Chapter #3 447
The average daily foreign exchange trading by banks around the world is closest to _______.
$1.5 Trillion
The market in which the immediate exchange of currencies take place is known as the _____ market
Spot
Foreign Bond
bond issued by a borrower foreign to the country where the bond is placed
A MNC's long-term financing decisions are satisfied in the _____ market and the ________.
international bond; international stock
Important Characteristics of a bank that allows foreign exchange
Advice about current market conditions, forecasting advice, quote competitiveness , speed of execution, special relationship with bank
T/F: Typically, a given stock will appear undervalued to investors from all countries at the same time.
False
T/F: A MNC frequently uses either forward or futures contracts to hedge its exposure to foreign receivables. To do so, the MNC can either sell the foreign currency forward or sell the futures contracts
True
T/F: A forward contract is an agreement between a firm and a bank to exchange currencies at a specified rate (the forward rate) in a specified number of days.
True
London Interbank Offer Rate (LIBOR)
the rate most often charged for very short-term loans (such as for one day) between banks
Assume the Canadian dollar is equal to $0.90 and the Argentine peso is equal to $0.30. The value of the Canadian dollars is ______ Argentine pesos.
(0.90/0.30) =3
Factors that affect the Ask/Bid Spread
+Order costs, +Inventory Costs, --Competition, -Volume, and +Currency risk
A year ago, Peter Allan invested in the stock of Jober, a German company. Over the last year, the stock declined in vlaue by 20%. However, the euro appreciated over the year by 10%. If peter sold the stock today, his return would be _______.
-12% (1+0.10)x(1-0.20)-1
Poland's currency is worth $.17 and the Japanese Yen is work $.008. What is the cross rate of the zloty with respect to yen? (How many yen equal a zloty)
.17/.008 = 21.25 1 zloty = 21.25 Yen
Assume a bank's bid rate for the Danish kroner (DKK) is $0.1875, while its ask rate is $0.1895. Assume you convert $1,000 to Danish kroner to take on your trip to Denmark. Immediately after conversion, a family emergency arises, and you are unable to go on your trip. Thus, you convert the Danish kroner back to dollars. 1.) How many Danish kroner will you receive when converting the dollars initially? 2.) How many dollars will you have left after the two conversions? 3.) What is the bank's bid/ask percentage spread?
1.) 5,277.04 Danish kroner ($1,000 / $0.01895) 2.) $989.45 (5,277.04 DKK x $0.1875) 3.) 1.06% (0.1895-0.1875) / 0.1895 4.)
If the direct exchange rate fo the euro is $1.25, what is the euro's indirect exchange rate. That is, what is the value of a dollar in euros?
1/1.25 = 0.8 Euros
Utah Bank's bid price for Canadian dollars is $0.7938 and its ask price is $0.81. What is the bid/ask % spread?
2% (Ask-Bid)/ Ask (.81-.7938) /.81
Compute the bid/asl % spread for Mexican peso retail transactions in which the ask rate is $.11 and the bid rate is .10
9.1%
Explain how syndicated loans are used in international markets.
A large MNC may want to obtain a large loan that no single bank wants to accommodate by itself. Thus, a bank may create a syndicate whereby several other banks also participate in the loan
Which of the following is probably not an example of the use of forward contracts by an MNC? a. Hedging pound payables by selling pounds forward b. Hedging peso payables by purchasing pesos forward c. Hedging peso receivables by selling pesos forward d. Hedging yen payables by purchasing yen forward e. All of these choices are examples of using forward contracts.
A. Hedging pound payable by selling pounds forward A firm with liabilities (payables) would hedge by buying $, not selling A firm with receivables woudl hedge by selling $ Outcome: if the pound fell, the value of the liabilities would fall, but the selling position would gain => one sided effect
Which of the following is not a possible bid/ask quotation for the Barbados dollar? Why? a. $.50/$.51 b. $.52/$.51 c. $.49/$.50 d. $.51/$.52 e. All of these choices are possible bid/ask quotations.
B. $0.52/$0.51 This is not possible because the bid quote will always be smaller than the ask quote.
A share of the ADR of the German firm Bergerschnus represents one share of this firm's stock that is traded on the Frankfurt Stock Exchange. The share price of Bergerschnus was 30 euros when the Frankfurt exchange closed. When the U.S. market opens, the euro is worth $1.15. The price of the ADR should be: a. $26.09. b. $34.50. c. $31.15. d. $30.00. e. None of these choices are correct. If the Bergerschnus ADR is convertible into three shares of stock, the ADR price would be?
