TEST BANK for International Financial Management, 11th Edition by Jeff Madura.

Test Bank for International Financial Management, 11th Edition by Jeff Madura

Chapter 1—Multinational Financial Management 1. The commonly accepted goal of the MNC is to: a. maximize short-term earnings. b. maximize shareholder wealth. c. minimize risk. d. A and C. e. maximize international sales.

ANS: B

PTS: 1

2. With regard to corporate goals, an MNC is mostly concerned with maximizing ____, and a purely domestic firm is mostly concerned with maximizing ____. a. shareholder wealth; short-term earnings b. shareholder wealth; shareholder wealth c. short-term earnings; sales volume d. short-term earnings; shareholder wealth ANS: B

PTS: 1

3. For the MNC, agency costs are typically: a. non-existent. b. larger than agency costs of a small purely domestic firm. c. smaller than agency costs of a small purely domestic firm. d. the same as agency costs of a small purely domestic firm.

ANS: B

PTS: 1

4. Which of the following could reduce agency problems for an MNC? a. stock options as managerial compensation. b. hostile takeover threat. c. investor monitoring. d. all of the above are forms of corporate control that could reduce agency problems for an MNC. ANS: D

PTS: 1

5. The valuation of an MNC should rise when an event causes the expected cash flows from foreign to ____ and when foreign currencies denominating these cash flows are expected to ____. a. decrease; appreciate b. increase; appreciate c. decrease; depreciate d. increase; depreciate ANS: B

PTS: 1

6. Which of the following theories identifies specialization as a reason for international business? a. theory of comparative advantage. b. imperfect markets theory. c. product cycle theory. d. none of the above ANS: A

PTS: 1

7. Which of the following theories identifies the non-transferability of resources as a reason for international business? a. theory of comparative advantage. b. imperfect markets theory. c. product cycle theory. d. none of the above ANS: B

PTS: 1

8. Which of the following theories suggests that firms seek to penetrate new markets over time? a. theory of comparative advantage. b. imperfect markets theory. c. product cycle theory. d. none of the above ANS: C

PTS: 1

9. Which of the following industries would most likely take advantage of lower costs in some less developed foreign countries? a. assembly line production. b. specialized professional services. c. nuclear missile planning. d. planning for more sophisticated computer technology.

ANS: A

PTS: 1

10. Due to the risks involved in international business, firms should: a. only consider international business in major countries. b. maintain international business to no more than 20% of total business. c. maintain international business to no more than 35% of total business. d. none of the above ANS: D

PTS: 1

11. A product cycle is the process by which a firm provides a specialized sales or service strategy, support assistance, and possibly an initial investment in the franchise in exchange for periodic fees. a. True b. False ANS: F

PTS: 1

12. Licensing is the process by which a firm provides its technology (copyrights, patents, trademarks, or trade names) in exchange for fees or some other specified benefits. a. True b. False ANS: T

PTS: 1

13. The agency costs of an MNC are likely to be lower if it: a. scatters its subsidiaries across many foreign countries. b. increases its volume of international business. c. uses a centralized management style. d. A and B. ANS: C

PTS: 1

14. An MNC may be more exposed to agency problems if most of its shares are held by: a. a few mutual funds b. a widely dispersed set of individual investors c. a few pension funds d. all of the above would prevent agency problems ANS: B

PTS: 1

15. The Sarbanes-Oxley Act improves corporate governance of MNCs because it: a. makes executives more accountable for verifying financial statements b. eliminates stock options as a form of compensation c. ties executive compensation to firm performance d. places a limit on the amount of funds that managers can spend ANS: A

PTS: 1

16. MNCs can improve their internal control process by all of the following, except: a. establishing a centralized data base of information b. ensuring that all data are reported consistently among subsidiaries c. ensuring that the MNC always borrows from countries where interest rates are lowest d. using a system that checks internal data for unusual discrepancies ANS: C

PTS: 1

17. Franchising is the process by which national governments sell state owned operations to corporations and other investors. a. True b. False ANS: F

PTS: 1

18. The parent of MNC can implement compensation plans that directly reward the subsidiary managers for enhancing the value of the MNC. a. True b. False ANS: T

PTS: 1

19. If a publicly-traded MNC's managers make poor decisions that reduce its value, it may encourage other firms to acquire it.

a. True b. False ANS: T

PTS: 1

20. Institutional investors such as mutual funds or pension funds which have large holdings of an MNC's stock do not normally want to take control of it and therefore have no influence over management of the MNC. a. True b. False ANS: F

PTS: 1

21. In comparing exporting to direct foreign investment (DFI), an exporting operation will likely incur ____ fixed production costs and ____ transportation costs than DFI. a. higher; higher b. higher; lower c. lower; lower d. lower; higher ANS: D

PTS: 1

22. Which of the following is an example of direct foreign investment? a. exporting to a country. b. establishing licensing arrangements in a country. c. purchasing existing companies in a country. d. investing directly (without brokers) in foreign stocks.

ANS: C

PTS: 1

23. According to the text, a disadvantage of licensing is that: a. it prevents a firm from importing. b. it is difficult to ensure quality control of the production process. c. it prevents a firm from exporting. d. none of the above ANS: B

PTS: 1

24. ____ are most commonly classified as a direct foreign investment. a. Foreign acquisitions b. Purchases of international stocks c. Licensing agreements d. Exporting transactions ANS: A

PTS: 1

25. Imperfect markets represent conditions under which factors of production are immobile. a. True b. False ANS: T

PTS: 1

26. The Sarbanes-Oxley Act (SOX) was enacted in 2002 required MNCs and other firms to implement an internal reporting process that could be easily monitored by executives and the board of directors. a. True

b. False ANS: T

PTS: 1

27. If markets were perfect, then labor and other costs of production would be perfectly stable (no movement across borders). a. True b. False ANS: F

PTS: 1

28. The valuation of an MNC is reduced if the required return on its investments in foreign countries is reduced. a. True b. False ANS: F

PTS: 1

29. Which of the following is not mentioned in the text as an additional risk resulting from international business? a. exchange rate fluctuations. b. political risk. c. interest rate risk. d. exposure to foreign economies.

ANS: C

PTS: 1

30. Licensing obligates a firm to provide ____, while franchising obligates a firm to provide ____. a. a specialized sales or service strategy; its technology b. its technology; a specialized sales or service strategy c. its technology; its technology d. a specialized sales or service strategy; a specialized sales or service strategy e. its technology; an initial investment ANS: B

PTS: 1

31. Which of the following is not a way in which agency problems can be reduced through corporate control? a. executive compensation. b. threat of hostile takeover. c. acquisition of a foreign subsidiary. d. monitoring by large shareholders.

ANS: C

PTS: 1

32. The goal of a multinational corporation (MNC) is the maximization of shareholder wealth. a. True b. False ANS: T

PTS: 1

33. A centralized management style, where major decisions about a foreign subsidiary are made by the parent company, results in an increase in agency costs. a. True b. False ANS: F

PTS: 1

34. If a U.S. firm sets up a plant in Mexico to benefit from low cost labor, it will likely have a comparative advantage over other firms in Mexico that sell the same product. a. True b. False ANS: F

PTS: 1

35. Although MNCs may need to convert currencies occasionally, they do not face any exchange rate risk, as exchange rates are stable over time. a. True b. False ANS: F

PTS: 1

36. One of the most prevalent factors conflicting with the realization of the goal of an MNC is the existence of agency problems. a. True b. False ANS: T

PTS: 1

37. A centralized management style for an MNC results in relatively high agency costs. a. True b. False ANS: F

PTS: 1

38. The imperfect markets theory states that factors of production are somewhat immobile, allowing firms to capitalize on a foreign country's resources. a. True b. False ANS: T

PTS: 1

39. If a U.S.-based MNC focused completely on importing, then its valuation would likely be adversely affected if most currencies were expected to appreciate against the dollar over time. a. True b. False ANS: T

PTS: 1

40. The acquisition of a foreign subsidiary is commonly considered by MNCs because the cost is less expensive than establishing a new subsidiary of the same size. a. True b. False ANS: F

PTS: 1

41. If a U.S.-based MNC focused completely on exporting, then its valuation would likely be adversely affected if most currencies were expected to appreciate against the dollar over time. a. True b. False ANS: F

PTS: 1

42. If markets were perfect, then labor and other costs of production would be easily transferable. a. True b. False ANS: T

PTS: 1

43. International trade: a. is a relatively conservative approach to foreign market penetration. b. entails minimal risk. c. does not require large amount of investment. d. all of the above.

ANS: D

PTS: 1

44. Assume that an American firm wants to engage in international business without major investment in the foreign country.

Which method is least appropriate in this situation? a. International Trade b. Licensing c. Franchising d. Direct foreign investment ANS: D

PTS: 1

45. The valuation of MNC accounts for all the cash flows received by the foreign subsidiaries plus all the cash flows remitted by the subsidiaries. a. True b. False ANS: F

PTS: 1

46. The MNC's value depends on all of the following, except: a. MNC's required rate of return b. Amount of MNC's cash flows in particular currency c. The exchange rate at which cash flows are converted to dollars d. The value of MNC depends on all of the above factors ANS: D

PTS: 1

47. Which of the following is not an example of political risk? a. Government may impose taxes on subsidiary b. Government may impose barriers on subsidiary c. Consumers may boycott the MNC d. Consumers' income levels will decrease, thus decreasing consumption.

ANS: D

PTS: 1

48. A microeconomic perspective focuses on external forces such as economic conditions that can affect the value of an MNC. a. True b. False ANS: F PTS: 1 49. Assume that an MNC has a subsidiary in Italy, which exports its products to various countries in Europe. Since all of the countries where it exports use Euro as their currency, this MNC is not subject to the exchange rate risk.

a. True b. False ANS: F

PTS: 1

50. International trade generally results in ____ exposure to international political risk and ____ exposure to international economic conditions, when compared to other methods of international business. a. higher; lower b. higher; higher c. lower; higher d. lower; lower ANS: D

PTS: 1

51. Assume that Boca Co. wants to expand its business to Japan, and wants complete control over the operations in Japan. Which method of international business is most appropriate for Boca Co? a. Joint venture b. Licensing c. Partial acquisition of existing Japanese firm d. Establishment of Japanese subsidiary ANS: B

PTS: 1

52. A decentralized management style of MNC results in relatively high agency costs. a. True b. False ANS: T

PTS: 1

53. The establishment of a new subsidiary is commonly considered by MNCs because the cost is less expensive than acquiring a foreign subsidiary of the same size. a. True b. False ANS: T

PTS: 1

54. Assume that Live Co. has expected cash flows of $200,000 from domestic operations, SF200,000 from Swiss operations, and 150,000 euros from Italian operations at the end of the year. The Swiss franc's value and euro's value are expected to be $.83 and $1.29 respectively, at the end this year. What are the expected dollar cash flows of Live Co? a. $200,000 b. $559,500 c. $582,500 d. $393,500 ANS: B

PTS: 1

55. Saller Co. has a subsidiary in Mexico. The expected cash flows in pesos to be received in the future from this subsidiary have not changed since last month, but the valuation of Saller Co. has declined since last month. What could've caused this decline in value? a. A weaker Mexican economy b. Lower Mexican interest rates c. Depreciation of the Mexican peso d. Appreciation of the Mexican peso.

ANS: C PTS: 1 56. Jensen Co. wants to establish a new subsidiary in Mexico that will sell computers to Mexican customers and remit earnings back to the U.S. parent. The value of this project will be favorably affected if the value of the peso ____ while it establishes the new subsidiary and ____ when the subsidiary starts operations. a. depreciates; appreciates b. appreciates; appreciates c. appreciates; depreciates d. depreciates; depreciates ANS: A

PTS: 1

57. A macroeconomic perspective focuses on the financial management decisions that affect the value of MNC. a. True b. False ANS: F

PTS: 1

58. An MNC will always use the same required rate of return in the valuation of foreign projects, as it would for its domestic projects. a. True b. False ANS: F

PTS: 1

59. Livingston Co. has a subsidiary in Korea. The subsidiary reinvests half of its net cash flows into operations and remits half to the parent. Livingston's expected cash flows from domestic business are $100,000 and the Korean subsidiary is expected to generate 100 million Korean won at the end of the year. The expected value of won is $.0012. What are the expected dollar cash flows of Livingston Co.? a. $100,000 b. $200,000 c. $160,000 d. $60,000 ANS: C

PTS: 1

60. A U.S.-based MNC has many foreign subsidiaries in Europe and does not expect to increase its investment there. Its value should increase if the value of the euro weakens over time. a. True b. False ANS: F

PTS: 1

61. If managers of foreign subsidiaries make decisions that maximize the values of their respective subsidiaries, they automatically maximize the value of the entire corporation. a. True b. False ANS: F

PTS: 1

62. A decentralized management style, where subsidiary managers make the relevant decisions regarding their subsidiary, may result in better decision making, as subsidiary managers are generally better informed about their subsidiary's operations. a. True b. False

ANS: T

PTS: 1

63. U.S.-based MNCs are typically not monitored by mutual funds and pension funds, as these institutions rarely hold stock in MNCs. a. True b. False ANS: F

PTS: 1

64. The Sarbanes-Oxley Act ensures a more transparent process for managers to report on the productivity and financial condition of their firm. a. True b. False ANS: T

PTS: 1

65. The Theory of Comparative Advantage begins by assuming that a given firm first becomes established in its home country and may subsequently penetrate foreign markets via geographic or product differentiation. a. True b. False ANS: F

PTS: 1

66. Under the Imperfect Markets Theory, it is assumed that factors of production are entirely mobile, so that firms can capitalize on a foreign country's resources. a. True b. False ANS: F

PTS: 1

67. Under the Product Cycle Theory, foreign demand can be initially satisfied by exporting. a. True b. False ANS: T

PTS: 1

68. Licensing allows firms to use their technology in foreign markets without a major investment in foreign countries. a. True b. False ANS: T

PTS: 1

69. International trade is the most common form of direct foreign investment (DFI). a. True b. False ANS: F

PTS: 1

70. When the parent's home currency is weak, remitted funds from foreign subsidiaries will convert to a smaller amount of the home currency. a. True b. False

ANS: F

PTS: 1

71. A purely domestic firm may be affected by exchange rate fluctuations if it faces at least some foreign competition. a. True b. False ANS: T

PTS: 1

72. One form of an exposure to political risk is terrorism. a. True b. False ANS: T

PTS: 1

73. The goal of a multinational corporation (MNC) is a. The minimization of taxes remitted from foreign subsidiaries. b. The establishment of subsidiaries in any country where operations would provide a return over and above the cost of capital, even if better projects are available domestically. c. The maximization of shareholder wealth. d. The maximization of social benefits resulting from actions such as the employment of foreign managers.

ANS: C

PTS: 1

74. Agency costs faced by multinational corporations (MNCs) may be larger than those faced by purely domestic firms because a. Monitoring of managers located in foreign countries is more difficult. b. Foreign subsidiary managers raised in different cultures may not follow uniform goals. c. MNCs are relatively large. d. All of the above e. A and B only ANS: D

PTS: 1

75. Which of the following is not one of the more common methods used by MNCs to improve their internal control process? a. Establishing a centralized database of information b. Ensuring that all data are reported consistently among subsidiaries c. Speeding the process by which all departments and all subsidiaries have access to the data that they need d. Making executives more accountable for financial statements by personally verifying their accuracy e. All of the above are common methods used by MNCs to improve their internal control process.

ANS: E

PTS: 1

76. Which of the following is not mentioned in the text as a theory of international business? a. Theory of Comparative Advantage b. Imperfect Markets Theory c. Product Cycle Theory d. Globalization of Business Theory e. All of the above are mentioned in the text as theories of international business ANS: D

PTS: 1

77. The most risky method(s) by which firms conduct international business is (are): a. Franchising. b. The acquisitions of existing operations. c. The establishment of new subsidiaries. d. All of the above e. B and C only ANS: E

PTS: 1

78. The least risky method by which firms conduct international business is: a. Franchising. b. The acquisitions of existing operations. c. International Trade. d. The establishment of new subsidiaries. e. Licensing ANS: C

PTS: 1

79. Which of the following does not constitute a form of direct foreign investment? a. Franchising b. International trade c. Joint ventures d. Acquisitions of existing operations e. Establishment of new foreign subsidiaries ANS: B

PTS: 1

Chapter 2—International Flow of Funds 1. Recently, the U.S. experienced an annual balance of trade representing a ____. a. large surplus (exceeding $100 billion) b. small surplus c. level of zero d. deficit ANS: D

PTS: 1

2. A high home inflation rate relative to other countries would ____ the home country's current account balance, other things equal. A high growth in the home income level relative to other countries would ____ the home country's current account balance, other things equal. a. increase; increase b. increase; decrease c. decrease; decrease d. decrease; increase ANS: C

PTS: 1

3. If a country's government imposes a tariff on imported goods, that country's current account balance will likely ____ (assuming no retaliation by other governments). a. decrease b. increase c. remain unaffected d. either A or C are possible ANS: B

PTS: 1

4. ____ purchases more U.S. exports than the other countries listed here. a. Italy b. Spain c. Mexico d. Canada ANS: D

PTS: 1

5. An increase in the current account deficit will place ____ pressure on the home currency value, other things equal. a. upward b. downward c. no d. upward or downward (depending on the size of the deficit) ANS: B

PTS: 1

6. If the home currency begins to appreciate against other currencies, this should ____ the current account balance, other things equal (assume that substitutes are readily available in the countries, and that the prices charged by firms remain the same). a. increase b. have no impact on © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

c. reduce d. all of the above are equally possible ANS: C

PTS: 1

7. The International Financial Corporation was established to: a. enhance development solely in Asia through grants. b. enhance economic development through non-subsidized loans (at market interest rates). c. enhance economic development through low-interest rate loans (below-market rates). d. enhance economic development of the private sector through investment in stock of corporations.

ANS: D

PTS: 1

8. The World Bank was established to: a. enhance development solely in Asia through grants. b. enhance economic development through non-subsidized loans (at market interest rates). c. enhance economic development through low-interest rate loans (below-market rates). d. enhance economic development of the private sector through investment in stock of corporations.

ANS: B

PTS: 1

9. The International Development Association was established to: a. enhance development solely in Asia through grants. b. enhance economic development through non-subsidized loans (at market interest rates). c. enhance economic development through low-interest rate loans (below-market rates). d. enhance economic development of the private sector through investment in stock of corporations.

ANS: C

PTS: 1

10. Which of the following would likely have the least direct influence on a country's current account? a. inflation. b. national income. c. exchange rates. d. tariffs. e. a tax on income earned from foreign stocks.

ANS: E

PTS: 1

11. The "J curve" effect describes: a. the continuous long-term inverse relationship between a country's current account balance and the country's growth in gross national product. b. the short-run tendency for a country's balance of trade to deteriorate even while its currency is depreciating. c. the tendency for exporters to initially reduce the price of goods when their own currency appreciates. d. the reaction of a country's currency to initially depreciate after the country's inflation rate declines.

ANS: B

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

12. An increase in the use of quotas is expected to: a. reduce the country's current account balance, if other governments do not retaliate. b. increase the country's current account balance, if other governments do not retaliate. c. have no impact on the country's current account balance unless other governments retaliate. d. increase the volume of a country's trade with other countries.

ANS: B

PTS: 1

13. The U.S. typically has a balance of trade surplus in its trade with ____. a. China b. Japan c. A and B d. none of the above ANS: D

PTS: 1

14. The North American Free Trade Agreement (NAFTA) increased restrictions on: a. trade between Canada and Mexico. b. trade between Canada and the U.S. c. direct foreign investment in Mexico by U.S. firms. d. none of the above.

ANS: D

PTS: 1

15. According to the text, international trade (exports plus imports combined) as a percentage of GDP is: a. higher in the U.S. than in European countries. b. lower in the U.S. than in European countries. c. higher in the U.S. than in about half the European countries, and lower in the U.S. than the others. d. about the same in the U.S. as in European countries.

ANS: B

PTS: 1

16. The direct foreign investment positions by U.S. firms have generally ____ over time. Restrictions by governments on direct foreign investment have generally ___ over time. a. increased; increased b. increased; decreased c. decreased; decreased d. decreased; increased ANS: B

PTS: 1

17. Which of the following countries purchases the largest amount of exports by U.S. firms? a. Mexico b. Japan c. Canada d. France ANS: C

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

18. The primary component of the current account is the: a. balance of trade. b. balance of money market flows. c. balance of capital market flows. d. unilateral transfers.

ANS: A

PTS: 1

19. As a result of the European Union, restrictions on exports between ____ were reduced or eliminated. a. member countries and the U.S. b. member countries c. member countries and European non-members d. none of the above ANS: B

PTS: 1

20. Over the last several years, international trade has generally: a. increased for most major countries. b. decreased for most major countries. c. stayed about constant for most major countries. d. increased for about half the major countries and decreased for the others.

ANS: A

PTS: 1

21. Which is not a concern about the North American Free Trade Agreement (NAFTA)? a. its impact on U.S. inflation. b. its impact on U.S. unemployment. c. lower environmental standards in Mexico. d. different health laws for workers in Mexico.

ANS: A

PTS: 1

22. A General Agreement on Tariffs and Trade (GATT) accord in 1993 called for: a. increased trade restrictions outside of North America. b. lower trade restrictions around the world. c. uniform environmental standards around the world. d. uniform worker health laws.

ANS: B

PTS: 1

23. Which of the following is mentioned in the text as a possible means by which the government may attempt to improve its balance of trade position (increase its exports or reduce its imports). a. It could attempt to reduce its home currency's value. b. The government could require firms to engage in outsourcing. c. The government could require that its local firms pursue outsourcing. d. All of the above are mentioned.

ANS: A

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

24. The demand for U.S. exports tends to increase when: a. economic growth in foreign countries decreases. b. the currencies of foreign countries strengthen against the dollar. c. U.S. inflation rises. d. none of the above.

ANS: B

PTS: 1

25. "Dumping" is used in the text to represent the: a. exporting of goods that do not meet quality standards. b. sales of junk bonds to foreign countries. c. removal of foreign subsidiaries by the host government. d. exporting of goods at prices below cost.

ANS: D

PTS: 1

26. ____ is (are) income received by investors on foreign investments in financial assets (securities). a. Portfolio income b. Direct foreign income c. Unilateral transfers d. Factor income ANS: D

PTS: 1

27. A weak home currency may not be a perfect solution to correct a balance of trade deficit because: a. it reduces the prices of imports paid by local companies. b. it increases the prices of exports by local companies. c. it prevents international trade transactions from being prearranged. d. foreign companies may reduce the prices of their products to stay competitive.

ANS: D

PTS: 1

28. Intracompany trade makes up approximately ____ percent of all international trade. a. 50 b. 70 c. 25 d. 13 e. 5 ANS: A

PTS: 1

29. Like the International Monetary Fund (IMF), the ____ is composed of a collection of nations as members. However, unlike the IMF, it uses the private rather than the government sector to achieve its objectives. a. World Bank b. International Financial Corporation (IFC) c. World Trade Organization (WTO) d. International Development Association (IDA) e. Bank for International Settlements (BIS) ANS: B

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

30. The World Bank's Multilateral Investment Guarantee Agency (MIGA): a. offers various forms of export insurance. b. offers various forms of import insurance. c. offers various forms of exchange rate risk insurance. d. provides loans to developing countries. e. offers various forms of political risk insurance.

