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CHAPTER 20 B-1
CHAPTER 20
INTERNATIONAL CORPORATE
FINANCE
Answers to Concept Questions
1. a. The dollar is selling at a premium because it is more expensive in the forward market than in the
b. The franc is expected to depreciate relative to the dollar because it will take more francs to buy
c. Inflation in Switzerland is higher than in the United States, as are nominal interest rates.
2. The exchange rate will increase, as it will take progressively more pesos to purchase a dollar. This is
the relative PPP relationship.
3. a. The Australian dollar is expected to weaken relative to the dollar, because it will take more A$
in the future to buy one dollar than it does today.
b. The inflation rate in Australia is higher.
c. Nominal interest rates in Australia are higher; relative real rates in the two countries are the same.
4. A Yankee bond is most accurately described by d.
5. Neither. For example, if a country’s currency strengthens, imports become cheaper (good), but its
exports become more expensive for others to buy (bad). The reverse is true for currency depreciation.
transportation, significantly lower wages, and less exposure to exchange rate risk. Disadvantages
include political risk and costs of supervising distant operations.
it may be that the owners of the multinational are primarily domestic and are ultimately concerned
about their wealth denominated in their home currency because, unlike a multinational, they are not
internationally diversified.
of goods that one dollar can buy; the pound will depreciate relative to the dollar.
b. False. The forward market would already reflect the projected deterioration of the euro relative
to the dollar. Only if you feel that there might be additional, unanticipated weakening of the euro
CHAPTER 20 B-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.
American importers: their situation in general worsens because the purchase of the imported
goods for a fixed number of euros will cost more in dollars.
result in a strengthened pound.
American importers: they would generally be worse off if the pound strengthens.
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
Brazilian sales, if fixed in reais, would become worth an unacceptably low number of dollars.
American importers: they would generally be much better off, because Brazilian goods will
10. IRP is the most likely to hold because it presents the easiest and least costly means to exploit any
arbitrage opportunities. Relative PPP is least likely to hold since it depends on the absence of market
imperfections and frictions in order to hold strictly.
whether the expectation is accurate. Assuming that the expectation is correct and that other traders do
not have the same information, there will be value to hedging the currency exposure.
provides direct diversification that shareholders could not attain by investing on their own. Another
reason could be if the political climate in the foreign country was more stable than in the home country.
Increased political risk can also be a reason you might prefer the home subsidiary investment.
Indonesia can serve as a great example of political risk. If it cannot be diversified away, investing in
13. Yes, the firm should undertake the foreign investment. If, after taking into consideration all risks, a
project in a foreign country has a positive NPV, the firm should undertake it. Note that in practice, the
stated assumption (that the adjustment to the discount rate has taken into consideration all political
and diversification issues) is a huge task. But once that has been addressed, the net present value
principle holds for foreign operations, just as for domestic.
foreign cash flow is remitted to the U.S. This problem could be overcome by selling forward contracts.
Another way of overcoming this problem would be to borrow in the country where the project is
located.
15. False. If the financial markets are perfectly competitive, the difference between the Eurodollar rate
and the U.S. rate will be due to differences in risk and government regulation. Therefore, speculating
in those markets will not be beneficial.
16. The difference between a Eurobond and a foreign bond is that the foreign bond is denominated in the
bonds because of registration differences. Eurobonds are unregistered securities.
Solutions to Questions and Problems
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(€.8031/$1) = €80.31
b. $1.2452
c. €5M($1.2452/€) = $6,226,000
d. New Zealand dollar
g. The most valuable is the Kuwait dinar. The least valuable is the Vietnam dong.
(£100)($1.5649/£1) = $156.49
b. You would still prefer £100. Using the $/£ exchange rate and the SF/$ exchange rate to find the
(£100)($1.5649/£1)(SF.9655) = SF 151.0911
The £/SF exchange rate is the inverse of the SF/£ exchange rate, so:
c. The value of the dollar will fall relative to the yen, since it takes more dollars to buy one yen in
take less dollars to buy one pound in the future than it does today.
(Can$1)/(Can$1.09/$1) = $.9174
d. The Canadian dollar is expected to depreciate in value relative to the dollar, because it takes more
Canadian dollars to buy one U.S. dollar in the future than it does today.
e. Interest rates in Canada are probably higher than they are in the United States.
