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units of a foreign currency that can be purchased by 1 unit of the home currency.
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A B C D E F G H I J K
11/23/2018
Euro
Swedish krona
7.0000
(2) What is an indirect quotation? What is the indirect quotation for kronor (the plural of krona is kronor).
Indirect quotations are are the number of units of foreign currency that can be purchased with one unit of
home currency (the home currency is the U. S. Dollar in this example).
Chapter 17. Mini Case for Multinational Financial Management
b. What are the six major factors which distinguish multinational financial management from financial
management as practiced by a purely domestic firm? Answer: See Chapter 17 Mini Case Show
c. Consider the following illustrative exchange rates.
(1) What is a direct quotation? What is the direct quote for euros?
1.2500
U.S. Dollars Required to
Buy One Unit of Foreign
Currency
Units of Foreign
Currency Required to
Buy One U.S. Dollar
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
a. What is a multinational corporation? Why do firms expand into other countries? Answer: See Chapter 17
Mini Case Show
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A B C D E F G H I J K
Cross rate between euros and kronor (Kronor per Euro):
Kronor Dollars
Dollar Euro
Cross Rate = EUR/SEK = 7.0000 ×1.2500
Cross Rate = EUR/SEK = 8.7500 Kronor per euro
Cross rate between kronor and euros (Euro per krona) is recipical of krona per euro cross rate:
Target Price = 1.75$ x 1.5
Target Price = 2.6250$
2.0 euros = 2.0 x 8.7500 kronor/euro
2.0 euros = 17.50 kronor
Indirect quotations are the reciprocal of the direct quotation, and direct quotations are the reciprocal of the
indirect quotation.
Cross Rate = EUR/SEK =
×
(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?
(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?
(7) What is exchange rate risk?
A cross rate is the exchange rate between any two currencies not involving U.S. dollars. In practice, cross
rates are usually calculated from direct or indirect rates. That is, on the basis of U.S. dollar exchange rates.
(4) What is a cross rate? Calculate the two cross rates between euros and kronor.
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A B C D E F G H I J K
Suppose the kronor per dollar exchange rate changes.
rh = 0.03000
rf = 0.02000
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: See Chapter 17 Mini Case Show
If interest rate parity holds, the computed forward rate would be the same as the observed forward rate, so
parity does not hold.
Exchange rate risk is the risk that the value of a cash flow in one currency translated from another currency
will decline due to a change in exchange rates.
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: See Chapter 17 Mini Case Show
e. What is a convertible currency? What problems arise when a multinational company operates in a country
whose currency is not convertible? Answer: See Chapter 17 Mini Case Show
Interest rate parity implies that investors should expect to earn the same return on similar-risk securities in
all countries:
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?
A U.S. investor could directly invest in the U.S. security and earn an annualized rate of 6%. Alternatively, the
U.S. investor could convert dollars to euros invest in the French security, and then convert profit back into
dollars. If the return on this strategy is higher than 6%, then the French security has the higher rate.
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Spot Rate = Ph/Pf
Purchasing power parity implies that the level of exchange rates adjusts so that identical goods cost the
same amount in different countries.
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A B C D E F G H I J K
= 800.00 euros
Example:
Buy $1,000 worth of euros in the spot market:
French investment return (in euros):
800.00 x 1.02000
= 816.00 euros
Buy contract today to exchange euros in 180 days at forward rate.
Annual return =
7.26%
k. To what extent do average capital structures vary across different countries? Answer: See Chapter 17 Mini Case Show
initially to refurbish the plant. The expected net cash flows from the plant for the next 2 years, in millions, are
CF1 = ¥500 and CF2 = ¥800. A similar project in the United States would have a risk-adjusted cost of capital
of 10%. In the United States, a 1-year government bond pays 2% interest and a 2-year bond pays 2.8%. In
Japan, a 1-year bond pays 0.05% and a 2-year bond pays 0.26%. What is the project’s NPV?
j. Briefly discuss the international capital markets. Answer: See Chapter 17 Mini Case Show
A U.S. investor could directly invest in the U.S. security and earn an annualized rate of 6%. Alternatively, the
U.S. investor could convert dollars to euros invest in the French security, and then convert profit back into
dollars. If the return on this strategy is higher than 6%, then the French security has the higher rate.
This is higher than return on U.S. security, so French securities have higher returns after
adjusting for exchange rates.
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?
i. What impact does relative inflation have on interest rates and exchange rates? Answer: See Chapter 17
Mini Case Show