Answers to End of Chapter Questions
1. Motives for Investing in Foreign Money Markets. Explain why an MNC may invest funds in a
financial market outside its own country.
ANSWER: The MNC may be able to earn a higher interest rate on funds invested in a financial
2. Motives for Providing Credit in Foreign Markets. Explain why some financial institutions prefer to
provide credit in financial markets outside their own country.
ANSWER: Financial institutions may believe that they can earn a higher return by providing credit in
3. Exchange Rate Effects on Investing. Explain how the appreciation of the Australian dollar against
the U.S. dollar would affect the return to a U.S. firm that invested in an Australian money market
security.
ANSWER: If the Australian dollar appreciates over the investment period, this implies that the U.S.
4. Exchange Rate Effects on Borrowing. Explain how the appreciation of the Japanese yen against the
U.S. dollar would affect the return to a U.S. firm that borrowed Japanese yen and used the proceeds
for a U.S. project.
ANSWER: If the Japanese yen appreciates over the borrowing period, this implies that the U.S. firm
5. Bank Services. List some of the important characteristics of bank foreign exchange services that
MNCs should consider.
ANSWER: The important characteristics are (1) competitiveness of the quote, (2) the firm’s
6. Bid/ask Spread. Utah Bank’s bid price for Canadian dollars is $.7938 and its ask price is $.81. What
is the bid/ask percentage spread?
7. Bid/ask Spread. Compute the bid/ask percentage spread for Mexican peso retail transactions in
which the ask rate is $.11 and the bid rate is $.10.
8. Forward Contract. The Wolfpack Corporation is a U.S. exporter that invoices its exports to the
United Kingdom in British pounds. If it expects that the pound will appreciate against the dollar in
the future, should it hedge its exports with a forward contract? Explain.
ANSWER: The forward contract can hedge future receivables or payables in foreign currencies to
9. Euro. Explain the foreign exchange situation for countries that use the euro when they engage in
international trade among themselves.
10. Indirect Exchange Rate. If the direct exchange rate of the euro is $1.25, what is the euro’s indirect
exchange rate? That is, what is the value of a dollar in euros?
11. Cross Exchange Rate. Assume Poland’s currency (the zloty) is worth $.17 and the Japanese yen is
worth $.008. What is the cross rate of the zloty with respect to yen? That is, how many yen equal a
zloty?
ANSWER: $.17/$.008 = 21.25
12. Syndicated Loans. Explain how syndicated loans are used in international markets.
ANSWER: A large MNC may want to obtain a large loan that no single bank wants to accommodate
13. Loan Rates. Explain the process used by banks in the Eurocredit market to determine the rate to
charge on loans.
ANSWER: Banks set the loan rate based on the prevailing LIBOR, and allow the loan rate to float
14. International Markets. What is the function of the international money market? Briefly describe
the reasons for the development and growth of the European money market. Explain how the
international money, credit, and bond markets differ from one another.
ANSWER: The function of the international money market is to efficiently facilitate the flow of
The international money market focuses on short-term deposits and loans, while the international
15. Evolution of Floating Rates. Briefly describe the historical developments that led to floating
exchange rates as of 1973.
ANSWER: Country governments had difficulty in maintaining fixed exchange rates. In 1971, the
bands were widened. Yet, the difficulty of controlling exchange rates even within these wider bands
16. International Diversification. Explain how the Asian crisis would have affected the returns to a U.S.
firm investing in the Asian stock markets as a means of international diversification. [See the chapter
appendix.]
ANSWER: The returns to the U.S. firm would have been reduced substantially as a result of the Asian
17. Eurocredit Loans.
a. With regard to Eurocredit loans, who are the borrowers?
b. Why would a bank desire to participate in syndicated Eurocredit loans?
c. What is LIBOR and how is it used in the Eurocredit market?
ANSWER:
a. Large corporations and some government agencies commonly request Eurocredit loans.
b. With a Eurocredit loan, no single bank would be totally exposed to the risk that the borrower may
c. LIBOR (London interbank offer rate) is the rate of interest at which banks in Europe lend to each
18. Foreign Exchange. You just came back from Canada, where the Canadian dollar was worth $.70.
You still have C$200 from your trip and could exchange them for dollars at the airport, but the airport
foreign exchange desk will only buy them for $.60. Next week, you will be going to Mexico and will
need pesos. The airport foreign exchange desk will sell you pesos for $.10 per peso. You met a tourist
at the airport who is from Mexico and is on his way to Canada. He is willing to buy your C$200 for
1,300 pesos. Should you accept the offer or cash the Canadian dollars in at the airport? Explain.
ANSWER: Exchange with the tourist. If you exchange the C$ for pesos at the foreign exchange desk,
19. Foreign Stock Markets. Explain why firms may issue stock in foreign markets. Why might U.S.
firms issue more stock in Europe since the conversion to the euro in 1999?
ANSWER: Firms may issue stock in foreign markets when they are concerned that their home
20. Financing With Stock. Chapman Co. is a privately owned MNC in the U.S. that plans to engage
in an initial public offering (IPO) of stock, so that it can finance its international expansion. At the
present time, world stock market conditions are very weak but are expected to improve. The U.S.
market tends to be weak in periods when the other stock markets around the world are weak. A
financial manager of Chapman Co. recommends that it wait until the world stock markets recover
before it issues stock. Another manager believes that Chapman Co. could issue its stock now even if
the price would be low, since its stock price should rise later once world stock markets recover. Who
is correct? Explain.
ANSWER: Chapman Co. should wait until the world stock markets recover, and the U.S. stock
Advanced Questions
21. Effects of September 11. Why do you think the terrorist attack on the U.S. was expected to cause a
decline in U.S. interest rates? Given the expectations for a potential decline in U.S. interest rates and
stock prices, how were capital flows between the U.S. and other countries likely affected?
ANSWER: The attack was expected to cause a weaker economy, which would result in lower U.S.
22. International Financial Markets. Walmart established two retail outlets in the city of Shanzen,
China, which has a population of 3.7 million. These outlets are massive and contain imports in
a. Explain how the Walmart outlets in China would use the spot market in foreign exchange.
ANSWER: The Walmart stores in China need other currencies to buy products from other countries,
b. Explain how Walmart might utilize the international money market when it is establishing other
Walmart stores in Asia.
ANSWER: Walmart may need to maintain some deposits in the Eurocurrency market that can be
used (when needed) to support the growth of Walmart stores in various foreign markets. When some
c. Explain how Walmart could use the international bond market to finance the establishment of new
outlets in foreign markets.
ANSWER: Walmart could issue bonds in the Eurobond market to generate funds needed to establish
23. Interest Rates. Why do interest rates vary among countries? Why are interest rates normally similar
for those European countries that use the euro as their currency? Offer a reason why the government
interest rate of one country could be slightly higher than the government interest rate of another
country, even though the euro is the currency used in both countries.
ANSWER: Interest rates in each country are based on the supply of funds and demand for funds for a
given currency. However, the supply and demand conditions for the euro are dictated by all
24. Interpreting Exchange Rate Quotations. Today you notice the following exchange rate
quotations:
*$1 is equal to 3.00 Argentine pesos
*1 Argentine peso = 0.50 Canadian dollars
* You need to purchase 100,000 Canadian dollars with U.S. dollars. How many U.S. dollars will you
need for your purchase?
ANSWER: Value of AP = $.333
25. Pricing ADRs. Today, the stock price of Genevo Company (based in Switzerland) is priced at
SF80 per share. The spot rate of the Swiss franc (SF) is $.70. During the next year, you expect that the
stock price of Genevo Company will decline by 3%. You also expect that the Swiss franc will
depreciate against the U.S. dollar by 8% during the next year. You own American depository receipts
(ADRs) that represent Genevo stock. Each share that you own represents one share of the stock traded
on the Swiss stock exchange. What is the estimated value of the ADR per share in one year?
ANSWER: Expected value of Swiss stock in 1 year = SF80 x (1 – .03) = SF77.6.
26. Explaining Variation in Bid/Ask Spreads. Go to the currency converter at
http://finance.yahoo.com/currency and determine the bid/ask spread for the euro. Then
determine the bid/ask spread for a currency in a less developed country. Why do you think is the main
reason for the difference in the bid/ask spreads between these two currencies?
ANSWER: The percentage spread is estimated as:
(Ask quote – Bid quote)/Ask quote.
A key part of this question is to ensure that students can obtain bid and ask quotations.
27. Direct Versus Indirect Exchange Rates. Assume that during this semester, the euro appreciated
against the dollar. Did the direct exchange rate of the euro increase or decrease? Did the indirect
exchange rate of the euro increase or decrease?
ANSWER: The indirect exchange rate is the reciprocal of the direct exchange rate. Thus, as the euro
28. Transparency and Stock Trading Activity. Explain the relationship between transparency of
firms and investor participation (or trading activity) among stock markets. Based on this relationship,
how can governments of countries increase the amount of trading activity (and therefore liquidity) of
their stock markets?
ANSWER: In general, stock market participation and trading activity is higher in countries where
managers of firms are encouraged to make decisions that serve shareholder interests, and where there
29. How Governance Affects Stock Market Liquidity. Identify some of the key factors that can
allow for stronger governance and therefore increase participation and trading activity in a stock
market.
ANSWER: Governance is stronger when:
*shareholders have voting power,
30. International Impact of the Credit Crisis. Explain how the international integration of financial
markets caused the credit crisis to spread across many countries.
ANSWER: Since financial markets are integrated, they allow institutional investors in one country to
invest in securities in other countries. Thus, the problems in the U.S. and U.K. financial markets
31. Issuing Stock in Foreign Markets. Bloomington Co. is a large U.S.-based MNC with large
subsidiaries in Germany. It has issued stock in Germany in order to establish its business. It could
have issued stock in the U.S. and then used the proceeds in order to support the growth in Europe.