ANS: E

PTS: 1

31. Also known as the "central banks' central bank," the ____ attempts to facilitate cooperation among countries with regard to international transactions and provides assistance to countries experiencing a financial crisis. a. World Bank b. International Financial Corporation (IFC) c. World Trade Organization d. International Development Association (IDA) e. Bank for International Settlements (BIS) ANS: E

PTS: 1

32. Direct foreign investment into the U.S. represents a ____. a. capital inflow b. trade inflow c. capital outflow d. trade outflow ANS: A

PTS: 1

33. A balance of trade surplus indicates an excess of imports over exports. a. True b. False ANS: F

PTS: 1

34. A weakening of the U.S. dollar with respect to the British pound would likely reduce the U.S. exports to Britain and increase U.S. imports from Britain over time. a. True b. False ANS: F

PTS: 1

35. The World Bank extends loans only to developed nations, while the International Development Association (IDA) extends loans only to developing nations. a. True b. False ANS: F

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

36. The World Bank frequently enters into cofinancing agreements. Under these agreements, financing is provided by the World Bank and/or official aid agencies, export credit agencies, or commercial banks. a. True b. False ANS: T

PTS: 1

37. The balance of payments is a measurement of all transactions between domestic and foreign residents over a specified period of time. a. True b. False ANS: T

PTS: 1

38. Changes in country ownership of long-term and short-term assets are measured in the balance of payments with the capital account. a. True b. False ANS: T

PTS: 1

39. Portfolio investment represents transactions involving long-term financial assets (such as stocks and bonds) between countries that do not affect the transfer of control. a. True b. False ANS: T

PTS: 1

40. The current account represents the investment in fixed assets in foreign countries that can be used to conduct business operations. a. True b. False ANS: F

PTS: 1

41. Exporting of products by one country to other countries at prices below cost is called elasticity. a. True b. False ANS: F

PTS: 1

42. Direct foreign investment by U.S.-based MNCs occurs primarily in the Bahamas and Brazil. a. True b. False ANS: F

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

43. The J curve effect is the initial worsening of the U.S. trade balance due to a weakening dollar because of established trade relationships that are not easily changed; as the dollar weakens, the dollar value of imports initially rises before the U.S. trade balance is improved. a. True b. False ANS: T

PTS: 1

44. Portfolio investments represent transactions involving long-term financial assets (such as stocks and bonds) between countries that do not affect the transfer of control. a. True b. False ANS: T

PTS: 1

45. Intracompany trade represents the exporting of products by one country to other countries below cost. a. True b. False ANS: F

PTS: 1

46. A tariff is a maximum limit on imports. a. True b. False ANS: F

PTS: 1

47. A country's net outflow of funds ____ affect its interest rates, and ____ affect its economic conditions. a. does; does b. does; does not c. does not; does not d. does not; does ANS: A

PTS: 1

48. The sale of patent rights by a U.S. firm to a Russian firm reflects a credit to the U.S. balance of payments account. a. True b. False ANS: T

PTS: 1

49. A U.S. purchase of patent rights from a firm in Mexico reflects a credit to the U.S. balance of payments account. a. True b. False ANS: F

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

50. Regarding the U.S. balance of payments, capital account items are relatively minor compared to the financial account items. a. True b. False ANS: T

PTS: 1

51. In recent years, the U.S. has had a relatively (compared to other countries) ____ balance of trade ____ with China. a. small; surplus b. large; surplus c. small; deficit d. large; deficit ANS: D

PTS: 1

52. The Central American Trade Agreement (CAFTA) is intended to raise tariffs and regulations between the U.S., the Dominican Republic, and Central American countries. a. True b. False ANS: F

PTS: 1

53. U.S. government officials would likely prefer that China devalue the yuan against the dollar. a. True b. False ANS: F

PTS: 1

54. Assume that some U.S. firms will purchase supplies from either China or from U.S. firms. If the Chinese yuan appreciates against the dollar, it should reduce the U.S. balance of trade deficit with China. a. True b. False ANS: T

PTS: 1

55. Assume the U.S. has a balance of trade surplus with the country of Thor. When individuals in Thor manufacture CDs and DVDs that look almost exactly like the original product produced in the U.S. and other countries, they ____ the U.S. balance of trade surplus with Thor. This activity is called ____. a. reduce; flipping b. reduce; pirating c. increase; pirating d. increase; flipping ANS: B

PTS: 1

56. Japan's annual interest rate has been relatively ____ compared to other countries for several years, because the supply of funds in its credit market has been very ____. a. low; small © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

b. high; small c. low; large d. high; large ANS: C

PTS: 1

57. Without the international capital flows, there would be ____ funding available in the U.S. across all risk levels, and the cost of funding would be ____ regardless of the firm's risk level. a. more; lower b. more; higher c. less; lower d. less; higher ANS: D

PTS: 1

58. The primary component of the capital account is the balance of trade. a. True b. False ANS: F

PTS: 1

59. A balance of trade surplus indicates an excess of merchandise imports over merchandise exports. a. True b. False ANS: F

PTS: 1

60. An American tourist visiting Germany and spending money there (for lodging, food, etc.) will reduce the U.S. current account deficit and reduce Germany's current account balance. a. True b. False ANS: F

PTS: 1

61. A balance of trade deficit indicates an excess of imports over exports. a. True b. False ANS: T

PTS: 1

62. The capital account reflects changes in country ownership of long-term (but not short-term) assets. a. True b. False ANS: F

PTS: 1

63. Outsourcing allows some MNCs to reduce costs but shifts jobs to other countries. a. True b. False ANS: T

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

64. A weakening of the U.S. dollar with respect to the British pound would likely reduce U.S. exports to the U.K. and increase U.S. imports from the U.K. a. True b. False ANS: F

PTS: 1

65. The World Bank extends loans only to developed nations, while the International Development Association (IDA) extends loans only to developing nations. a. True b. False ANS: F

PTS: 1

66. The ____ is the difference between exports and imports. a. balance of trade b. balance on goods and services c. balance of payments d. current account e. capital account ANS: A

PTS: 1

67. Which of the following will probably not result in an increase in a country's current account balance (assuming everything else constant)? a. A decrease in the country's rate of inflation b. A decrease in the country's national income level c. An increase in government restrictions in the form of tariffs or quotas d. An appreciation of the country's currency e. All of the above will result in an increased current account balance.

ANS: D

PTS: 1

68. Which of the following factors probably does not directly affect a country's capital account and its components? a. Inflation b. Interest rates c. Withholding taxes on foreign income d. Exchange rate movements e. All of the above will directly affect a country's capital account.

ANS: A

PTS: 1

69. The ____, an accord among 117 nations, called for lower tariffs around the world. a. General Agreement on Tariffs and Trade (GATT) b. North American Free Trade Agreement (NAFTA) c. Single European Act of 1987 d. European Union Accord e. None of the above ANS: A

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

70. Which of the following is not likely to represent a strategy by the government of Country X to reduce its balance of trade deficit with Country Y? a. The government of Country X eliminates environmental restrictions. b. The government of Country X subsidizes firms in its country to facilitate dumping. c. The government of Country X provides tax breaks to firms in specific industries. d. The government of Country X removes a tariff on goods imported from Country Y. ANS: D

PTS: 1

71. Which of the following statements is not true? a. Exporters commonly complain that they are being mistreated because the currency of their country is too weak. b. Outsourcing affects the balance of trade because it means that a service is purchased in another country. c. Sometimes, trade policies are used to punish countries for various actions. d. Tariffs imposed by the EU have caused some friction between EU countries that commonly import products and other EU countries. e. All of the above are true.

ANS: A

PTS: 1

72. Which of the following would increase the current account of Country X? Country Y is Country X's sole trading partner. a. Inflation increases in countries X and Y by comparable amounts. b. Country X's and Country Y's currencies depreciate by the same amount. c. Country X imposes tariffs on imports from Country Y, and Country Y retaliates by imposing an identical tax on X's exports. d. The central banks of Country X and Country Y reduce the money supply to increase interest rates. e. Country X imposes a quota on imports, and Country Y retaliates by imposing an identical quota on X's exports.

ANS: D

PTS: 1

73. ____ represent aid, grants, and gifts from one country to another. a. Transfer payments b. Factor income c. The balance of trade d. The balance of payments e. The capital account ANS: A

PTS: 1

74. Which of the following is not a goal of the International Monetary Fund (IMF)? a. To promote cooperation among countries on international monetary issues b. To promote stability in exchange rates

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

c. To enhance a country's long-term economic growth via the extension of structural adjustment loans d. To promote free trade e. To promote free mobility of capital funds across countries ANS: C

PTS: 1

75. According to the "J curve effect," a weakening of the U.S. dollar relative to its trading partners' currencies would result in an initial ____ in the current account balance, followed by a subsequent ____ in the current account balance. a. decrease; increase b. increase; decrease c. decrease; decrease d. increase; increase ANS: A

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Chapter 3—International Financial Markets 1. Assume that a bank's bid rate on Swiss francs is $.45 and its ask rate is $.47. Its bid-ask percentage spread is: a. about 4.44%. b. about 4.26%. c. about 4.03%. d. about 4.17%.

ANS: B SOLUTION:

Bid-ask percentage spread = ($.47  $.45)/$.47 = 4.26%

PTS: 1 2. Assume that a bank's bid rate on Japanese yen is $.0041 and its ask rate is $.0043. Its bid-ask percentage spread is: a. about 4.99%. b. about 4.88%. c. about 4.65%. d. about 4.43%.

ANS: C SOLUTION:

Bid-ask percentage spread = ($.0043  $.0041)/$.0043 = 4.65%

PTS: 1 3. The bid/ask spread for small retail transactions is commonly in the range of ____ percent. a. 3 to 7 b. .01 to .03 c. 10 to 15 d. .5 to 1 ANS: A

PTS: 1

4. ____ is not a factor that affects the bid/ask spread. a. Order costs b. Inventory costs c. Volume d. All of the above factors affect the bid/ask spread ANS: D

PTS: 1

5. The forward rate is the exchange rate used for immediate exchange of currencies. a. True b. False ANS: F

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

6. The ask quote is the price for which a bank offers to sell a currency. a. True b. False ANS: T

PTS: 1

7. According to the text, the forward rate is commonly used for: a. hedging. b. immediate transactions. c. previous transactions. d. bond transactions.

ANS: A

PTS: 1

8. If a U.S. firm desires to avoid the risk from exchange rate fluctuations, and it is receiving 100,000 in 90 days, it could: a. obtain a 90-day forward purchase contract on euros. b. obtain a 90-day forward sale contract on euros. c. purchase euros 90 days from now at the spot rate. d. sell euros 90 days from now at the spot rate.

ANS: B

PTS: 1

9. If a U.S. firm desires to avoid the risk from exchange rate fluctuations, and it will need C$200,000 in 90 days to make payment on imports from Canada, it could: a. obtain a 90-day forward purchase contract on Canadian dollars. b. obtain a 90-day forward sale contract on Canadian dollars. c. purchase Canadian dollars 90 days from now at the spot rate. d. sell Canadian dollars 90 days from now at the spot rate.

ANS: A

PTS: 1

10. Assume the Canadian dollar is equal to $.88 and the Peruvian Sol is equal to $.35. The value of the Peruvian Sol in Canadian dollars is: a. about .3621 Canadian dollars. b. about .3977 Canadian dollars. c. about 2.36 Canadian dollars. d. about 2.51 Canadian dollars.

ANS: B SOLUTION:

$.35/$.88 = .3977

PTS: 1 11. Which of the following is not true with respect to spot market liquidity? a. The more willing buyers and sellers there are, the more liquid a market is.

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

b. The spot markets for heavily traded currencies such as the Japanese yen are very liquid. c. A currency's liquidity affects the ease with which an MNC can obtain or sell that currency. d. If a currency is illiquid, an MNC is typically able to quickly purchase that currency at a reasonable exchange rate.

ANS: D

PTS: 1

12. Forward markets for currencies of developing countries are: a. prohibited. b. less liquid than markets for developed countries. c. more liquid than markets for developed countries. d. only available for use by government agencies.

ANS: B

PTS: 1

13. A forward contract can be used to lock in the ____ of a specified currency for a future point in time. a. purchase price b. sale price c. A or B d. none of the above ANS: C

PTS: 1

14. The forward market: a. for euros is very illiquid. b. for Eastern European countries is very liquid. c. does not exist for some currencies. d. none of the above ANS: C

PTS: 1

15. ____ is not a bank characteristic important to customers in need of foreign exchange. a. Quote competitiveness b. Speed of execution c. Forecasting advice d. Advice about current market conditions e. All of the above are important bank characteristics to customers in need of foreign exchange.

ANS: E

PTS: 1

16. The Basel II accord is focused on eliminating inconsistencies in ____ across countries. a. capital requirements b. deposit rates c. deposit insurance d. bank failure policies ANS: A

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

17. The international money market primarily concentrates on: a. short-term lending (one year or less). b. medium-term lending. c. long-term lending. d. placing bonds with investors. e. placing newly issued stock in foreign markets.

ANS: A

PTS: 1

18. The international credit market primarily concentrates on: a. short-term lending (less than one year). b. medium-term lending. c. long-term lending. d. providing an exchange of foreign currencies for firms who need them. e. placing newly issued stock in foreign markets.

ANS: B

PTS: 1

19. The main participants in the international money market are: a. consumers. b. small firms. c. large corporations. d. small European firms needing European currencies for international trade.

ANS: C

PTS: 1

20. LIBOR is: a. the interest rate commonly charged for loans between banks. b. the average inflation rate in European countries. c. the maximum loan rate ceiling on loans in the international money market. d. the maximum deposit rate ceiling on deposits in the international money market. e. the maximum interest rate offered on bonds that are issued in London.

ANS: A

PTS: 1

21. A syndicated loan: a. represents a loan by a single bank to a syndicate of corporations. b. represents a loan by a single bank to a syndicate of country governments. c. represents a direct loan by a syndicate of oil-producing exporters to a less developed country. d. represents a loan by a group of banks to a borrower. e. A and B ANS: D

PTS: 1

22. The international money market is primarily served by: a. the governments of European countries, which directly intervene in foreign currency markets. b. government agencies such as the International Monetary Fund that enhance development of countries. c. several large banks that accept deposits and provide loans in various currencies. © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

d. small banks that convert foreign currency for tourists and business visitors.

ANS: C

PTS: 1

23. International money market transactions normally represent: a. the equivalent of $1 million or more. b. the equivalent of $1,000 to $10,000. c. the equivalent of between $10,000 and $100,000. d. the equivalent of between $100,000 and $200,000.

ANS: A

PTS: 1

24. A put option is the amount or percentage by which the existing spot rate exceeds the forward rate. a. True b. False ANS: F

PTS: 1

25. From 1944 to 1971, the exchange rate between any two currencies was typically: a. fixed within narrow boundaries. b. floating, but subject to central bank intervention. c. floating, and not subject to central bank intervention. d. nonexistent; that is currencies were not exchanged, but gold was used to pay for all foreign transactions.

ANS: A

PTS: 1

26. As a result of the Smithsonian Agreement, the U.S. dollar was: a. the currency to be used by all countries as a medium of exchange for international trade. b. forced to be freely floating relative to all currencies without any boundaries. c. devalued relative to major currencies. d. revalued (upward) relative to major currencies.

ANS: C

PTS: 1

27. According to the text, the average foreign exchange trading around the world ____ per day. a. equals about $200 billion b. equals about $400 billion c. equals about $700 billion d. exceeds $1 trillion ANS: D

PTS: 1

28. Assume a Japanese firm invoices exports to the U.S. in U.S. dollars. Assume that the forward rate and spot rate of the Japanese yen are equal. If the Japanese firm expects the U.S. dollar to ____ against the yen, it would likely wish to hedge. It could hedge by ____ dollars forward. a. depreciate; buying b. depreciate; selling c. appreciate; selling d. appreciate; buying ANS: B

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

29. The bid-ask spread on an exchange rate can be used to directly determine: a. how an exchange rate will change. b. the transaction cost of foreign exchange. c. the forward premium. d. the currency option premium.

ANS: B

PTS: 1

30. Futures contracts are typically ____; forward contracts are typically ____. a. sold on an exchange; sold on an exchange b. offered by commercial banks; sold on an exchange c. sold on an exchange; offered by commercial banks d. offered by commercial banks; offered by commercial banks ANS: C

PTS: 1

31. Eurobonds: a. are usually issued in bearer form. b. typically carry several protective covenants. c. cannot contain call provisions. d. A and B ANS: A

PTS: 1

32. Which of the following is true? a. Non-U.S. firms may desire to issue bonds in the U.S. due to less regulations in the U.S. b. U.S. firms may desire to issue bonds in the U.S. due to less regulations in the U.S. c. U.S. firms may desire to issue bonds in the non-U.S. markets due to less regulations in non-U.S. countries. d. A and B ANS: C

PTS: 1

33. Eurobonds: a. can be issued only by European firms. b. can be sold only to European investors. c. A and B d. none of the above ANS: D

PTS: 1

34. Which currency is used the most to denominate Eurobonds? a. the British pound. b. the Japanese yen. c. the U.S. dollar. d. the Swiss franc.

ANS: C

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

35. When the foreign exchange market opens in the U.S. each morning, the opening exchange rate quotations will be based on the: a. closing prices in the U.S. during the previous day. b. closing prices in Canada during the previous day. c. prevailing prices in locations where the foreign exchange markets have been open. d. officially set by central banks before the U.S. market opens.

ANS: C

PTS: 1

36. The U.S. dollar is not ever used as a medium of exchange in: a. industrialized countries outside the U.S. b. in any Latin American countries. c. in Eastern European countries where foreign exchange restrictions exist. d. none of the above ANS: D

PTS: 1

37. Which of the following is not true regarding the Bretton Woods Agreement? a. It called for fixed exchange rates between currencies. b. Governments intervened to prevent exchange rates from moving more than 1 percent above or below their initially established levels. c. The agreement lasted from 1944 until 1971. d. Each country used gold to back its currency. e. All of the above are true regarding the Bretton Woods Agreement.

ANS: D

PTS: 1

38. A Japanese yen is worth $.0080, and a Fijian dollar (F$) is worth $.5900. What is the value of the yen in Fijian dollars (i.e., how many Fijian dollars do you need to buy a yen)? a. 73.75. b. 125. c. 1.69. d. 0.014. e. none of the above ANS: D SOLUTION:

($.008/$.59) = F$.014/¥

PTS: 1 39. The existence of imperfect markets has prevented the internationalization of financial markets. a. True b. False ANS: F

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

40. 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. a. True b. False ANS: T

PTS: 1

41. An investor engaging in a transaction whereby he or she contracts to purchase British pounds one year from now is an example of a spot market transaction. a. True b. False ANS: F

PTS: 1

42. The Single European Act prevented a trend toward increased globalization in the banking industry. a. True b. False ANS: F

PTS: 1

43. A cross exchange rate expresses the amount of one foreign currency per unit of another foreign currency. a. True b. False ANS: T

PTS: 1

44. 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. a. True b. False ANS: F

PTS: 1

45. The strike price is also known as the premium price. a. True b. False ANS: F

PTS: 1

46. The interest rate commonly charged for loans between banks is called the cross rate. a. True b. False ANS: F

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

47. The Bretton Woods Agreement is an agreement to standardize banks' capital requirements across countries; the resulting capital ratios are computed using risk-weighted assets. a. True b. False ANS: F

PTS: 1

48. The Basel Accord is an agreement among the major European countries to make regulations more uniform across European countries and to reduce taxes on goods traded between these countries. a. True b. False ANS: F

PTS: 1

49. A futures contract is a contract specifying a standard volume of a particular currency to be exchanged on a specific settlement date. a. True b. False ANS: T

PTS: 1

50. Eurobonds are certificates representing bundles of stock. a. True b. False ANS: F

PTS: 1

51. A share of the ADR of a Dutch firm represents one share of that firm's stock that is traded on a Dutch stock exchange. The share price of the firm was 15 euros when the Dutch market closed. As the U.S. market opens, the euro is worth $1.10. Thus, the price of the ADR should be ____. a. $13.64 b. $15.00 c. $16.50 d. 16.50 euros e. none of the above ANS: C SOLUTION:

15  $1.10 = $16.50

PTS: 1 52. The ADR of a British firm is convertible into 3 shares of stock. The share price of the firm was 30 pounds when the British market closed. When the U.S. market opens, the pound is worth $1.63. The price of this ADR should be $____. a. 48.90 b. 146.70

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

c. 55.21 d. none of the above ANS: B SOLUTION:

3  30  $1.63 = $146.70

PTS: 1 53. If there is a large supply of savings relative to the demand for short-term funds, the interest rate for that country will be relatively low. a. True b. False ANS: T

PTS: 1

54. If there is a strong demand to borrow a currency, and a low supply of savings in that currency, the interest rate will be relatively low. a. True b. False ANS: F

PTS: 1

55. The preferences of corporations and governments to borrow in foreign currencies and of investors to make short-term investments in foreign currencies resulted in the creation of the international bond market. a. True b. False ANS: F

PTS: 1

56. Large commercial banks play a major role in the international money market by accepting short-term deposits in large amounts (such as the equivalent of $1 million or more) and in various currencies, and channeling the money to corporations and government agencies that need to borrow those short-term funds in the desired currencies. a. True b. False ANS: T

PTS: 1

57. The term "eurobor" is widely used to reflect the interbank offer rate on euros. a. True b. False ANS: T

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

58. The term "eurobor" is widely used to reflect the total amount of euros borrowed by the firms in Europe per month to finance their growth. a. True b. False ANS: F

PTS: 1

59. Institutional investors such as commercial banks, mutual funds, insurance companies, and pension funds from many countries are major participants in the international bond market. a. True b. False ANS: T

PTS: 1

60. In response to the Sarbanes-Oxley Act, the reporting costs were reduced, and many non-U.S. firms that issued new shares of stock decided to place their stock in the United States. a. True b. False ANS: F

PTS: 1

61. Global regulations require that shareholders in all countries have the same rights wherever there are stock markets. a. True b. False ANS: F

PTS: 1

62. Shareholders have more voting power in some countries than others. a. True b. False ANS: T

PTS: 1

63. Shareholders can have influence on a wider variety of management issues in some countries. a. True b. False ANS: T

PTS: 1

64. The legal protection of shareholders is the same among countries. a. True b. False ANS: F

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

65. Shareholders in some countries may have more power to effectively sue publicly-traded firms if their executives or directors commit financial fraud. a. True b. False ANS: T

PTS: 1

66. In general, common law countries such as the U.S., Canada, and the United Kingdom allow for more legal protection than French civil law countries such as France or Italy. a. True b. False ANS: T

PTS: 1

67. The government enforcement of securities laws varies among countries. a. True b. False ANS: T

PTS: 1

68. The degree of financial information that must be provided by public companies is the same among countries. a. True b. False ANS: F

PTS: 1

69. In general, stock markets allow for more price efficiency and attract more investors when they have all of the following except: a. more voting rights for shareholders. b. more legal protection. c. more enforcement of the laws. d. less stringent accounting requirements.

ANS: D

PTS: 1

70. In general, companies are attracted to the stock market in which there are very limited voting rights for shareholders. a. True b. False ANS: F

PTS: 1

71. If companies can rely on stock markets to obtain funds, they will have to rely more heavily on the ____ market to raise long-term funds. a. derivative

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

b. long-term credit c. money d. foreign exchange ANS: B

PTS: 1

72. The strike price on a currency option is also known as an exercise price. a. True b. False ANS: T

PTS: 1

73. Assume that the bank's bid quote of Mexican peso is $.126 and ask price is $.129. If you have Mexican pesos, what is the amount of pesos that you need to purchase $100,000? a. 12,600 b. 775,194 c. 793,651 d. 12,900 ANS: C

PTS: 1

74. When receiving quotations on a currency's exchange rate, the bank's bid quote is the rate at which the bank is willing to sell currency. a. True b. False ANS: F

PTS: 1

75. An obligation to purchase a specific amount of currency at a future point in time is called a: a. call option b. spot contract c. put option d. forward contract e. both B and D ANS: D

PTS: 1

76. Which of the following is not a method that can be used to invest internationally? a. Investment in MNC stocks b. American depository receipts (ADRs) c. World Equity benchmark Shares (WEBS) d. International mutual funds e. All of the above are methods that can be used to invest internationally.

