Finance Chapter 31 Homework The dollar is selling at a premium because it is

CHAPTER 31

INTERNATIONAL CORPORATE

FINANCE

Answers to Concepts Review and Critical Thinking Questions

1. a. The dollar is selling at a premium because it is more expensive in the forward market than in the

spot market (SF 1.11 versus SF 1.09).

3. a. The Australian dollar is expected to weaken relative to the dollar, because it will take more A$

4. No. 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.

5. Additional advantages include being closer to the final consumer and, thereby, saving on

6. One key thing to remember is that dividend payments are made in the home currency. More generally,

7. a. False. If prices are rising faster in Great Britain, it will take more pounds to buy the same amount

of goods that one dollar can buy; the pound will depreciate relative to the dollar.

8. 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

9. IRP is the most likely to hold because it presents the easiest and least costly means to exploit any

10. It all depends on whether the forward market expects the same appreciation over the period and

11. One possible reason investment in the foreign subsidiary might be preferred is if this investment

provides direct diversification that shareholders could not attain by investing on their own. Another

12. 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

13. If the foreign currency depreciates, the U.S. parent will experience an exchange rate loss when the

14. 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

Solutions to Questions and Problems

NOTE: All end-of-chapter problems were solved using a spreadsheet. Many problems require multiple

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(€.8523/$1) = €85.23

b. $1.1733

2. a. You would prefer £100, since:

(£100)($1.3258/£1) = $132.58

b. You would still prefer £100. Using the $/£ exchange rate and the SF/$ exchange rate to find the

3. a. F180 = ¥109.730(per $). The yen is selling at a premium because it is more expensive in the

forward market than in the spot market ($.009022 versus $.0091133).

4. a. The U.S. dollar, since one Canadian dollar will buy:

(Can$1)/(Can$1.27/$1) = $.7874

b. The cost in U.S. dollars is:

5. a. The cross rate in ¥/£ terms is:

(¥107/$1)($1.43/£1) = ¥153.01/£1

6. We can rearrange the interest rate parity condition to answer this question. The equation we will use

is:

RFC = (FT – S0)/S0 + RUS

7. If we invest in the U.S. for the next three months, we will have:

$30,000,000(1.0019)3 = $30,171,325.11

8. Using the relative purchasing power parity equation:

Ft = S0 × [1 + (hFC – hUS)]t

9. The profit will be the quantity sold, times the sales price minus the cost of production. The production

cost is in Singapore dollars, so we must convert this to U.S. dollars. Doing so, we find that if the

exchange rates stay the same, the profit will be:

Profit = 30,000[$115 – {(S$146.50)/(S$1.3566/$1)}]

10. a. If IRP holds, then:

F180 = (Kr 7.87)[1 + (.05 – .03)]1/2

F180 = Kr 7.9483

Kr 1.02758 – Kr 1.02435 = Kr .00322

11. The international Fisher effect states that the real interest rate across countries is equal. We can

rearrange the international Fisher effect as follows to answer this question:

RUS – hUS = RFC – hFC

12. a. The yen is expected to get stronger, since it will take fewer yen to buy one dollar in the future

than it does today.

13. We need to find the change in the exchange rate over time, so we need to use the relative purchasing

power parity relationship:

Ft = S0 × [1 + (hFC – hUS)]t

Using this relationship, we find the exchange rate in one year should be:

14. First, we need to forecast the future spot rate for each of the next three years. From interest rate and

So:

E(S2) = (1.0310/1.0290)2 ($1.19/€) = $1.1946/€

E(S3) = (1.0310/1.0290)3 ($1.19/€) = $1.1970/€

Now we can use these future spot rates to find the dollar cash flows. The dollar cash flow each year

will be:

15. a. Implicitly, it is assumed that interest rates won’t change over the life of the project, but the

exchange rate is projected to decline because the Euroswiss rate is lower than the Eurodollar rate.

b. We can use uncovered interest parity to calculate the dollar cash flows at each time. The equation

is:

E[ST] = (SF 1.17)[1 + (.05 – .06)]t

E[ST] = 1.17(.99)t

16. a. To construct the balance sheet in dollars, we need to convert the account balances to dollars. At

the current exchange rate, we get:

Assets = solaris 51,000 × ($/solaris 1.20) = $42,500.00

Debt = solaris 16,000 × ($/solaris 1.20) = $13,333.33

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:

18. a. The domestic Fisher effect is:

1 + RUS = (1 + rUS)(1 + hUS)

1 + rUS = (1 + RUS)/(1 + hUS)

This relationship must hold for any country, that is:

RFC = 1.10(1.07/1.05) – 1 = .121

Next, we find the NPV in euros as: