exam 2 homework answers international business finance
Find the present value of a 2-year Treasury bond that pays a semi-annual coupon, has a coupon rate of 6 percent, a yield to maturity of 5 percent, a par value of $1,000 when the yield to maturity is 5 percent.
$1,018.81
Yesterday, you entered into a futures contract to buy €62,500 at $1.50 per €. Your initial performance bond is $1,500 and your maintenance level is $500. At what settle price will you get a demand for additional funds to be posted?
$1.4840 per €.
The current spot exchange rate is $1.55 = €1.00 and the three-month forward rate is $1.60 = €1.00. Consider a three-month American call option on €62,500. For this option to be considered at-the-money, the strike price must be
$1.55 = €1.00
The current spot exchange rate is $1.55 = €1.00 and the three-month forward rate is $1.60 = €1.00. Consider a three-month American call option on €62,500 with a strike price of $1.50 = €1.00. If you pay an option premium of $5,000 to buy this call, at what exchange rate will you break-even?
$1.58 = €1.00
Yesterday, you entered into a futures contract to sell €75,000 at $1.79 per €. Your initial performance bond is $1,500 and your maintenance level is $500. At what settle price will you get a demand for additional funds to be posted?
$1.8033 per €.
Your firm has a British customer that is willing to place a $1 million order, but wants to pay in pounds instead of dollars. The spot exchange rate is $1.85 = £1.00 and the one-year forward rate is $1.90 = £1.00. The lead time on the order is such that payment is due in one year. What is the fairest exchange rate to use?
$1.90 = £1.00
The current spot exchange rate is $1.55 = €1.00 and the three-month forward rate is $1.60 = €1.00. Consider a three-month American call option on €62,500 with a strike price of $1.50 = €1.00. Immediate exercise of this option will generate a profit of
$3,125.
Suppose that Boeing Corporation exported a Boeing 747 to Lufthansa and billed €10 million payable in one year. The money market interest rates and foreign exchange rates are given as follows: -The U.S. one-year interest rate: 6.10% per annum -The euro zone one-year interest rate: 9.00% per annum -The spot exchange rate:$1.50/€ -The one-year forward exchange rate$1.46/€ Assume that Boeing sells a currency forward contract of €10 million for delivery in one year, in exchange for a predetermined amount of U.S. dollars. Which of the following is/are true? On the maturity date of the contract Boeing will (i) have to deliver €10 million to the bank (the counter party of the forward contract). (ii) take delivery of $14.6 million (iii) have a zero net euro exposure (iv) have a profit, or a loss, depending on the future changes in the exchange rate, from this British sale.
(i), (ii), and (iii)
Suppose that Boeing Corporation exported a Boeing 747 to Lufthansa and billed €10 million payable in one year. The money market interest rates and foreign exchange rates are given as follows: The U.S. one-year interest rate: 6.10% per annumThe euro zone one-year interest rate: 9.00% per annumThe spot exchange rate:$1.50/€The one-year forward exchange rate$1.46/€ Assume that Boeing sells a currency forward contract of €10 million for delivery in one year, in exchange for a predetermined amount of U.S. dollars. Which of the following is/are true? On the maturity date of the contract Boeing will (i) have to deliver €10 million to the bank (the counter party of the forward contract). (ii) take delivery of $14.6 million (iii) have a zero net euro exposure (iv) have a profit, or a loss, depending on the future changes in the exchange rate, from this British sale.
(i), (ii), and (iii)
Translation exposure refers to
-accounting exposure. -the effect that an unanticipated change in exchange rates will have on the consolidated financial reports of an MNC. -the change in the value of a foreign subsidiaries assets and liabilities denominated in a foreign currency, as a result of exchange rate change fluctuations, when viewed from the perspective of the parent firm.
A firm's operating exposure is
-defined as the extent to which the firm's operating cash flows would be affected by the random changes in exchange rates. -determined by the structure of the markets in which the firm sources its inputs, such as labor and materials, and sells its products. -determined by the firm's ability to mitigate the effect of exchange rate changes by adjusting its markets, product mix, and sourcing.
Under the current rate method,
-income statement items are to be translated at the exchange rate at the dates the items are recognized. -an appropriately weighted average exchange rate for the period may be used for translation. -all balance sheet accounts are translated at the current exchange rate, except stockholder equity.
A "Eurobond" issue is
-one denominated in a particular currency but sold to investors in national capital markets other than the country that issued the denominating currency. -usually a bearer bond. -for example, a Dutch borrower issuing dollar-denominated bonds to investors in the U.K., Switzerland, and the Netherlands.
A "registered bond" is one that
-shows the owner's name on the bond. -the owner's name is recorded by the issuer. -the owner's name is assigned to a bond serial number recorded by the issuer.
When exchange rates change,
-this can alter the operating cash flow of a domestic firm. -this can alter the competitive position of a domestic firm. -this can alter the home currency values of a multinational firm's assets and liabilities. -so all of the above are true
U.S. corporations
Are allowed to issue bearer bonds to non-U.S. citizens
A Japanese exporter has a €1,000,000 receivable due in one year. Detail a strategy using a money market hedge that will eliminate any exchange rate risk. 1-year rates of interest Borrowing Lending Dollar 4.5% 4.00% Euro 6.00% 5.25% Yen 1.00% 0.75% Spot exchange rates $1.25=€1.00 $1.00=¥100 1-year Forward Rates $1.2262=€1.00 $1.03=¥100
Borrow €943,396.22 today. Convert the euro to dollars at the spot exchange rate, convert these dollars to yen at the spot rate, receive ¥117,924,528.30.
A European option is different from an American option in that
European options can only be exercised at maturity; American options can be exercised prior to maturity.
The current/noncurrent method of foreign currency translation was generally accepted in the United States from the 1930s until 1975, when
FASB 8 became effective.
How many methods of foreign currency translation have been used in recent years? (U.S. GAAP.)
Four
What paradigm is used to define the futures price?
IRP
Under which accounting method are most income statement accounts translated at the average exchange rate for the period?
Monetary/nonmonetary method
A Japanese exporter has a €1,000,000 receivable due in one year. Spot and forward exchange rate data is given: Spot exchange rates $1.20=€1.00 $1.00=¥100 1-year Forward Rates $1.25=€1.00 $1.00=¥120 Contract size €62,500 ¥12,500,000 The one-year risk free rates are i$ = 4.03%; i€ = 6.05%; and i¥ = 1%. Detail a strategy using forward contracts
Sell €1m forward using 16 contracts at the forward rate of $1.25 per €1. Buy ¥150,000,000 forward using 12 contracts, at the forward rate of $1.00 = ¥120.
Your firm is a U.K.-based exporter of bicycles. You have sold an order to a French firm for €1,000,000 worth of bicycles. Payment from the French firm (in euro) is due in 12 months. Use a money market hedge to redenominated this one-year receivable into a pound-denominated receivable with a one-year maturity. Contract Size Country U.S. $ equiv. Currency per U.S. $ £10,000 Britain (pound) $1.9600 £0.5102 interest APR 12 months forward $2.0000 £0.5000 €10,000 Euro $1.5600 €0.6410 i$ = 1% 12 months forward $1.6000 €0.6250 i€ = 2% SFr.10,000 Swiss franc $0.9200 SFr.1.0870 i£ = 3% 12 months forward $1.0000 SFr.1.0000 iSFr. = 4% The following were computed without rounding. Select the answer closest to yours.
Step 1: €1,000,000 / 1.02 = €980,392; Step 2: (€1 / $1.56) = (€980,392 / X), where X = $1,529,411.77; Step 3: ($1.96 / £1) = ($1,529,411.77 / X), where X = £780,312.12; Step 4: £780,312.12 × (1.03) = £803,721.49
Generally speaking, a firm with recurrent exposure can best hedge using which product?
Swaps
An "option" is
a contract giving the owner (buyer) of the option the right, but not the obligation, to buy (call) or sell (put) a given quantity of an asset at a specified price at some time in the future.
Straight fixed-rate bond issues have
a designated maturity date at which the principal of the bond issue is promised to be repaid. During the life of the bond, fixed coupon payments, which are a percentage of the face value, are paid as interest to the bondholders.
If you owe a foreign currency denominated debt, you can hedge with
a long position in a currency forward contract, or buying the foreign currency today and investing it in the foreign county.
If you have a long position in a foreign currency, you can hedge with
a short position in a currency forward contract.
The underlying principle of the current rate method is
all balance sheet accounts are translated at the current exchange rate, except stockholder equity.
Shelf registration
allows an issuer to preregister a securities issue, and then "shelve" the securities for later sale.
A minor currency is
anything other than the "big six": U.S. dollar, British pound, Japanese yen, euro, Canadian dollar, and Swiss franc.
Using the temporal method, monetary accounts, such as cash
are translated at the current spot exchange rate.
Euro-medium term notes
are typically fixed-rate corporate notes issued with maturities ranging from less than a year to about ten years.
Floating-rate notes (FRN)
are typically medium-term bonds with coupon payments indexed to some reference rate (e.g., LIBOR), and appeal to investors with strong need to preserve the principal value of the investment should they need to liquidate prior to the maturity of the bonds.
The link between the home currency value of a firm's assets and liabilities and exchange rate fluctuations is
asset exposure.
Eurobonds are usually
bearer bonds
To hedge a foreign currency payable,
buy call options on the foreign currency. Correct
To hedge a foreign currency receivable,
buy put options on the foreign currency with a strike in the domestic currency.
Investments in R&D
can allow the firm to maintain and strengthen its competitive position, as well as cut costs and enhance productivity.
From the perspective of a corporate CFO, when hedging a payable versus a receivable
credit risk considerations are more germane for a receivable.
The most direct and popular way of hedging transaction exposure is by
currency forward contracts.
The simplest of all translation methods to apply is
current rate method.