ANS: E

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

77. The interest rate in developing countries is usually very low. a. True b. False ANS: F

PTS: 1

78. Assume that $1 is equal to .85 Euros and 98 yen. The value of yen in euros is a. .01 b. 118 c. 1.18 d. .0087 ANS: D

PTS: 1

79. When obtaining a loan, the risk premium paid above LIBOR depends on the: a. risk-free interest rate of the borrower. b. credit risk of the borrower. c. borrower's stock price. d. lender's stock price.

ANS: B

PTS: 1

80. The largest global exchange is: a. NASDAQ b. Tokyo Stock Exchange c. NYSE Euronext d. London Stock Exchange ANS: C

PTS: 1

81. Which of the following is not true about syndicated loans? a. A borrower that receives a syndicated loan incurs various fees besides the interest rate. b. The loans are only denominated in U.S. dollars. c. The loans are provided by a group of banks to a borrower. d. The loans are usually formed in 6 weeks or less.

ANS: B

PTS: 1

82. The interest rate on the syndicated loan depends on the: a. currency denominating the loan. b. maturity of the loan. c. creditworthiness of the borrower. d. interbank lending rate. e. all of the above.

ANS: E

PTS: 1

83. Assume a U.S. firm has to pay for Korean imports in 60 days. It expects that Korean won will depreciate, but it still wants to hedge its risk. What type of hedging is more appropriate in this situation: a. Buy dollars forward © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

b. Sell dollars forward c. Purchase call option d. Purchase put option ANS: C

PTS: 1

84. Certificates representing bundles of stock of non-U.S. firms are called: a. Eurobonds b. ADRs c. FRNs d. Eurobor ANS: B

PTS: 1

85. Assume that the spot rate of the Singapore dollar is $.664. The ADR of a Singapore firm is convertible into 3 shares of stock. The price of an ADR is $20. What is the share price of the firm in Singapore dollars? a. 10 b. 13.28 c. 30.12 d. 39.84 ANS: A

PTS: 1

86. Which of the following is not true regarding ADRs? a. ADRs are denominated in the currency of the stock's home country. b. ADRs enable U.S. investors to avoid cross-border transactions c. ADRs allow non-U.S. firms to tap into U.S. market for funds. d. ADRs sometimes allow for arbitrage opportunities.

ANS: A

PTS: 1

87. The more intense the competition for the traded currency, the larger the bid/ask spread. a. True b. False ANS: F

PTS: 1

88. Banks charge larger bid/ask spreads than they would on less liquid, less traded currencies. a. True b. False ANS: F

PTS: 1

89. At any given point in time, a bank's bid quote will be greater than its ask quote. a. True b. False ANS: F

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

90. An MNC with receivables in Japanese Yen purchases yen forward to hedge its exposure to exchange rate fluctuations. a. True b. False ANS: F

PTS: 1

91. 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. a. True b. False ANS: F

PTS: 1

92. The LIBOR varies among currencies because the market supply of and demand for funds vary among currencies. a. True b. False ANS: T

PTS: 1

93. The international money market is frequently accessed by MNCs for short-term investment and financing decisions, while longer term financing decisions are made in the international credit market or the international bond market and in international stock markets. a. True b. False ANS: T

PTS: 1

94. Which of the following is not a possible bid/ask quotation for the Barbados dollar? a. $.50/$.51 b. $.49/$.50 c. $.52/$.51 d. $.51/$.52 e. All of the above are possible bid/ask quotations.

ANS: C

PTS: 1

95. Your company expects to receive 5,000,000 Japanese yen 60 days from now. You decide to hedge your position by selling Japanese yen forward. The current spot rate of the yen is $.0089, while the forward rate is $.0095. You expect the spot rate in 60 days to be $.0090. How many dollars will you receive for the 5,000,000 yen 60 days from now if you sell yen forward? a. $44,500 b. $45,000 c. $526 million d. $47,500 e. $556 million ANS: D

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

96. 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 receivables by selling pesos forward c. Hedging yen payables by purchasing yen forward d. Hedging peso payables by purchasing pesos forward e. All of the above are examples of using forward contracts.

ANS: A

PTS: 1

97. 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. a. direct; indirect b. indirect; direct c. direct; direct d. indirect; indirect e. cannot be answered without more information ANS: A

PTS: 1

98. You observe a quotation of the Japanese yen (¥) of $0.007. You are, however, interested in the number of yen per dollar. Thus, you calculate the ____ quotation of ____ ¥/$. a. direct; 142.86 b. indirect; 142.86 c. indirect; 150 d. direct; 150 e. indirect; 0 ANS: B

PTS: 1

99. Which of the following is not true regarding electronic communications networks (ECNs)? a. They have a visible trading floor. b. Trades are executed by a computer network. c. They have been created in many countries to match orders between buyers and sellers. d. They allow investors to place orders on their computers. e. All of the above are true.

ANS: A

PTS: 1

100. Which of the following is probably not appropriate for an MNC wishing to reduce its exposure to British pound payables? a. Purchase pounds forward b. Buy a pound futures contract c. Buy a pound put option d. Buy a pound call option ANS: C

PTS: 1

101. Futures contracts are sold on exchanges and are consequently ____ than forward contracts, which can be ____ to satisfy an MNC's needs. a. more standardized; standardized b. more standardized; custom-tailored © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

c. more custom-tailored; standardized d. more custom-tailored; custom-tailored e. less standardized; custom-tailored ANS: B

PTS: 1

102. An MNC's short-term financing decisions are satisfied in the ____ market, while its medium debt financing decisions are satisfied in the ____ market. a. international money; international credit b. international money; international bond c. international credit; international money d. international bond; international credit e. international money; international stock ANS: A

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Chapter 4—Exchange Rate Determination 1. The value of the Australian dollar (A$) today is $0.73. Yesterday, the value of the Australian dollar was $0.69. The Australian dollar ____ by ____%. a. depreciated; 5.80 b. depreciated; 4.00 c. appreciated; 5.80 d. appreciated; 4.00 ANS: C SOLUTION:

($0.73  $0.69)/$0.69 = 5.80%

PTS: 1 2. If a currency's spot rate market is ____, its exchange rate is likely to be ____ to a single large purchase or sale transaction. a. liquid; highly sensitive b. illiquid; insensitive c. illiquid; highly sensitive d. none of the above.

ANS: C

PTS: 1

3. ____ is not a factor that causes currency supply and demand schedules to change. a. Relative inflation rates b. Relative interest rates c. Relative income levels d. Expectations e. All of the above are factors that cause currency supply and demand schedules to change.

ANS: E

PTS: 1

4. A large increase in the income level in Mexico along with no growth in the U.S. income level is normally expected to cause (assuming no change in interest rates or other factors) a(n) ____ in Mexican demand for U.S. goods, and the Mexican peso should ____. a. increase; appreciate b. increase; depreciate c. decrease; depreciate d. decrease; appreciate ANS: B

PTS: 1

5. An increase in U.S. interest rates relative to German interest rates would likely ____ the U.S. demand for euros and ____ the supply of euros for sale. a. reduce; increase b. increase; reduce c. reduce; reduce d. increase; increase ANS: A

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

6. Investors from Germany, the United States, and the U.K. frequently invest in each other based on prevailing interest rates. If British interest rates increase, German investors are likely to buy ____ dollar-denominated securities, and the euro is likely to ____ relative to the dollar. a. fewer; depreciate b. fewer; appreciate c. more; depreciate d. more; appreciate ANS: A

PTS: 1

7. When the "real" interest rate is relatively low in a given country, then the currency of that country is typically expected to be: a. weak, since the country's quoted interest rate would be high relative to the inflation rate. b. strong, since the country's quoted interest rate would be low relative to the inflation rate. c. strong, since the country's quoted interest rate would be high relative to the inflation rate. d. weak, since the country's quoted interest rate would be low relative to the inflation rate.

ANS: D

PTS: 1

8. Assume that the inflation rate becomes much higher in the U.K. relative to the U.S. This will place ____ pressure on the value of the British pound. Also, assume that interest rates in the U.K. begin to rise relative to interest rates in the U.S. The change in interest rates will place ____ pressure on the value of the British pound. a. upward; downward b. upward; upward c. downward; upward d. downward; downward ANS: C

PTS: 1

9. In general, when speculating on exchange rate movements, the speculator will borrow the currency that is expected to appreciate and invest in the country whose currency is expected to depreciate. a. True b. False ANS: F

PTS: 1

10. Baylor Bank believes the New Zealand dollar will appreciate over the next five days from $.48 to $.50.

The following annual interest rates apply: Currency Dollars New Zealand dollar (NZ$)

Lending Rate 7.10% 6.80%

Borrowing Rate 7.50% 7.25%

Baylor Bank has the capacity to borrow either NZ$10 million or $5 million. If Baylor Bank's forecast is correct, what will its dollar profit be from speculation over the five-day period (assuming it does not use any of its existing consumer deposits to capitalize on its expectations)? a. $521,325. b. $500,520. c. $104,262. d. $413,419. © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

e. $208,044.

ANS: E SOLUTION: 1. Borrow $5 million.

2.

Convert to NZ$: $5,000,000/$.48 = NZ$10,416,667.

3.

Invest the NZ$ at an annualized rate of 6.80% over five days.

NZ$10,416,667  [1 + 6.80% (5/360)] = NZ$10,426,505

4.

Convert the NZ$ back to dollars: NZ$10,426,505  $.50 = $5,213,252

5.

Repay the dollars borrowed. The repayment amount is: $5,000,000  [1 + 7.5% (5/360)] = $5,000,000  [1.00104] = $5,005,208

6.

After repaying the loan, the remaining dollar profit is: $5,213,252  $5,005,208 = $208,044

PTS: 1 11. Assume the following information regarding U.S. and European annualized interest rates: Currency U.S. Dollar ($) Euro (€)

Lending Rate 6.73% 6.80%

Borrowing Rate 7.20% 7.28%

Trensor Bank can borrow either $20 million or €20 million. The current spot rate of the euro is $1.13.

Furthermore, Trensor Bank expects the spot rate of the euro to be $1.10 in 90 days. What is Trensor Bank's dollar profit from speculating if the spot rate of the euro is indeed $1.10 in 90 days? a. $579,845. b. $583,800. c. $588,200. d. $584,245. e. $980,245.

ANS: A SOLUTION: 1. Borrow €20 million. © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

2.

Convert the €20 million to €20,000,000  $1.13 = $22,600,000.

3.

Invest the $22,600,000 at an annualized rate of 6.73% for 90 days. $22,600,000  [1 + 6.73% (90/360)] = $22,980,245

4.

Determine euros owed: €20,000,000  [1 + 7.28% (90/360)] = €20,364,000.

5.

Determine dollars needed to repay euro loan: €20,364,000  $1.10 = $22,400,400.

6.

The dollar profit is $22,980,245  $22,400,400 = $579,845.

PTS: 1 12. The equilibrium exchange rate of pounds is $1.70. At an exchange rate of $1.72 per pound: a. U.S. demand for pounds would exceed the supply of pounds for sale and there would be a shortage of pounds in the foreign exchange market. b. U.S. demand for pounds would be less than the supply of pounds for sale and there would be a shortage of pounds in the foreign exchange market. c. U.S. demand for pounds would exceed the supply of pounds for sale and there would be a surplus of pounds in the foreign exchange market. d. U.S. demand for pounds would be less than the supply of pounds for sale and there would be a surplus of pounds in the foreign exchange market. e. U.S. demand for pounds would be equal to the supply of pounds for sale and there would be a shortage of pounds in the foreign exchange market.

ANS: D

PTS: 1

13. Assume that Swiss investors have francs available to invest in securities, and they initially view U.S. and British interest rates as equally attractive. Now assume that U.S. interest rates increase while British interest rates stay the same. This would likely cause: a. the Swiss demand for dollars to decrease and the dollar will depreciate against the pound. b. the Swiss demand for dollars to increase and the dollar will depreciate against the Swiss franc. c. the Swiss demand for dollars to increase and the dollar will appreciate against the Swiss franc. d. the Swiss demand for dollars to decrease and the dollar will appreciate against the pound.

ANS: C

PTS: 1

14. The real interest rate adjusts the nominal interest rate for: a. exchange rate movements. b. income growth.

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

c. inflation. d. government controls. e. none of the above ANS: C

PTS: 1

15. If U.S. inflation suddenly increased while European inflation stayed the same, there would be: a. an increased U.S. demand for euros and an increased supply of euros for sale. b. a decreased U.S. demand for euros and an increased supply of euros for sale. c. a decreased U.S. demand for euros and a decreased supply of euros for sale. d. an increased U.S. demand for euros and a decreased supply of euros for sale.

ANS: D

PTS: 1

16. If inflation in New Zealand suddenly increased while U.S. inflation stayed the same, there would be: a. an inward shift in the demand schedule for NZ$ and an outward shift in the supply schedule for NZ$. b. an outward shift in the demand schedule for NZ$ and an inward shift in the supply schedule for NZ$. c. an outward shift in the demand schedule for NZ$ and an outward shift in the supply schedule for NZ$. d. an inward shift in the demand schedule for NZ$ and an inward shift in the supply schedule for NZ$.

ANS: A

PTS: 1

17. If the U.S. and Japan engage in substantial financial flows but little trade, ____ directly influences their exchange rate the most. If the U.S. and Switzerland engage in much trade but little financial flows, ____ directly influences their exchange rate the most. a. interest rate differentials; interest rate differentials b. inflation and interest rate differentials; interest rate differentials c. income and interest rate differentials; inflation differentials d. interest rate differentials; inflation and income differentials e. inflation and income differentials; interest rate differentials ANS: D

PTS: 1

18. If inflation increases substantially in Australia while U.S. inflation remains unchanged, this is expected to place ____ pressure on the value of the Australian dollar with respect to the U.S. dollar. a. upward b. downward c. either upward or downward (depending on the degree of the increase in Australian inflation) d. none of the above; there will be no impact ANS: B

PTS: 1

19. Assume that British corporations begin to purchase more supplies from the U.S. as a result of several labor strikes by British suppliers. This action reflects: a. an increased demand for British pounds. © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

b. a decrease in the demand for British pounds. c. an increase in the supply of British pounds for sale. d. a decrease in the supply of British pounds for sale.

ANS: C

PTS: 1

20. The exchange rates of smaller countries are very stable because the market for their currency is very liquid. a. True b. False ANS: F

PTS: 1

21. The phrase "the dollar was mixed in trading" means that: a. the dollar was strong in some periods and weak in other periods over the last month. b. the volume of trading was very high in some periods and low in other periods. c. the dollar was involved in some currency transactions, but not others. d. the dollar strengthened against some currencies and weakened against others.

ANS: D

PTS: 1

22. Assume that the U.S. places a strict quota on goods imported from Chile and that Chile does not retaliate. Holding other factors constant, this event should immediately cause the U.S. demand for Chilean pesos to ____ and the value of the peso to ____. a. increase; increase b. increase; decline c. decline; decline d. decline; increase ANS: C

PTS: 1

23. Any event that increases the U.S. demand for euros should result in a(n) ____ in the value of the euro with respect to ____, other things being equal. a. increase; U.S. dollar b. increase; nondollar currencies c. decrease; nondollar currencies d. decrease; U.S. dollar ANS: A

PTS: 1

24. Any event that reduces the U.S. demand for Japanese yen should result in a(n) ____ in the value of the Japanese yen with respect to ____, other things being equal. a. increase; U.S. dollar b. increase; nondollar currencies c. decrease; nondollar currencies d. decrease; U.S. dollar ANS: D

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

25. Any event that increases the supply of British pounds to be exchanged for U.S. dollars should result in a(n) ____ in the value of the British pound with respect to ____, other things being equal. a. increase; U.S. dollar b. increase; nondollar currencies c. decrease; nondollar currencies d. decrease; U.S. dollar ANS: D

PTS: 1

26. Any event that reduces the supply of Swiss francs to be exchanged for U.S. dollars should result in a(n) ____ in the value of the Swiss franc with respect to ____, other things being equal. a. increase; U.S. dollar b. increase; nondollar currencies c. decrease; nondollar currencies d. decrease; U.S. dollar ANS: A

PTS: 1

27. Assume that the U.S. experiences a significant decline in income, while Japan's income remains steady. This event should place ____ pressure on the value of the Japanese yen, other things being equal. (Assume that interest rates and other factors are not affected.) a. upward b. downward c. no d. upward and downward (offsetting) ANS: B

PTS: 1

28. News of a potential surge in U.S. inflation and zero Chilean inflation places ____ pressure on the value of the Chilean peso. The pressure will occur ____. a. upward; only after the U.S. inflation surges b. downward; only after the U.S. inflation surges c. upward; immediately d. downward; immediately ANS: C

PTS: 1

29. Assume that Canada places a strict quota on goods imported from the U.S. and that the U.S. does not retaliate. Holding other factors constant, this event should immediately cause the supply of Canadian dollars to be exchanged for U.S. dollars to ____ and the value of the Canadian dollar to ____. a. increase; increase b. increase; decline c. decline; decline d. decline; increase ANS: D

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

30. Assume that Japan places a strict quota on goods imported from the U.S. and the U.S. places a strict quota on goods imported from Japan. This event should immediately cause the U.S. demand for Japanese yen to ____, and the supply of Japanese yen to be exchanged for U.S. dollars to ____. a. increase; increase b. increase; decline c. decline; decline d. decline; increase ANS: C

PTS: 1

31. Which of the following is not mentioned in the text as a factor affecting exchange rates? a. relative interest rates. b. relative inflation rates. c. government controls. d. expectations. e. all of the above are mentioned in the text as factors affecting exchange rates.

ANS: E

PTS: 1

32. If a country experiences high inflation relative to the U.S., its exports to the U.S. should ____, its imports should ____, and there is ____ pressure on its currency's equilibrium value. a. decrease; increase; upward b. decrease; decrease; upward c. increase; decrease; downward d. decrease; increase; downward e. increase; decrease; upward ANS: D

PTS: 1

33. If a country experiences an increase in interest rates relative to U.S. interest rates, the inflow of U.S. funds to purchase its securities should ____, the outflow of its funds to purchase U.S. securities should ____, and there is ____ pressure on its currency's equilibrium value. a. increase; decrease; downward b. decrease; increase; upward c. increase; decrease; upward d. decrease; increase; downward e. increase; increase; upward ANS: C

PTS: 1

34. An increase in U.S. inflation relative to Singapore inflation places upward pressure on the Singapore dollar. a. True b. False ANS: T

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

35. When expecting a foreign currency to depreciate, a possible way to speculate on this movement is to borrow dollars, convert the proceeds to the foreign currency, lend in the foreign country, and use the proceeds from this investment to repay the dollar loan. a. True b. False ANS: F

PTS: 1

36. Since supply and demand for a currency are constant (primarily due to government intervention), currency values seldom fluctuate. a. True b. False ANS: F

PTS: 1

37. Relatively high Japanese inflation may result in an increase in the supply of yen for sale and a reduction in the demand for yen. a. True b. False ANS: T

PTS: 1

38. The main effect of interest rate movements on exchange rates is through their effect on international trade. a. True b. False ANS: F

PTS: 1

39. Country X frequently engages in trade flows with the U.S. (such as imports and exports). Country Y frequently engages in capital flows with the U.S. (such as financial investments). Everything else held constant, an increase in U.S. interest rates would affect the exchange rate of Country X's currency more than the exchange rate of Country Y's currency. a. True b. False ANS: F

PTS: 1

40. Increases in relative income in one country vs. another result in an increase in the first country's currency value. a. True b. False ANS: F

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

41. Trade-related foreign exchange transactions are more responsive to news than financial flow transactions. a. True b. False ANS: F

PTS: 1

42. Signals regarding future actions of market participants in the foreign exchange market sometimes result in overreactions. a. True b. False ANS: T

PTS: 1

43. The markets that have a smaller amount of foreign exchange trading for speculatory purposes than for trade purposes will likely experience more volatility than those where trade flows play a larger role. a. True b. False ANS: T

PTS: 1

44. Liquidity of a currency can affect the extent to which speculation can impact the currency's value. a. True b. False ANS: T

PTS: 1

45. Forecasting a currency's future value is difficult, because it is difficult to identify how the factors affecting the currency value will change, and how they will interact to impact the currency's value. a. True b. False ANS: T

PTS: 1

46. The standard deviation should be applied to values rather than percentage movements when comparing volatility among currencies. a. True b. False ANS: F

PTS: 1

47. Movements of foreign currencies tend to be more volatile for shorter time horizons. a. True b. False ANS: F

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

48. If a currency's spot market is ____, its exchange rate is likely to be ____ to a single large purchase or sale transaction. a. liquid; highly sensitive b. illiquid; insensitive c. liquid; insensitive d. none of the above ANS: C

PTS: 1

49. The value of euro was $1.30 last week. During last week the euro depreciated by 5%. What is the value of euro today? a. $1.365 b. $1.235 c. $1.330 d. $1.30 ANS: B SOLUTION:

$1.3  (1  .05) = $1.235

PTS: 1 50. Government controls can only affect the supply of a given currency for sale and not the demand. a. True b. False ANS: F

PTS: 1

51. If one foreign currency will appreciate against the dollar, then all foreign currencies will appreciate against the dollar but by different degrees. a. True b. False ANS: F

PTS: 1

52. Assume that the income levels in U.K. start to rise, while U.S. income levels remain unchanged. This will place ____ pressure on the value of British pound. Also, assume that U.S. interest rates rise, while the British pound remains unchanged. This will place ____ pressure on the value of British pound. a. downward; downward b. upward; downward c. upward; upward d. downward; upward ANS: D

PTS: 1

53. If the Fed announces that it will decrease the U.S. interest rates, and European Central Bank takes no action, then the value of euro will ____ against the value of U.S. dollar. The Fed's action is called ____ intervention. a. appreciate; direct b. depreciate; direct c. appreciate; indirect © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

d. depreciate; indirect ANS: C 54.

PTS: 1

Assume that the total value of investment transactions between U.S. and Mexico is minimal. Also assume that total dollar value of trade transactions between these two countries is very large. Now assume that Mexico's inflation has suddenly increased, and Mexican interest rates have suddenly increased. Overall, this would put ____ pressure on the value of Mexican peso. The inflation effect should be ____ pronounced than the interest rate effect. a. downward; more b. upward; more c. downward; less d. upward; less ANS: A

PTS: 1

55. If U.S. experiences a sudden surge in inflation and surge in interest rates while Japanese inflation and interest rates remain unchanged, the value of Japanese yen will ____ against the U.S. dollar. a. appreciate b. depreciate c. remain unchanged d. cannot be determined from the information provided.

