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CHAPTER 21
INTERNATIONAL CORPORATE
FINANCE
Answers to Concepts Review and Critical Thinking Questions
1. a. The dollar is selling at a premium because it is more expensive in the forward market than in
b. The franc is expected to depreciate relative to the dollar because it will take more francs to buy
2. The exchange rate will increase, as it will take progressively more pesos to purchase a dollar. This is
3. a. The Australian dollar is expected to weaken relative to the dollar, because it will take more A$
5. It depends. For example, if a country’s currency strengthens, imports become cheaper (good), but its
6. The main advantage is the avoidance of the tariff. Additional advantages include being closer to the
7. One key thing to remember is that dividend payments are made in the home currency. More
generally, it may be that the owners of the multinational are primarily domestic and are ultimately
8. a. False. If prices are rising faster in Great Britain, it will take more pounds to buy the same
b. False. The forward market would already reflect the projected deterioration of the euro relative
CHAPTER 21 - 2
9. a. American exporters: Their situation in general improves because a sale of the exported goods
for a fixed number of euros will be worth more dollars.
b. American exporters: They would generally be better off if the British government’s intentions
c. American exporters: They would generally be much worse off, because an extreme case of
fiscal expansion like this one will make American goods prohibitively expensive to buy, or else
10. IRP is the most likely to hold because it presents the easiest and least costly means to exploit any
Solutions to Questions and Problems
NOTE: All end of chapter problems were solved using a spreadsheet. Many problems require multiple
steps. Due to space and readability constraints, when these intermediate steps are included in this
solutions manual, rounding may appear to have occurred. However, the final answer for each problem is
found without rounding during any step in the problem.
Basic
1. Using the quotes from the table, we get:
a. $100(€.7210/$1) = €72.10
b. $1.3869
CHAPTER 21 - 3
2. a. You would prefer £100, since:
b. You would still prefer £100. Using the $/£ exchange rate and the SF/$ exchange rate to find the
amount of Swiss francs £100 will buy, we get:
c. Using the quotes in the book to find the SF/£ cross rate, we find:
The £/SF exchange rate is the inverse of the SF/£ exchange rate, so:
3. a. F180 = ¥102.21 (per $). The yen is selling at a premium because it is more expensive in the
b. F90 = $.9216/C$1. The Australian dollar is selling at a discount because it is less expensive in
c. The value of the dollar will fall relative to the yen, since it takes more dollars to buy one yen in
4. a. The U.S. dollar, since one Canadian dollar will buy:
b. The cost in U.S. dollars is:
Among the reasons that absolute PPP doesn’t hold are tariffs and other barriers to trade,
transaction costs, taxes, and different tastes.
c. The U.S. dollar is selling at a premium, because it is more expensive in the forward market than
d. The Canadian dollar is expected to depreciate in value relative to the dollar, because it takes
CHAPTER 21 - 4
5. a. The cross rate in ¥/£ terms is:
b. The yen is quoted too low relative to the pound. Take out a loan for $1 and buy £.5917. Use the
£.5917 to purchase yen at the cross-rate, which will give you:
Use the yen to buy back dollars and repay the loan. The cost to repay the loan will be one
dollar, so the profit is:
You arbitrage profit is $.0184 per dollar used.
6. We can rearrange the interest rate parity condition to answer this question. The equation we will use
is:
RFC = (Ft – S0)/S0 + RUS
Using this relationship, we find:
7. If we invest in the U.S. for the next three months, we will have:
If we invest in Great Britain, we must exchange the dollars today for pounds and exchange the
pounds for dollars in three months. After making these transactions, the dollar amount we would
have in three months would be:
The company should invest in the U.S.
8. Using the relative purchasing power parity equation:
We find:
Z3.06 = Z3.03[1 + (hFC – hUS)]3
CHAPTER 21 - 5
Inflation in Poland is expected to exceed that in the U.S. by .33% over this period.
9. The profit will be the quantity sold, times the sales price minus the cost of production. The
If the exchange rate rises, we must adjust the cost by the increased exchange rate, so:
If the exchange rate falls, we must adjust the cost by the decreased exchange rate, so:
To calculate the breakeven change in the exchange rate, we need to find the exchange rate that makes
the cost in Singapore dollars equal to the selling price in U.S. dollars, so:
This is a change of:
10. a. If IRP holds, then:
Since given F180 is Kr6.03, an arbitrage opportunity exists; the forward premium is too high.
