International Cash Management ❖ 16
f. If any political situation causes friction between Mexico and the U.S., the demand for the service
offered by your business would possibly decline.
Chapter 2
Your business provides DVDs for free to customers who pay for the English courses that you offer in
Mexico. You consider the idea of mass production of the DVDs in the U.S., so that you can sell (export)
them to distributors or to retail stores throughout Mexico. You would price the DVDs in dollars when
exporting them. The DVDs are not as effective without the teaching but can be useful to individuals who
want to learn the basics of the English language.
a. If you pursue this idea, explain how the factors that affect international trade flows (identified in
Chapter 2) could affect the Mexican demand for your DVDs. Which of these factors would likely
have the largest impact on the Mexican demand for your DVDs? What other factors would affect
the Mexican demand for the DVDs?
b. If you believe the Mexican government would impose a tariff on the DVDs exported to Mexico,
how could you still execute this business idea at a relatively low cost while avoiding the tariff?
Describe any disadvantages of this idea that would avoid the tariff.
ANSWER:
a. The demand may be affected by local inflation in Mexico. If local inflation is high, any DVDs on
learning English that are produced by local competitors may be subject to increased prices. This
could encourage Mexico consumers to purchase your DVDs. The national income level of
Mexico may be relevant since it affects the ability of Mexican consumers to spend money. An
b. If you expect that the Mexican government will impose a significant tariff on the DVDs, you
could still execute the business idea by setting up a licensing agreement with a firm in Mexico.
International Cash Management ❖ 17
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risk. Yet, even if the DVDs were priced in dollars, you are exposed to risk because the demand
for the DVDs would likely decline if the peso declined against the dollar.
Chapter 3
Assuming that the business in Mexico grows, explain how financial markets could help to finance the
growth of the business.
ANSWER:
Chapter 4
Given the factors that affect the value of a foreign currency, describe the type of economic or other
conditions in Mexico that could cause the Mexican peso to weaken, and therefore to adversely affect your
business.
ANSWER:
Chapter 5
Explain how currency futures could be used to hedge your business in Mexico. Explain how currency
options could be used to hedge your business in Mexico.
ANSWER:
Chapter 6
a. Explain how your business would likely be affected (at least in the short run) if the central bank
of Mexico intervened in the foreign exchange market by exchanging Mexican pesos for dollars in
the foreign exchange market.
b. Explain how your business would likely be affected if the central bank of Mexico used indirect
intervention by lowering Mexican interest rates (assume inflationary expectations have not
changed).
ANSWER:
International Cash Management ❖ 18
a. This form of direct intervention places downward pressure on the peso, which would adversely
Chapter 7
Mexican interest rates are normally substantially higher than U.S. interest rates.
a. What does this imply about the forward premium or discount of the Mexican peso?
b. What does this imply about your business using the forward or futures contracts to hedge your
periodic profits in pesos that must be converted into dollars?
c. Do you think you would frequently hedge your exposure to Mexican pesos? Explain your answer.
ANSWER:
a. The forward rate will contain a discount, which means that the futures or forward contract will
generate an amount of dollars that is less than today’s spot rate.
International Cash Management ❖ 19
Chapter 8
Mexican interest rates are normally substantially higher than U.S. interest rates.
a. What does this imply about the inflation differential (Mexico inflation minus U.S. inflation),
assuming that the peso interest rate is the same in both countries? Does this imply that the
Mexican peso will appreciate or depreciate? Explain.
b. It may be argued that the high Mexican interest rate should entice U.S. investors to invest in
Mexican money market securities, which could cause the peso to appreciate. Reconcile this
theory with your answer (a). If you believe that the high Mexican interest rate does not entice
U.S. investors, explain why.
c. Assume that the difference between Mexican and U.S. interest rates is typically attributed to a
difference in expected inflation in the two countries. Also assume that purchasing power parity
holds. Do you think that your business cash flows would be adversely affected? In reality,
purchasing power parity does not hold consistently. Assume that the inflation differential
(Mexico inflation minus U.S. inflation) is not fully offset by the exchange rate movement of the
peso. Would this benefit or hurt your business? Now assume that the inflation differential is more
than offset by the exchange rate movement of the peso. Would this benefit or hurt your business?