What is a possible advantage of issuing the stock in Germany to finance German operations? Also,
why might the German investors prefer to purchase the stock that was issued in Germany rather than
purchase the stock of Bloomington on a U.S. stock exchange?
ANSWER: By issuing stock in Germany, Bloomington can use the euro proceeds to support its
growth in Germany. It can establish a secondary market in Germany by listing the stock on an
32. Interest Rates Among Countries. As of today, the interest rate in Countries X, Y, and Z, are similar.
In the next month, Country X is expected to have a weak economy, while Countries Y and Z are
expected to experience a 6% increase in economic growth. However, conditions this month will also
cause an increase in default risk of borrowers in Country Z in the next month because of political
concerns, while the default risk of Countries X and Y remain unchanged. During the next month,
which country should have the highest interest rate? Which country should have the lowest interest
rate?
ANSWER: Country Z should have the highest interest rate because it will have strong economic
Solution to Continuing Case Problem: Blades, Inc.
1. One point of concern for you is that 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 operation are invested in Thailand, how will U.S.
operations be affected? (Assume that Blades is currently paying 10 percent on dollars borrowed, and
needs more financing for its firm.)
ANSWER: If the cash flows generated in Thailand are all used to support U.S. operations, then
Blades will have to borrow additional funds in the U.S. (or the international money market) at an
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. The expected spot rate for the baht
in one year is about $0.022 (Ben Holt’s plan). Under the second plan, net baht-denominated cash
flows are converted to dollars immediately and invested in the U.S. for one year at 8 percent. For this
question, assume that all baht-denominated cash flows are due today. Does Holt’s plan seem superior
in terms of dollar cash flows available after one year? Compare the choice of investing the funds
versus using the funds to provide needed financing to the firm.
ANSWER: (See spreadsheet attached.) If Blades can borrow funds at an interest rate below 8 percent,
it should invest the excess funds generated in Thailand at 8 percent and borrow funds at the lower
Plan 1–Ben Holt’s Plan
Calculation of baht-denominated revenue:
Calculation of baht-denominated cost of goods sold:
Calculation of dollar receipts due to conversion of baht into dollars:
Plan 2—Immediate Conversion
Calculation of baht-denominated revenue:
Calculation of baht-denominated cost of goods sold:
Calculation of dollar receipts due to conversion of baht into dollars:
Net baht-denominated cash flows to be converted (826,920,000 – 206,712,000) 620,208,000
Calculation of dollar difference between the two plans:
Thus, the cash flow generated in one year by Plan 1 exceed those generated by Plan 2 by approximately
$384,529. Therefore, Ben Holt’s plan should not be implemented.
Solution to Supplemental Case: Gretz Tool Company
a. Citicorp could facilitate the following financial transactions:
1. Foreign Exchange. Citicorp could provide whatever currency was needed by Gretz in the foreign
exchange market.
2. Short-Term Financing. Citicorp could provide short-term loans to Gretz in whatever currency is
desired through the international money market. (Citicorp would be the creditor here.) Citicorp
could also accept short-term deposits in various currencies through the international money
market.
3. Medium-Term Financing. Citicorp could provide medium-term loans to Gretz in whatever
currency is desired through the international credit market (Citicorp would be the creditor here).
4. Long-Term Financing. Citicorp could place bonds issued by Gretz in the international bond
market (Citicorp would normally serve as an intermediary rather than the creditor here). Citicorp
could also help Gretz place newly issued stock in foreign stock markets.
b. Normally, a subsidiary would prefer to borrow the currency that it uses to invoice its products. Thus,
the future cash inflows would be in the same currency that is needed to pay back the loan, and
exchange rate risk is avoided. Since the British subsidiary probably invoices its products in British
pounds, this is the logical currency to borrow.
However, the high interest rate on the British pound may cause the subsidiary to consider borrowing a
different currency. Yet, it must recognize the risk involved. The currency borrowed would initially
be converted to pounds. At a future point in time, pounds will be converted to that currency to repay
the loan. Thus, the risk is that the currency borrowed appreciates against the franc over the period of
concern. This concept is covered in detail in later chapters. At this point, the objective is to simply
make the student aware of the possible alternatives and the risk-return tradeoff involved.
Small Business Dilemma
Use of the Foreign Exchange Markets by the Sports Exports Company
1. Explain how the Sports Exports Company could utilize the spot market to facilitate the exchange of
currencies. Be specific.
ANSWER: The Sports Exports Company would have an account with a commercial bank. As it
2. Explain how the Sports Exports Company is exposed to exchange rate risk and how it could use the
forward market to hedge this risk.
ANSWER: The Sports Exports Company is exposed to exchange rate risk, because the value of the
The Sports Exports Company could engage in a forward contract in which it would sell pounds
forward in exchange for dollars. For example, if it anticipated receiving a payment in pounds 30 days