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Answers to End of Chapter Questions
1. International Cash Management. Discuss the general functions involved in international cash
management. Explain how the MNC’s optimization of cash flow can distort the profits of each
subsidiary.
ANSWER: The general functions of international cash management are optimizing cash flows and
When subsidiaries adjust their cash transactions between each other to reduce taxes or financing
costs, their individual performances are distorted. For example, a subsidiary that makes a late
2. Netting. Explain the benefits of netting. How can a centralized cash management system be
beneficial to the MNC?
ANSWER: Netting is a centralized compilation of inter-subsidiary cash flows. It is designed to
A centralized cash management system is beneficial in that it allows for netting, which can reduce
3. Leading and Lagging. How can an MNC implement leading and lagging techniques to help
subsidiaries in need of funds?
ANSWER: A subsidiary in need of funds would receive cash inflows from another subsidiary sooner
4. International Fisher Effect. If a U.S. firm believes that the international Fisher effect holds, what
are the implications regarding a strategy of continually attempting to generate high returns from
investing in currencies with high interest rates?
ANSWER: High interest rate currencies will typically depreciate to offset their interest rate
5. Investing Strategy. Tallahassee Co. has $2 million in excess cash that it has invested in Mexico at an
annual interest rate of 60 percent. The U.S. interest rate is 9 percent. By how much would the
Mexican peso have to depreciate to cause such a strategy to backfire?
1 + 9%
1 + 60% -1 = - 31.875%
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International Cash Management 2
ANSWER: If the peso depreciates by more than 31.875 percent, the effective yield on the Mexican
6. Investing Strategy. Why would a U.S. firm consider investing short-term funds in euros even when it
does not have any future cash outflows in euros?
ANSWER: The interest rate on the euro may be higher, or the euro may have a high probability of
7. Covered Interest Arbitrage. Evansville, Inc. has $2 million in cash available for 90 days. It is
considering the use of covered interest arbitrage, since the euro’s 90-day interest rate is higher than
the U.S. interest rate. What will determine whether this strategy is feasible?
ANSWER: If interest rate parity exists, then the forward rate of the euro contains a discount that
8. Effective Yield. Fort Collins, Inc. has $1 million in cash available for 30 days. It can earn 1% on a
30-day investment in the U.S. Alternatively, if it converts the dollars to Mexican pesos, it can earn 1
1/2% on a Mexican deposit. The spot rate of the Mexican peso is $.12. The spot rate 30 days from
now is expected to be $.10. Should Ft. Collins invest its cash in the U.S. or in Mexico? Substantiate
your answer.
ANSWER: If Fort Collins Inc. invests in a Mexican deposit, it will convert $1 million to 8,333,333
pesos, which will accumulate to 8,458,333 pesos after one month (due to the 1 1/2% interest rate). If
9. Effective Yield. Rollins, Inc., has $3 million in cash available for 180 days. It can earn 7% on a U.S.
Treasury bill or 9% on a British Treasury bill. The British investment does require conversion of
dollars to British pounds. Assume that interest rate parity holds and that Rollins believes the 180-day
forward rate is a reliable predictor of the spot rate to be realized 180 days from now. Would the
British investment provide an effective yield that is below, above, or equal to the yield on the U.S.
investment? Explain your answer.
ANSWER: If the forward rate is an accurate forecast of the future spot rate, then the return on a
10. Effective Yield. Repeat question 9, but this time assume that Rollins, Inc., expects the 180-day
forward rate of the pound to substantially overestimate the spot rate to be realized in 180 days.
ANSWER: In this case, the future spot rate will be less than the forward rate. If it was equal to the
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International Cash Management 3
11. Effective Yield. Repeat question 9, but this time assume that Rollins, Inc., expects the 180-day
forward rate of the pound to substantially underestimate the spot rate to be realized in 180 days.