d. Assume that the nominal interest rate in Mexico is presently much higher than the interest rate in
the U.S., which is due to a high rate of expected inflation in Mexico. You consider implementing
a marketing campaign in which you would hire a local firm to promote your business, but you
would have to borrow funds to finance this campaign. A consultant advises you to delay the
marketing campaign for a year, so that you can capitalize on the high nominal interest rate in
Mexico. He suggests that you retain the profits that you would normally have remitted to the
U.S., and deposit them in a Mexican bank. The Mexican peso cash flows that your business
deposits will grow at a high rate of interest over the year. Should you follow the consultant’s
advice?
ANSWER:
a. A higher nominal interest rate in Mexico implies a higher level of expected inflation. According
to purchasing power parity, the Mexican peso will depreciate.
b. The differential should be a positive number, meaning higher Mexican inflation.
Based on PPP, the higher Mexican inflation should result in the depreciation of the Mexican peso.
International Cash Management ❖ 20
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of the peso and will not invest in Mexican money market securities. Therefore, the high nominal
interest rate in Mexico may cause the peso to weaken (through the signal about expected
inflation) rather than strengthen.
d. The consultant is ignoring the fact that the high nominal interest rate reflects a high rate of
expected inflation. Thus, while your funds accumulate interest, the prices in Mexico are rising
rapidly. The price that you would need to pay for the marketing campaign may rise by a higher
rate than the rate of interest earned on your funds. Delaying the campaign should not be
motivated by a high nominal interest rate in Mexico.
Chapter 9
a. Mexican interest rates are normally substantially higher than U.S. interest rates. What does this
imply about the forward rate as a forecast of the future spot rate?
b. Does the forward rate reflect a forecast of appreciation or depreciation of the Mexican peso?
Explain how the degree of the expected change implied by the forward rate forecast is tied to the
interest rate differential.
c. Do you think that today’s forward rate or today’s spot rate of the peso would be a better forecast
of the future spot rate of the peso?
ANSWER:
a. The forward rate contains a discount. Thus, if the forward rate is used to forecast the peso in the
future, it implies a lower spot rate in the future than the prevailing spot rate today (depreciation of
Chapter 10
Recall that your Mexican business invoices in Mexican pesos.
a. You are already aware that a decline in the value of the peso could reduce your dollar cash flows.
Yet, according to purchasing power parity, a weak peso should only occur in response to a high
level of Mexican inflation, and such high inflation should increase your profits. If this theory
holds precisely, your cash flows would not really be exposed. Should you be concerned about
your exposure, or not? Explain.
b. If you shift your invoicing policy to be only in dollars, how will your transaction exposure be
affected?
c. Why might the demand for your business change if you shift your invoice policy? What are the
implications for economic exposure?
International Cash Management ❖ 21
ANSWER:
a. You should be concerned about your exposure, because you can not assume that the inflation rate
in Mexico would perfectly offset the depreciation of the Mexican peso. In addition, even if the
inflation rate in Mexico perfectly offsets the depreciation of the peso, that does not guarantee that
your business will achieve inflated profits that match the country’s rate of inflation. For example,
Chapter 11
Mexican interest rates are normally substantially higher than U.S. interest rates.
a. Assuming that interest rate parity exists, do you think hedging with a forward rate would be
beneficial if the spot rate of the Mexican peso was expected to decline slightly over time?
b. Would hedging with a money market hedge be beneficial if the spot rate of the Mexican peso was
expected to decline slightly over time (assume zero transaction costs)? Explain.
c. What are some limitations on using currency futures or options that may make it difficult for you
to perfectly hedge against exchange rate risk over the next year or so?
d. In general, there is a lack of long-term currency futures and options on the Mexican pesos. A
consultant suggests that this is no problem because you can hedge your position a quarter at a
time. In other words, the profits that you remit at any point in the future can be hedged by taking
a currency futures or options position three months or so before that time. Thus, while the
consultant recognizes that the peso could weaken substantially in the long-term, he sees no reason
why you should worry about it as long as you continually create a short-term hedge. Do you
agree?