5. a. The cross rate in ¥/£ terms is:
(¥115/$1)($1.54/£1) = ¥177.10/£1
b. The yen is quoted too low relative to the pound. Take out a loan for $1 and buy ¥115. Use the
¥115(£1/¥175) = £.6571
Use the pounds to buy back dollars and repay the loan. The cost to repay the loan will be:
is:
RFC = (FT – S0)/S0 + RUS
Using this relationship, we find:
CHAPTER 20 B-5
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:
($30,000,000)(£.6431/$1)(1.0039)3/(£.6439/$1) = $30,314,660.02
Ft = S0 × [1 + (hFC – hUS)]t
We find:
Z3.64 = Z3.37[1 + (hFC – hUS)]3
hFC – hUS = (Z3.64/Z3.37)1/3 – 1
exchange rates stay the same, the profit will be:
Profit = 30,000[$121 – {(S$147.80)/(S$1.3043/$1)}]
Profit = $230,475.35
If the exchange rate rises, we must adjust the cost by the increased exchange rate, so:
Profit = 30,000[$121 – {(S$147.80)/1.1(S$1.3043/$1)}]
Profit = $539,523.05
CHAPTER 20 B-6
F180 = (Kr 6.95)[1 + (.057 – .038)]1/2
F180 = Kr 7.0157
Since given F180 is Kr7.03, 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 7.03. Convert the
loan proceeds into dollars:
Kr 1 ($1/Kr 6.95) = $.14388
Invest these dollars at 3.8%, ending up with $.14656. Convert the dollars back into krone as
$.14656(Kr 7.03/$1) = Kr 1.03029
F180 = (Kr 6.95)[1 + (.057 – .038)]1/2
F180 = Kr 7.0157
RUS – hUS = RFC – hFC
hFC = RFC + hUS – RUS
a. hAUS = .025 + .025 – .033
hAUS = .017, or 1.7%
b. hCAN = .039 + .025 – .033
c. hTAI = .054 + .025 – .033
12. a. The yen is expected to get stronger, since it will take fewer yen to buy one dollar in the future
b. hUS – hJAP (¥119.18 – ¥119.32)/¥119.32
hUS – hJAP = –.0012, or –.12%
Ft = S0 × [1 + (RFC – RUS)]t
Using this relationship, we find the exchange rate in one year should be:
F1 = 243[1 + (.0219 – .0163)]1
F1 = HUF 244.36
F2 = 243[1 + (.0219 – .0163)]2
F2 = HUF 245.73
14. First, we need to forecast the future spot rate for each of the next three years. From uncovered interest
rate parity, the expected exchange rate is:
E(St) = S0[1 + (RFC – RUS)]t
So:
E(S1) = $.79/€[1 + (.0230 – .0310)]1 = $.7837/€
E(S2) = $.79/€[1 + (.0230 – .0310)]2 = $.7774/€
E(S3) = $.79/€[1 + (.0230 – .0310)]3 = $.7712/€
Year 0 cash flow = –€12,200,000($.79/€) = –$9,638,000.00
Year 1 cash flow = €2,700,000($.7837/€) = $2,115,936.00
Year 2 cash flow = €2,900,000($.7774/€) = $2,254,490.62
rate.
equation is:
E(St) = (Fr .94)[1 + (.06 – .05)]t
CHAPTER 20 B-8
E(St) = .94(1.01)t
So, the cash flows each year in U.S. dollar terms will be:
t Fr E(St) US$
0 –21,000,000 .9400 –$22,340,425.53
1 6,100,000 .9494 $6,425,110.60
2 6,100,000 .9589 $6,361,495.64
3 6,100,000 .9685 $6,298,510.53
4 6,100,000 .9782 $6,236,149.04
5 6,100,000 .9879 $6,174,404.99
And the NPV is:
NPV = –$22,340,425.53 + $6,425,110.60/1.12 + $6,361,495.64/1.122 + $6,298,510.53/1.123 +
$6,236,149.04/1.124 + $6,174,404.99/1.125
NPV = $417,489.79
RFr = 1.12[1 + (.06 – .05)] – 1
RFr = .1312, or 13.12%
So, the NPV in Swiss francs is:
NPV = (Fr 392,440.40)($1/Fr .94)
NPV = $417,489.79
16. a. To construct the balance sheet in dollars, we need to convert the account balances to dollars. At
Assets = solaris 35,000/($/solaris 1.20) = $29,166.67
Debt = solaris 12,000/($/solaris 1.20) = $10,000
Equity = solaris 23,000/($/solaris 1.20) = $19,166.67
Debt = solaris 12,000/($/solaris 1.40) = $8,571.43
Equity = solaris 23,000/($/solaris 1.40) = $16,428.57
c. If the exchange rate is solaris 1.15/$, the accounts will be:
CHAPTER 20 B-9
Debt = solaris 12,000/($/solaris 1.15) = $10,434.78
Equity = solaris 23,000/($/solaris 1.15) = $20,000
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)
Liabilities
Sol 12,000.00
Equity
25,100.00
Assets
Sol 37,100.00
Total liabilities & equity
Sol 37,100.00
1 + rUS = (1 + RUS)/(1 + hUS)
E[St] = Ft = S0[(1 + RFC)/(1 + RUS)]t
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 +
{€.9M/[1.0193(€.5/$1)]}/1.13
CHAPTER 20 B-10
NPV = $316,230.72
For the foreign currency approach, we first find the return in the euros as:
RFC = 1.10(1.07/1.05) – 1 = .121