ANS: D

PTS: 1

56. If the Japanese yen is expected to appreciate against the U.S. dollar and interest rates in the U.S. and Japan are similar, banks may try speculating on this anticipated exchange rate movement by borrowing ____ and investing in ____. a. yen; dollars b. yen; yen c. dollars; yen d. dollars; dollars ANS: C

PTS: 1

57. British investors frequently invest in the U.S. or Italy, depending on the prevailing interest rates. If Italian interest rates suddenly rise high above U.S. rates, the investors will ____ the supply of pounds to be exchanged for dollars and thus put ____ pressure on the value of the pound against the U.S. dollar. a. increase; downward b. decrease; upward c. increase; upward d. decrease; downward ANS: B

PTS: 1

58. The equilibrium exchange rate of the Swiss franc is $0.90. At an exchange rate $.83: a. U.S. demand for Swiss francs would exceed the supply of francs for sale and there would be a shortage of francs in the foreign exchange market. b. U.S. demand for Swiss francs would be less than the supply of francs for sale and there would be a shortage of francs in the foreign exchange market. c. U.S. demand for Swiss francs would exceed the supply of francs for sale and there would © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

be a surplus of francs in the foreign exchange market. d. U.S. demand for Swiss francs would be less than the supply of francs for sale and there would be a surplus of Swiss francs in the foreign exchange market.

ANS: A

PTS: 1

59. Financial flow foreign exchange transactions are more responsive to news than trade-related transactions. a. True b. False ANS: T

PTS: 1

60. Assume that the British government eliminates all controls on imports by British companies. Other things being equal, the U.S. demand for pounds would ____, the supply of pounds for sale would ____, and the equilibrium value of the pound would ____. a. increase; increase; increase b. decrease; increase; decrease c. remain unchanged; increase; decrease d. remain unchanged; increase; increase ANS: C

PTS: 1

61. Country X frequently engages in trade flows with the U.S. (such as imports and exports). Country Y frequently engages in capital flows with the U.S. (such as financial investments). Everything else held constant, an increase in U.S. inflation would affect the exchange rate of Country Y's currency more than the exchange rate of Country X's currency. a. True b. False ANS: F

PTS: 1

62. Assume that U.S. inflation is expected to surge in the near future. The expectation of surge in inflation will most likely place ____ pressure on U.S. dollar immediately. a. upward b. downward c. no d. cannot be determined ANS: A

PTS: 1

63. When the Japanese yen appreciates against the U.S. dollar, this means that the U.S. dollar is strengthening relative to the yen. a. True b. False ANS: F

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

64. Illiquid currencies tend to exhibit less volatile exchange rate movements than liquid currencies. a. True b. False ANS: F

PTS: 1

65. The supply curve for a currency is downward sloping since U.S. corporations would be encouraged to purchase more foreign goods when the foreign currency is worth less. a. True b. False ANS: F

PTS: 1

66. Relatively high Japanese inflation may result in an increase in the supply of yen for sale and a reduction in the demand for yen, other things being equal. a. True b. False ANS: T

PTS: 1

67. If the British government desires an appreciation in its currency with respect to the U.S. dollar, it would consider intervening in the foreign exchange market by buying dollars with pounds. a. True b. False ANS: F

PTS: 1

68. Country X frequently engages in trade flows with the U.S. (such as imports and exports). Country Y frequently engages in financial flows with the U.S. (such as financial investments). Everything else held constant, an increase in U.S. interest rates would affect the exchange rate of Country X's currency more than the exchange rate of Country Y's currency. a. True b. False ANS: F

PTS: 1

69. Illiquid currencies tend to exhibit ____ volatile exchange rate movements, as the equilibrium prices of their currencies adjust to ____ changes in supply and demand conditions. a. less; even minor b. less; only large c. more; even minor d. more; only large e. none of the above ANS: C

PTS: 1

70. Which of the following is not mentioned in the text as a factor affecting exchange rates? a. Relative interest rates b. Relative inflation rates © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

c. Government controls d. Expectations e. All of the above are mentioned in the text as factors affecting exchange rates.

ANS: E

PTS: 1

71. Which of the following events would most likely result in an appreciation of the U.S. dollar? a. U.S. inflation is very high. b. The Fed indicates that it will raise U.S. interest rates. c. Future U.S. interest rates are expected to decline. d. Japan is expected to increase interest rates in the near future.

ANS: B

PTS: 1

72. Which of the following interactions will likely have the least effect on the dollar's value? Assume everything else is held constant. a. A reduction in U.S. inflation accompanied by an increase in real U.S. interest rates b. A reduction in U.S. inflation accompanied by an increase in nominal U.S. interest rates c. An increase in U.S. inflation accompanied by an increase in nominal, but not real, U.S. interest rates d. An increase in Singapore's inflation accompanied by an increase in real U.S. interest rates e. An increase in Singapore's interest rates accompanied by an increase in U.S. inflation.

ANS: C

PTS: 1

73. If a country experiences high inflation relative to the U.S., its exports to the U.S. should ____, its imports should ____, and there is ____ pressure on its currency's equilibrium value. a. decrease; increase; upward b. decrease; decrease; upward c. increase; decrease; downward d. decrease; increase; downward e. increase; decrease; upward ANS: D

PTS: 1

74. If a country experiences an increase in interest rates relative to U.S. interest rates, the inflow of U.S. funds to purchase its securities should ____, the outflow of its funds to purchase U.S. securities should ____, and there is ____ pressure on its currency's equilibrium value. a. increase; decrease; downward b. decrease; increase; upward c. increase; decrease; upward d. decrease; increase; downward e. increase; increase; upward ANS: C

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Chapter 5—Currency Derivatives 1. Kalons, Inc. is a U.S.-based MNC that frequently imports raw materials from Canada. Kalons is typically invoiced for these goods in Canadian dollars and is concerned that the Canadian dollar will appreciate in the near future. Which of the following is not an appropriate hedging technique under these circumstances? a. purchase Canadian dollars forward. b. purchase Canadian dollar futures contracts. c. purchase Canadian dollar put options. d. purchase Canadian dollar call options.

ANS: C

PTS: 1

2. Graylon, Inc., based in Washington, exports products to a German firm and will receive payment of €200,000 in three months. On June 1, the spot rate of the euro was $1.12, and the 3-month forward rate was $1.10. On June 1, Graylon negotiated a forward contract with a bank to sell €200,000 forward in three months. The spot rate of the euro on September 1 is $1.15. Graylon will receive $____ for the euros. a. 224,000 b. 220,000 c. 200,000 d. 230,000 ANS: B SOLUTION:

€200,000  $1.10 = $220,000

PTS: 1 3. The one-year forward rate of the British pound is quoted at $1.60, and the spot rate of the British pound is quoted at $1.63. The forward ____ is ____ percent. a. discount; 1.9 b. discount; 1.8 c. premium; 1.9 d. premium; 1.8 ANS: B SOLUTION:

(F/S)  1 = ($1.60/$1.63)  1 = 1.8 percent.

PTS: 1 4. The 90-day forward rate for the euro is $1.07, while the current spot rate of the euro is $1.05. What is the annualized forward premium or discount of the euro? a. 1.9 percent discount. b. 1.9 percent premium. c. 7.6 percent premium. d. 7.6 percent discount.

ANS: C SOLUTION:

[(F/S)  1]  360/90 = 7.6 percent.

PTS: 1 © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

5. Thornton, Inc. needs to invest five million Nepalese rupees in its Nepalese subsidiary to support local operations. Thornton would like its subsidiary to repay the rupees in one year. Thornton would like to engage in a swap transaction. Thus, Thornton would: a. convert the rupees to dollars in the spot market today and convert rupees to dollars in one year at today's forward rate. b. convert the dollars to rupees in the spot market today and convert dollars to rupees in one year at the prevailing spot rate. c. convert the dollars to rupees in the spot market today and convert rupees to dollars in one year at today's forward rate. d. convert the dollars to rupees in the spot market today and convert rupees to dollars in one year at the prevailing spot rate.

ANS: C

PTS: 1

6. In the U.S., the typical currency futures contract is based on a currency value in terms of: a. euros. b. U.S. dollars. c. British pounds. d. Canadian dollars.

ANS: B

PTS: 1

7. Currency futures contracts sold on an exchange: a. contain a commitment to the owner, and are standardized. b. contain a commitment to the owner, and can be tailored to the desire of the owner. c. contain a right but not a commitment to the owner, and can be tailored to the desire of the owner. d. contain a right but not a commitment to the owner, and are standardized.

ANS: A

PTS: 1

8. Currency options sold through an options exchange: a. contain a commitment to the owner, and are standardized. b. contain a commitment to the owner, and can be tailored to the desire of the owner. c. contain a right but not a commitment to the owner, and can be tailored to the desire of the owner. d. contain a right but not a commitment to the owner, and are standardized.

ANS: D

PTS: 1

9. Currency options are commonly traded through the ____ system. a. robot b. Euro c. GLOBEX d. Scope ANS: C

PTS: 1

10. Forward contracts: a. contain a commitment to the owner, and are standardized. b. contain a commitment to the owner, and can be tailored to the desire of the owner. © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

c. contain a right but not a commitment to the owner, and can be tailored to the desire of the owner. d. contain a right but not a commitment to the owner, and are standardized.

ANS: B

PTS: 1

11. Which of the following is the most likely strategy for a U.S. firm that will be receiving Swiss francs in the future and desires to avoid exchange rate risk (assume the firm has no offsetting position in francs)? a. purchase a call option on francs. b. sell a futures contract on francs. c. obtain a forward contract to purchase francs forward. d. all of the above are appropriate strategies for the scenario described.

ANS: B

PTS: 1

12. Which of the following is the most unlikely strategy for a U.S. firm that will be purchasing Swiss francs in the future and desires to avoid exchange rate risk (assume the firm has no offsetting position in francs)? a. purchase a call option on francs. b. obtain a forward contract to purchase francs forward. c. sell a futures contract on francs. d. all of the above are appropriate strategies for the scenario described.

ANS: C

PTS: 1

13. If your firm expects the euro to substantially depreciate, it could speculate by ____ euro call options or ____ euros forward in the forward exchange market. a. selling; selling b. selling; purchasing c. purchasing; purchasing d. purchasing; selling ANS: A

PTS: 1

14. When you own ____, there is no obligation on your part; however, when you own ____, there is an obligation on your part. a. call options; put options b. futures contracts; call options c. forward contracts; futures contracts d. put options; forward contracts ANS: D

PTS: 1

15. The greater the variability of a currency, the ____ will be the premium of a call option on this currency, and the ____ will be the premium of a put option on this currency, other things equal. a. greater; lower b. greater; greater c. lower; greater d. lower; lower ANS: B

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

16. When currency options are not standardized and traded over-the-counter, there is ____ liquidity and a ____ bid/ask spread. a. less; narrower b. more; narrower c. more; wider d. less; wider ANS: D

PTS: 1

17. The shorter the time to the expiration date for a currency, the ____ will be the premium of a call option, and the ____ will be the premium of a put option, other things equal. a. greater; greater b. greater; lower c. lower; lower d. lower; greater ANS: C

PTS: 1

18. Assume that a speculator purchases a put option on British pounds (with a strike price of $1.50) for $.05 per unit. A pound option represents 31,250 units. Assume that at the time of the purchase, the spot rate of the pound is $1.51 and continually rises to $1.62 by the expiration date. The highest net profit possible for the speculator based on the information above is: a. $1,562.50. b. $1,562.50. c. $1,250.00. d. $625.00.

ANS: B SOLUTION:

The premium of the option is $.05  (31,250 units) = $1,562.50. Since the option will not be exercised, the net profit is $1,562.50.

PTS: 1 19. Which of the following is true? a. The futures market is primarily used by speculators while the forward market is primarily used for hedging. b. The futures market is primarily used for hedging while the forward market is primarily used for speculating. c. The futures market and the forward market are primarily used for speculating. d. The futures market and the forward market are primarily used for hedging.

ANS: A

PTS: 1

20. Which of the following is true? a. Most forward contracts between firms and banks are for speculative purposes. b. Most future contracts represent a conservative approach by firms to hedge foreign trade. c. The forward contracts offered by banks have maturities for only four possible dates in the future. d. none of the above ANS: D

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

21. If you expect the euro to depreciate, it would be appropriate to ____ for speculative purposes. a. buy a euro call and buy a euro put b. buy a euro call and sell a euro put c. sell a euro call and sell a euro put d. sell a euro call and buy a euro put ANS: D

PTS: 1

22. If you expect the British pound to appreciate, you could speculate by ____ pound call options or ____ pound put options. a. purchasing; selling b. purchasing; purchasing c. selling; selling d. selling; purchasing ANS: A

PTS: 1

23. Which of the following is correct? a. The longer the time to maturity, the less the value of a currency call option, other things equal. b. The longer the time to maturity, the less the value of a currency put option, other things equal. c. The higher the spot rate relative to the exercise price, the greater the value of a currency put option, other things equal. d. The lower the exercise price relative to the spot rate, the greater the value of a currency call option, other things equal.

ANS: D

PTS: 1

24. Research has found that the options market is: a. efficient before controlling for transaction costs. b. efficient after controlling for transaction costs. c. highly inefficient. d. none of the above ANS: B

PTS: 1

25. Assume no transactions costs exist for any futures or forward contracts. The price of British pound futures with a settlement date 180 days from now will: a. definitely be above the 180-day forward rate. b. definitely be below the 180-day forward rate. c. be about the same as the 180-day forward rate. d. none of the above; there is no relation between the futures and forward prices.

ANS: C

PTS: 1

26. Assume that a currency's spot and future prices are the same, and the currency's interest rate is higher than the U.S. rate. The actions of U.S. investors to lock in this higher foreign return would ____ the currency's spot rate and ____ the currency's futures price. a. put upward pressure on; put upward pressure on b. put downward pressure on; put upward pressure on © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

c. put upward pressure on; put downward pressure on d. put downward pressure on; put downward pressure on ANS: C

PTS: 1

27. A firm sells a currency futures contract, and then decides before the settlement date that it no longer wants to maintain such a position. It can close out its position by: a. buying an identical futures contract. b. selling an identical futures contract. c. buying a futures contract with a different settlement date. d. selling a futures contract for a different amount of currency. e. purchasing a put option contract in the same currency.

ANS: A

PTS: 1

28. If the spot rate of the euro increased substantially over a one-month period, the futures price on euros would likely ____ over that same period. a. increase slightly b. decrease substantially c. increase substantially d. stay the same ANS: C

PTS: 1

29. A U.S. firm is bidding for a project needed by the Swiss government. The firm will not know if the bid is accepted until three months from now. The firm will need Swiss francs to cover expenses but will be paid by the Swiss government in dollars if it is hired for the project. The firm can best insulate itself against exchange rate exposure by: a. selling futures in francs. b. buying futures in francs. c. buying franc put options. d. buying franc call options.

ANS: D

PTS: 1

30. A firm wants to use an option to hedge 12.5 million in receivables from New Zealand firms. The premium is $.03. The exercise price is $.55. If the option is exercised, what is the total amount of dollars received (after accounting for the premium paid)? a. $6,875,000. b. $7,250,000. c. $7,000,000. d. $6,500,000. e. none of the above ANS: D SOLUTION:

Dollars received from exercising option = NZ$12.5 million  $.55 = $6,875,000. Premium paid for options = NZ$12.5 million  $.03 = $375,000.

Amount of dollars received minus premium = $6,500,000.

PTS: 1 31. If you purchase a straddle on euros, this implies that you: © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

a. b. c. d. e.

finance the purchase of a call option by selling a put option in the euros. finance the purchase of a call option by selling a call option in the euros. finance the purchase of a put option by selling a put option in the euros. finance the purchase of a put option by selling a call option in the euros. none of the above

ANS: E

PTS: 1

32. The premium on a pound put option is $.03 per unit. The exercise price is $1.60. The break-even point is ____ for the buyer of the put, and ____ for the seller of the put. (Assume zero transactions costs and that the buyer and seller of the put option are speculators.) a. $1.63; $1.63 b. $1.63; $1.60 c. $1.63; $1.57 d. $1.57; $1.63 e. none of the above ANS: E SOLUTION:

Break-even point on put option to both the buyer and seller is $1.60  $.03 = $1.57.

PTS: 1 33. The existing spot rate of the Canadian dollar is $.82. The premium on a Canadian dollar call option is $.04. The exercise price is $.81. The option will be exercised on the expiration date if at all. If the spot rate on the expiration date is $.87, the profit as a percent of the initial investment (the premium paid) is: a. 0 percent. b. 25 percent. c. 50 percent. d. 150 percent. e. none of the above ANS: C SOLUTION:

The net profit per unit is: $.87  $.81  $.04 = $.02. The net profit per unit as a percent of the initial investment per unit is: $.02/$.04 = 50%.

PTS: 1 34. You purchase a call option on pounds for a premium of $.03 per unit, with an exercise price of $1.64; the option will not be exercised until the expiration date, if at all. If the spot rate on the expiration date is $1.65, your net profit per unit is: a. $.03. b. $.02. c. $.01. d. $.02. e. none of the above ANS: B SOLUTION:

Net profit per unit = $1.65  $1.64  $.03 = $.02.

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

PTS: 1 35. You purchase a put option on Swiss francs for a premium of $.02, with an exercise price of $.61. The option will not be exercised until the expiration date, if at all. If the spot rate on the expiration date is $.58, your net profit per unit is: a. $.03. b. $.02. c. $.01. d. $.02. e. none of the above ANS: E SOLUTION:

Net profit per unit = $.61  $.58  $.02 = $.01.

PTS: 1 36. You are a speculator who sells a call option on Swiss francs for a premium of $.06, with an exercise price of $.64. The option will not be exercised until the expiration date, if at all. If the spot rate of the Swiss franc is $.69 on the expiration date, your net profit per unit, assuming that you have to buy Swiss francs in the market to fulfill your obligation, is: a. $.02. b. $.01. c. $.01. d. $.02. e. none of the above ANS: C SOLUTION:

Net profit per unit = $.64 + $.06  $.69 = $.01.

PTS: 1 37. You are a speculator who sells a put option on Canadian dollars for a premium of $.03 per unit, with an exercise price of $.86. The option will not be exercised until the expiration date, if at all. If the spot rate of the Canadian dollar is $.78 on the expiration date, your net profit per unit is: a. $.08. b. $.03. c. $.05. d. $.08. e. none of the above ANS: E SOLUTION:

Net profit = $.78 + $.03  $.86 = $.05.

PTS: 1 38. European currency options can be exercised ____; American currency options can be exercised ____. a. any time up to the expiration date; any time up to the expiration date b. any time up to the expiration date; only on the expiration date c. only on the expiration date; only on the expiration date d. only on the expiration date; any time up to the expiration date © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

ANS: D

PTS: 1

39. Macomb Corporation is a U.S. firm that invoices some of its exports in Japanese yen. If it expects the yen to weaken, it could ____ to hedge the exchange rate risk on those exports. a. sell yen put options b. buy yen call options c. buy futures contracts on yen d. sell futures contracts on yen ANS: D

PTS: 1

40. A call option on Australian dollars has a strike (exercise) price of $.56. The present exchange rate is $.59. This call option can be referred to as: a. in the money. b. out of the money. c. at the money. d. at a discount.

ANS: A

PTS: 1

41. A put option on British pounds has a strike (exercise) price of $1.48. The present exchange rate is $1.55. This put option can be referred to as: a. in the money. b. out of the money. c. at the money. d. at a discount.

ANS: B

PTS: 1

42. Which of the following is not an instrument used by U.S.-based MNCs to cover their foreign currency positions? a. forward contracts. b. futures contracts. c. non-deliverable forward contracts. d. options. e. all of the above are instruments used to cover foreign currency positions.

ANS: E

PTS: 1

43. When the futures price on euros is below the forward rate on euros for the same settlement date, astute investors may attempt to simultaneously ____ euros forward and ____ euro futures. a. sell; sell b. buy; sell c. sell; buy d. buy; buy ANS: B

PTS: 1

44. When the futures price is equal to the spot rate of a given currency, and the foreign country exhibits a higher interest rate than the U.S. interest rate, astute investors may attempt to simultaneously ____ the foreign currency, invest it in the foreign country, and ____ futures in the foreign currency. a. buy; buy © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

b. sell; buy c. buy; sell d. buy; buy ANS: C

PTS: 1

45. Which of the following would result in a profit of a euro futures contract when the euro depreciates? a. buy a euro futures contract; sell a futures contract after the euro has depreciated. b. sell a euro futures contract; buy a futures contract after the euro has depreciated. c. buy a euro futures contract; buy an additional futures contract after the euro has depreciated. d. none of the above would result in a profit when the euro depreciates.

ANS: B

PTS: 1

46. Which of the following is not true regarding options? a. Options are traded on exchanges, never over-the-counter. b. Similar to futures contracts, margin requirements are normally imposed on option traders. c. Although commissions for options are fixed per transaction, multiple contracts may be involved in a transaction, thus lowering the commission per contract. d. Currency options can be classified as either put or call options. e. All of the above are true.

ANS: A

PTS: 1

47. A U.S. corporation has purchased currency put options to hedge a 100,000 Canadian dollar (C$) receivable. The premium is $.01 and the exercise price of the option is $.75. If the spot rate at the time of maturity is $.85, what is the net amount received by the corporation if it acts rationally? a. $74,000. b. $84,000. c. $75,000. d. $85,000.

ANS: B SOLUTION:

Dollars received from selling Canadian dollars in the spot market = C$100,000  $.85 = $85,000. Premium paid for options = C$100,000  $.01 = $1,000. Amount of dollars received less premium = $84,000.

PTS: 1 48. A U.S. corporation has purchased currency call options to hedge a 70,000 pound payable. The premium is $.02 and the exercise price of the option is $.50. If the spot rate at the time of maturity is $.65, what is the total amount paid by the corporation if it acts rationally? a. $33,600. b. $46,900. c. $44,100. d. $36,400.

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

ANS: D SOLUTION:

Dollars paid when exercising the option = £70,000  $.50 = $35,000.

Premium paid for options = £70,000  $.02 = $1,400. Amount of dollars paid = $35,000 + $1,400 = $36,400.

PTS: 1 49. Frank is an option speculator. He anticipates the Danish kroner to appreciate from its current level of $.19 to $.21. Currently, kroner call options are available with an exercise price of $.18 and a premium of $.02. Should Frank attempt to buy this option? If the future spot rate of the Danish kroner is indeed $.21, what is his profit or loss per unit? a. no; $0.01. b. yes; $0.01. c. yes; $0.01. d. yes; $0.03.

ANS: B SOLUTION:

The net profit per unit is: $.21  $.18  $.02 = $.01.

PTS: 1 50. Carl is an option writer. In anticipation of a depreciation of the British pound from its current level of $1.50 to $1.45, he has written a call option with an exercise price of $1.51 and a premium of $.02. If the spot rate at the option's maturity turns out to be $1.54, what is Carl's profit or loss per unit (assuming the buyer of the option acts rationally)? a. $0.01. b. $0.01. c. $0.04. d. $0.04. e. $0.03.

ANS: A SOLUTION:

The net profit per unit is $1.51 + $.02  $1.54 = $.01.

PTS: 1 51. Johnson, Inc., a U.S.-based MNC, will need 10 million Thai baht on August 1. It is now May 1.

Johnson has negotiated a non-deliverable forward contract with its bank. The reference rate is the baht's closing exchange rate (in $) quoted by Thailand's central bank in 90 days. The baht's spot rate today is $.02. If the rate quoted by Thailand's central bank on August 1 is $.022, Johnson will ____ $____. a. pay; 20,000 b. be paid; 20,000 c. pay; 2,000 d. be paid; 2,000 e. none of the above

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

ANS: B SOLUTION:

Amount received per unit = $.022  $.02 = $.002  THB10,000,0000 = $20,000.

PTS: 1 52. If the observed put option premium is less than what is suggested by the put-call parity equation, astute arbitrageurs could make a profit by ____ the put option, ____ the call option, and ____ the underlying currency. a. selling; buying; buying b. buying; selling; buying c. selling; buying; selling d. buying; buying; buying ANS: B

PTS: 1

53. A put option premium has a lower bound that is equal to the greater of zero and the difference between the underlying ____ prices. The upper bound of a call option premium is the ____ price. a. spot and exercise; exercise b. spot and exercise; spot c. exercise and spot; exercise d. exercise and spot; spot ANS: C

PTS: 1

54. A call option premium has a lower bound that is equal to the greater of zero and the difference between the underlying ____ prices. The upper bound of a call option premium is the ____ price. a. spot and exercise; exercise b. spot and exercise; spot c. exercise and spot; exercise d. exercise and spot; spot ANS: B

PTS: 1

55. Assume the spot rate of the Swiss franc is $.62 and the one-year forward rate is $.66. The forward rate exhibits a ____ of ____. a. premium; about 6% b. discount; about 6% c. discount; about 6.45% d. premium; about 6.45% ANS: D SOLUTION:

Premium = (Forward rate  Spot rate)/Spot rate = ($.66  $.62)/$.62 = 6.45%

PTS: 1 56. Assume the spot rate of a currency is $.37 and the 90-day forward rate is $.36. The forward rate of this currency exhibits a ____ of ____ on an annualized basis. a. discount; 11.11% b. premium; 11.11% c. premium; 10.81% © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

d. discount; 10.81% ANS: D SOLUTION:

Discount

= [(FR  SR)/SR]  (360/90) = [($.36  $.37)/$.37]  (360/90) = 10.81% (Discount)

PTS: 1 57. Which of the following are most commonly traded on an exchange? a. forward contracts. b. futures contracts. c. currencies d. none of the above ANS: B

PTS: 1

58. Conditional currency options are: a. options that do not require premiums. b. options where the premiums are canceled if a trigger level is reached. c. options that allow the buyer to decide what currency the option will be settled in. d. none of the above ANS: B

PTS: 1

59. Which of the following is true regarding the options markets? a. Hedgers and speculators both attempt to lower risk. b. Hedgers attempt to lower risk, while speculators attempt to make riskless profits. c. Hedgers and speculators are both necessary in order for the market to be liquid. d. all of the above ANS: C

PTS: 1

60. The premium of a currency put option will increase if: a. the volatility of the underlying asset goes up. b. the time to maturity goes up. c. the spot rate declines. d. none of the above ANS: D

PTS: 1

61. Which of the following is true of options? a. The writer decides whether the option will be exercised. b. The writer pays the buyer the option premium. c. The buyer decides if the option will be exercised. d. More than one of these.

ANS: C

PTS: 1

62. The purchase of a currency put option would be appropriate for which of the following? a. Investors who expect to buy a foreign bond in one month. b. Corporations who expect to buy foreign currency to finance foreign subsidiaries. © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

c. Corporations who expect to collect on a foreign account receivable in one month. d. all of the above ANS: B

PTS: 1

63. If you have bought the right to sell, you are a: a. call writer. b. put buyer. c. futures buyer. d. put writer.

ANS: B

PTS: 1

64. If you have a position where you might be obligated to buy Euros, you are: a. a call writer. b. a put writer. c. a put buyer. d. a futures seller.

ANS: C

PTS: 1

65. Which of the following is true for futures, but not for forwards? a. actual delivery. b. no transactions costs. c. self regulation. d. none of the above ANS: D

PTS: 1

66. Your company expects to receive 5,000,000 Japanese yen 60 days from now. You decide to hedge your position by selling Japanese yen forward. The current spot rate of the yen is $.0089, while the forward rate is $.0095. You expect the spot rate in 60 days to be $.0090. How many dollars will you receive for the 5,000,000 yen 60 days from now? a. $44,500. b. $45,000. c. $526 million. d. $47,500.

ANS: D SOLUTION:

¥5,000,000  $.0095/¥ = $47,500

PTS: 1 67. The spot rate for the Singapore dollar is $.588. The 30-day forward rate is $.590. The forward rate contains an annualized ____ of ____%. a. discount; 4.07 b. premium; 4.07 c. discount; 4.08 d. premium; 4.08 e. premium; 3.40 ANS: D © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

SOLUTION:

($.59  $.588)/$.588  (360/30) = 4.08%

PTS: 1 68. Non-deliverable forward contracts (NDFs) are frequently used for currencies in emerging markets. a. True b. False ANS: T

PTS: 1

69. The price of a futures contract will generally vary significantly from that of a forward contract. a. True b. False ANS: F

PTS: 1

70. If the futures rate is lower than the forward rate, astute investors would attempt to simultaneously buy futures and sell forward. Such actions would place downward pressure on the futures price and upward pressure on the forward rate. a. True b. False ANS: F

PTS: 1

71. Forward contracts are usually liquidated by actual delivery of the currency, while futures contracts are usually liquidated by offsetting transactions. a. True b. False ANS: T

PTS: 1

72. If an investor who previously sold futures contracts wishes to liquidate his position, he could sell futures contracts with the same maturity date. a. True b. False ANS: F

PTS: 1

73. Since futures contracts are traded on an exchange, the exchange will always take the "other side" of the transaction in terms of accepting the credit risk. a. True b. False ANS: T

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

74. Currency options are only traded on exchanges. That is, there is no over-the-counter market for options. a. True b. False ANS: F

PTS: 1

75. Both call and put option premiums are affected by the level of the existing spot price relative to the strike price; for example, a high spot price relative to the strike price will result in a relatively high premium for a call option but a relatively low premium for a put option. a. True b. False ANS: T

PTS: 1

76. The writer of a call option is obligated to sell the underlying currency to the buyer of the option if the option is exercised. a. True b. False ANS: T

PTS: 1

77. The lower bound of the call option premium is the greater of zero and the difference between the spot rate and the exercise price; the upper bound of a currency call option is the spot rate. a. True b. False ANS: T

PTS: 1

78. The lower bound of a put option premium is the greater of zero and the difference between the exercise price and the spot rate; the upper bound of a currency put option is the exercise price. a. True b. False ANS: T

PTS: 1

79. Due to put-call parity, we can use the same formula to price calls and puts. a. True b. False ANS: F

PTS: 1

80. If an actual put option premium is less than what is suggested by the put-call parity relationship, arbitrage can be conducted. a. True b. False ANS: T

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

81. If the futures rate is above the forward rate, actions by rational investors would put upward pressure on the forward rate and downward pressure on the futures rate. a. True b. False ANS: T

PTS: 1

82. Futures contracts are standardized with respect to delivery date and the futures price specified for the settlement date. a. True b. False ANS: F

PTS: 1

83. If an investor who has previously purchased a futures contract wishes to liquidate her position, she would sell an identical futures contract with the same settlement date. a. True b. False ANS: T

PTS: 1

84. Margin requirements are deposits placed by investors in futures contracts with their respective brokerage firms when they take their position. They are intended to minimize credit risk associated with futures contracts. a. True b. False ANS: T

PTS: 1

85. A European option can only be exercised at the expiration date, while an American option can be exercised any time prior to the expiration date. a. True b. False ANS: T

PTS: 1

86. The highest amount a buyer of a call or a put option can lose is the exercise price. a. True b. False ANS: F

PTS: 1

87. A straddle is a speculative strategy that represents the purchase of both a call and a put. a. True b. False ANS: T

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

88. A currency put option is a contract specifying a standard volume of a particular currency to be exchanged on a specific settlement date. a. True b. False ANS: F

PTS: 1

89. An option writer is the seller of a call or a put option. a. True b. False ANS: T

PTS: 1

90. The forward premium is the price specified in a call or put option. a. True b. False ANS: F

PTS: 1

91. An 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 futures. a. True b. False ANS: T

PTS: 1

92. Hedgers should buy puts if they are hedging an expected inflow of foreign currency. a. True b. False ANS: T

PTS: 1

93. Forward contracts are the best technique for managing exposure arising from project bidding. a. True b. False ANS: F

PTS: 1

94. The currency futures markets are regulated by the International Monetary Fund. a. True b. False ANS: F

PTS: 1

95. It is possible to have an opportunity loss when using futures to hedge. a. True b. False ANS: T

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

96. Margin is used in the forward market to mitigate default risk. a. True b. False ANS: F

PTS: 1

97. There are no transactions costs associated with trading futures or options. a. True b. False ANS: F

PTS: 1

98. Futures and options are available for crossrates. a. True b. False ANS: T

PTS: 1

99. Options can be traded on an exchange or over the counter. a. True b. False ANS: T

PTS: 1

100. The writer of an uncovered call can experience a loss limited to the option premium. a. True b. False ANS: F

PTS: 1

101. American style options can be exercised any time up to maturity. a. True b. False ANS: F

PTS: 1

102. If a currency put option is out of the money, then the present exchange rate is less than the strike price. a. True b. False ANS: F

PTS: 1

103. As mentioned in the text, the most common maturities for forward rates are: a. one, three, six, and twelve months. b. one, three, six, and twelve years. c. two, three, and five years. d. two, three, and five weeks.

ANS: A

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

104. Managers of MNCs are typically expected to use currency derivatives for speculation in order to improve profits. a. True b. False ANS: F

PTS: 1

105. The 180-day forward rate for the euro is $1.34, while the current spot rate of the euro is $1.29. What is the annualized forward premium or discount of the euro? a. 7.46% premium b. 7.46% discount c. 7.75% premium d. 7.75% discount ANS: C SOLUTION:

[(F/S)  1]  360/180 = [($1.34/$1.29)  1]  360/180 = 7.75%

PTS: 1 106. The annualized forward premium on the euro is 7%. What is the 90-day forward rate on the euro if the spot rate today is $1.25? a. $1.27 b. $1.34 c. $1.16 d. $1.23 ANS: A SOLUTION:

$1.25  [1 + 7%/(360/90)] = $1.27

PTS: 1 107. The one-year forward rate of the Japanese yen is quoted at $.013, and the spot rate of Japanese yen is quoted at $.011. The forward ____ is ____ percent. a. discount; 18.18 b. premium; 18.18 c. discount; 15.38 d. premium; 15.38 ANS: B SOLUTION:

(F/S)  1 = ($.013/$.011)  1 = 18.18%

PTS: 1 108. The spot rate of British pound is quoted at $1.49. The 90-day forward rate exhibits a 2% discount.

What is the 90-day forward rate of the pound? a. $1.52 b. $1.61 c. $1.37 d. $1.46 ANS: D © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

SOLUTION:

$1.49  (1  .02) = $1.46

PTS: 1 109. The spot rate of euro is quoted at $1.29. The annualized forward premium on the euro is 10%. What is the 30-day forward rate of the euro? a. $1.28 b. $1.30 c. $1.42 d. $1.16 ANS: B SOLUTION:

$1.29  [1+ 0.10/(360/30)] = $1.30

PTS: 1 110. The premium on a euro call option is $.02. The exercise price is $1.32. The break-even point is ____ for the buyer of the call, and ____ for the seller of the call. (Assume zero transactions costs and that the buyer and seller of the put option are speculators.) a. $1.30; $1.30 b. $1.34; $1.30 c. $1.30; $1.34 d. $1.34; $1.34 ANS: D SOLUTION:

Break-even point on call option to both the buyer and seller is $1.32 + $.02 = $1.34.

PTS: 1 111. If you have a position where you might be obligated to sell pounds, you are: a. a call writer. b. a call buyer. c. a put writer. d. a put buyer.

ANS: A

PTS: 1

112. If you have bought a right to buy foreign currency, you are: a. a call writer. b. a call buyer. c. a put writer. d. a put buyer.

ANS: B

PTS: 1

113. The premium on a pound put option is $.04. The spot rate and the exercise price is $1.52. The spot rate at the time of this option expiration is expected to be $1.51. The speculators could profit by: a. writing a put option. b. buying a put option. c. buying a call option © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

d. writing a call option and buying a call option simultaneously.

ANS: D

PTS: 1

114. A call option on Japanese yen has a strike (exercise) price of $.012. The present exchange rate is $.011. This call option can be referred to as: a. in the money. b. out of the money. c. at the money. d. at a discount.

ANS: B

PTS: 1

115. A put option on Swiss franc has a strike (exercise) price of $.92. The present exchange rate is $.89.

This put option can be referred to as: a. in the money. b. out of the money. c. at the money. d. at a discount.

ANS: A

PTS: 1

116. Crown Co. is expecting to receive 100,000 British pounds in one year. Crown expects the spot rate of British pound to be $1.49 in a year, so it decides to avoid exchange rate risk by hedging its receivables.

The spot rate of the pound is quoted at $1.51. The strike price of put and call options are $1.54 and $1.53 respectively. The premium on both options is $.03. The one-year forward rate exhibits a 2.65% premium. Assume there are no transaction costs. What is the best possible hedging strategy and how many U.S. dollars Crown Co. will receive under this strategy? a. buy a put option and receive $150,000. b. sell pounds forward and receive $155,000. c. sell a call option and receive $156,000. d. sell a put option and receive $157,000.

ANS: B SOLUTION:

There are only two feasible choices for hedging in these circumstances: selling pounds forward or buying a put option.

Sell pounds forward: One-year forward rate = $1.51  (1 + .0265) = $1.55 Dollars received = 100,000  $1.55 = $155,000 Buy put option: Amount received per unit = $1.54  $.03 = $1.51 Total amount of receivables in U.S.$ = 100,000  $1.51 = $151,000

PTS: 1 117. J&L Co. is a U.S.-based MNC that frequently exports computers to Italy. J&L typically invoices these goods in euros and is concerned that the euro will depreciate in the near future. Which of the following is not an appropriate technique under these circumstances? a. purchase euro put options. © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

b. sell euros forward. c. sell euro futures contracts. d. sell euro put options.

ANS: D

PTS: 1

118. The ____ the existing spot price relative to the strike price, the ____ valuable the call options will be. a. higher; less b. higher; more c. lower; less d. lower; more ANS: A

PTS: 1

119. The ____ the existing spot price relative to the strike price, the ____ valuable the put options will be. a. higher; less b. higher; more c. lower; less d. lower; more ANS: D

PTS: 1

120. On January 1st, Madison Co. ordered raw material from Japan and agreed to pay 100 million yen for this order on April 1st. It negotiated a 3-month forward contract to obtain 100 million Japanese yen on that date at $.009. On February 1st, the Japanese firm informed Madison Co. that it won't be able to fulfill that order. The Japanese yen spot rate on February 1st is $.0087 and 2-month forward rate exhibits 3% discount. To offset its existing contract Madison Co. will negotiate a forward contract to ____ for the date of April 1st and the profit/loss generated from this transaction is a ____ U.S. dollars. a. sell yen; gain of $60,000 b. sell yen; loss of $60,000 c. buy yen; gain of $30,000 d. to buy yen; loss of $30,000 ANS: B SOLUTION:

2-month forward rate = $.0087  (1  .03) = $.0084 Profit/loss from transaction = (100,000,000  $.0084)  (100,000,000  .009) = $60,000 loss.

PTS: 1 121. Assume that a speculator received news that makes her believe that the yen will appreciate or depreciate substantially in the near future, but she is not certain of the direction. Also assume that exercise price of call and put options are the same. The most appropriate method for speculation is ____and it may be achieved by ____. a. straddle; purchase put option and purchase call option. b. strangle; purchase put option and sell call option. c. strangle; sell put option and sell put option. d. straddle; sell put option and buy call option.

ANS: A

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

122. Which of the following does not represent the risk from using forward contracts? a. if a forward contract is used to hedge receivables, and the spot exchange rate at the expiration of contract exceeds the contract price. b. if a forward contract is used to hedge receivables, and the spot exchange rate at the time of expiration of contract is lower than the contract price. c. if a forward contract is used to hedge payables, and the spot exchange rate at the time of expiration of contract is lower than the contract price. d. if a forward contract is used to hedge payables or receivables and the amount to be received or paid is cancelled.

ANS: B

PTS: 1

123. The writer of a put option has a right, but not obligation, to buy the underlying currency from the option buyer. a. True b. False ANS: F

PTS: 1

124. A straddle can only be achieved if the exercise prices of put and call options are the same. a. True b. False ANS: T

PTS: 1

125. An MNC frequently uses either forward or futures contracts to hedge its exposure to foreign payables.

To do so, the MNC can either sell the foreign currency forward or sell futures. a. True b. False ANS: F

PTS: 1

126. Hedgers should buy calls if they are hedging an expected outflow of foreign currency. a. True b. False ANS: T

PTS: 1

127. If a currency's forward rate exhibits a discount, the currency is forced to appreciate. a. True b. False ANS: F

PTS: 1

128. If a currency's forward rate exhibits a premium, that currency is forced to depreciate. a. True b. False ANS: F

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

129. If a currency call option is in the money, then the present exchange rate exceeds the strike price. a. True b. False ANS: T

PTS: 1

130. If the forward rate for a currency is less than the spot rate for that currency, the forward rate is said to exhibit a premium. a. True b. False ANS: F

PTS: 1

131. If an MNC desires to offset a forward contract that it previously created, it can simply ignore its obligation. a. True b. False ANS: F

PTS: 1

132. Non-deliverable forward contracts (NDFs) are frequently used for currencies in emerging markets. a. True b. False ANS: T

PTS: 1

133. Forward contracts are usually negotiated with a commercial bank, while futures contracts are traded on an organized exchange. a. True b. False ANS: T

PTS: 1

134. Since corporations have specialized needs, they usually prefer futures contracts to forward contracts for hedging purposes. a. True b. False ANS: F

PTS: 1

135. A speculator in futures contracts expecting the value of a foreign currency to depreciate would likely sell futures contracts. a. True b. False ANS: T

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

136. Currency options are only traded on exchanges. That is, there is no over-the-counter market for options. a. True b. False ANS: F

PTS: 1

137. A currency call option grants the right to sell a specific currency at a designated price within a specific time period. a. True b. False ANS: F

PTS: 1

138. Currency call options allow the purchaser to lock in the price paid for a currency. Therefore, they are often used by MNCs to hedge foreign currency payables. a. True b. False ANS: T

PTS: 1

139. When the current exchange rate is less than the strike price, a call option with that strike price will be in the money and a put option with that strike price will be out of the money. a. True b. False ANS: F

PTS: 1

140. Both call and put option premiums are affected by the level of the existing spot price relative to the strike price; for example, a high spot price relative to the strike price will result in a relatively high premium for a call option but a relatively low premium for a put option. a. True b. False ANS: T

PTS: 1

141. Both call and put option premiums are affected by the level of the existing spot rate relative to the strike price, the length of time before the expiration date, and the potential variability of the currency. a. True b. False ANS: T

PTS: 1

142. A straddle represents the purchase of either two call or two put options at the same exercise price. a. True b. False ANS: F

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

143. A European option can be exercised at any time prior to maturity, while an American option can only be exercised at maturity. a. True b. False ANS: F

PTS: 1

144. The lower bound of the call option premium is the greater of zero and the difference between the spot rate and the exercise price; the upper bound of a currency call option is the spot rate. a. True b. False ANS: T

PTS: 1

145. The lower bound of a put option premium is the greater of zero and the difference between the exercise price and the spot rate; the upper bound of a currency put option is the exercise price. a. True b. False ANS: T

PTS: 1

146. If an actual put option premium is less than what is suggested by the put-call parity relationship, arbitrage can be conducted. a. True b. False ANS: T

PTS: 1

147. An advantage of a short straddle is that it provides the option writer with income from two separate sources. a. True b. False ANS: T

PTS: 1

148. The disadvantage of a long strangle relative to a long straddle is that the underlying currency has to fluctuate more prior to expiration. a. True b. False ANS: T

PTS: 1

149. With a bull spread, the spreader believes that the underlying currency will appreciate substantially, even more so than with a strangle. a. True b. False ANS: F

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

150. A forward rate for a currency is said to exhibit a discount if a. the forward rate exceeds the existing spot rate. b. the forward rate is less than the existing spot rate. c. the forward rate exceeds the expected future spot rate. d. the forward rate is less than the expected future spot rate. e. none of the above ANS: B

PTS: 1

151. If the spot rate of the British pound is $1.50, and the one-year forward rate has a discount of 3 percent, the one-year forward rate is $____. a. 1.50 b. 1.47 c. 1.55 d. 1.46 e. None of the above ANS: D

PTS: 1

152. Which of the following is not true regarding futures contracts? a. Unlike forward contracts, they are generally traded on an exchange. b. Futures contracts are standardized with respect to delivery date and size of the contract. c. There is an active over-the-counter market for currency futures contracts. d. Currency futures can be used by speculators who attempt to profit from exchange rate movements.

ANS: C

PTS: 1

153. When the futures price is above the forward rate, astute investors may attempt to simultaneously buy a currency forward and sell futures in that currency. These actions would place ____ pressure on the forward rate and ____ pressure on the futures rate. a. upward; downward b. upward; upward c. downward; upward d. downward; downward ANS: A

PTS: 1

154. Assume that the British pound (£) futures price for September is $1.60. Given that 62,500 units are in a British pound futures contract, the seller of British pound futures will receive $____ on the delivery date. a. 39,062.50 b. 100,000 c. 48,000 d. 87,062.50 ANS: B

PTS: 1

155. Which of the following would result in a profit of a futures contract when the underlying currency depreciates? a. Buy a futures contract; sell a futures contract after the currency has depreciated © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

b. Sell a futures contract; buy a futures contract after the currency has depreciated c. Buy a futures contract; buy an additional futures contract after the currency has depreciated d. None of the above would result in a profit when the underlying currency of the futures contract depreciates.

ANS: B

PTS: 1

156. Currency futures can be used by MNCs to hedge payables. That is, an MNC would ____ futures to hedge a foreign payable position. Also, currency futures can be used for speculation. For example, a speculator expecting a currency to appreciate would ____ futures. a. buy; buy b. sell; sell c. buy; sell d. sell; buy ANS: A

PTS: 1

157. Which of the following is not true regarding options? a. Options are traded on exchanges, never over-the-counter. b. Similar to futures contracts, margin requirements are normally imposed on option traders. c. Although commissions for options are fixed per transaction, multiple contracts may be involved in a transaction, thus lowering the commission per contract. d. Currency options can be classified as either put or call options. e. All of the above are true.

ANS: A

PTS: 1

158. When the existing spot rate exceeds the exercise price, a call option is ____, and a put option is ____. a. out of the money; in the money b. out of the money; out of the money c. in the money; in the money d. in the money; out of the money ANS: D

PTS: 1

159. When a currency call option is classified as "in the money," this indicates that a. the spot rate of the currency is less than the exercise price of the option. b. the spot rate of the currency is greater than the exercise price of the option. c. the buyer of the option would generate a profit; that is, the spot rate would exceed the sum of the exercise price and the premium paid. d. the buyer of the option would generate a profit; that is, the exercise price would exceed the sum of the spot rate and the premium paid.

ANS: B

PTS: 1

160. A U.S. corporation has purchased currency call options to hedge a 70,000 pound (£) payable. The premium is $0.02 and the exercise price of the option is $0.50. If the spot rate at the time of maturity is $0.65, what is the total amount paid by the corporation if it acts rationally? a. $33,600 b. $46,900 c. $44,100 © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

d. $36,400 ANS: D

PTS: 1

161. Andrea is an option speculator. She anticipates the Canadian dollar to depreciate from its current level of $0.90 to $0.85. Currently, Canadian dollar call options are available with an exercise price of $0.91 and a premium of $0.02. Also, Canadian dollar put options are available with an exercise price of $0.88 and a premium of $0.02. If the future spot rate of the Canadian dollar is $0.85, what is Andrea's profit or loss per unit? a. $0.03 b. $0.05 c. $0.01 d. $0.04 ANS: C

PTS: 1

162. Which of the following is not true regarding options? a. The buyer of a call option has the right to buy the currency at the strike price. b. The writer of a call option has the obligation to sell the currency to the buyer if the option if exercised. c. The buyer of a put option has the right to sell the currency at the strike price. d. The writer of a put option has the obligation to sell the currency to the buyer if the option is exercised.