B. $34.50 ( 30 Euros x $1.15) $34.50 x 3 = $103.50
Process used by banks in the Eurocredit market to determine the rate to charge on loans.
Banks set the loan rate based on the prevailing LIBOR, and allow the loan rate to float (change every 6 mo) in accordance with changes in LIBOR
Which of the following is not a reason why an MNC may decide to issue stock in a foreign country? a. The MNC wishes to establish a global image. b. The market in which the stock is to be issued is highly liquid. c. The market in which the stock is to be issued is very large, contributing to the market's liquidity. d. Regulations in the market in which the stock is to be issued are more stringent than regulations in the home market. e. All of these choices are reasons why an MNC may decide to issue stock in a foreign country.
D. Regulations in the market in which the stock is to be issued are more stringent than regulations in the home market.
Brief history that led to floating exchange rates in 1973
Difficulty maintaining fixed exchange rates. 1971 banks widened, but difficult to control still 1973 bands were eliminated s.t. rate could respond to market forces without limits (gov't can intervene periodically
A quotation representing the value of a foreign currency in dollars is referred to as a(n) ______ quotation; a quotation representing the number of units of a foreign currency per dollar is referred to as a(n) _____ quotation.
Direct; Indirect
A bond sold in countries other than the country represented by the currency denominating it is known as a:
Eurobond
Today, the stock price of Genevo Company (based in Switzerland) is priced at SF80 per share. The spot rate of the Swiss franc (SF) is $.70. During the next year, you expect that the stock price of Genevo Company will decline by 3%. You also expect that the Swiss franc will depreciate against the U.S. dollar by 8% during the next year. You own American depository receipts (ADRs) that represent Genevo stock. Each share that you own represents one share of the stock traded on the Swiss stock exchange. What is the estimated value of the ADR per share in one year?
Expected value of Swiss stock in 1 year = SF80 x (1 - .03) = SF77.6. Expected value of Swiss franc in 1 year = $.70 (1 - .08) = $.644 Expected value of ADR in 1 year = SF77.6 x ($.644 per franc) = $49.97.
T/F: An American Depository Receipt (ADR) is a drawing right, and it is available only for US stocks.
False
T/F: An investor engaging in a transaction whereby her or she contracts to purchase British pounds one year from now is an example of a spot market transaction.
False
T/F: In 1914, when World War I began, the gold standard was implements; it lasted until 1944, when exchange rates were fixed under the Bretton Woods Agreement.
False
T/F: A currency put option provides the right, but not the obligation, to buy a specific currency at a specific price within a specific period of time
False Put Options => Selling Call Option => Buying
An obligation to sell a specific amount of currency at a specific exchange ate at a future point in time is called a
Forward Contract
Function of the International Money market? -Reasons for development/growth -How does international money, credit and bond market differ
Function: efficiently facilitate the flow of international funds from firms or governments with excess funds to those in need of funds. Growth: 1.) regulation in the US that limited foreign lending by US bank 2.) regulated ceilings place on interest rate of dollar deposits in the US that encourage deposits to be placed in the Eurocurrency market where ceilings were nonexistent Money Mkt: Focus ST Deposit/Loan Credit Mkt: tap medium-term loans Bond: LT funds
Risk associated with international bond
Interest Rate, Exchange Rate, Liquidity, Credit Risk
Why do interest rates vary among countries? Why are interest rates normally similar for those European countries that use the euro as their currency? Offer a reason why the government interest rate of one country could be slightly higher than the government interest rate of another country, even though the euro is the currency used in both countries.
Interest rates in each country are based on the supply of funds and demand for funds for a given currency. However, the supply and demand conditions for the euro are dictated by all participating countries in aggregate, and do not vary among participating countries. Yet, the government interest rate in one country that uses the euro could be slightly higher than others that use the euro if it is subject to default risk. The higher interest rate would reflect a risk premium.
The market in which financial intermediaries transfer short-term funds from surplus units to deficit units is known as the ______ market.
International Money Market
Blank Corp is a US exporter that invoices its export to the UK in British pounds. If it expects that the pound will appreciate against the dollar in the future, should it hedge its exports with a forward contract? Explain.
