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Answers and Solutions: 17 - 1
Chapter 17
Multinational Financial Management
ANSWERS TO END-OF-CHAPTER QUESTIONS
17-1 a. A multinational corporation is one that operates in two or more countries.
b. The exchange rate specifies the number of units of a given currency that can be
purchased for one unit of another currency. The fixed exchange rate system was in
effect from the end of World War II until August 1971. Under the system, the U. S.
dollar was linked to gold at the rate of $35 per ounce, and other currencies were then
tied to the dollar. Under the floating exchange rate system, which is currently in
effect, the forces of supply and demand are allowed to determine currency prices with
little government intervention.
c. A country has a deficit trade balance when it imports more goods from abroad than it
d. Exchange rate risk refers to the fluctuation in exchange rates between currencies over
time. A convertible currency is one which can be traded in the currency markets and
can be redeemed at current market rates. When an exchange rate is pegged, the rate is
fixed against a major currency such as the U. S. dollar. Consequently, the values of
the pegged currencies move together over time.
e. Interest rate parity holds that investors should expect to earn the same return in all
Answers and Solutions: 17 - 2
g. Repatriation of earnings is the cash flow, usually in the form of dividends or royalties,
from the foreign branch or subsidiary to the parent company. These cash flows must
be converted to the currency of the parent, and thus are subject to future exchange
rate changes. A foreign government may restrict the amount of cash that may be
repatriated. Political risk refers to the possibility of expropriation and to the
unanticipated restriction of cash flows to the parent by a foreign government.
i. The Euro is a currency used by the nations in the European Monetary Union who
signed the Treaty of Maastricht.
17-2 The U. S. dollar. The primary reason for using the dollar was that it provided a relatively
stable benchmark, and it was accepted universally for transaction purposes.
1-5 There will be an excess supply of dollars in the foreign exchange markets, and thus, will
tend to drive down the value of the dollar. Foreign investments in the United States will
increase.
Answers and Solutions: 17 - 3
17-7 The foreign project’s cash flows have to be converted to U. S. dollars, since the
shareholders of the U. S. corporation (assuming they are mainly U. S. residents) are
17-8 A Eurodollar is a dollar deposit in a foreign bank, normally a European bank. The
foreign bank need not be owned by foreigners--it only has to be located in a foreign
country. For example, a Citibank subsidiary in Paris accepts Eurodollar deposits. The
17-9 No, interest rate parity implies that an investment in the U. S. with the same risk as a
similar investment in a foreign country should have the same return. Interest rate parity
is expressed as:
17-10 Purchasing power parity assumes there are neither transaction costs nor regulations which
limit the ability to buy and sell goods across different countries. In many cases, these
assumptions are incorrect, which explains why PPP is often violated. An additional
Answers and Solutions: 17 - 4
SOLUTIONS TO END-OF-CHAPTER PROBLEMS
17-1 $1 = 9 Mexican pesos; $1 = 111.23 Japanese yen; Cross exchange rate, yen/peso = ?
= 12.358 yen per peso.
17-2 rNom, 6-month T-bills = 7%; rNom of similar default-free 6-month Japanese bonds = 5.5%;
Spot exchange rate, e0: 1 Yen = $0.009; 6-month forward exchange rate = ft = ?
)r1(
)r1(
e
f
f
h
0
t
+
+
=
.
ft = $0.00907.
The 6-month forward exchange rate is 1 yen = $0.00907.
Answers and Solutions: 17 - 5
17-3 U. S. Computer = $500; French Computer = 550 euros; Spot rate between euro and
dollar = ?
17-4 Dollars should sell for 1/1.50, or 0.6667 euros per dollar.
17-5 The current exchange rate is 0.60 dollars per Swiss franc. A 10 percent appreciation will
make it 0.66 dollars per Swiss franc. To find Swiss francs per dollar, divide 1 by the
exchange rate: 1/0.66 = 1.5152 Swiss francs per dollar.