Borrow Kr1 today at 5.7% interest. Agree to a 180-day forward contract at Kr 6.03. Convert the
loan proceeds into dollars:
Invest these dollars at 3.8%, ending up with $.17119. Convert the dollars back into krone as
CHAPTER 21 - 6
b. To find the forward rate that eliminates arbitrage, we use the interest rate parity condition, so:
11. The international Fisher effect states that the real interest rate across countries is equal. We can
rearrange the international Fisher effect as follows to answer this question:
RUS – hUS = RFC – hFC
hFC = RFC + hUS – RUS
a. hAUS = .04 + .031 – .037
b. hCAN = .07 + .031 – .037
c. hTAI = .09 + .031 – .037
12. a. The yen is expected to get stronger, since it will take fewer yen to buy one dollar in the future
than it does today.
b. hJAP – hUS (¥102.80 – ¥103.15) / ¥103.15
The approximate inflation differential between the U.S. and Japan is –1.35% annually, i.e., the
U.S. inflation is 1.35% greater.
13. We need to find the change in the exchange rate over time so we need to use the relative purchasing
power parity relationship:
E(St) = S0 × [1 + (hFC – hRUS)]t
Using this relationship, we find the exchange rate in one year should be:
The exchange rate in two years should be:
And the exchange rate in five years should be:
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Intermediate
14. First, we need to forecast the future spot rate for each of the next three years. From interest rate and
purchasing power parity, the expected exchange rate is:
E(ST) = [(1 + RUS) / (1 + RFC)]T S0
So:
E(S1) = (1.0230 / 1.0180)1 $1.36/€ = $1.3667/€
Now we can use these future spot rates to find the dollar cash flows. The dollar cash flow each year
will be:
Year 0 cash flow = –€$10,500,000($1.36/€) = –$14,280,000
And the NPV of the project will be:
15. a. Implicitly, it is assumed that interest rates won’t change over the life of the project, but the
b. We can use relative purchasing power parity to calculate the dollar cash flows at each time. The
equation is:
So, the cash flows each year in U.S. dollar terms will be:
tSF E[St] US$
0 –16.7M 1.0900 –$15,321,100.92
1 +4.7M 1.0791 $4,355,481.42
CHAPTER 21 - 8
And the NPV is:
c. Rearranging the relative purchasing power parity equation to find the required return in Swiss
francs, we get:
So the NPV in Swiss francs is:
Converting the NPV to dollars at the spot rate, we get the NPV in U.S. dollars as:
16. a. To construct the balance sheet in dollars, we need to convert the account balances to dollars. At
the current exchange rate, we get:
Assets = solaris 34,000($ / solaris 1.50) = $22,666.67
b. In one year, if the exchange rate is solaris 1.60/$, the accounts will be:
Assets = solaris 34,000($ / solaris 1.60) = $21,250
c. If the exchange rate is solaris 1.41/$, the accounts will be:
Assets = solaris 34,000($ / solaris 1.41) = $24,113.48
CHAPTER 21 - 9
Challenge
17. First, we need to construct the end of year balance sheet in solaris. Since the company has retained
earnings, the equity account will increase, which necessarily implies the assets will also increase by
the same amount. So, the balance sheet at the end of the year in solaris will be:
Balance Sheet (solaris)
Now we need to convert the balance sheet accounts to dollars, which gives us:
Assets = solaris 35,250($ / solaris 1.54) = $22,889.61
18. a. The domestic Fisher effect is:
This relationship must hold for any country, that is:
The international Fisher effect states that real rates are equal across countries, so:
b. The exact form of unbiased interest rate parity is:
c. The exact form for relative PPP is:
d. For the home currency approach, we calculate the expected currency spot rate at time t as:
We then convert the euro cash flows using this equation at every time, and find the present
value. Doing so, we find:
NPV = – [€2M / €.5] + {€.9M / [1.019(€.5)]} / 1.1 + {€.9M / [1.0192(€.5)]} / 1.12 +
CHAPTER 21 - 10
For the foreign currency approach we first find the return in the euros as:
Next, we find the NPV in euros as:
And finally, we convert the euros to dollars at the current exchange rate, which is:
