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Discussion in the Board Room
This exercise is intended to apply many of the key concepts to broad issues that are discussed by
managers who make financial decisions. It does not replace the more detailed questions and problems at
the end of the chapter. Instead, it focuses on broad financial issues to facilitate class discussion and
simulate a board room discussion. It serves as a running case in which broad concepts from every chapter
are applied to the same business throughout the school term. The exercise not only enables you to apply
concepts to the real world, but also develops your intuitive and communication skills.
There are several alternative ways in which this exercise is used in a course.
1. Apply it on a chapter-by-chapter basis to ensure that the broad chapter concepts are understood before
moving to the next chapter.
2. Use it to encourage online discussion for courses taught online.
3. Use it as a review just before each exam, covering all chapters assigned for that exam.
4. Use it as a comprehensive case discussion near the end of the semester, as a means of reviewing the
key concepts that were described throughout the course.
5. Use it for presentations, in which individuals or teams present their views on the questions that were
assigned to them.
This exercise has been placed on the course web site so that students can download it, and insert their
answers after the questions. By the end of the course, the students will have applied all the major concepts
of the text to a single firm. The focus on a single firm will allow students to recognize how some of their
decisions about concepts covered in the earlier chapters interact with decisions to be made in later
chapters.
BACKGROUND
One of the best methods of learning broad concepts in this text is to put yourself in the place of an MNC
manager or board member, and apply the concepts to make financial decisions. Board members do not
normally make the decisions that are discussed here, but must have the conceptual skills to monitor the
policies that are implemented by the MNC’s managers. Thus, they must frequently ask themselves what
they would do if they were making the managerial decisions or setting corporate polices.
Consider the following business that you could easily create: a business that teaches individuals in a
non-U.S. country to speak English. While this business is very basic, it still requires the same type of
decisions faced by large MNCs. Assume that you initially establish this business in Mexico.
Details of Your Business. You live in the U.S. You invested $60,000 to establish a business of a language
school called EE (Escuela de Engles) in Mexico City, Mexico. You hire local individuals in Mexico who
can speak English and train others how to speak English. You have a small subsidiary in Mexico, which
has an office and an attached classroom that you lease. Clients can come to your subsidiary for a 1-month
structured course in English, taught by your employees. You advertise in the local newspapers to promote
the teaching services offered by your business.
You also serve some individuals from Mexico who have taken English classes and want to come to the
U.S. for a one-week intense course in which they can improve and practice their English and practice it.
All revenue and expenses associated with your business are denominated in Mexican pesos. Most of the
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International Cash Management 2
profits from the business in Mexico are sent to you by your subsidiary at the end of each month. While
your expenses are somewhat stable, your revenue varies with the number of clients who sign up for the
English-speaking courses in Mexico.
You only need to know this background so that you can answer the related questions that are asked about
your business throughout the term. Answer each question as if you were serving on the board of your
business or as a manager of the business. The questions in the early chapters force you to assess the
firm’s opportunities and exposure, while the later chapters force you to offer your input on potential
strategies that your business may pursue.
Chapter 1
a. Discuss the corporate control of your business. Explain why your business in Mexico is exposed
to agency problems.
b. How would you attempt to monitor the ongoing operations of the business?
c. Explain how you might be able to use a compensation plan that limits the potential agency
problems?
d. Assume that you have been approached by a competitor in Mexico to engage in a joint venture.
The competitor would offer the classroom facilities (so that you would not need to rent classroom
facilities), while your employees would provide the teaching. You would split the profits with this
business. Discuss how your potential return and your risk would change if you pursue the joint
venture.
e. Explain the conditions that would cause your business to be adversely affected by exchange rate
movements.
f. Explain how your business could be adversely affected by political risk.
ANSWER:
a. Agency problems could exist, because the employees of your business in Mexico may not make
c. You could compensate your employees according to the annual profits generated there. In this
d. Your cost is reduced. Your potential return is reduced because you are sharing your profits. Your
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International Cash Management 3
f. If any political situation causes friction between Mexico and the U.S., the demand for the service
Chapter 2
Your business provides CDs for free to customers who pay for the English courses that you offer in
Mexico. You consider the idea of mass production of the CDs in the U.S., so that you can sell (export)
them to distributors or to retail stores throughout Mexico. You would price the CDs in dollars when
exporting them. The CDs are not as effective without the teaching, but can be useful to individuals who
want to learn the basics of the English language.
a. If you pursue this idea, explain how the factors that affect international trade flows (identified in
Chapter 2) could affect the Mexican demand for your CDs. Which of these factors would likely
have the largest impact on the Mexican demand for your CDs? What other factors would affect
the Mexican demand for the CDs?
b. If you believe the Mexican government would impose a tariff on the CDs exported to Mexico,
how could you still execute this business idea at a relatively low cost while avoiding the tariff?