17-6 Cross rate = Swiss francs/dollars dollars/pounds = Swiss francs/pounds
= 1.6 1.5 = 2.4 Swiss francs per pound.
17-8 $1 = 7.8 pesos; headphones = $15.00; Price of headphones in Mexico = ?
Ph = Pf(Spot rate).
Check: Spot rate = $15/117 pesos = $0.1282 for 1 peso.
17-9 The U. S. dollar liability of the corporation falls from (0.10 dollars per peso)(50,000,000
pesos) = $5,000,000 to (0.09 dollars per peso)(50,000,000 pesos) = $4,500,000,
corresponding to a gain of 500,000 U. S. dollars for the corporation. However, the real
17-10 a. The automobile’s value has increased because the dollar has declined in value relative
to the yen.
17-11 a. (1,000,000 Swiss francs) / (0.6028 Swiss francs per dollar) = $1,658,925.
b. (1,000,000 Swiss francs) / (0.6075 Swiss francs per dollar) = $1,646,091.
Answers and Solutions: 17 - 7
17-12 rNom of 90-day U. S. risk-free securities = 5%; of 90-day German risk-free securities =
5.3%; Spot rate = 1 euro = $0.80; ft selling at premium or discount = ?
)r1(
)r1(
rateSpot
f
f
h
t
+
+
=
.
17-13 First, convert the pesos to dollars: D1 = (30 pesos)(0.10 dollars per peso) = 3 pesos.
Second, find the growth rate in dollar denominated pesos. If the peso is depreciating 4% a
year with respect to the dollar, then the exchange rate at t=2 will be (0.10 dollars per
peso)(1 – 0.04) = 0.096 dollars per peso. This is a growth rate of (0.096 – 0.10)/0.10 =
−0.04 = −4%. In other words, the exchange rate is “growing” at the rate it is depreciating.
Therefore, the total growth rate in dollar denominated dividends is:
Answers and Solutions: 17 - 8
17-14 a. If a U.S. based company undertakes the project, the rate of return for the project is a
simple calculation, as is the net present value.
b. This analysis is from the perspective of a Korean investor, so Korea is the home
country and the U.S is the foreign country. The interest rate parity relationship uses
direct quotes for exchange rates; direct quotes are number of units of home currency
per unit of foreign currency. Therefore, a direct quote from a Korean perspective is
the number of won per dollar.
According to interest rate parity, the following condition holds:
Answers and Solutions: 17 - 9
c. First, we must adjust the cash flows to reflect Nam Sung’s home currency.
The expected Won cash flows are
Year 0: (−1,000,000 dollars)(1,050 won per dollar) = −1,050.00 million won.
Answers and Solutions: 17 - 10
SOLUTION TO SPREADSHEET PROBLEM
Mini Case: 17 - 11
MINI CASE
With the growth in demand for exotic foods, Possum Products' CEO Michael Munger is
considering expanding the geographic footprint of its line of dried and smoked low-fat
opossum, ostrich, and venison jerky snack packs. Historically, jerky products have
performed well in the southern United States, but there are indications of a growing
demand for these unusual delicacies in Europe. Munger recognizes that the expansion
carries some risk--Europeans may not be as accepting of opossum jerky as initial research
suggest--so the expansion will proceed in steps. The first step will be to set up sales
subsidiaries in France and Sweden (the two countries with the highest indicated demand),
and the second is to set up a production plant in France with the ultimate goal of product
distribution throughout Europe.
Possum Products' CFO, Kevin Uram, although enthusiastic about the plan, is
nonetheless concerned about how an international expansion and the additional risk that
entails will affect the firm's financial management process. He has asked you, the firm’s
most recently hired financial analyst, to develop a 1-hour tutorial package that explains the
basics of multinational financial management. The tutorial will be presented at the next
board of directors’ meeting. To get you started, Uram has supplied you with the following
list of questions.
a. What is a multinational corporation? Why do firms expand into other
countries?
Answer: Use the examples given here when discussing why firms “go international.”
1. To seek new markets. Coca-Cola and McDonald’s have expanded around the
world to seek new markets. Likewise, Sony, Toshiba, and other Japanese
consumer electronics manufacturers have aggressively pushed into the u. S.
Mini Case: 17 - 12
b. What are the six major factors which distinguish multinational financial
management from financial management as practiced by a purely domestic
firm?
Answer: 1. Different currency denominations. Cash flows in various parts of multinational
corporate systems will be denominated in different currencies. Hence, an analysis
of exchange rates, and the effect of fluctuating currency values, must be included
in all financial analyses.
Mini Case: 17 - 13
c. Consider the following illustrative exchange rates.
U. S. Dollars required to buy
one unit of foreign currency
Euro 1.2500
Swedish krona 0.1481
U.S. Dollars Required to Buy
One Unit of Foreign Currency
Units of Foreign Currency
Required to Buy One U.S. Dollar
c. 1. What is a direct quotation? What is the direct quote for euros??
Mini Case: 17 - 14
Answer: From a U.S. perspective, the quotes in the first column are called direct quotes
c. 2. What is an indirect quotation? What is the indirect quotation for kronor (the
plural of krona is kronor).
Answer: Indirect quotations are the number of units of foreign currency that can be purchased
c. 3. The euro and British pound usually are quoted as direct quotes. Most other
currencies are quoted as indirect quotes. How would you calculate the indirect quote for a
euro? How would you calculate the direct quote for a krona?
Answer: Indirect quotations are the reciprocal of the direct quotation, and direct quotations are
the reciprocal of the indirect quotation.
c. 4. What is a cross rate? Calculate the two cross rates between euros and kronor.
Answer: The exchange rate between any two currencies which does not involve U. S. Dollars
is a cross rate. Use the exchange rates versus the dollar, so use the direct for the
Mini Case: 17 - 15
c. 5. Assume Possum Products can produce a package of jerky and ship it to France
for $1.75. If the firm wants a 50 percent markup on the product, what should
the jerky sell for in France?
Answer: To achieve the markup, the price in dollars must be ($1.75)(1.50) = $2.625.
c. 6. Now assume Possum Products begins producing the same package of jerky in
France. The product costs 2.0 euros to produce and ship to Sweden, where it can
be sold for 20 kronor. What is the dollar profit on the sale?
Answer: Using the unrounded cross rate of 8.50 kronor per euro, we get:
c. 7. What is exchange rate risk?
Answer: The volatility inherent in a floating exchange rate system increases the uncertainty of
Mini Case: 17 - 16
d. Briefly describe the current International Monetary System. How does the
current system differ from the system that was in place prior to August 1971?
Answer: Prior to 1971, the world operated on a fixed exchange rate system. The value of the
U. S. Dollar was linked to gold at the fixed price of $35 per ounce, and the values of
Central banks, like the U. S. Federal Reserve and the Bank of England, do
intervene in the currency markets to smooth out fluctuations, but it is impossible for a
central bank to permanently prop up a weak currency. Also, governments do enter
into agreements to try to keep currencies within predetermined ranges. However, if
market forces move the exchange rate outside one of these ranges, there is little that
the countries can do other than adjust the target range.
Seventeen participating countries in the European Monetary Union (as of Spring
2011) use the “euro.” The European Central Bank controls the monetary policy of
the EMU nations using the Euro.
Mini Case: 17 - 17
e. What is a convertible currency? What problems arise when a multinational
company operates in a country whose currency is not convertible?
Answer: A currency is convertible when it is traded on the world currency exchanges and
when the issuing country stands ready to redeem the currency at market rates.
f. What is the difference between spot rates and forward rates? When is the
forward rate at a premium to the spot rate? At a discount?
Answer: Spot rates are the rates paid to buy currency for immediate delivery (actually, two
days after the date of the trade). Forward rates are the rates paid to buy currency for
delivery at some agreed-upon date in the future (say, 90 days).
Mini Case: 17 - 18
g. What is interest rate parity? Currently, you can exchange 1 euro for 1.2700
dollars in the 180-day forward market, and the risk-free rate on 180-day
securities is 6 percent in the United States and 4 percent in France. Does interest
rate parity hold? If not, which securities offer the highest expected return?