ANSWER:
a. Based on interest rate parity, the forward rate of the peso should have a large discount. Therefore,
hedging would not be beneficial if the peso is expected to depreciate slightly because the future
spot rate would be valued higher than the prevailing forward rate today.
International Cash Management ❖ 22
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beneficial. If you do not hedge, the peso is expected to just depreciate slightly. If you hedge, you
have to borrow at a much higher rate than the rate earned on your money market investment, so
this cost to you makes the hedge undesirable.
c. Currency futures of options may not be available in the size that fits the profit that you wish to
remit periodically. In addition, your future profit is not certain in any period, so even if there were
futures or options contracts that could fit any size, you would not know the exact size to select.
d. The consultant is wrong. If the peso depreciates substantially over time, the amount of dollars that
you will receive from continuous short-term hedging will decline over time. If the peso declines
consistently over time, then the spot rate at the beginning of each quarter will be lower. Assume
that the interest rate differential between Mexico and the U.S. stays about the same over time.
Then the forward rate will decline at the beginning of each quarter in line with the decline in the
spot rate. Even if the forward discount changed over time, the forward rate is still highly
influenced by the prevailing spot rate at any point in time. Thus, if the spot rate continually
declines, the forward rate will as well, which means that a given profit denominated in the pesos
will convert into less dollars in each period.
Chapter 12
a. Explain how your business is subject to translation exposure.
b. How could you hedge against this translation exposure?
c. Is it worthwhile for your business to hedge the translation exposure?
ANSWER:
a. The profits earned by your business in Mexico must be translated into dollars for reporting
purposes. If the peso depreciates over a period, the profits earned by your business in pesos will
Chapter 13
Assume that you wanted to expand your Learning English business to other non-U.S. countries where
some individuals may want to speak English.
a. Explain why you might be able to stabilize the profits of your total business in this manner.
Review the motives for direct foreign investment that are identified in this chapter. Which of
these motives are most important?
b. Why would a city such as Montreal be a less desirable site for your business than a city such as
Mexico City?
International Cash Management ❖ 23
c. Describe the conditions in which your total business would experience weak effects even if the
business was spread across 3 or 4 countries.
d. What factors affect the probability of these conditions occurring? (In other words, explain why
the conditions could occur in one set of countries, but not another set of countries).
e. What data would you review to assess the probability of these conditions occurring?
f. Consider that the prevailing service you offer is teaching individuals in Mexico to speak English,
and your business has already created some supplemental pamphlets and CDs that translate
common Spanish terms into English. How could you expand your business in a manner that may
allow you to benefit from economies of scale (and perhaps even benefit from your existing
business reputation)? When you attempt to benefit from economies of scale, do you forgo
diversification benefits? Explain.
g. How would you come to a decision on whether to pursue business expansion that capitalizes on
economies of scale even if it would forgo diversification benefits? Do you think economies of
scale would be more important or less important than diversification for your business?
h. Is there any way to achieve economies of scale and yet still achieve diversification benefits?
ANSWER:
a. First, you must be capable of training the individuals, so it would be easier if you already knew
the language. Regarding the motives mentioned in the text, a key factor is that there must be a
demand for your service. In addition, you want to be in a country where you may have some
International Cash Management ❖ 24
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g. You would have the weigh the costs and benefits. It would likely be much easier for you to
expand your business in Mexico, and you may be willing to give up diversification benefits so
that you can more easily expand. Also, it should be easier for you to train new employees. You
already have a system that works in Mexico and you have a reputation, which are beneficial.
h. You may be able to still achieve diversification benefits by expanding to a different city in
Mexico. Your existing business is influenced by the income of individuals in one Mexico City,
while your new business would be influenced by the income of individuals in another city. The
income levels of the two cities does not always change in the same manner, although there is
probably some degree of correlation.
Chapter 14
a. Review the different items that are used in the multinational capital budgeting example (Spartan
Inc.). Describe the items that would be included on a spreadsheet if you were to conduct a
multinational capital budgeting analysis of investing dollars to expand your existing language
business in a different location.
b. Assume that you recognize your limitations in predicting the future exchange rate of the invoice
currency for your expanded business. You think that there are several possible exchange rate
scenarios, each with equal probability of occurrence. Explain how you could use this information
to estimate the future NPV and make a decision about whether to accept or reject the project.
c. Now assume that there is also much uncertainty about the demand for your service by individuals.
