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Chapter 19: Multinational Financial Management
Integrated Case
525
7. To retain customers. It makes good business sense to follow
customers abroad to retain the business. Large U.S. banks,
B. What are the five major factors that distinguish multinational
financial management from financial management as practiced by a
purely domestic firm?
Answer: [Show S19-4 here.]
1. Different currency denominations. Cash flows in various parts
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Chapter 19: Multinational Financial Management
Integrated Case
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C. Consider the following illustrative exchange rates:
U.S. Dollars Required to Buy
One Unit of Foreign Currency
Japanese yen 0.009
Australian dollar 0.650
(1) Are these currency prices direct quotations or indirect quotations?
C. (2) Calculate the indirect quotations for yen and Australian dollars.
Answer: [Show S19-6 here.] Indirect quotations, which are the number of
units of foreign currency that can be purchased with one U.S. dollar,
C. (3) What is a cross rate? Calculate the two cross rates between yen
and Australian dollars.
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Chapter 19: Multinational Financial Management
Answer: [Show S19-7 here.] The exchange rate between any two currencies
that does not involve U.S. dollars is a cross rate. Here are the two
cross rates between yen and Australian dollars:
C. (4) Assume that Citrus Products can produce a liter of orange juice and
ship it to Japan for $1.75. If the firm wants a 50% markup on the
product, what should the orange juice sell for in Japan?
C. (5) Now assume that Citrus Products begins producing the same liter of
orange juice in Japan. The product costs 250 yen to produce and
ship to Australia, where it can be sold for 6 Australian dollars. What
is the U.S. dollar profit on the sale?
Answer: [Show S19-9 here.] 250 yen are equal to 250(0.0138) = 3.45
Chapter 19: Multinational Financial Management
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C. (6) What is exchange rate risk?
Answer: [Show S19-10 here.] The volatility inherent in a floating exchange
D. Briefly describe the current international monetary system. What
are the different types of exchange rate systems?
Answer: [Show S19-11 through S19-14 here.] Every nation has a monetary
system and a monetary authority. Moreover, if countries are to
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Chapter 19: Multinational Financial Management
Floating Exchange Rate System:
1. Freely Floating. Occurs when the exchange rate is determined by
Fixed Exchange Rate System:
1. No local currency. The most extreme position is for the country
to have no local currency of its own. The country uses another
E. What is the difference between spot rates and forward rates?
When is the forward rate at a premium to the spot rate? When is it
at a discount?
Chapter 19: Multinational Financial Management
Integrated Case
531
Answer: [Show S19-15 and S19-16 here.] Spot rates are the rates paid to
buy currency for immediate delivery (actually, two days after the
F. What is interest rate parity? Currently, you can exchange 1 yen for
0.0095 U.S. dollar in the 30-day forward market, and the risk-free
rate on 30-day securities is 4% in both Japan and the United
States. Does interest rate parity hold? If not, which securities offer
the highest expected return?
Answer: [Show S19-17 through S19-20 here.] Interest rate parity holds
that investors should expect to earn the same return in all countries
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Chapter 19: Multinational Financial Management
Chapter 19: Multinational Financial Management
Integrated Case
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G. What is purchasing power parity (PPP)? If grapefruit juice costs
$2.00 a liter in the United States and purchasing power parity
holds, what should be the price of grapefruit juice in Australia?
Answer: [Show S19-21 and S19-22 here.] Purchasing power parity,
sometimes referred to as the law of one price (LOP), implies that the
H. What effect does relative inflation have on interest rates and
exchange rates?
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Chapter 19: Multinational Financial Management
Answer: [Show S19-23 here.] To illustrate, consider the situation between
Japan and the U.S. Japan has generally had a lower inflation rate
I. (1) Briefly explain the three major types of international credit markets.
Answer: [Show S19-24 and S19-25 here.] Individuals buy securities issued by
Chapter 19: Multinational Financial Management
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I. (2) Briefly explain how ADRs work.
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Chapter 19: Multinational Financial Management
Answer: [Show S19-26 here.] U.S. investors can invest in foreign companies
through American Depository Receipts (ADRs). ADRs are
J. What is the effect of multinational operations on capital budgeting
decisions?
Answer: [Show S19-27 here.] The same general principles that apply to
domestic capital budgeting also apply to foreign capital budgeting.
However, foreign capital budgeting is complicated by the following
three primary factors:
K. To what extent do average capital structures vary across different
countries?
Chapter 19: Multinational Financial Management
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Answer: [Show S19-28 here.] There is some evidence that average capital
structures vary among the large industrial countries. One problem,