Describe any disadvantages of this idea that would avoid the tariff.
ANSWER:
a. The demand may be affected by local inflation in Mexico. If local inflation is high, any CDs on
learning English that are produced by local competitors may be subject to increased prices. This
The value of the Mexican peso may influence the demand for CDs. If the peso strengthens against
The exchange rate movements would likely have the largest effect. However, a large change in
any of the other factors could also have a large impact. While exchange rates may adjust in a
Beyond the factors listed in Chapter 2 of the text, another key factor is the general demand by
b. If you expect that the Mexican government will impose a significant tariff on the CDs, you could
still execute the business idea by setting up a licensing agreement with a firm in Mexico. That is,
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International Cash Management 4
Mexico may be able to produce and distribute the CDs in Mexico. Under these conditions, you
would probably price the CDs in pesos, which means that you would have more profits in pesos
that would be remitted to the U.S. parent and would be exposed to exchange rate risk. Yet, even if
the CDs were priced in dollars, you are exposed to risk because the demand for the CDs would
likely decline if the peso declined against the dollar.
Chapter 3
Assuming that the business in Mexico grows, explain how financial markets could help to finance the
growth of the business.
ANSWER:
The financial markets could provide short-term loans to cover short-term financing needs. They could
Chapter 4
Given the factors that affect the value of a foreign currency, describe the type of economic or other
conditions in Mexico that could cause the Mexican peso to weaken, and therefore to adversely affect your
business.
ANSWER:
Any factors that could cause the Mexican peso to weaken would cause concern, given that your business
Chapter 5
Explain how currency futures could be used to hedge your business in Mexico. Explain how currency
options could be used to hedge your business in Mexico.
ANSWER:
You could sell Mexican peso futures to hedge the expected monthly profits in Mexican pesos that would
Chapter 6
a. Explain how your business would likely be affected (at least in the short run) if the central bank
of Mexico intervened in the foreign exchange market by exchanging Mexican pesos for dollars in
the foreign exchange market.
b. Explain how your business would likely be affected if the central bank of Mexico used indirect
intervention by lowering Mexican interest rates (assume inflationary expectations have not
changed).
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International Cash Management 5
ANSWER:
a. This form of direct intervention places downward pressure on the peso, which would adversely
b. Lower interest rates would cause a reduced demand for interest-bearing securities denominated in
Chapter 7
Mexican interest rates are normally substantially higher than U.S. interest rates.
a. What does this imply about the forward premium or discount of the Mexican peso?
b. What does this imply about your business using the forward or futures contracts to hedge your
periodic profits in pesos that must be converted into dollars?
c. Do you think you would frequently hedge your exposure to Mexican pesos? Explain your answer.
ANSWER:
a. The forward rate will contain a discount, which means that the futures or forward contract will
b. When hedging with the forward rate, you are locking in an exchange rate that may be
c. Whether you think you would hedge frequently or not, you should recognize the tradeoff
involved. You either have to accept a large discount when hedging with a forward contract or you
Chapter 8
Mexican interest rates are normally substantially higher than U.S. interest rates.
a. What does this imply about the inflation differential (Mexico inflation minus U.S. inflation),
assuming that the peso interest rate is the same in both countries? Does this imply that the
Mexican peso will appreciate or depreciate? Explain.
b. It may be argued that the high Mexican interest rate should entice U.S. investors to invest in
Mexican money market securities, which could cause the peso to appreciate. Reconcile this
theory with your answer (a). If you believe that the high Mexican interest rate does not entice
U.S. investors, explain why.
c. Assume that the difference between Mexican and U.S. interest rates is typically attributed to a
difference in expected inflation in the two countries. Also assume that purchasing power parity
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International Cash Management 6
holds. Do you think that your business cash flows would be adversely affected? In reality,
purchasing power parity does not hold consistently. Assume that the inflation differential (Mexico
inflation minus U.S. inflation) is not fully offset by the exchange rate movement of the peso.