ANSWER: In this case, Rollins Inc. will receive more when converting the pounds back to dollars
12. Effective Yield. Assume that the one-year U.S. interest rate is 10% and the one-year Canadian
interest rate is 13%. If a U.S. firm invests its funds in Canada, by what percentage will the Canadian
dollar have to depreciate to make its effective yield the same as the U.S. interest rate from the U.S.
firm’s perspective?
ANSWER:
13. Investing in a Currency Portfolio. Why would a firm consider investing in a portfolio of foreign
currencies instead of just a single foreign currency?
ANSWER: A portfolio of currencies reduces the probability of the foreign investment backfiring due
14. Interest Rate Parity. Dallas Co. has determined that the interest rate on euros is 16 percent while the
U.S. interest rate is 11 percent for one-year Treasury bills. The one-year forward rate of the euro has
a discount of 7 percent. Does interest rate parity exist? Can Dallas achieve a higher effective yield
by using covered interest arbitrage than by investing in U.S. Treasury bills? Explain.
ANSWER: If interest rate parity (IRP) existed, the forward rate of the euro should have a discount
reflecting the interest rate differential:
15. Diversified Investments. Hofstra, Inc., has no European business and has cash invested in six
European countries, each of which uses the euro as its local currency. Are Hofstra’s short-term
investments well diversified and subject to a low degree of exchange rate risk? Explain.
ANSWER: The short-term investments are not well diversified, because the entire portfolio of
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International Cash Management 4
16. Investing Strategy. Should McNeese Co. consider investing funds in Latin America countries where
it may expand facilities? The interest rates are high and the proceeds from the investment could be
used to help support the investment. When would this strategy backfire?
ANSWER: McNeese could benefit from investing at a high interest rate. However, this strategy could
17. Impact of September 11. Palos Co. commonly invests some of its excess dollars in foreign
government short-term securities in order to earn a higher short-term interest rate on its cash.
Describe how the potential return and risk of this strategy may have changed after the September 11,
2001 terrorist attack on the U.S.
ANSWER: The attack on the U.S. caused short-term interest rates in the U.S. to decline, which made
Advanced Questions
18. Investing in a Portfolio. Pittsburgh Co. plans to invest its excess cash in Mexican pesos for one
year. The one-year Mexican interest rate is 19%. The probability of the peso’s percentage change in
value during the next year is shown below:
Possible Rate of Change
in the Mexican Peso Over Probability of
the Life of the Investment Occurrence
–15% 20%
–4% 50%
0% 30%
What is the expected value of the effective yield based on this information? Given that the U.S.
interest rate for one year is 7%, what is the probability that a one-year investment in pesos will
generate a lower effective yield than could be generated if Pittsburgh Co. simply invested
domestically?
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International Cash Management 5
ANSWER:
Effective Yield if this
Possible Rate of Rate of Change in the
Change in Peso Probability Peso Does Occur
–15% 20% (1.19) [1 + (–15%)] – 1 =1.15%
19. Effective Yield of Portfolio. Ithaca Co. considers placing 30% of its excess funds in a one-year
Singapore dollar deposit and the remaining 70% of its funds in a one-year Canadian dollar deposit.
The Singapore one-year interest rate is 15%, while the Canadian one-year interest rate is 13%. The
possible percentage changes in the two currencies for the next year are forecasted as follows:
Possible % Change in Probability of that
the Spot Rate Over Change in the Spot
Currency the Investment Horizon Rate Occurring
Singapore dollar –2% 20%
Singapore dollar 1% 60%
Singapore dollar 3% 20%
Canadian dollar 1% 50%
Canadian dollar 4% 40%
Canadian dollar 6% 10%
Given this information, determine the possible effective yields of the portfolio and the probability
associated with each possible portfolio yield. Given a one-year U.S. interest rate of 8%, what is the
probability that the portfolio’s effective yield will be lower than the yield achieved from investing in
the U.S.? (See Appendix 21.)
