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251
© Pearson Education Limited 2008
International Financial Management
Where profit is, loss is hidden nearby.
JAPANESE PROVERB
Chapter 24: International Financial Management
252
© Pearson Education Limited 2008
ANSWERS TO QUESTIONS
1. A number of environmental factors make the international investment different from a
domestic investment, not in principle, but in fact. Such things as taxes, accounting
2. A joint venture gives the company a partner in the foreign country. The relationship is
usually beneficial in reducing political risk. Also, the foreign nationals better understand the
3. The wisdom of particular restrictions placed on multinationals by the various countries
4. It depends on the relative tax rates. If the foreign branch is taxed at a rate equal to or lower
However, if the foreign branch pays taxes at a higher rate, the US parent receives a tax
5. The three types of risk exposure to changes in exchange rates between two countries are as
follows: (i) translation exposure; (ii) transactions exposure; and (iii) economic exposure.
The first is the change in accounting statements caused by a change in the exchange rates.
6. The “functional currency” determines the translation process. With a local currency, all
assets and liabilities are translated at the current rate of exchange. Such translation gains or
losses do not appear in the income statement, only in the owners’ equity account. With the
7. Natural hedges exist when profit margins, in dollars, tend to be maintained regardless of
exchange-rate movements. The key is the relationship between revenues (prices) and costs
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When one is globally determined and the other domestically determined, there is exchange-
risk exposure.
It is important to determine whether a natural hedge exists before engaging in other types of
hedges. If an operation has little exposure because of a natural hedge, the use of a financing
8. With a
forward discount, the foreign currency’s forward price is less than its spot price. If
the forward price exceeds the spot price, there is a forward premium. The Canadian dollar
9. A
forward contract is a “two-sided” hedge, used to offset movements in the spot market for
a foreign currency. The contract involves the exchange of one currency for another at a
A currency option is a “one-sided” hedge, where one protects against adverse currency
movements. The holder has the right, but not the obligation, to buy (call) or sell (put) a
10. In theory, purchasing-power parity should hold. This theory simply says that product
markets should equilibrate internationally, so that standardized goods sell at the same price
11. The interest-rate parity theorem implies an equality between the forward and spot rate ratio
and the ratio of interest rates for two countries. It is depicted by Equation (24.1) in the
12. A degree of self-insurance is usually worthwhile. The larger the company, usually the
greater the degree of self-insurance. Because of imperfections and incompleteness in
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13. A Eurodollar is a US dollar on deposit in a bank outside the US, generally in Europe. The
14. The bill of lading serves as a receipt from the transporter to the exporter that certain goods
15. In an import letter of credit, the importer is the borrower. Technically, the exporter is the
16. The creditworthiness of the bankers’ acceptance is as good as that of the bank that accepts
17. Differences in credit information, communications, slower transportation, and complications
SOLUTIONS TO PROBLEMS
1. a. $100 × 0.62 = 62 Britland ounces
b. 50 / 1.90 = $26.32
2. a. (100,000 – 2,000) × $0.55 = $53,900
c. Time value of money component:
Protection from devaluation component:
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition, Instructor’s Manual
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3. a.
End of Year(s) 0 1-3 4-6 7-6 10-19
Expected cash flow
NPV at 16% of dollar cash flows shown above = –$0.66 million. Therefore, the project is
not acceptable.
b.
End of Year(s) 0 1–3 4–6 7–9 10–19
Expected cash flow
NPV at 16% of dollar cash flows shown above = $0.51 million. With the guildnote
appreciating relative to the US dollar, dollar cash flows are greater. The project is now
acceptable, but not by a wide margin.
4. The Trance franc (TFr) strengthening by 5 percent means an exchange rate of 5.70 × 0.95 =
5.415 Trance francs to the dollar.
Transaction loss –TFr 35,340
The Trance franc weakening by 5 percent means an exchange rate of 5.70 × 1.05 = 5.985
Trance francs to the dollar.
5. The US dollar cost to purchase one bushel of Canadian Wheat = Can. $4.56 × (1/1.2) =
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6. a. Fyen/Syen = (1 + ryen)/(1 + r$)
b. Fyen / 140 = (1 + (0.04/4)) / (1 + (0.06 / 4)) = 1.01 / 1.015
The implied forward exchange rate is higher.
7. Foreign taxes:
The company would be able to obtain a tax credit for the full $70,000 paid in Swiss taxes.
However, it would be able to obtain a tax credit of only 0.38 × $200,000 = $76,000 for the
Algerian taxes paid, because the Algerian rate exceeds the US rate. Total tax credits =
$70,000 + $76,000 = $146,000.
US taxes:
8. a. Principal and interest payment due in yen (¥) with annual compounding at 10 percent
interest:
b. Principal and interest payment due in dollars with annual compounding at 13 percent
interest:
c. Tsunami will be better off, as it makes a dollar equivalent loan of $500,000 and receives
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9. The approximate expected internal rate of return for the investment in the copper mining
venture is:
IRR Probability
–100% × 0.10 = –10.0%
As the 4.4 percent return is less than the going rate on a risk-free investment such as
It is important to point out that for multi-period investments, the expected value of
SOLUTIONS TO SELF-CORRECTION PROBLEMS
1. a. $1,000 / 0.100 = 10,000 lisos
b. 30
× $1.500 = $45
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2.
IN DOLLARS 12/31/X2
Guildnote
Functional
Currency
Dollar
Functional
Currency
Balance Sheet
Cash $ 160 $ 160
Current liabilities $ 760 $ 760
Income Statement
Sales $3,782 $3,782
Operating income $ 165 $ 260
Translation gain 128
When the guildnote is used as the functional currency, all balance sheet items except
common stock and retained earnings are translated at the current exchange rate of 2.50. All
income statement items are translated at the average exchange rate of 2.75 for the year,
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3. a. It would hedge by selling marks forward 90 days. Upon delivery of 50,000 marks in
b. The mark is at a forward premium because the 90-day forward rate of marks per dollar
c. [(1.70 – 1.71)/1.71] × [365 days/90 days] = rM – r$ = –0.0237