ANS: D

PTS: 1

163. If the observed put option premium is less than what is suggested by the put-call parity equation, astute arbitrageurs could make a profit by ____ the put option, ____ the call option, and ____ the underlying currency. a. selling; buying; buying b. buying; selling; buying c. selling; buying; selling d. buying; buying; buying ANS: B

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Chapter 6—Government Influence on Exchange Rates 1. To force the value of the pound to appreciate against the dollar, the Federal Reserve should: a. sell dollars for pounds in the foreign exchange market and the European Central Bank (ECB) should sell dollars for pounds in the foreign exchange market. b. sell pounds for dollars in the foreign exchange market and the European Central Bank (ECB) should sell dollars for pounds in the foreign exchange market. c. sell pounds for dollars in the foreign exchange market and the European Central Bank (ECB) should not intervene. d. sell dollars for pounds in the foreign exchange market and the European Central Bank (ECB) should sell pounds for dollars in the foreign exchange market.

ANS: A

PTS: 1

2. A weak dollar is normally expected to cause: a. high unemployment and high inflation in the U.S. b. high unemployment and low inflation in the U.S. c. low unemployment and low inflation in the U.S. d. low unemployment and high inflation in the U.S. ANS: D

PTS: 1

3. A strong dollar is normally expected to cause: a. high unemployment and high inflation in the U.S. b. high unemployment and low inflation in the U.S. c. low unemployment and low inflation in the U.S. d. low unemployment and high inflation in the U.S. ANS: B

PTS: 1

4. To force the value of the British pound to depreciate against the dollar, the Federal Reserve should: a. sell dollars for pounds in the foreign exchange market and the Bank of England should sell dollars for pounds in the foreign exchange market. b. sell pounds for dollars in the foreign exchange market and the Bank of England should sell dollars for pounds in the foreign exchange market. c. sell pounds for dollars in the foreign exchange market and the Bank of England should sell pounds for dollars in the foreign exchange market. d. sell dollars for pounds in the foreign exchange market and the Bank of England should sell pounds for dollars in the foreign exchange market.

ANS: C

PTS: 1

5. Consider two countries that trade with each other, called X and Y. According to the text, inflation in Country X will have a greater impact on inflation in Country Y under the ____ system. Now, consider two other countries that trade with each other, called A and B. Unemployment in Country A will have a greater impact on unemployment in Country B under the ____ system. a. floating rate; fixed rate

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

b. floating rate; floating rate c. fixed rate; fixed rate d. fixed rate; floating rate ANS: C

PTS: 1

6. A primary result of the Bretton Woods Agreement was: a. the establishment of the European Monetary System (EMS). b. establishing specific rules for when tariffs and quotas could be imposed by governments. c. establishing that exchange rates of most major currencies were to be allowed to fluctuate 1% above or below their initially set values. d. establishing that exchange rates of most major currencies were to be allowed to fluctuate freely without boundaries (although the central banks did have the right to intervene when necessary).

ANS: C

PTS: 1

7. A primary result of the Smithsonian Agreement was: a. the establishment of the European Monetary System (EMS). b. establishing that exchange rates of most major countries were to be allowed to fluctuate 2.25% above or below their initially set values. c. establishing specific rules for when tariffs and quotas could be imposed by governments. d. establishing that exchange rates of most major currencies were to be allowed to fluctuate freely without boundaries (although the central banks did have the right to intervene when necessary).

ANS: B

PTS: 1

8. Under a fixed exchange rate system: a. a foreign exchange market does not exist. b. central bank intervention in the foreign exchange market is not necessary. c. central bank intervention in the foreign exchange market is often necessary. d. central bank intervention in the foreign exchange market is not allowed.

ANS: C

PTS: 1

9. Under a managed float exchange rate system, the Fed may attempt to stimulate the U.S. economy by ____ the dollar. Such an adjustment in the dollar's value should ____ the U.S. demand for products produced by major foreign countries. a. weakening; increase b. weakening; decrease c. strengthening; increase d. strengthening; decrease ANS: B

PTS: 1

10. The value of the Canadian dollar, Japanese yen, and Australian dollar with respect to the U.S. dollar are part of a: a. pegged system. b. fixed system. © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

c. managed float system. d. crawling peg system.

ANS: C

PTS: 1

11. The interest rate of a country with a currency board: a. is less stable than it would be without a currency board. b. is typically below the interest rate of the currency to which it is tied. c. will move in tandem with the interest rate of the currency to which it is tied. d. is completely independent of the interest rate of the currency to which it is tied.

ANS: C

PTS: 1

12. The currency of Country X is pegged to the currency of Country Y. Assume that Country Y's currency depreciates against the currency of Country Z. It is likely that Country X will export ____ to Country Z and import ____ from Country Z. a. more; more b. less; less c. more; less d. less; more ANS: C

PTS: 1

13. Assume Countries A, B, and C produce goods that are substitutes of each other and that these countries engage in trade with each other. Assume that Country A's currency floats against Country B's currency, and that Country C's currency is pegged to B's. If A's currency depreciates against B, then A's exports to C should ____, and A's imports from C should ____. a. decrease; increase b. decrease; decrease c. increase; decrease d. increase; increase ANS: C

PTS: 1

14. Assume a central bank exchanges its currency for other foreign currencies in the foreign exchange market, but does not adjust for the resulting change in the money supply. This is an example of: a. pegged intervention. b. indirect intervention. c. nonsterilized intervention. d. sterilized intervention. e. A and D ANS: C

PTS: 1

15. If the Fed desires to weaken the dollar without affecting the dollar money supply, it should: a. exchange dollars for foreign currencies, and sell some of its existing Treasury security holdings for dollars. b. exchange foreign currencies for dollars, and sell some of its existing Treasury security holdings for dollars. c. exchange dollars for foreign currencies, and buy existing Treasury securities with dollars. d. exchange foreign currencies for dollars, and buy existing Treasury securities with dollars.

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

ANS: A

PTS: 1

16. Which of the following is an example of direct intervention in foreign exchange markets? a. lowering interest rates. b. increasing the inflation rate. c. exchanging dollars for foreign currency. d. imposing barriers on international trade.

ANS: C

PTS: 1

17. A strong dollar places ____ pressure on inflation, which in turn places ____ pressure on the dollar. a. upward; upward b. downward; upward c. upward; downward d. downward; downward ANS: B

PTS: 1

18. The Fed may use a stimulative monetary policy with least concern about causing inflation if the dollar's value is expected to: a. remain stable. b. strengthen. c. weaken. d. none of the above will have an impact on inflation.

ANS: B

PTS: 1

19. A weaker dollar places ____ pressure on U.S. inflation, which in turn places ____ pressure on U.S. interest rates, which places ____ pressure on U.S. bond prices. a. upward; downward; upward b. upward; downward; downward c. upward; upward; downward d. downward; upward; upward e. downward; downward; upward ANS: C

PTS: 1

20. The euro is the currency: a. adopted in all western European countries as of 1999. b. adopted in all eastern European countries as of 1999. c. adopted in all European countries as of 1999. d. none of the above ANS: D

PTS: 1

21. The euro has not been adopted by: a. Slovenia. b. the U.K. c. Germany. d. France.

ANS: B

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

22. The exchange rate mechanism (ERM) refers to the method of linking ____ currencies to each other within boundaries. a. Latin American b. European c. Asian d. North American ANS: B

PTS: 1

23. Countries that have adopted the euro must agree on a single ____ policy. a. monetary b. fiscal c. worker compensation d. foreign relations ANS: A

PTS: 1

24. Countries that have adopted the euro tend to have very similar ____. a. interest rates b. inflation rates c. income tax rates d. budget deficits ANS: A

PTS: 1

25. The risk-free interest rates among countries that have adopted the euro should: a. not necessarily be similar to risk-free rates in other countries. b. equal the U.S. risk-free rate. c. equal the risk-free rates in other European countries. d. equal the risk-free rates in Asian countries.

ANS: A

PTS: 1

26. Which of the following is true regarding the euro? a. Exchange rate risk between participating European currencies is completely eliminated, encouraging more trade and capital flows across European borders. b. It allows for more consistent economic conditions across countries. c. It prevents each country from conducting its own monetary policy. d. All of the above are true.

ANS: D

PTS: 1

27. It has been argued that the exchange rate can be used as a policy tool. Assume that the U.S. government would like to reduce unemployment. Which of the following is an appropriate action given this scenario? a. Weaken the dollar b. Strengthen the dollar c. Buy dollars with foreign currency in the foreign exchange market d. Implement a tight monetary policy ANS: A

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

28. It has been argued that the exchange rate can be used as a policy tool. Assume that the U.S. government would like to reduce inflation. Which of the following is an appropriate action given this scenario? a. Sell dollars for foreign currency b. Buy dollars with foreign currency c. Lower interest rates d. None of the above ANS: B

PTS: 1

29. To strengthen the dollar using sterilized intervention, the Fed would ____ dollars and simultaneously ____ Treasury securities. a. buy; sell b. sell; buy c. buy; buy d. sell; sell ANS: C

PTS: 1

30. As foreign exchange activity has grown, a given degree of central bank intervention has become: a. more effective. b. more frequent. c. less effective. d. none of the above ANS: C

PTS: 1

31. When using indirect intervention, a central bank is likely to focus on: a. inflation. b. interest rates. c. income levels. d. expectations of future exchange rates.

ANS: B

PTS: 1

32. Which of the following countries was probably the least affected (directly or indirectly) by the Asian crisis? a. Thailand. b. Indonesia. c. Russia. d. China. e. Malaysia.

ANS: D

PTS: 1

33. Which of the following is not true regarding Thailand? a. Thailand was one of the slowest growing countries before the Asian crisis. b. High levels of spending and low levels of saving placed upward pressure on prices of real estate, products, and on Thailand's local interest rate.

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

c. Thailand's baht was linked to the dollar prior to July 1997, which made Thailand an attractive site for foreign investors. d. Thai banks provided many loans that were very risky in their attempt to make use of all of their funds. e. All of the above are true.

ANS: A

PTS: 1

34. China's yuan is presently: a. allowed to fluctuate freely without any central bank intervention. b. allowed to fluctuate but with central bank intervention. c. pegged to the dollar. d. pegged to the euro.

ANS: B

PTS: 1

35. During the period 1944-1971, the U.S. used a ____ system. a. euro exchange rate b. fixed c. dirty float d. flexible ANS: B

PTS: 1

36. Which of the following are examples of currency controls? a. import restrictions. b. prohibition of remittance of funds. c. ceilings on granting credit to foreign firms. d. all of the above ANS: D

PTS: 1

37. From a financial management perspective, which of the following is true regarding the introduction of the Euro? a. U.S.-based MNCs are not subject to exchange rate risk when they have transactions in euros. b. The euro is pegged to all other European currencies. c. Transactions costs decline for MNCs that conduct transactions within Europe. d. The euro replaced the British pound.

ANS: C

PTS: 1

38. Which of the following countries have not adopted the euro? a. Germany b. Italy c. Switzerland d. France ANS: C

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

39. Which of the following are true about the Southeast Asian currency crisis? a. It was preceded by several years of large capital inflows to Asia. b. It was preceded by a five-year recession in Asia. c. Asian interest rates declined during the crisis. d. Asian exchange rates were pegged to the Japanese yen to resolve the crisis.

ANS: A

PTS: 1

40. Under a fixed exchange rate system, U.S. inflation would have a greater impact on inflation in other countries than it would under a freely floating exchange rate system. a. True b. False ANS: T

PTS: 1

41. An advantage of a fixed exchange rate system is that governments are not required to constantly intervene in the foreign exchange market to maintain exchange rates within specified boundaries. a. True b. False ANS: F

PTS: 1

42. Under the system known as the "dirty" float, official boundaries for the exchange rate exist, but they are wider than they are under a fixed exchange rate system. a. True b. False ANS: F

PTS: 1

43. Under a pegged exchange rate system, the home currency's value is pegged to a foreign currency. a. True b. False ANS: T

PTS: 1

44. A major advantage of the euro is the complete elimination of exchange rate risk on transactions between participating European countries, which encourages more trade and capital flows within Europe. a. True b. False ANS: T

PTS: 1

45. The European countries conforming to the euro are completely insulated from movements in the euro's value with respect to other currencies. a. True b. False ANS: F

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

46. The establishment of the euro allows for more consistent economic conditions across countries but eliminates the power of any individual European country to solve local economic problems with its own unique monetary policy. a. True b. False ANS: T

PTS: 1

47. The Asian crisis is generally believed to have started in Japan. a. True b. False ANS: F

PTS: 1

48. A possible reason why China was less affected by the Asian crisis is that its government exerts more influence on private enterprise than the governments of other Asian countries. a. True b. False ANS: T

PTS: 1

49. Currency devaluation can boost a country's exports, but currency revaluation can increase foreign competition. a. True b. False ANS: T

PTS: 1

50. Market forces are the determinant of exchange rates in a freely floating exchange rate system. a. True b. False ANS: T

PTS: 1

51. If a government wishes to stimulate its economy in the form of increased foreign demand for its country's products, it could attempt to weaken its currency. a. True b. False ANS: T

PTS: 1

52. In a sterilized exchange rate arrangement, a country's home currency value is pegged to a foreign currency or to some unit of account. a. True b. False ANS: F

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

53. The Bank of England is responsible for setting the monetary policy for the European countries participating in the euro. a. True b. False ANS: F

PTS: 1

54. The Fed's indirect method of intervention is to trade dollars for or against other currencies. a. True b. False ANS: F

PTS: 1

55. China is commonly criticized for keeping the yuan's value at superficially high levels. a. True b. False ANS: F

PTS: 1

56. The Bretton Woods Agreement created a system under which exchange rates are determined by market forces without intervention by various governments. a. True b. False ANS: F

PTS: 1

57. Nonsterilized intervention is intervention by a central bank in the foreign exchange market without adjusting for the change in money supply. a. True b. False ANS: T

PTS: 1

58. The euro is pegged to other currencies of European countries that have not adopted the euro. a. True b. False ANS: T

PTS: 1

59. The Smithsonian Agreement was an agreement to allow currencies of major countries to float without any barriers. a. True b. False ANS: F

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

60. An example of indirect intervention by the Bank of Japan would be for the Bank of Japan to use interest rates to increase the value of the yen vs. the dollar. a. True b. False ANS: T

PTS: 1

61. A strong home currency can harm exports; exporters typically benefit from a weaker home country currency. a. True b. False ANS: T

PTS: 1

62. An advantage of freely floating exchange rates is that a country with floating exchange rates is more insulated from unemployment problems in other countries. a. True b. False ANS: T

PTS: 1

63. All European countries now use the euro as their currency. a. True b. False ANS: F

PTS: 1

64. A country with a currency board does not have control over its local interest rates. a. True b. False ANS: T

PTS: 1

65. Dollarization refers to the replacement of local currency with U.S. dollars. a. True b. False ANS: T

PTS: 1

66. A country with fixed exchange rates often faces constraints on growth. a. True b. False ANS: T

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

67. The Bretton Woods Agreement called for the establishment of a single European currency. a. True b. False ANS: F

PTS: 1

68. The European Central Bank is responsible for monetary policy in all countries that adopted the euro as its currency. a. True b. False ANS: T

PTS: 1

69. A currency peg is insulated from economic or political conditions, such that the exchange rate in the market will only change if the country's government breaks the peg and sets a new exchange rate. a. True b. False ANS: F

PTS: 1

70. If foreign investors fear that a peg may be broken because of fund outflows from that country, they may attempt to purchase more of that currency before the peg is broken. a. True b. False ANS: F

PTS: 1

71. Normally, when a pegged exchange rate is broken because of a crisis in that country, there is downward pressure on the local currency of that country. a. True b. False ANS: T

PTS: 1

72. Which one of the following is a disadvantage of a fixed exchange rate system: a. Importers are insulated from the risk that the currency will appreciate over time. b. Management of an MNC is less difficult. c. The government might change the value of the currency. d. Exporters are insulated from the risk that the currency will depreciate over time.

ANS: C

PTS: 1

73. The Smithsonian Agreement called for a devaluation of the U.S. dollar by about ____ percent. a. 2.25 b. 6 c. 10 d. 8 ANS: D

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

74. Which of the following did not occur as a result of Bretton Woods Agreement? a. Each currency was valued in terms of gold. b. Values of all currencies were fixed with respect to each other. c. Currencies were allowed to fluctuate no more than 1% above or below the initially set rates. d. The United States experienced no balance-of-trade deficits.

ANS: D

PTS: 1

75. Assume that Japan and the United States frequently trade with each other. Under the freely floating exchange rate system, high inflation in the U.S. will place ____ pressure on Japanese yen, ____ the amount of Japanese yen available for sale, and result in ____ inflation in Japan. a. upward; reduce; unchanged b. upward; increase; higher c. downward; reduce; unchanged d. downward; increase; higher ANS: A

PTS: 1

76. Which one is not a disadvantage of a freely floating exchange rate system? a. It can adversely affect a country that has high unemployment. b. It can adversely affect a country that has high inflation. c. The government may intervene to change the value of a given currency. d. The exchange rate risk is high and may be costly to manage.

ANS: C

PTS: 1

77. A "dirty" float represents a system of: a. freely floating exchange rates. b. fixed exchange rates. c. floating exchange rates, but the central bank can manipulate the currency. d. fixed exchange rates, but the central bank can manipulate the currency.

ANS: C

PTS: 1

78. If a U.S. firm plans to frequently purchases goods from Hong Kong over the next several years, it does not have to worry about exchange rate risk. a. True b. False ANS: F

PTS: 1

79. If the French government wants to decrease inflation in France, it will exchange foreign currency for euros. a. True b. False ANS: F

PTS: 1

80. The European Central Bank is located in: a. London. b. Denmark. © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

c. Luxembourg. d. Frankfurt.

ANS: D

PTS: 1

81. Which of the following is not true regarding the eurozone? a. Members cannot set unique monetary policy individually. b. Members cannot apply their own fiscal policies. c. Members have to agree on the ideal monetary policy. d. Its creation allowed for greater political union among its members.

ANS: B

PTS: 1

82. Assuming no credit risk, the interest rates among countries in the eurozone should be similar. a. True b. False ANS: T

PTS: 1

83. Which of the following is not a reason for devaluation of a currency? a. high inflation. b. to reduce balance-of-trade deficit. c. to decrease the amount of imports. d. high unemployment.

ANS: A

PTS: 1

84. Which of the following is the most likely reason for revaluation of a currency? a. To reduce inflation. b. To stimulate the local economy. c. To increase the amount of exports. d. To increase balance-of-trade surplus.

ANS: A

PTS: 1

85. To weaken the dollar using sterilized intervention, the Fed will ____ U.S. dollars and simultaneously ____ Treasury securities. a. buy; sell b. sell; sell c. sell; buy d. buy; sell ANS: B

PTS: 1

86. The monetary policy implemented by the European Central Bank always results in favorable effects on all countries in the eurozone. a. True b. False ANS: F

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

87. If the Fed desires to strengthen the dollar without affecting the dollar money supply, it should: a. exchange dollars for foreign currencies, and sell some of its existing Treasury security holdings for dollars. b. exchange foreign currencies for dollars, and sell some of its existing Treasury security holdings for dollars. c. exchange dollars for foreign currencies, and buy existing Treasury securities with dollars. d. exchange foreign currencies for dollars, and buy existing Treasury securities with dollars.

ANS: D

PTS: 1

88. Assume that the Fed intervenes by exchanging dollars for euros in the foreign exchange market. This will cause an ____ U.S. dollars and an ____ euros. a. inward shift in demand for; outward shift in supply of b. inward shift in demand for; inward shift in supply of c. outward shift in supply of; outward shift in demand for d. outward shift in supply of; inward shift in demand for ANS: C

PTS: 1

89. If the Fed ____ the interest rates when inflationary expectations remain unchanged, the most likely result is that the value of dollar will ____ and the economy may ____. a. increases; appreciate; weaken b. decreases; appreciate; weaken c. increases; depreciate; strengthen d. decreases; appreciate; strengthen ANS: A

PTS: 1

90. A central bank may attempt to stimulate a stagnant economy by weakening the value of the currency. a. True b. False ANS: T

PTS: 1

91. A common way to reduce inflation is to weaken the value of the domestic currency. a. True b. False ANS: F

PTS: 1

92. If a speculator expects that the Fed will intervene by exchanging dollars for Japanese yen, she would most likely ____ to capitalize on this intervention. a. purchase yen put options b. sell yen futures contracts c. purchase yen call options d. buy U.S. Treasury bonds ANS: C

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

93. If a speculator expects that the Fed will intervene by exchanging euros for U.S. dollars, she would most likely ____ to capitalize on this intervention. a. purchase euro put options b. purchase euro futures contracts c. purchase yen call options d. sell U.S. Treasury bonds ANS: A

PTS: 1

94. If the Fed decides to weaken the dollar utilizing unsterilized intervention, it should be aware that this action may backfire because it will increase money supply and thus increase inflation. a. True b. False ANS: T

PTS: 1

95. A strong dollar places ____ pressure on U.S. inflation, which in turn places ____ pressure on U.S. interest rates, which in turn place ____ pressure on U.S. bond prices. a. downward; upward; upward b. downward; downward; upward c. upward; upward; downward d. upward; downward; upward ANS: B

PTS: 1

96. The currency of Country X is pegged to the currency of Country Y. Assume that Country Y's currency appreciates against the currency of Country Z. It is likely that Country X will export ____ to Country Z and import ____ from Country Z. a. more; more b. more; less c. less; less d. less; more ANS: D

PTS: 1

97. If the Bank of England announces that it will start to frequently intervene in order to reduce the fluctuations of British pound, the premiums on call and put options will increase. a. True b. False ANS: F

PTS: 1

98. One of the best-known pegged exchange rate arrangements that was established by several European countries in April 1972 and was difficult to maintain is called the: a. European Monetary System (EMS). b. snake agreement. c. Maastricht Treaty. d. European Union.

ANS: B

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

99. Direct intervention is usually more effective than indirect intervention. a. True b. False ANS: F

PTS: 1

100. Currency devaluations have the potential to reduce unemployment, while currency revaluations have the potential to reduce inflation. a. True b. False ANS: T

PTS: 1

101. Under a fixed exchange rate system, U.S. inflation would have a greater impact on inflation in other countries than it would under a freely floating exchange rate system. a. True b. False ANS: T

PTS: 1

102. An advantage of a fixed exchange rate system is that governments are not required to constantly intervene in the foreign exchange market to maintain exchange rates within specified boundaries. a. True b. False ANS: F

PTS: 1

103. In a freely floating exchange rate system, high U.S. inflation rate may be magnified. This is because the depreciation of the dollar would result in more expensive foreign imports, thus reducing foreign competition. a. True b. False ANS: T

PTS: 1

104. Under the system known as the "dirty" float, official boundaries for the exchange rate exist, but they are wider than they are under a fixed exchange rate system. a. True b. False ANS: F

PTS: 1

105. In order to stimulate a stagnant economy, a government operating under a managed float may attempt to weaken its currency. a. True b. False ANS: T

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

106. Assume the Fed desires to strengthen the dollar. If it buys dollars and simultaneously buys Treasury securities, this is an example of sterilized intervention. a. True b. False ANS: T

PTS: 1

107. Using indirect intervention, the Fed attempts to affect the dollar's value indirectly by influencing the factors that determine it, such as interest rates. a. True b. False ANS: T

PTS: 1

108. While a weak currency can reduce unemployment at home, it can also lead to higher inflation, as local companies are better able to raise prices. a. True b. False ANS: T

PTS: 1

109. While a strong currency is a possible cure for high inflation, it may cause higher unemployment due to the attractive foreign prices that result from a strong home currency. a. True b. False ANS: T

PTS: 1

110. Countries usually do not have difficulty maintaining a pegged exchange rate, even when they are experiencing major political or economic problems. a. True b. False ANS: F

PTS: 1

111. Which of the following is not true regarding the Mexican peso crisis? a. Mexico encouraged firms and consumers to buy an excessive amount of imports because the peso was stronger than it should have been. b. Many speculators based in the U.S. speculated on the potential decline in the peso by investing their funds in Mexico. c. In December of 1994, the central bank of Mexico allowed the peso to float freely. d. The central bank of Mexico increased interest rates after the peso declined in value in order to prevent investors from withdrawing their investments in Mexico's debt securities. e. All of the above are true.