ANSWER:
Possible % Change Effective Yield Based on the
in the Singapore Dollar % Change in the Singapore Dollar
–2% (1.15) [1 + (–2%)] – 1 =12.7%
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International Cash Management 6
Possible % Change in Effective Yield Based on the
the Canadian Dollar % Change in the Canadian Dollar
1% (1.13) [1 + (1%)] – 1 =14.13%
Solution to Continuing Case Problem: Blades, Inc.
1. There is a tradeoff between the higher interest rates in Thailand and the delayed conversion of baht
into dollars. Explain what this means.
ANSWER: If the net baht-denominated cash flows are converted into dollars today, Blades is not
2. If the net baht received from the Thailand subsidiary are invested in Thailand, how will U.S.
operations be affected?
ANSWER: If the cash flows generated in Thailand are invested in Thailand, then Blades will have to
borrow additional funds in the U.S. at an interest rate of 10 percent in order to support its U.S.
3. Construct a spreadsheet that compares the cash flows resulting from two plans. Under the first plan,
net baht-denominated cash flows (received today) will be invested in Thailand at 15 percent for a
one-year period, after which the baht will be converted to dollars. Under the second plan, net
baht-denominated cash flows are converted to dollars immediately and 60 percent of the funds will be
used to support U.S. operations, while 40 percent are invested in the U.S. for one year at 8 percent.
Which plan is superior given the expectation of the baht’s value in one year?
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International Cash Management 7
ANSWER: (See spreadsheet attached.) The cash flow generated in one year if the funds are invested
in Thailand exceed the cash flows generated if the funds are remitted back to the U.S. today and
Plan 1—Invest Funds in Thailand
Calculation of baht-denominated revenues:
Repayment of baht-denominated loan:
Principal THB 420,000,000
Calculation of interest on U.S. dollar loan needed to support U.S. operations:
Dollar receipts if baht were remitted now:
Calculation of dollar receipts due to conversion of baht into dollars in one year:
Plan 2—Convert Funds Immediately
Calculation of baht-denominated revenues:
Repayment of baht-denominated loan:
Calculation of dollar receipts due to conversion of baht into dollars:
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International Cash Management 8
Calculation of dollar difference between the two plans:
Plan 1 $ 3,596,198
Plan 2 3,594,456
Solution to Supplemental Case: Islander Corporation
a. By using a spreadsheet format, the percentage changes in exchange rates can be easily computed for
each scenario. Using these percentage changes along with the interest rates, the effective yield can be
computed for each currency under each scenario. The effective yields are provided below for each
scenario, along with the expected value of the effective yield (using the probabilities assigned to each
scenario):
Somewhat Expected Value
Strong $ Stable $ Weak $ of Effective
Currency Scenario Scenario Scenario Financ ing Rate
Australian dollar –0.56% 14.51% 28.07% 14.05%
Based on the expected values of effective yields for the currencies, the optimal composition of each
portfolio is disclosed in the following table:
Percentage of Funds Invested in:
Type of Portfolio A$ BP C$ JY US$
Risk neutral 100 0 0 0 0
The effective yields for each portfolio can be determined on the spreadsheet by creating a compute
statement that sums weighted effective yields based on the weights assigned above. These yields are
disclosed below:
Portfolio’s Effective
Yield Under a: Expected Value
Strong $ Stable $ Weak $ of Effective
Portfolio Scenario Scenario Scenario Financing Rate
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International Cash Management 9
Small Business Dilemma
Cash Management at the Sports Exports Company
1. If Logan invests the excess cash in U.S. Treasury bills, would this reduce the firm’s exposure to
exchange rate risk?
ANSWER: No. At the present time, the Sports Exports Company receives more pounds than it uses.
2. Logan decided to use the excess cash to pay off the British loan. However, a friend advised him to
invest the cash in British Treasury bills, stating that “the loan provides an offset to the pound
receivables, so you would be better off investing in British Treasury bills than paying off the loan.” Is
his friend correct? What should Logan do?