It should not hedge because this corp will benefit from the appreciation of the pound when it converts the pounds to $.
Who are the borrowers of Eurocredit loans
Large corp and some government agencies
What is a perk of a liquid spot market?
Liquid spot market => there are many buyers and sellers so it is very easy to buy and sell said currency
Why would a MNC invest funds in a financial market outside its own country?
Might be able to earn a higher interest rate on funds invested in a different financial market. The exchange rate of the currency involved might be expected to appreciate
Floating Exchange Rate System
Once the boundaries imposed by the Smithsonian Agreement were eliminated, adopted free moving rates, which allows rates to more with market forces
Ask Price
Price at which a trader of foreign exchange (typically a bank) is willing to sell a particular currency.
Why do some financial institutions prefer to provide credit in financial markets outside of their own country?
The FI may believe that it can earn a higher return by providing credit, if interest rate level are higher and the economic conditions are strong s.t. the risk of default on credit provided is low. It can also help to diversify their credit s.t. they are not too exposed to the economic conditions in any single country
How would the appreciation of the Australian dollar against the US dollar affect the return of a US firm that invested in an Australian money market security.
The US firm purchases the Australian dollars to make its investment at a lower exchange rate than the rate at which is will convert to US dollar => the firm will benefit as it is getting a higher return
Why do you think the terrorist attack on the U.S. was expected to cause a decline in U.S. interest rates? Given the expectations for a potential decline in U.S. interest rates and stock prices, how were capital flows between the U.S. and other countries likely affected?
The attack was expected to cause a weaker economy, which would result in lower US intR. Given the lower intR, and weak stock prices, the amount of funds invested by foreign investors in US securities would be reduced
Assume that during this semester, the euro appreciated against the dollar. Did the direct exchange rate of the euro increase or decrease? Did the indirect exchange rate of the euro increase or decrease?
The indirect exchange rate is the reciprocal of the direct exchange rate. Thus, as the euro appreciates against the U.S. dollar over time, this means that the direct rate of the euro increases while the indirect rate of the euro decreases.
T/F: The LIBRO various among currencies because the market supply of and demand for funds vary among countries.
True
T/F: Under the gold standard, each currency was convertible into gold at a specified rate, and the exchange rate between two currencies was determined by their relative convertibility rates per ounce of gold.
True
T/F: With an ECN (Electronic Communication Network), investors can place orders on their computers that are then executed by the computer system and confirmed through the Internet to the investor.
True
Today you notice the following exchange rate quotations: *$1 is equal to 3.00 Argentine pesos*1 Argentine peso = 0.50 Canadian dollars*You need to purchase 100,000 Canadian dollars with U.S. dollars. How many U.S. dollars will you need for your purchase?
Value of AP = $.333Value of C$ in AP = 2Value of C$ in $ = $.666So you need $66,666 to purchase C$100,000.
You just came back from Canada, where the Canadian dollar was worth $.70. You still have C$200 from your trip and could exchange them for dollars at the airport, but the airport foreign exchange desk will only buy them for $.60. Next week, you will be going to Mexico and will need pesos. The airport foreign exchange desk will sell you pesos for $.10 per peso. You met a tourist at the airport who is from Mexico and is on his way to Canada. He is willing to buy your C$200 for 1,300 pesos. Should you accept the offer or cash the Canadian dollars in at the airport? Explain.
You should exchange with the tourist. If you exchange the C$ for pesos at the desk the cross-rate is .60/.10 = 6 => get 1,200 pesos (C$200x6 = 1,200) If you exchange C$ for pesos with tourist you will get 1,300
Floating Rate Notes (FRNs)
a variable rate provision in some Eurobonds that adjusts the coupon rate over time according to prevailing market rates
Single European Act
act intended to remove numerous barriers imposed on trade and capital flows between European countries.
Basel Accord
agreement among country representative in 1988 to establish standardized risk-based capital requirements for banks across countries.
Forward Contract
agreement to buy or sell a specified currency at a specified exchange rate on a specified future date.
