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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
Units of Foreign Currency
c. 1. What is a direct quotation? What is the direct quote for euros??
Answer: From a U.S. perspective, the quotes in the first column are called direct quotes because
Mini Case: 17 – 15
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
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.
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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
d. What is the gold standard monetary system? What is International Monetary
Fund (IMF)? What is the fixed exchange rate system? Briefly describe the current
International Monetary System. What is a monetary union?
Answer: By 1914, governments of most developed countries were issuing paper currencies that
could be redeemed for gold from the government’s treasury, so the monetary system
Mini Case: 17 – 17
Mini Case: 17 – 18
e. What is a freely convertible currency? What is a partially convertible currency?
What is a nonconvertible currency? What problems arise when a multinational
company operates in a country whose currency is not freely convertible?
Answer: A freely convertible currency is traded in the international currency markets with no
government restrictions. It is also called a fully convertible currency and a hard
currency. Countries with free floating exchange systems also have fully convertible
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f. What is the difference between spot rates and forward rates? When is the foreign
currency forward rate selling 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).
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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?
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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
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 than
Mini Case: 17 – 22
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
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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
l. Briefly describe a company’s risk exposure if it invests in an international project.
Answer:
1. Exchange Rate Risk Due to Changes in Exchange Rates
Exchange rate risk can be mitigated for short-term cash flows by using
forward contracts, but longer-term cash flows still have exchange risk.
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m. 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.
line and NPV are shown below.
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n. 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
n. 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
Mini Case: 17 – 26
n. 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 firm.