ANSWER: Jim’s friend is incorrect. By investing in British Treasury bills, Jim would not be any less
Part 5—Integrative Problem
Short-Term Asset and Liability Management
Kent Company is a large U.S. firm with no international business. It has two branches within the U.S., an
eastern branch and a western branch. Each branch presently makes investing or financing decisions
independently, as if it was a separate entity. The East branch has excess cash of $15 million to invest for
the next year. It can invest its funds in Treasury bills denominated in dollars or any of four foreign
currencies. The only restriction enforced by the parent is that a maximum of $5 million can be invested
or financed in any single foreign currency.
The western branch needs to borrow $15 million over one year to support its U.S. operations. It can
borrow funds in any of these same currencies (although any foreign funds borrowed need to be converted
to dollars to finance the U.S. operations). The only restriction enforced by the parent is that a maximum
equivalent of $5 million can be borrowed in any single currency.
A large bank serving the international money market has offered Kent Company the following terms:
Currency
Annual Interest
Rate on Deposits
Annual Interest Rate
Charged on Loans
U.S. dollar 6% 9%
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International Cash Management 10
Australian dollar 11 14
Kent Company has created one-year forecasts of each currency (shown below) that can be used by the
branches in making their investing or financing decisions:
Currency Spot Exchange Rate
Forecasted Annual
Percentage Change
in Exchange Rates
Australian dollar $.70 –4%
1. Determine the investment portfolio composition for Kent’s eastern branch that would maximize the
expected effective yield, while satisfying the restriction imposed by the parent.
When accounting for the interest rate and forecasted exchange rates, the expected effective yields are
listed below:
Currency
Expected Effective
Yield on Investment
U.S. dollar 6.00%
Australian dollar 6.56
Canadian dollar 4.86
New Zealand dollar 12.27
Japanese yen 8.00
ANSWER:
Given these expected effective yields, the investment should be allocated as follows:
2. What is the expected effective yield of the investment portfolio?
ANSWER: Based on 33.3% allocated to each of three currencies (NZ$, JY, A$), the portfolio’s
expected effective yield is:
3. Based on the expected effective yield for the portfolio and the initial investment amount of $15
million, determine the annual interest to be earned on the portfolio.
ANSWER: The expected interest earned is the portfolio’s expected effective yield times the initial
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International Cash Management 11
4. Determine the financing portfolio composition for Kent’s western branch that would minimize the
expected effective financing rate, while satisfying the restriction imposed by the parent.
When accounting for the interest rate and forecasted exchange rate, the expected effective financing
rates are listed below:
Currency
Expected Effective
Financing Rate
U.S. dollar 9.00%
Australian dollar 9.44
Canadian dollar 7.80
New Zealand dollar 15.36
Japanese yen 11.00
ANSWER:
Given these expected financing rates, the financing should be allocated as follows:
5. What is the expected effective financing rate of the total amount of funds borrowed?
ANSWER: Based on 33.3% financed with each of three currencies (C$, U.S.$, A$), the expected
financing rate for the entire portfolio of funds borrowed is:
6. Based on the expected effective financing rate for the portfolio and the total amount of $15 million
borrowed, determine the expected loan repayment amount beyond the principal borrowed.
ANSWER: The expected loan repayment amount beyond the principal borrowed is the portfolio’s
7. When the expected interest received by the eastern branch and paid by the western branch of Kent
Company are consolidated, what is the net amount of interest received?
ANSWER:
Net = Interest received – Interest paid
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International Cash Management 12
8. If the eastern branch and western branch worked together, the eastern branch could loan its $15
million to the western branch. Nevertheless, one could argue that the branches could not have taken
advantage of interest rate differentials or expected exchange rate effects among currencies. Given the
data provided in this example, would you have recommended that the two branches make their
short-term investment and financing decisions independently, or should the eastern branch lend its
excess cash to the western branch? Explain.
ANSWER: If one branch lends to another, the interest received by one branch will be exactly equal
However, there is much exchange rate risk involved in the investing and financing in foreign
currencies, especially when considering that $15 million was to be invested by one branch and
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