Explain how you can attempt to incorporate this uncertainty along with the uncertainty of
exchange rate movements so that you can make a decision about whether to accept or reject the
project.
d. Explain how you would derive a required rate of return for your capital budgeting analysis. What
type of information would you use to derive the required rate of return?
ANSWER:
a. Demand and price would be used to estimate total revenue. There may be a variable cost per unit
if you provide a CD, pamphlets, and other supplemental materials. There would likely be an
annual lease expense from leasing a classroom. The depreciation expense would exist if you
purchase office equipment or a building. The host government tax will likely exist and is needed
International Cash Management ❖ 25
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d. Your required rate of return should represent the return that you require to invest in the project.
Thus, the first step is to determine what rate you would earn if you could invest the funds in a
dollar-denominated risk-free asset over the same time period. Then, you need to add a risk
premium on to the risk-free rate. The premium should reflect the extra return you would need to
pursue this project. You have some idea of the risk that is involved in the project based on the
degree of uncertainty surrounding the demand for your service and the exchange rate.
Chapter 15
You have an opportunity to purchase a private competitor called Fernand in Mexico. You will use only
your funds if you decide to purchase the company.
a. When you attempt to determine the value of this company, how will you derive your required rate
of return? Specifically, should you use the U.S. or Mexico risk-free rate as a base when deriving
your required rate of return? Why?
b. Another Mexican firm called Vascon also considers the purchase of this firm. Explain why
Vascon’s required rate of return may be higher than your required rate of return? Is there any
reason why Vascon’s required rate of return may be lower than your required rate of return?
c. Assume that you and Vascon have the same expectations regarding the Mexican cash flows that
will be generated by Fernand. Fernand’s owner is willing to sell the company for 2 million
Mexican pesos. You and Vascon use a similar process to determine the feasibility of acquiring a
target. You both compare the present value of the target’s cash flows to the purchase price of the
target. Based on your analysis, Fernand would generate a positive net present value for your
firm. Based on Vascon’s analysis, Fernand would generate a negative net present value for
Vascon. How could you determine that the acquisition of Fernand is feasible, while Vascon
determines that the acquisition of Fernand is not feasible?
d. Repeat Question c, except reverse the assumptions. Based on your analysis, Fernand would
generate a negative net present value for your firm. Based on Vascon’s analysis, Fernand would
generate a positive net present value for Vascon. How could you determine that the acquisition of
Fernand is not feasible, while Vascon determines that the acquisition of Fernand is feasible?
ANSWER:
a. You should use a U.S. risk-free rate as a based since you are using U.S. funds to make the
investment.
b. Vascon should use the Mexican risk-free rate as a base since it would use Mexican pesos to make
the investment. Its required rate of return may be higher because the risk-free rate in Mexico is
International Cash Management ❖ 26
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d. Fernand may be less feasible to you than to Vascon if your required rate of return is higher than
Vascon’s, or if the dollar cash flows to you are expected to be adversely affected by depreciation
of the Mexican peso over time. The expected cash flows of Fernand would not be converted by
Vascon into dollars.
Chapter 16
a. Review the political risk factors and identify those that could possibly affect your business.
Explain how your cash flows could be affected?
b. Explain why any threats of terrorism due to friction between two countries could possibly your
business, even if the terrorism has no effect on the relations between the U.S. and Mexico.
c. Assume there is an upcoming election in Mexico that may result in a complete change in
government.
d. Explain why such an election can have significant effects on your cash flows.
ANSWER:
a. If the attitude of consumers in Mexico toward the U.S. or other English-speaking countries
deteriorates, there may be less travel by Mexico’s people to these countries. Thus, there may be
less interest in learning the English language.
