
lower than the domestic interest rate.
b.
higher than the domestic interest rate.
c.
similar to the domestic interest rate.
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d.
highly variable.
22. Euronotes are underwritten by:
a.
European central banks.
b.
commercial banks.
c.
the International Monetary Fund.
d.
the Federal Reserve System.
23. If interest rate parity exists and the forward rate is expected to overestimate the future spot rate, then uncovered
foreign financing is expected to result in an effective financing rate that will be:
a.
similar to the U.S. financing rate.
b.
lower than the U.S. financing rate.
c.
higher than the U.S. financing rate.
d.
lower than the U.S. interest rate if the forward rate exhibits a discount and higher than the U.S. interest rate if
the forward rate exhibits a premium.
24. Assume the U.S. financing rate is 10 percent and that the financing rate in Germany is 9 percent. The expected cost of
financing in dollars and financing in euros next year would be the same if the euro is expected to:
a.
appreciate by 0.92 percent.
b.
depreciate by 0.92 percent.
c.
appreciate by 1.00 percent.
d.
depreciate by 1.00 percent.
25. A negative effective financing rate indicates that an MNC:
a.
paid only a small amount in interestover and above the amount borrowed.
b.
has been negatively affected by a large appreciation of the foreign currency.
c.
actually paid fewer dollars to repay the loan than it borrowed.
d.
would have been better off borrowing in the United States.
26. Assume that interest rate parity holds between the United States and Japan. The U.S. one-year interest rate is 7
percent, and Japan’s one-year interest rate is 6 percent. What is the approximate effective financing rate of a one-year loan
denominated in Japanese yen assuming that the MNC covered its exposure by purchasing yen one year forward?
a.
6 percent
b.
7 percent
c.
1 percent
d.
This question cannot be answered without more information.
27. A risk-averse firm would prefer to borrow ____ when the expected financing costs in a foreign country are similar to
the costs in the local country.
a.
locally
b.
in the foreign country
c.
locally OR in the foreign country
d.
part of the funds locally, and part from the foreign country
28. A negative effective financing rate for a U.S. firm indicates that the firm:
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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 these are correct.
29. Which of the following is not a source of external short-term financing for MNCs?
a.
Eurobonds
b.
Euro-commercial paper
c.
Euronotes
d.
ADRs
e.
Eurobands AND ADRs
30. A firm without any exposure to foreign exchange rates would likely increase this exposure the most by:
a.
borrowing domestically.
b.
borrowing a portfolio of foreign currencies that are not highly correlated.
c.
borrowing a portfolio of foreign currencies that are highly correlated.
d.
borrowing two foreign currencies that are negatively correlated.
31. Assume the annual British interest rate is above the annual U.S. interest rate. Also assume the pound’s forward rate of
$1.75 equals the pound’s spot rate. Given this information, interest rate parity ____ exist, and the U.S. firm ____ lock in a
lower financing cost by borrowing pounds for one year.
a.
does; could
b.
does; could not
c.
does not; could not
d.
does not; could
32. Assume that interest rates of most industrialized countries are similar to the U.S. interest rate. In the last few months,
the currencies of all industrialized countries weakened substantially against the U.S. dollar. If non-U.S. firms based in
these foreign countries financed with U.S. dollars during this period (even when they had no receivables in dollars), their
effective financing rate would have been:
a.
negative.
b.
zero.
c.
positive, but lower than the interest rate of their respective countries.
d.
higher than the interest rate of their respective countries.
33. Maston Corporation has forecasted the value of the Russian ruble as follows for the next year:
Percentage Change
Probability of Occurrence
−5%
20%
−3%
50%
1%
30%
If the Russian interest rate is 30 percent, the expected cost of financing a one-year loan in rubles is:
a.
27.14 percent.
b.
32.86 percent.
c.
26.10 percent.
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d.
None of these are correct.
34. Assume the U.S. one-year interest rate is 9 percent, while the Chilean one-year interest rate is 13 percent. If the
Chilean peso ____ by ____ percent, a U.S.-based MNC would incur the same financing cost in dollars as in Chilean pesos
over a one-year period.
a.
depreciates; 3.54
b.
appreciates; 3.54
c.
depreciates; 3.67
d.
appreciates; 3.67
35. Assume that the Swiss franc has an annual interest rate of 8 percent and is expected to depreciate by 6 percent against
the dollar. From a U.S. perspective, the effective financing rate from borrowing francs is:
a.
8 percent.
b.
14.48 percent.
c.
2 percent.
d.
1.52 percent.
36. Assume the U.S. interest rate is 7.5 percent, the New Zealand interest rate is 6.5 percent, the spot rate of the NZ$ is
$.52, and the one-year forward rate of the NZ$ is $.50. At the end of the year, the spot rate is $.48. Based on this
information, what is the effective financing rate for a U.S. firm that takes out a one-year, uncovered NZ$ loan?
a.
about −1.7 percent
b.
about 0.0 percent
c.
about 14.7 percent
d.
about 15.4 percent
e.
about 8.3 percent
37. The effective financing rate of financing in a foreign currency is directly determined by the ____ over the loan period
and the ____ over the loan period.
a.
interest rate of the domestic currency; percentage change in the value of the foreign currency
b.
interest rate of the foreign currency; percentage change in the value of the foreign currency
c.
interest rate of the foreign currency; percentage change in inflation
d.
interest rate of the domestic currency; percentage change in inflation
38. 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; appreciates
b.
foreign currency’s interest rate; depreciates
c.
domestic interest rate; depreciates
d.
domestic interest rate; appreciates
39. If interest rate parity does not hold, and the forward ____ is ____ the interest rate differential, then foreign financing
with a simultaneous hedge of that position in the forward market results in higher financing costs than those of domestic
financing.
a.
premium; higher than
b.
discount; higher than
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c.
premium; less than
d.
premium; higher than AND discount; higher than
Exhibit 20-1
Assume a U.S.-based MNC is borrowing Romanian leu at an interest rate of 8 percent 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.
40. Refer to Exhibit 20-1 above. What is the effective financing rate for the MNC assuming it borrows leu on an
uncovered basis?
a.
about 10 percent
b.
about −10 percent
c.
about −1 percent
d.
about −2 percent
e.
None of these are correct.
41. The interest rates on Euronotes are based on:
a.
the prime lending rate.
b.
the euro’s spot rate.
c.
the federal funds rate.
d.
LIBOR.
42. 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 percent. 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 the MNC needs $____ to
repay the loan.
a.
375,000; 449,400
b.
449,400; 375,000
c.
6,000,000; 5,357,143
d.
5,357,143; 6,000,000
43. Kushter, Inc. would like to finance in euros. European interest rates are currently 4 percent, and the euro is expected to
depreciate by 2 percent over the next year. What is Kushter’s effective financing rate next year?
a.
1.92 percent
b.
2.00 percent
c.
6.08 percent
d.
None of these are correct.
44. If Boston Co. has ____ in Canadian dollars, it could reduce its exposure to exchange rate risk by borrowing ____.
a.
payables; U.S. dollars
b.
receivables; U.S. dollars
c.
payables; Canadian dollars
d.
receivables; Canadian dollars
45. Which of the following is a scenario under which a U.S.-based MNC probably would not consider short-term foreign
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financing?
a.
Canadian dollars offer a lower interest rate than is available in the United States and are expected to appreciate
over the maturity of the loan.
b.
Australian dollars offer a lower interest rate than is available in the United States and are expected to
depreciate over the maturity of the loan.
c.
The MNC has net receivables in British pounds.
d.
Canadian dollars offer a lower interest rate than is available in the United States and are expected to appreciate
over the maturity of the loan AND the MNC has net receivables in British pounds.
e.
None of these are correct.
46. Countries with a ____ rate of inflation tend to have a ____ interest rate.
a.
high; low
b.
low; high
c.
high; high
d.
high; low AND low; high
Exhibit 20-1
Assume a U.S.-based MNC is borrowing Romanian leu at an interest rate of 8 percent 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.
47. Refer to Exhibit 20-1 above. What is the effective financing rate for the MNC assuming that it borrows leu on a
covered basis?
a.
10 percent
b.
−10 percent
c.
−1 percent
d.
1 percent
e.
None of these are correct.
48. If interest rate parity exists, the attempt to finance with a foreign currency while covering the position to avoid
exchange rate risk will result in an effective financing rate that is ____ the domestic interest rate.
a.
lower than
b.
greater than
c.
similar to
d.
None of these are correct.
49. MNCs may be able to lock in a lower cost by financing in a low-interest-rate foreign currency if they have:
a.
future cash inflows in that foreign currency.
b.
future cash outflows in that foreign currency.
c.
offsetting future cash inflows and outflows in that foreign currency.
d.
no other cash flows in that foreign currency.
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