ANS: B

PTS: 1

112. Which of the following is true regarding the euro? a. Exchange rate risk between participating European currencies is completely eliminated, encouraging more trade and capital flows across European borders. b. It allows for more consistent economic conditions across countries. © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

c. It prevents each country from conducting its own monetary policy. d. All of the above are true.

ANS: D

PTS: 1

113. Among the reasons for government intervention are: a. to smooth exchange rate movement. b. to establish implicit exchange rate boundaries. c. to respond to temporary disturbances. d. all of the above ANS: D

PTS: 1

114. Which of the following is not true regarding government intervention? a. Under the direct method of intervention, an appreciation of the dollar would be accomplished by exchanging dollars for foreign currencies. b. Under nonsterilized intervention, the Fed would intervene in the foreign exchange market without adjusting the money supply. c. Under sterilized intervention, the Fed would intervene simultaneously in the foreign exchange and Treasury markets. d. Under indirect intervention, the Fed would attempt to affect the dollar's value by indirectly influencing the factors that determine it, such as interest rates. e. All of the above are true.

ANS: A

PTS: 1

115. Assume that the dollar has been consistently depreciating over a long period. The Fed decides to counteract this movement by intervening in the foreign exchange market using sterilized intervention.

The Fed would a. buy dollars with foreign currency and simultaneously sell Treasury securities for dollars. b. buy dollars with foreign currency and simultaneously buy Treasury securities with dollars. c. sell dollars for foreign currency and simultaneously sell Treasury securities for dollars. d. sell dollars for foreign currency and simultaneously buy Treasury securities with dollars. e. none of the above ANS: B

PTS: 1

116. Assume that the dollar has been consistently appreciating over a long period. The Fed decides to counteract this movement by intervening in the foreign exchange market using nonsterilized intervention. The Fed would a. buy dollars with foreign currency and simultaneously sell Treasury securities for dollars. b. buy dollars with foreign currency and simultaneously buy Treasury securities with dollars. c. sell dollars for foreign currency and simultaneously sell Treasury securities for dollars. d. sell dollars for foreign currency and simultaneously buy Treasury securities with dollars. e. none of the above ANS: E

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

117. Which of the following is an appropriate form of indirect intervention? a. To strengthen the dollar, the Fed increases the money supply to lower interest rates. b. To weaken the dollar, the Fed reduces the money supply to increase interest rates. c. To strengthen the dollar in the long run, the Fed attempts to reduce U.S. inflation. d. To weaken the dollar in the long run, the Fed attempts to reduce U.S. inflation.

ANS: C

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Chapter 7—International Arbitrage and Interest Rate Parity 1. Due to ____, market forces should realign the relationship between the interest rate differential of two currencies and the forward premium (or discount) on the forward exchange rate between the two currencies. a. forward realignment arbitrage b. triangular arbitrage c. covered interest arbitrage d. locational arbitrage ANS: C

PTS: 1

2. Due to ____, market forces should realign the spot rate of a currency among banks. a. forward realignment arbitrage b. triangular arbitrage c. covered interest arbitrage d. locational arbitrage ANS: D

PTS: 1

3. Due to ____, market forces should realign the cross exchange rate between two foreign currencies based on the spot exchange rates of the two currencies against the U.S. dollar. a. forward realignment arbitrage b. triangular arbitrage c. covered interest arbitrage d. locational arbitrage ANS: B

PTS: 1

4. If interest rate parity exists, then ____ is not feasible. a. forward realignment arbitrage b. triangular arbitrage c. covered interest arbitrage d. locational arbitrage ANS: C

PTS: 1

5. In which case will locational arbitrage most likely be feasible? a. One bank's ask price for a currency is greater than another bank's bid price for the currency. b. One bank's bid price for a currency is greater than another bank's ask price for the currency. c. One bank's ask price for a currency is less than another bank's ask price for the currency. d. One bank's bid price for a currency is less than another bank's bid price for the currency.

ANS: B

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

6. When using ____, funds are not tied up for any length of time. a. covered interest arbitrage b. locational arbitrage c. triangular arbitrage d. B and C ANS: D

PTS: 1

7. When using ____, funds are typically tied up for a significant period of time. a. covered interest arbitrage b. locational arbitrage c. triangular arbitrage d. B and C ANS: A

PTS: 1

8. Assume that the interest rate in the home country of Currency X is a much higher interest rate than the U.S. interest rate. According to interest rate parity, the forward rate of Currency X: a. should exhibit a discount. b. should exhibit a premium. c. should be zero (i.e., it should equal its spot rate). d. B or C ANS: A

PTS: 1

9. If the interest rate is higher in the U.S. than in the United Kingdom, and if the forward rate of the British pound (in U.S. dollars) is the same as the pound's spot rate, then: a. U.S. investors could possibly benefit from covered interest arbitrage. b. British investors could possibly benefit from covered interest arbitrage. c. neither U.S. nor British investors could benefit from covered interest arbitrage. d. A and B ANS: B

PTS: 1

10. If the interest rate is lower in the U.S. than in the United Kingdom, and if the forward rate of the British pound is the same as its spot rate: a. U.S. investors could possibly benefit from covered interest arbitrage. b. British investors could possibly benefit from covered interest arbitrage. c. neither U.S. nor British investors could benefit from covered interest arbitrage. d. A and B ANS: A

PTS: 1

11. Assume that the U.S. investors are benefiting from covered interest arbitrage due to high interest rates on euros. Which of the following forces should result from the act of this covered interest arbitrage? a. downward pressure on the euro's spot rate. b. downward pressure on the euro's forward rate. c. downward pressure on the U.S. interest rate. d. upward pressure on the euro's interest rate.

ANS: B

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

12. Assume that Swiss investors are benefiting from covered interest arbitrage due to a high U.S. interest rate. Which of the following forces results from the act of this covered interest arbitrage? a. upward pressure on the Swiss franc's spot rate. b. upward pressure on the U.S. interest rate. c. downward pressure on the Swiss interest rate. d. upward pressure on the Swiss franc's forward rate.

ANS: D

PTS: 1

13. Assume that a U.S. firm can invest funds for one year in the U.S. at 12% or invest funds in Mexico at 14%. The spot rate of the peso is $.10 while the one-year forward rate of the peso is $.10. If U.S. firms attempt to use covered interest arbitrage, what forces should occur? a. spot rate of peso increases; forward rate of peso decreases. b. spot rate of peso decreases; forward rate of peso increases. c. spot rate of peso decreases; forward rate of peso decreases. d. spot rate of peso increases; forward rate of peso increases.

ANS: A

PTS: 1

14. Assume the bid rate of a New Zealand dollar is $.33 while the ask rate is $.335 at Bank X. Assume the bid rate of the New Zealand dollar is $.32 while the ask rate is $.325 at Bank Y. Given this information, what would be your gain if you use $1,000,000 and execute locational arbitrage? That is, how much will you end up with over and above the $1,000,000 you started with? a. $15,385. b. $15,625. c. $22,136. d. $31,250.

ANS: A SOLUTION:

$1,000,000/$.325 = NZ$3,076,923  $.33 = $1,015,385. Thus, the profit is $15,385.

PTS: 1 15. Based on interest rate parity, the larger the degree by which the foreign interest rate exceeds the U.S. interest rate, the: a. larger will be the forward discount of the foreign currency. b. larger will be the forward premium of the foreign currency. c. smaller will be the forward premium of the foreign currency. d. smaller will be the forward discount of the foreign currency.

ANS: A

PTS: 1

16. Assume the following information: You have $1,000,000 to invest: Current spot rate of pound 90-day forward rate of pound 3-month deposit rate in U.S. 3-month deposit rate in Great Britain

= = = =

$1.30 $1.28 3% 4%

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

If you use covered interest arbitrage for a 90-day investment, what will be the amount of U.S. dollars you will have after 90 days? a. $1,024,000. b. $1,030,000. c. $1,040,000. d. $1,034,000. e. none of the above ANS: A SOLUTION:

$1,000,000/$1.30 = 769,231 pounds  (1.04) = 800,000 pounds  1.28 = $1,024,000

PTS: 1 17. Assume that the U.S. interest rate is 10%, while the British interest rate is 15%. If interest rate parity exists, then: a. British investors who invest in the United Kingdom will achieve the same return as U.S. investors who invest in the U.S. b. U.S. investors will earn a higher rate of return when using covered interest arbitrage than what they would earn in the U.S. c. U.S. investors will earn 15% whether they use covered interest arbitrage or invest in the U.S. d. U.S. investors will earn 10% whether they use covered interest arbitrage or invest in the U.S. ANS: D

PTS: 1

18. Assume the following information: U.S. investors have $1,000,000 to invest: 1-year deposit rate offered on U.S. dollars 1-year deposit rate offered on Singapore dollars 1-year forward rate of Singapore dollars Spot rate of Singapore dollar

= = = =

12% 10% $.412 $.400

Given this information: a. interest rate parity exists and covered interest arbitrage by U.S. investors results in the same yield as investing domestically. b. interest rate parity doesn't exist and covered interest arbitrage by U.S. investors results in a yield above what is possible domestically. c. interest rate parity exists and covered interest arbitrage by U.S. investors results in a yield above what is possible domestically. d. interest rate parity doesn't exist and covered interest arbitrage by U.S. investors results in a yield below what is possible domestically.

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

ANS: B SOLUTION:

= S$2,500,000  (1.1) = S$2,750,000  $.412 = $1,133,000 Yield = ($1,133,000  $1,000,000)/$1,000,000 = 13.3% This yield exceeds what is possible domestically. $1,000,000/$.400

PTS: 1 19. Assume the following information: Current spot rate of New Zealand dollar Forecasted spot rate of New Zealand dollar 1 year from now One-year forward rate of the New Zealand dollar Annual interest rate on New Zealand dollars Annual interest rate on U.S. dollars

= = = = =

$.41 $.43 $.42 8% 9%

Given the information in this question, the return from covered interest arbitrage by U.S. investors with $500,000 to invest is ____%. a. about 11.97 b. about 9.63 c. about 11.12 d. about 11.64 e. about 10.63 ANS: E SOLUTION:

= NZ$1,219,512  (1.08) = NZ$1,317,073  .42 = $553,171 Yield = ($553,171  $500,000)/$500,000 = 10.63% $500,000/$.41

PTS: 1 20. Assume the following bid and ask rates of the pound for two banks as shown below:

Bank A Bank B

Bid $1.41 $1.39

Ask $1.42 $1.40

As locational arbitrage occurs: a. the bid rate for pounds at Bank A will increase; the ask rate for pounds at Bank B will increase. b. the bid rate for pounds at Bank A will increase; the ask rate for pounds at Bank B will decrease. c. the bid rate for pounds at Bank A will decrease; the ask rate for pounds at Bank B will decrease. d. the bid rate for pounds at Bank A will decrease; the ask rate for pounds at Bank B will increase.

ANS: D

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

21. Assume the bid rate of a Singapore dollar is $.40 while the ask rate is $.41 at Bank X. Assume the bid rate of a Singapore dollar is $.42 while the ask rate is $.425 at Bank Z. Given this information, what would be your gain if you use $1,000,000 and execute locational arbitrage? That is, how much will you end up with over and above the $1,000,000 you started with? a. $11,764. b. $11,964. c. $36,585. d. $24,390. e. $18,219.

ANS: D SOLUTION:

$1,000,000/$.41 = S2,439,024  $.42 = $1,024,390

PTS: 1 22. Based on interest rate parity, the larger the degree by which the U.S. interest rate exceeds the foreign interest rate, the: a. larger will be the forward discount of the foreign currency. b. larger will be the forward premium of the foreign currency. c. smaller will be the forward premium of the foreign currency. d. smaller will be the forward discount of the foreign currency.

ANS: B

PTS: 1

23. Assume the following exchange rates: $1 = NZ$3, NZ$1 = MXP2, and $1 = MXP5. Given this information, as you and others perform triangular arbitrage, the exchange rate of the New Zealand dollar (NZ) with respect to the U.S. dollar should ____, and the exchange rate of the Mexican peso (MXP) with respect to the U.S. dollar should ____. a. appreciate; depreciate b. depreciate; appreciate c. depreciate; depreciate d. appreciate; appreciate e. remain stable; appreciate ANS: A

PTS: 1

24. Assume the following information: Spot rate today of Swiss franc 1-year forward rate as of today for Swiss franc Expected spot rate 1 year from now Rate on 1-year deposits denominated in Swiss francs Rate on 1-year deposits denominated in U.S. dollars

= = = = =

$.60 $.63 $.64 7% 9%

From the perspective of U.S. investors with $1,000,000, covered interest arbitrage would yield a rate of return of ____%. a. 5.00 b. 12.35 c. 15.50 d. 14.13 e. 11.22 © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

ANS: B SOLUTION:

= SF1,666,667  (1.07) = SF1,783,333  $.63 = $1,123,500 Yield = ($1,123,500  $1,000,000)/$1,000,000 = 12.35% $1,000,000/$.60

PTS: 1 25. Assume the following information for a bank quoting on spot exchange rates: Exchange rate of Singapore dollar in U.S. $ Exchange rate of pound in U.S. $ Exchange rate of pound in Singapore dollars

= = =

$.32 $1.50 S$4.50

Based on the information given, as you and others perform triangular arbitrage, what should logically happen to the spot exchange rates? a. The Singapore dollar value in U.S. dollars should appreciate, the pound value in U.S. dollars should appreciate, and the pound value in Singapore dollars should depreciate. b. The Singapore dollar value in U.S. dollars should depreciate, the pound value in U.S. dollars should appreciate, and the pound value in Singapore dollars should depreciate. c. The Singapore dollar value in U.S. dollars should depreciate, the pound value in U.S. dollars should appreciate, and the pound value in Singapore dollars should appreciate. d. The Singapore dollar value in U.S. dollars should appreciate, the pound value in U.S. dollars should depreciate, and the pound value in Singapore dollars should appreciate.

ANS: D

PTS: 1

26. Assume the British pound is worth $1.60, and the Canadian dollar is worth $.80. What is the value of the Canadian dollar in pounds? a. 2.0. b. 2.40. c. .80. d. .50. e. none of the above ANS: D SOLUTION:

$.80/$1.60 = 0.50

PTS: 1 27. Assume that the euro's interest rates are higher than U.S. interest rates, and that interest rate parity exists. Which of the following is true? a. Americans using covered interest arbitrage earn the same rate of return as Germans who attempt covered interest arbitrage. b. Americans who invest in the U.S. earn the same rate of return as Germans who attempt covered interest arbitrage. c. Americans who invest in the U.S. earn the same rate of return as Germans who invest in Germany d. A and B e. None of the above ANS: E

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

28. Assume the U.S. interest rate is 2% higher than the Swiss rate, and the forward rate of the Swiss franc has a 4% premium. Given this information: a. Swiss investors who attempt covered interest arbitrage earn the same rate of return as if they invested in Switzerland. b. U.S. investors who attempt covered interest arbitrage earn a higher rate of return than if they invested in the U.S. c. A and B d. none of the above ANS: B

PTS: 1

29. Assume that British interest rates are higher than U.S. rates, and that the spot rate equals the forward rate. Covered interest arbitrage puts ____ pressure on the pound's spot rate, and ____ pressure on the pound's forward rate. a. downward; downward b. downward; upward c. upward; downward d. upward; upward ANS: C

PTS: 1

30. Assume that interest rate parity holds, and the euro's interest rate is 9% while the U.S. interest rate is 12%. Then the euro's interest rate increases to 11% while the U.S. interest rate remains the same. As a result of the increase in the interest rate on euros, the euro's forward ____ will ____ in order to maintain interest rate parity. a. discount; increase b. discount; decrease c. premium; increase d. premium; decrease ANS: D

PTS: 1

31. Assume the bid rate of a Swiss franc is $.57 while the ask rate is $.579 at Bank X. Assume the bid rate of the Swiss franc is $.560 while the ask rate is $.566 at Bank Y. Given this information, what would be your gain if you use $1,000,000 and execute locational arbitrage? That is, how much will you end up with over and above the $1,000,000 you started with? a. $7,067. b. $8,556. c. $10,114. d. $12,238.

ANS: A SOLUTION:

$1,000,000/$.566 = SF1,766,784  $.57 = $1,007,067. Thus, the profit is $7,067.

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

32. Assume the following information: You have $1,000,000 to invest: Current spot rate of pound 90-day forward rate of pound 3-month deposit rate in U.S. 3-month deposit rate in U.K.

= = = =

$1.60 $1.57 3% 4%

If you use covered interest arbitrage for a 90-day investment, what will be the amount of U.S. dollars you will have after 90 days? a. $1,020,500. b. $1,045,600. c. $1,073,330. d. $1,094,230. e. $1,116,250.

ANS: A SOLUTION:

$1,000,000/$1.60 = 625,000 pounds  (1.04) = 650,000 pounds  1.57 = $1,020,500

PTS: 1 33. Assume the following information: U.S. investors have $1,000,000 to invest: 1-year deposit rate offered by U.S. banks 1-year deposit rate offered on Swiss francs 1-year forward rate of Swiss francs Spot rate of Swiss franc

= = = =

12% 10% $.62 $.60

Given this information: a. interest rate parity exists and covered interest arbitrage by U.S. investors results in the same yield as investing domestically. b. interest rate parity doesn't exist and covered interest arbitrage by U.S. investors results in a yield above what is possible domestically. c. interest rate parity exists and covered interest arbitrage by U.S. investors results in a yield above what is possible domestically. d. interest rate parity doesn't exist and covered interest arbitrage by U.S. investors results in a yield below what is possible domestically.

ANS: B SOLUTION:

$1,000,000/$.60 = SF1,666,667  (1.1) = SF1,833,333  $.62 = $1,136,667 Yield = ($1,136,667  $1,000,000)/$1,000,000 = 13.7% This yield exceeds what is possible domestically.

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

34. Assume the following information: Current spot rate of Australian dollar Forecasted spot rate of Australian dollar 1 year from now 1-year forward rate of Australian dollar Annual interest rate for Australian dollar deposit Annual interest rate in the U.S.

= = = = =

$.64 $.59 $.62 9% 6%

Given the information in this question, the return from covered interest arbitrage by U.S. investors with $500,000 to invest is ____%. a. about 6.00 b. about 9.00 c. about 7.33 d. about 8.14 e. about 5.59 ANS: E SOLUTION:

= A$781,250  (1.09) = A$851,563  $.62 = $527,969 Yield = ($527,969  $500,000)/$500,000 = 5.59% $500,000/$.64

PTS: 1 35. Assume the following bid and ask rates of the pound for two banks as shown below:

Bank C Bank D

Bid $1.61 $1.58

Ask $1.63 $1.60

As locational arbitrage occurs: a. the bid rate for pounds at Bank C will increase; the ask rate for pounds at Bank D will increase. b. the bid rate for pounds at Bank C will increase; the ask rate for pounds at Bank D will decrease. c. the bid rate for pounds at Bank C will decrease; the ask rate for pounds at Bank D will decrease. d. the bid rate for pounds at Bank C will decrease; the ask rate for pounds at Bank D will increase.

ANS: D

PTS: 1

36. Assume the bid rate of an Australian dollar is $.60 while the ask rate is $.61 at Bank Q. Assume the bid rate of an Australian dollar is $.62 while the ask rate is $.625 at Bank V. Given this information, what would be your gain if you use $1,000,000 and execute locational arbitrage? That is, how much will you end up with over and above the $1,000,000 you started with? a. $10,003. b. $12,063. c. $14,441. d. $16,393. e. $18,219. © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

ANS: D SOLUTION:

$1,000,000/$.61 = A$1,639,344  $.62 = $1,016,393. Thus, the profit is $16,393.

PTS: 1 37. Assume the following information for a bank quoting on spot exchange rates: Exchange rate of Singapore dollar in U.S. $ Exchange rate of pound in U.S. $ Exchange rate of pound in Singapore dollars

= = =

$.60 $1.50 S$2.6

Based on the information given, as you and others perform triangular arbitrage, what should logically happen to the spot exchange rates? a. The Singapore dollar value in U.S. dollars should appreciate, the pound value in U.S. dollars should appreciate, and the pound value in Singapore dollars should depreciate. b. The Singapore dollar value in U.S. dollars should depreciate, the pound value in U.S. dollars should appreciate, and the pound value in Singapore dollars should depreciate. c. The Singapore dollar value in U.S. dollars should depreciate, the pound value in U.S. dollars should appreciate, and the pound value in Singapore dollars should appreciate. d. The Singapore dollar value in U.S. dollars should appreciate, the pound value in U.S. dollars should depreciate, and the pound value in Singapore dollars should appreciate.

ANS: B

PTS: 1

38. Bank A quotes a bid rate of $.300 and an ask rate of $.305 for the Malaysian ringgit (MYR). Bank B quotes a bid rate of $.306 and an ask rate of $.310 for the ringgit. What will be the profit for an investor who has $500,000 available to conduct locational arbitrage? a. $2,041,667. b. $9,804. c. $500. d. $1,639.

ANS: D SOLUTION:

$500,000/$.305 = MYR1,639,344  $.306 = $501,639. Thus, the profit is $1,639.

PTS: 1 39. Which of the following is an example of triangular arbitrage initiation? a. buying a currency at one bank's ask and selling at another bank's bid, which is higher than the former bank's ask. b. buying Singapore dollars from a bank (quoted at $.55) that has quoted the South African rand (SAR)/Singapore dollar (S$) exchange rate at SAR2.50 when the spot rate for the rand is $.20. c. buying Singapore dollars from a bank (quoted at $.55) that has quoted the South African rand/Singapore dollar exchange rate at SAR3.00 when the spot rate for the rand is $.20. d. converting funds to a foreign currency and investing the funds overseas.

ANS: C

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

40. You just received a gift from a friend consisting of 1,000 Thai baht, which you would like to exchange for Australian dollars (A$). You observe that exchange rate quotes for the baht are currently $.023, while quotes for the Australian dollar are $.576. How many Australian dollars should you expect to receive for your baht? a. A$39.93. b. A$25,043.48. c. A$553.00. d. none of the above ANS: A SOLUTION:

$.023/$.576  THB1,000 = A$39.93.

PTS: 1 41. National Bank quotes the following for the British pound and the New Zealand dollar:

Value of a British pound (£) in $ Value of a New Zealand dollar (NZ$) in $ Value of a British pound in New Zealand dollars

Quoted Bid Price $1.61 $.55

Quoted Ask Price $1.62 $.56

NZ$2.95

NZ$2.96

Assume you have $10,000 to conduct triangular arbitrage. What is your profit from implementing this strategy? a. $77.64. b. $197.53. c. $15.43. d. $111.80.