The recognized methods for consolidating the financial reports of an MNC are
current/noncurrent method, monetary/nonmonetary method, temporal method, and current rate method. Correct
The generally accepted method for consolidating the financial reports of an MNC from the 1930s to 1975 was the
current/noncurrent method.
Private placement bond issues
do not have to meet the strict information disclosure requirements of publicly traded issues
"Yankee" bonds are
dollar-denominated foreign bonds originally sold to U.S. investors.
A balance sheet hedge seeks to
eliminate any mismatch of net assets and net liabilities denominated in the same currency.
A purely domestic firm that sources and sells only domestically,
faces exchange rate risk to the extent that it has international competitors in the domestic market.
With regard to contractual size,
futures contracts are characterized by a standardized amount of the underlying asset.
With regard to trading location,
futures contracts are traded competitively on organized exchanges
With regard to expiration date,
futures contracts have standardized delivery dates.
With regard to trading costs,
futures contracts involve the bid-ask spread plus the broker's commission.
The price elasticity of demand for commodity products tends to be
highly elastic.
The firm may not be able to pass through changes in the exchange rate
in markets with low product differentiation or in markets with high price elasticities.
The choice between a forward market hedge and a money market hedge often comes down to
interest rate parity.
An exporter can shift exchange rate risk to their customers by
invoicing in their home currency.
A "global bond" issue
is a very large international bond offering by a single borrower that is simultaneously sold in several national bond markets.
A CME contract on €125,000 with September delivery
is an example of a futures contract.
The underlying principle of the temporal method is
monetary accounts are translated at the current exchange rate; other accounts are translated at the current exchange rate if they are carried on the books at current value; items carried at historical cost are translated at historic exchange rates.
A "foreign bond" issue is
one offered by a foreign borrower to investors in a national market and denominated in that nation's currency (e.g., a German MNC issuing dollar-denominated bonds to U.S. investors).
With regard to operational hedging versus financial hedging,
operational hedging provides a more stable long-term approach than does financial hedging.
Contingent exposure can best be hedged with
options.
An exporter faced with exposure to an appreciating currency can reduce transaction exposure with a strategy of
paying early, collecting late.
An exporter faced with exposure to a depreciating currency can reduce transaction exposure with a strategy of
paying late, collecting early.
A "bearer bond" is one that
possession is evidence of ownership.
A derivatives hedge that seeks to eliminate translation exposure
really involves speculation about foreign exchange rate changes.
A financial subsidiary used for centralizing exposure management functions is also referred to as a(an)
reinvoice center
Currency risk
represents random changes in exchange rates.
The management of translation exposure is best described as
selecting a mechanical means for handling the consolidation process for MNCs that logically deals with exchange rate changes.
An exporter can share exchange rate risk with their customers by
splitting the difference, and invoicing half of sales in local currency and half of sales in home currency, as well as invoicing sales in a currency basket such as the SDR as the invoice currency.
The "reporting currency" is defined in FASB 52 as
the currency in which the MNC prepares its consolidated financial statements.
The "functional currency" is defined in FASB 52 as
the currency of the primary economic environment in which the entity operates.
Operating exposure measures
the extent to which the firm's operating cash flows will be affected by unexpected changes in exchange rates.
Economic exposure refers to
the extent to which the value of the firm would be affected by unanticipated changes in exchange rate.
A U.S. firm has sold an Italian firm €1,000,000 worth of product. In one year the U.S. firm gets paid. To hedge, the U.S. firm bought put options on the euro with a strike price of $1.65. They paid an option premium $0.01 per euro. If at maturity, the exchange rate is $1.60,
the firm will realize $1,640,000 on the sale net of the cost of hedging.
A U.S. firm holds an asset in Great Britain and faces the following scenario: State 1 Probability 25% Spot rate$2.50/£ P*£1,800 State 2 50% $2.00/£ £2,250 State 3 25% $1.60/£ £2,812.50
the firm's exposure to the exchange rate is made worse.
In terms of the types of instruments offered,
the international bond market has been much more innovative than the U.S. market.
When cross-hedging,
the main thing is to find one asset that covaries with another asset in some predictable way.
Transaction exposure is defined as
the sensitivity of realized domestic currency values of the firm's contractual cash flows denominated in foreign currencies to unexpected exchange rate changes.
Exchange rate risk of a foreign currency payable is an example of
transaction exposure.
The sensitivity of "realized" domestic currency values of the firm's contractual cash flows denominated in foreign currency to unexpected changes in the exchange rate is
transaction exposure.
A CFO should be least worried about
translation exposure.
Suppose a U.S.-based MNC maintains a vacation home for employees in the British countryside and the local price of this property is always moving together with the pound price of the U.S. dollar. As a result,
whenever the pound depreciates against the dollar, the local currency price of this property goes up by the same proportion. Additionally, the firm is not exposed to currency risk even if the pound-dollar exchange rate fluctuates randomly.
A firm with a highly elastic demand for its products
will be unable to pass increased costs following unfavorable changes in the exchange rate without significantly lowering the quantity sold.
With any hedge,
your losses on one side should about equal your gains on the other side.