Eurobonds
bond that are sold in countries other than the country whose currency is used to denominate the bonds
Parallel Bond
bonds placed in different countries and denominated in the respective currencies of the countries where they are placed
American Depository Receipts (ADRs)
certificates representing ownership of foreign stocks, which are traded on stock exchanges in the United States
Eurocredit market
collection of banks that accepts deposits and provides loans in large denominations and in a variety of currencies. The banks that comprise this market are the same banks that comprise the Eurocurrency market; the difference is that the Eurocredit loans are longer term than the so-called Eurocurrency loans
Explain why firms may issue stock in foreign markets. Why might US firms issue more stock in Europe since the conversion to the euro in 1999?
concern their home market will not absorb the entire issue. Firm could have foreign currency inflows in the foreign country that can be used to pay dividend on foreign-issued stock. Desire to enhance global image Since the euro can be used in several countries, firms may need a large amount of euros if they are expanding across Europe
Smithsonian Agreement
conference between nations in 1971 that resulted in a devaluation of the dollar against major currencies and a widening of boundaries (2 percent in either direction) around the newly established exchange rates
Bretton Woods Agreement
conference held in Bretton Woods, New Hampshire, in 1944, resulting in an agreement to maintain exchange rates of currencies within very narrow boundaries; this agreement lasted until 1971
Currency Put option
contract granting the right to sell a particular currency at a specified price (exchange rate) within a specified period of time
Currency Futures Contract
contract specifying a standard volume fo a particular currency to be exchanged on a specific settlement date.
Currency Call Option
contract that grants the right to purchase a specific currency at a specific price (exchange rate) within a specific period of time.
Spot Rate
current exchange rate of currency
Petrodollars
deposits of dollars by countries that receive dollars revenues due to the sale of petroleum to other countries; the term commonly refers to OPEC deposits of dollars in the Eurocurrency markets
Bid/Ask Spread
difference between the price at which a bank is willing to buy a currency and the price at which it will sell that currency.
Eurodollars
dollar deposits in banks in Europe (and on other continents)
Cross Exchange Rate
exchange rate between currency A and currency B, given the value of currencies A and B with respect to a third currency.
Indirect Quotations
exchange rate quotations representing the value measured by number of units per dollar 1EUR = 1.08238 USD
As a result of the Bretton Woods Agreement, the exchange rate between any two currencies was typically
fixed within narrow boundaries
Syndicate
group of banks that participate in loans
The main focus of the Basel Accord is requiring banks to
hold more capital if they take more risk
Eurocredit Loans
loans of one year or longer that are extended by banks to MNCs or government agencies in Europe
Foreign Exchange Market
market composed primarily of banks, serving firms and consumers who wish to buy or sell various currencies.
Asian Money Market
market in Asia in which banks collect deposits and make loans denominated in US dollars
Spot Market
market in which exchange transactions occur for immediate exchange
Forward Market
market in which forward contracts are created
In general, stock markets allow for more governance and attract more investors when they have
more enforcement of the laws, more legal protection for shareholders, voting rights for shareholders, Uniform Accounting
Why would a bank desire to participate in syndicated Eurocredit loans.
no single bank totally exposed to the risk that the borrower may fail to repay the loan (risk is spread)
Yankee Stock Offerings
offerings of stock by non-US firms in the US markets.
Strike Price
price (exchange rate) at which the owner of a currency call option is allowed to buy a specified currency; or the price (exchange rate) at which the owner of a currency put option is allowed to sell a specified currency
Bid Price
price that a trader of foreign exchange (typically a bank) is willing to pay for a particular currency
Exercise Price
price(exchange rate) at which the owner of a currency call option is allowed to buy a specified currency; or the price (exchange rate) at which the owner of a currency put option is allowed to sell a specified currency.
If a US firm needs 100,000 euros in 90 days and wishes to avoid the risk from exchange rate fluctuations, it could
purchase a 90-day forward contract on euros
Direct Quotations
quotations that report the value of a foreign currency in dollars (number of dollars per unit of other currency) 1USD = .92819 EUR
How is LIBOR used in the Eurocredit Market
serves as a bade from which loan rates and other loans are determined in the Eurocredit market
The international money market primarily concentrates on
short-term deposits and loans
Forward Rate
specified exchange rate within the forward contract
Explain how the appreciation of the Japanese yen against the dollar would affect the return to a US firm that borrowed Japanese yen and used the proceeds for a US project.
the US firm converted yen to US dollars at a lower exchange rate than the rate at which it paid for the yen at the time it would repay the loan. The cost of borrowing is not higher as a result of the appreciation