Answer: Interest rate parity holds that investors should expect to earn the same return in all
countries after adjusting for risk. What is the implied forward rate, given the spot rate
of $1.2500?
t
If interest rate parity held, then ft = $1.2623; however, ft = $1.2700, so parity doesn’t
hold.
The French securities offer the highest return as calculated below:
1. Assume you convert $1,000 to euros in the spot market. In the spot market, spot
rate = 0.8000 euros per dollar. Convert $1,000 0.8000 euros/dollar = 800 euros.
Mini Case: 17 - 19
h. What is purchasing power parity? If a package of jerky costs $2.00 a liter in the
United States and purchasing power parity holds, what should be the price of
the jerky package in France?
Answer: Purchasing power parity, sometimes referred to as the law of one price (LOP),
implies that the level of exchange rates adjusts so that identical goods cost the same
i. What impact does relative inflation have on interest rates and exchange rates?
Answer: To illustrate, consider the situation between Japan and the U. S. Japan has generally
had a lower inflation rate than the U. S., so Japanese interest rates have been lower
Mini Case: 17 - 20
j. Briefly discuss the international capital markets.
Answer: Individuals buy securities issued by foreign governments and firms, and U. S. Firms
issue securities abroad. These transactions take place in the international capital
markets. Here is a brief description of the major international capital markets:
1. A eurodollar is a U. S. dollar deposited in a bank outside the United States. The
major difference between a “regular” dollar and a eurodollar is its location. This
2. International bonds, which are any bond sold outside the country of the borrower,
fall into two categories. Foreign bonds are bonds sold by a foreign borrower, but
denominated in the currency of the country in which they are sold. Thus, when
Mini Case: 17 - 21
k. To what extent do average capital structures vary across different countries?
Answer: There is some evidence that average capital structures vary among the large industrial
countries. One problem, however, when interpreting these numbers is that different
l. Briefly describe special problems that occur in multinational capital budgeting
and describe the process for evaluating a foreign project. Now consider the
following project. A U.S. company has the opportunity to lease a manufacturing
facility in Japan for two years. The company must spend ¥1 billion initially to
refurbish the plant. The expected net cash flows from the plant for the next two
years, in millions, are: CF1 = ¥500 and CF2 = ¥800. A similar project in the U.S.
would have a risk adjusted cost of capital of 10 percent. What is the project’s
NPV?
Answer: The same general principles which apply to domestic capital budgeting also apply to
foreign capital budgeting. However, foreign capital budgeting is complicated by the
following three primary factors:
1. Tax law differences. Foreign operations are usually taxed at the local level, and
then funds repatriated, or returned, to the parent corporation may be subject to
Mini Case: 17 - 22
where the exchange rates are expressed in direct quotations.
The indirect spot exchange rate is 110 yen per dollar, so the direct rate is 1/110 =
0.009091 dollars per yen. The expected forward rates are:
Maturity (in years)
rh
rf
Spot rate
($/¥)
Expected
forward rate
($/¥)
1
2.0%
0.05%
0.009091
0.009268
2
2.8%
0.26%
0.009091
0.009557
The current dollar cost of the project is £1,000(0.009091 $/¥) = $9.09 million.
The Year 1 cash flow in dollars is ¥500 (0.009268$/¥) = $12.29 million. The
complete time line and NPV are shown below.
Mini Case: 17 - 23
m. What is the impact of multinational operations on each of the following financial
management topics?
1. Cash management.
Answer: Although multinational and domestic firms have the same objectives for cash
management and use similar procedures, the multinational firm faces a more complex
m. 2. Credit management.
Answer: Granting credit is riskier for a multinational firm than for a domestic corporation
because, in addition to the normal risk of default, the credit granting corporation must
m. 3. Inventory management.
Answer: As with other aspects of financial management, inventory management in a
multinational setting is similar to but more complex than that in a purely domestic