Would this benefit or hurt your business? Now assume that the inflation differential is more than
offset by the exchange rate movement of the peso. Would this benefit or hurt your business?
d. Assume that the nominal interest rate in Mexico is presently much higher than the interest rate in
the U.S., which is due to a high rate of expected inflation in Mexico. You consider implementing
a marketing campaign in which you would hire a local firm to promote your business, but you
would have to borrow funds to finance this campaign. A consultant advises you to delay the
marketing campaign for a year, so that you can capitalize on the high nominal interest rate in
Mexico. He suggests that you retain the profits that you would normally have remitted to the
U.S., and deposit them in a Mexican bank. The Mexican peso cash flows that your business
deposits will grow at a high rate of interest over the year. Should you follow the advice of the
consultant?
ANSWER:
a. A higher nominal interest rate in Mexico implies a higher level of expected inflation. According
b. The differential should be a positive number, meaning higher Mexican inflation.
If the inflation differential is not fully offset, the benefit to your cash flows from inflation is not
c. U.S. investors would only attempt to capitalize on the high Mexican interest rates if they believed
that they would earn a higher return than U.S. interest rates after accounting for the exchange rate
d The consultant is ignoring the fact that the high nominal interest rate reflects a high rate of
Chapter 9
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International Cash Management 7
a. Mexican interest rates are normally substantially higher than U.S. interest rates. What does this
imply about the forward rate as a forecast of the future spot rate?
b. Does the forward rate reflect a forecast of appreciation or depreciation of the Mexican peso?
Explain how the degree of the expected change implied by the forward rate forecast is tied to the
interest rate differential.
c. Do you think that today’s forward rate or today’s spot rate of the peso would be a better forecast
of the future spot rate of the peso.
ANSWER:
a. The forward rate contains a discount. Thus, if the forward rate is used to forecast the peso in the
b. The larger the interest rate differential, the larger is the forward rate discount, and the larger is the
c. The forward rate should be a better forecast because it captures the potential adverse effects of the
Chapter 10
Recall that your Mexican business invoices in Mexican pesos.
a. You are already aware that a decline in the value of the peso could reduce your dollar cash flows.
Yet, according to purchasing power parity, a weak peso should only occur in response to a high
level of Mexican inflation, and such high inflation should increase your profits. If this theory
holds precisely, your cash flows would not really be exposed. Should you be concerned about
your exposure, or not? Explain.
b. If you shift your invoicing policy to be only in dollars, how will your transaction exposure be
affected?
c. Why might the demand for your business change if you shift your invoice policy? What are the
implications for economic exposure?
ANSWER:
a. You should be concerned about your exposure, because you can not assume that the inflation rate
in Mexico would perfectly offset the depreciation of the Mexican peso. In addition, even if the
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International Cash Management 8
b. You are still subject to transaction exposure, but of a different type. Your business will now be
affected by exchange rate movements in the opposite direction. You would still have some cash
c. The demand for your business would likely be affected if you shift the invoice policy. If the peso
weakens, your clients would have to pay more pesos to obtain the dollars needed for your service.
Chapter 11
Mexican interest rates are normally substantially higher than U.S. interest rates.
a. Assuming that interest rate parity exists, do you think hedging with a forward rate would be
beneficial if the spot rate of the Mexican peso was expected to decline slightly over time?
b. Would hedging with a money market hedge be beneficial if the spot rate of the Mexican peso was
expected to decline slightly over time (assume zero transaction costs)? Explain.
c. What are some limitations on using currency futures or options that may make it difficult for you
to perfectly hedge against exchange rate risk over the next year or so.
d. In general, there is a lack of long-term currency futures and options on the Mexican pesos. A
consultant suggests that this is no problem because you can hedge your position a quarter at a
time. In other words, the profits that you remit at any point in the future can be hedged by taking
a currency futures or options position three months or so before that time. Thus, while the
consultant recognizes that the peso could weaken substantially in the long-term, he sees no reason
why you should worry about it as long as you continually create a short-term hedge. Do you
agree?
ANSWER:
a. Based on interest rate parity, the forward rate of the peso should have a large discount. Therefore,
b. Hedging with a money market hedge would involve borrowing pesos and converting the pesos
into dollars. The borrowing rate of the peso would be much higher than the investment rate in
c. Currency futures of options may not be available in the size that fits the profit that you wish to
d. The consultant is wrong. If the peso depreciates substantially over time, the amount of dollars that
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International Cash Management 9
Chapter 12
a. Explain how your business is subject to translation exposure.
b. How could you hedge against this translation exposure?
c. Is it worthwhile for your business to hedge the translation exposure?
ANSWER:
a. The profits earned by your business in Mexico must be translated into dollars for reporting
b. You could hedge this translation exposure by selling forward or futures contracts on pesos. If the
c. Since you have a small business, and do not have to worry about satisfying shareholders, you
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