Chapter 17
a. Assume that your business is considering expansion within Mexico. You plan to invest a small
amount of U.S. dollar equity into this project and finance the remainder with debt. You can
obtain debt financing for the expansion in Mexico, but the interest rates in Mexico are higher than
in the U.S. Yet, if you used mostly U.S. debt financing, you are more exposed to exchange rate
risk. Explain why.
b. If you pursue a new project in Mexico, you want to assess the feasibility of the project if you use
mostly U.S. debt financing, versus mostly Mexican debt financing. Yet, you also want to capture
possible exchange rate effects on your cash flows over time. How can you use capital budgeting
to conduct your comparison?
c. You would prefer to avoid using Mexican debt to finance your expansion in Mexico because the
interest rates are high. A consultant suggests that you seek one or more investors in Mexico who
International Cash Management ❖ 27
would be willing to take an equity position in your business. You would provide them with
periodic dividends and they would be partial owners of your company. The consultant suggests
that this strategy circumvents the high cost of capital in Mexico because it uses equity financing
instead of debt financing. Is the consultant correct?
ANSWER:
a. All of your revenue is denominated in Mexican pesos, while your debt costs would be
denominated in dollars. This results in a larger amount of Mexican peso cash flows that have to
be converted and are subject to possible depreciation of the pesos.
Chapter 18
a. Recall from the previous chapter that your business is considering expansion within Mexico.
Recall that you plan to invest a small amount of U.S. dollar equity into this project and finance
the remainder with debt. You can obtain debt financing for the expansion in Mexico, but the
interest rates in Mexico are higher than in the U.S. Today, you receive credit offers from different
banks. You can either obtain a fixed-rate loan in the U.S. at 8 percent for the life of this project,
or a floating-rate loan (rate changes each year in response to market interest rates) in Mexico at
10 percent. Explain how you could estimate the net present value of the project for each
alternative financing method. Include in your explanation how you would account for the
uncertainty of future interest rate movements of the Mexican debt.
International Cash Management ❖ 28
ANSWER:
a. You can use capital budgeting in which you assess the return on your equity investment. The
financing expenses can be counted as cash outflows. In either case, you pay your labor cost and
rent cost in Mexican pesos in each month (or whatever) before you convert the Mexican peso
Chapter 19
Your business provides CDs on learning English that compliment the teaching that is provided by your
employees based in Mexico. Assume that you decide to capitalize on these CDs by selling them to a large
retail store based in Mexico. The CDs are not as effective without the teaching but can be useful to
individuals who want to learn the basics of the English language. You do not want to take the risk of
sending a case of CDs to the retail store unless you can be sure of receiving payment. Explain how you
can ensure payment for the CDs.
ANSWER:
Chapter 20
If you decide to implement a major marketing campaign in Mexico, you will incur high expenses in
Mexican pesos. You would need to finance the cost of your marketing. You could either borrow dollars at
a low interest rate and convert them to Mexican pesos to cover the cost or borrow Mexican pesos to cover
the cost. You would expect to pay off the loan on a monthly basis over the next year with the use of a
portion of the revenue you generate from your business in Mexico.
a. Would your business be more exposed to exchange rate risk if you borrow dollars or Mexican
pesos?
b. Explain how you would make the decision to borrow dollars versus Mexican pesos. What is the
key factor (other than the interest rate of each currency) that will determine whether you should
borrow dollars or Mexican pesos?
International Cash Management ❖ 29
ANSWER:
a. You are more exposed to exchange rate risk if you borrow dollars, because you would need to
remit more Mexican pesos cash flows to the U.S., which have to be converted to dollars.
Chapter 21
Assume that decide not to implement the marketing campaign that you considered in the previous chapter.
You may pursue it next year instead and will attempt to invest some of your profits this year in money
market investments, and then use this money to cover the campaign next year. You can retain your profits
earned this year by investing them in a Mexican bank where interest rates are high. Alternatively, you
could invest the profits in a dollar-denominated bank account. That is, you could convert your Mexican
peso profits to dollars periodically and accumulate the dollars over the year. At the end of the year, you
could convert the dollars back to Mexican pesos, so that you can pay for the marketing campaign. Explain
how you could decide between these two alternatives.
ANSWER:
To measure the funds that accumulate in the Mexican peso account: Estimate the amount of profits that
you would invest in the Mexican peso account and determine the amount by which the funds would