ANS: C SOLUTION:

= £6,172.84  2.95 = NZ$18,209.88  $.55 = $10,015.43.

Thus, the profit is $15.43. $10,000/$1.62

PTS: 1 42. Assume the following information: You have $900,000 to invest: Current spot rate of Australian dollar (A$) 180-day forward rate of the Australian dollar 180-day interest rate in the U.S. 180-day interest rate in Australia

= = = =

$.62 $.64 3.5% 3.0%

If you conduct covered interest arbitrage, what is the dollar profit you will have realized after 180 days? a. $56,903. b. $61,548. c. $27,000. d. $31,500. © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

ANS: A SOLUTION:

$900,000/$.62 = A$1,451,612  (1.03) = A$1,495,161  $.64 = $956,903.

Thus, the profit is $56,903.

PTS: 1 43. Assume the following information: You have $400,000 to invest: Current spot rate of Sudanese dinar (SDD) 90-day forward rate of the dinar 90-day interest rate in the U.S. 90-day interest rate in Sudan

= = = =

$.00570 $.00569 4.0% 4.2%

If you conduct covered interest arbitrage, what amount will you have after 90 days? a. $416,000.00. b. $416,800.00. c. $424,242.86. d. $416,068.77. e. none of the above ANS: D SOLUTION:

$400,000/$.0057

= SDD70,175,438.60  (1.042) = SDD73,122,807.02  $.00569 = $416,068.77

PTS: 1 Exhibit 7-1 Assume the following information: You have $300,000 to invest: The spot bid rate for the euro (€) is $1.08 The spot ask quote for the euro is $1.10 The 180-day forward rate (bid) of the euro is $1.08 The 180-day forward rate (ask) of the euro is $1.10 The 180-day interest rate in the U.S. is 6% The 180-day interest rate in Europe is 8% 44. Refer to Exhibit 7-1. If you conduct covered interest arbitrage, what amount will you have after 180 days? a. $318,109.10. b. $330,000.00. c. $312,218.20. d. $323,888.90. e. none of the above

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

ANS: A SOLUTION:

$300,000/$1.10

= €277,777.80  (1.08) = €294,444.40  $1.08 = $318,109.10

PTS: 1 45. Refer to Exhibit 7-1. If you conduct covered interest arbitrage, what is your percentage return after 180 days? Is covered interest arbitrage feasible in this situation? a. 7.96%; feasible b. 6.04%; feasible c. 6.04%; not feasible d. 4.07%; not feasible e. 10.00%; feasible ANS: B SOLUTION:

$318,109.10/$300,000  1 = 6.04%. Since this rate is slightly higher than the U.S. interest rate of 6%, covered interest arbitrage is feasible.

PTS: 1 46. According to interest rate parity (IRP): a. the forward rate differs from the spot rate by a sufficient amount to offset the inflation differential between two currencies. b. the future spot rate differs from the current spot rate by a sufficient amount to offset the interest rate differential between two currencies. c. the future spot rate differs from the current spot rate by a sufficient amount to offset the inflation differential between two currencies. d. the forward rate differs from the spot rate by a sufficient amount to offset the interest rate differential between two currencies.

ANS: D

PTS: 1

47. Assume that interest rate parity holds. The Mexican interest rate is 50%, and the U.S. interest rate is 8%. Subsequently, the U.S. interest rate decreases to 7%. According to interest rate parity, the peso's forward ____ will ____. a. premium; increase b. discount; decrease c. discount; increase d. premium; decrease ANS: C

PTS: 1

48. If the cross exchange rate of two nondollar currencies implied by their individual spot rates with respect to the dollar is less than the cross exchange rate quoted by a bank, locational arbitrage is possible. a. True b. False ANS: F

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

49. For locational arbitrage to be possible, one bank's ask rate must be higher than another bank's bid rate for a currency. a. True b. False ANS: F

PTS: 1

50. Assume locational arbitrage is possible and involves two different banks. The realignment that would occur due to market forces would increase one bank's ask rate and would decrease the other bank's bid rate. a. True b. False ANS: T

PTS: 1

51. Triangular arbitrage tends to force a relationship between the interest rates of two countries and their forward exchange rate premium or discount. a. True b. False ANS: F

PTS: 1

52. The interest rate on euros is 8%. The interest rate in the U.S. is 5%. The euro's forward rate should exhibit a premium of about 3%. a. True b. False ANS: F

PTS: 1

53. Capitalizing on discrepancies in quoted prices involving no risk and no investment of funds is referred to as interest rate parity. a. True b. False ANS: F

PTS: 1

54. Realignment in the exchange rates of banks will eliminate locational arbitrage. More specifically, market forces will increase the ask rate of the bank from which the currency was bought to conduct locational arbitrage and will decrease the bid rate of the bank to which the currency was sold to conduct locational arbitrage. a. True b. False ANS: T

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

55. Locational arbitrage involves investing in a foreign country and covering against exchange rate risk by engaging in forward contracts. a. True b. False ANS: F

PTS: 1

56. To capitalize on high foreign interest rates using covered interest arbitrage, a U.S. investor would convert dollars to the foreign currency, invest in the foreign country, and simultaneously sell the foreign currency forward. a. True b. False ANS: T

PTS: 1

57. If interest rate parity (IRP) exists, then the rate of return achieved from covered interest arbitrage should be equal to the rate available in the foreign country. a. True b. False ANS: F

PTS: 1

58. If interest rate parity (IRP) exists, then triangular arbitrage will not be possible. a. True b. False ANS: F

PTS: 1

59. Forward rates are driven by the government rather than market forces. a. True b. False ANS: F

PTS: 1

60. The foreign exchange market is an over-the-counter market. a. True b. False ANS: F

PTS: 1

61. The yield curve of every country has its own unique shape. a. True b. False ANS: T

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

62. Assume the following information: U.S. investors have $1,000,000 to invest: 1-year deposit rate offered by U.S. banks 1-year deposit rate offered on British pounds 1-year forward rate of Swiss francs Spot rate of Swiss franc

= = = =

10% 13.5% $1.26 $1.30

Given this information: a. interest rate parity exists and covered interest arbitrage by U.S. investors results in the same yield as investing domestically. b. interest rate parity doesn't exist and covered interest arbitrage by U.S. investors results in a yield above what is possible domestically. c. interest rate parity exists and covered interest arbitrage by U.S. investors results in a yield above what is possible domestically. d. interest rate parity doesn't exist and covered interest arbitrage by U.S. investors results in a yield below what is possible domestically.

ANS: A SOLUTION:

$1,000,000/$1.30 = 793,651 pounds  (1.135) = 900,794  $1.26 = $1,100,076.

Yield: ($1,100,076  $1,000,000)/($1,000,000) = 10%.

PTS: 1 63. If quoted exchange rates are the same across different locations, then ____ is not feasible. a. triangular arbitrage b. covered interest arbitrage c. locational arbitrage d. A and C ANS: D

PTS: 1

64. Points above the IRP line represent situations where: a. covered interest arbitrage is feasible from the perspective of domestic investors and results in the same yield as investing domestically. b. covered interest arbitrage is feasible from the perspective of domestic investors and results in a yield above what is possible domestically. c. covered interest arbitrage is feasible from the perspective of foreign investors and results in a yield above what is possible in their local markets. d. covered interest arbitrage is not feasible for neither domestic nor foreign investors.

ANS: C

PTS: 1

65. Points below the IRP line represent situations where: a. covered interest arbitrage is feasible from the perspective of domestic investors and results in the same yield as investing domestically. b. covered interest arbitrage is feasible from the perspective of domestic investors and results in a yield above what is possible domestically. c. covered interest arbitrage is feasible from the perspective of foreign investors and results © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

in a yield above what is possible in their local markets. d. covered interest arbitrage is not feasible for neither domestic nor foreign investors.

ANS: B

PTS: 1

66. Which of the following might discourage covered interest arbitrage even if interest rate parity does not exist? a. transaction costs. b. political risk. c. differential tax laws. d. all of the above.

ANS: D

PTS: 1

67. Assume that interest rate parity holds. U.S. interest rate is 13% and British interest rate is 10%. The forward rate on British pounds exhibits a ____ of ____ percent. a. discount; 2.73 b. premium; 2.73 c. discount; 3.65 d. premium; 3.65 ANS: B

PTS: 1

68. Assume the following information: Exchange rate of Japanese yen in U.S. $ Exchange rate of euro in U.S. $ Exchange rate of euro in Japanese yen

= = =

$.011 $1.40 140 yen

What will be the yield for an investor who has $1,000,000 available to conduct triangular arbitrage? a. $100,000 b. $90,909 c. 10% d. 9.09% ANS: C SOLUTION:

Exchange dollars for pounds = $1,000,000/$1.4 = 714.286; exchange pounds for yen = 714,286  140 = 100,000,000 yen. Exchange yen for dollars = 100,000,000 yen  $.011 = $1,100,000. Yield = ($1,100,000  $1,000,000)/$1,000,000 = 10%

PTS: 1 69. Assume the following information:

Value of an Australian dollar (A$) in $ Value of Mexican peso in $ Value of an Australian dollar in Mexican pesos

Quoted Bid Price $0.67 $.074 8.2

Quoted Ask Price $0.69 $.077 8.5

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Assume you have $100,000 to conduct triangular arbitrage. What will be your profit from implementing this strategy? a. $6,133 b. $2,368 c. $6,518 d. $13,711 ANS: B SOLUTION:

$100,000/$.077 = 1,298,701 pesos/8.5 = A$152,788  $0.67 = $102,368 Profit = $102,368  $100,000

PTS: 1 70. The interest rate on yen is 7%. The interest rate in the U.S. is 9%. The yen's forward rate should exhibit a premium of about 2%. a. True b. False ANS: T

PTS: 1

71. The interest rate on pounds in the U.K. is 8%. The interest rate in the U.S. is 5%. Interest rate parity exists. U.S. investors will earn a lower return domestically than British investors earn domestically. a. True b. False ANS: T

PTS: 1

72. Assume that the real interest rate in the U.S. and in the U.K. is 3%. The expected annual inflation in the U.S. is 3%, while in the U.K. it is 4%. The forward rate on the pound should exhibit a premium of about 1%. a. True b. False ANS: F

PTS: 1

73. If the cross exchange rate of two nondollar currencies implied by their individual spot rates with respect to the dollar is less than the cross exchange rate quoted by a bank, locational arbitrage is possible. a. True b. False ANS: F

PTS: 1

74. For locational arbitrage to be possible, one bank's ask rate must be higher than another bank's bid rate for a currency. a. True b. False ANS: F

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

75. Technology enables more consistent prices among banks and reduces the likelihood of significant discrepancies in foreign exchange quotations among locations. a. True b. False ANS: T

PTS: 1

76. Assume locational arbitrage is possible and involves two different banks. The realignment that would occur due to market forces would increase one bank's ask rate and would decrease the other bank's bid rate. a. True b. False ANS: T

PTS: 1

77. Locational arbitrage explains why prices among banks at different locations will not normally differ by a significant amount. a. True b. False ANS: T

PTS: 1

78. Cross exchange rates are used to determine the relationship between the dollar and two nondollar currencies. a. True b. False ANS: F

PTS: 1

79. Triangular arbitrage tends to force a relationship between the interest rates of two countries and their forward exchange rate premium or discount. a. True b. False ANS: F

PTS: 1

80. The equilibrium state in which covered interest arbitrage is no longer possible is called interest rate parity (IRP). a. True b. False ANS: T

PTS: 1

81. If interest rate parity exists, then the rate of return achieved from covered interest arbitrage should be equal to the interest rate available in the foreign country. a. True b. False ANS: F

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

82. Interest rate parity (IRP) states that the foreign currency's forward rate premium or discount is roughly equal to the interest rate differential between the U.S. and the foreign country. a. True b. False ANS: T

PTS: 1

83. The interest rate in South Africa is 8%. The interest rate in the U.S. is 5%. The South African forward rate should exhibit a premium of about 3%. a. True b. False ANS: F

PTS: 1

84. The larger the degree by which the foreign interest rate exceeds the home interest rate, the larger will be the forward discount of the foreign currency specified by the interest rate parity (IRP) formula. a. True b. False ANS: T

PTS: 1

85. For points lying to the left of the interest rate parity (IRP) line, covered interest arbitrage is not possible from a U.S. investor's perspective, but is possible from a foreign investor's perspective. a. True b. False ANS: T

PTS: 1

86. If interest rate parity (IRP) exists, then foreign investors will earn the same returns as U.S. investors. a. True b. False ANS: F

PTS: 1

87. If interest rate parity (IRP) does not hold, there is still the possibility that covered interest arbitrage is not worthwhile because of such factors as transaction costs, currency restrictions, and differential tax laws. a. True b. False ANS: T

PTS: 1

88. Which of the following is not mentioned in the text as a form of international arbitrage? a. Locational arbitrage b. Triangular arbitrage c. Transactional arbitrage d. Covered interest arbitrage e. All of the above are mentioned in the text as forms of international arbitrage.

ANS: C

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

89. Bank A quotes a bid rate of $0.300 and an ask rate of $0.305 for the Malaysian ringgit (MYR). Bank B quotes a bid rate of $0.306 and an ask rate of $0.310 for the ringgit. What will be the profit for an investor that has $500,000 available to conduct locational arbitrage? a. $2,041,667 b. $9,804 c. $500 d. $1,639 ANS: D

PTS: 1

90. American Bank quotes a bid rate of $0.026 and an ask rate of $0.028 for the Indian rupee (INR); National Bank quotes a bid rate of $0.024 and an ask rate for $0.025. Locational arbitrage would involve: a. buying rupees from American Bank at the bid rate and selling them to National Bank at the ask rate. b. buying rupees from National Bank at the ask rate and selling them to American Bank at the bid rate. c. buying rupees from American Bank at the ask rate and selling to National Bank at the bid rate. d. buying rupees from National Bank at the bid rate and selling them to American Bank at the ask rate. e. Locational arbitrage is not possible in this case.

ANS: B

PTS: 1

91. Assume you discovered an opportunity for locational arbitrage involving two banks and have taken advantage of it. Because of your and other arbitrageurs' actions, the following adjustments must take place. a. One bank's ask price will rise and the other bank's bid price will fall. b. One bank's ask price will fall and the other bank's bid price will rise. c. One bank's bid/ask spread will widen and the other bank's bid/ask spread will fall. d. A and C ANS: D

PTS: 1

92. Which of the following is an example of triangular arbitrage initiation? a. Buying a currency at one bank's ask and selling at another bank's bid, which is higher than the former bank's ask. b. Buying Singapore dollars from a bank (quoted at $0.55) that has quoted the South African rand (ZAR)/Singapore dollar (S$) exchange rate at ZAR2.50 when the spot rate for the South African rand is $0.20. c. Buying Singapore dollars from a bank (quoted at $0.55) that has quoted the South African rand/Singapore dollar exchange rate at ZAR3.00 when the spot rate for the South African rand is $0.20. d. Converting funds to a foreign currency and investing the funds overseas.

ANS: C

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

93. Hewitt Bank quotes a value for the Japanese yen (¥) of $0.007, and a value for the Canadian Dollar (C$) of $0.821. The cross exchange rate quoted by the bank for the Canadian dollar is ¥118.00. You have $5,000 to conduct triangular arbitrage. How much will you end up with if you conduct triangular arbitrage? a. $6,053.27 b. $5,030.45 c. $6,090.13 d. Triangular arbitrage is not possible in this case.

ANS: B

PTS: 1

94. National Bank quotes the following for the British pound and the New Zealand dollar:

Value of a British pound (£) in $ Value of a New Zealand dollar (NZ$) in $ Value of a British pound in New Zealand dollars

Quoted Bid Price $1.61 $0.55

Quoted Ask Price $1.62 $0.56

NZ$2.95

NZ$2.96

Assume you have $10,000 to conduct triangular arbitrage. What is your profit from implementing this strategy? a. $77.64 b. $197.53 c. $15.43 d. $111.80 ANS: C

PTS: 1

95. Which of the following is not true regarding covered interest arbitrage? a. Covered interest arbitrage tends to force a relationship between the interest rates of two countries and their forward exchange rate premium or discount. b. Covered interest arbitrage involves investing in a foreign country and covering against exchange rate risk. c. Covered interest arbitrage opportunities only exist when the foreign interest rate is higher than the interest rate in the home country. d. If covered interest arbitrage is possible, you can guarantee a return on your funds that exceeds the returns you could achieve domestically. e. All of the above are true regarding covered interest arbitrage.

ANS: C

PTS: 1

96. Which of the following is not true regarding covered interest arbitrage? a. Covered interest arbitrage is a reason for observing interest rate parity (IRP). b. If the forward rate is equal to the spot rate, conducting covered interest arbitrage will yield a return that is exactly equal to the interest rate in the foreign country. c. When interest rate parity holds, covered interest arbitrage is not possible. d. When interest rate disparity exists, covered interest arbitrage may not be profitable. e. All of the above are true.

ANS: E

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

97. Which of the following is not true regarding interest rate parity (IRP)? a. When interest rate parity holds, covered interest arbitrage is not possible. b. When the interest rate in the foreign country is higher than that in the home country, the forward rate of that country's currency should exhibit a discount. c. When the interest rate in the foreign country is lower than that in the home country, the forward rate of that country's currency should exhibit a premium. d. When covered interest arbitrage is not feasible, interest rate parity must hold. e. All of the above are true.

ANS: D

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Chapter 8—Inflation, Interest Rates, and Exchange Rates 1. Assume a two-country world: Country A and Country B. Which of the following is correct about purchasing power parity (PPP) as related to these two countries? a. If Country A's inflation rate exceeds Country B's inflation rate, Country A's currency will weaken. b. If Country A's interest rate exceeds Country B's inflation rate, Country A's currency will weaken. c. If Country A's interest rate exceeds Country B's inflation rate, Country A's currency will strengthen. d. If Country B's inflation rate exceeds Country A's inflation rate, Country A's currency will weaken.

ANS: A

PTS: 1

2. Given a home country and a foreign country, purchasing power parity (PPP) suggests that: a. a home currency will depreciate if the current home inflation rate exceeds the current foreign interest rate. b. a home currency will appreciate if the current home interest rate exceeds the current foreign interest rate. c. a home currency will appreciate if the current home inflation rate exceeds the current foreign inflation rate. d. a home currency will depreciate if the current home inflation rate exceeds the current foreign inflation rate.

ANS: D

PTS: 1

3. The international Fisher effect (IFE) suggests that: a. a home currency will depreciate if the current home interest rate exceeds the current foreign interest rate. b. a home currency will appreciate if the current home interest rate exceeds the current foreign interest rate. c. a home currency will appreciate if the current home inflation rate exceeds the current foreign inflation rate. d. a home currency will depreciate if the current home inflation rate exceeds the current foreign inflation rate.

ANS: A

PTS: 1

4. Because there are a variety of factors in addition to inflation that affect exchange rates, this will: a. reduce the probability that PPP shall hold. b. increase the probability that PPP shall hold. c. increase the probability the IFE will hold. d. B and C ANS: A

PTS: 1

5. Because there are sometimes no substitutes for traded goods, this will: a. reduce the probability that PPP shall hold. b. increase the probability that PPP shall hold. c. increase the probability the IFE will hold. © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

d. B and C ANS: A

PTS: 1

6. According to the IFE, if British interest rates exceed U.S. interest rates: a. the British pound's value will remain constant. b. the British pound will depreciate against the dollar. c. the British inflation rate will decrease. d. the forward rate of the British pound will contain a premium. e. today's forward rate of the British pound will equal today's spot rate.

ANS: B

PTS: 1

7. Given a home country and a foreign country, the international Fisher effect (IFE) suggests that: a. the nominal interest rates of both countries are the same. b. the inflation rates of both countries are the same. c. the exchange rates of both countries will move in a similar direction against other currencies. d. none of the above ANS: D

PTS: 1

8. Given a home country and a foreign country, purchasing power parity suggests that: a. the inflation rates of both countries will be the same. b. the nominal interest rates of both countries will be the same. c. A and B d. none of the above ANS: D

PTS: 1

9. If interest rates on the euro are consistently below U.S. interest rates, then for the international Fisher effect (IFE) to hold: a. the value of the euro would often appreciate against the dollar. b. the value of the euro would often depreciate against the dollar. c. the value of the euro would remain constant most of the time. d. the value of the euro would appreciate in some periods and depreciate in other periods, but on average have a zero rate of appreciation.

ANS: A

PTS: 1

10. If the international Fisher effect (IFE) did not hold based on historical data, then this suggests that: a. some corporations with excess cash can lock in a guaranteed higher return on future foreign short-term investments. b. some corporations with excess cash could have generated profits on average from covered interest arbitrage. c. some corporations with excess cash could have generated higher profits on average from foreign short-term investments than from domestic short-term investments. d. most corporations that consistently invest in foreign short-term investments would have generated the same profits (on average) as from domestic short-term investments.

ANS: C

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

11. Under purchasing power parity, the future spot exchange rate is a function of the initial spot rate in equilibrium and: a. the income differential. b. the forward discount or premium. c. the inflation differential. d. none of the above ANS: C

PTS: 1

12. According to the international Fisher effect, if U.S. investors expect a 5% rate of domestic inflation over one year, and a 2% rate of inflation in European countries that use the euro, and require a 3% real return on investments over one year, the nominal interest rate on one-year U.S. Treasury securities would be: a. 2%. b. 3%. c. 2%. d. 5%. e. 8%.

ANS: E SOLUTION:

5% + 3% = 8%

PTS: 1 13. According to the international Fisher effect, if investors in all countries require the same real rate of return, the differential in nominal interest rates between any two countries: a. follows their exchange rate movement. b. is due to their inflation differentials. c. is zero. d. is constant over time. e. C and D ANS: B

PTS: 1

14. Assume that U.S. and British investors require a real return of 2%. If the nominal U.S. interest rate is 15%, and the nominal British rate is 13%, then according to the IFE, the British inflation rate is expected to be about ____ the U.S. inflation rate, and the British pound is expected to ____. a. 2 percentage points above; depreciate by about 2% b. 3 percentage points above; depreciate by about 3% c. 3 percentage points below; appreciate by about 3% d. 3 percentage points below; depreciate by about 3% e. 2 percentage points below; appreciate by about 2% ANS: E

PTS: 1

15. Assume U.S. and Swiss investors require a real rate of return of 3%. Assume the nominal U.S. interest rate is 6% and the nominal Swiss rate is 4%. According to the international Fisher effect, the franc will ____ by about ____. a. appreciate; 3% b. appreciate; 1% c. depreciate; 3% d. depreciate; 2% © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

e. appreciate; 2% ANS: E

PTS: 1

16. Assume that the U.S. and Chile nominal interest rates are equal. Then, the U.S. nominal interest rate decreases while the Chilean nominal interest rate remains stable. According to the international Fisher effect, this implies expectations of ____ than before, and that the Chilean peso should ____ against the dollar. a. lower U.S. inflation; depreciate b. lower U.S. inflation; appreciate c. higher U.S. inflation; depreciate d. higher U.S. inflation; appreciate ANS: A

PTS: 1

17. According to the international Fisher effect, if Venezuela has a much higher nominal rate than other countries, its inflation rate will likely be ____ than other countries, and its currency will ____. a. lower; strengthen b. lower; weaken c. higher; weaken d. higher; strengthen ANS: C

PTS: 1

18. If interest rate parity holds, then the one-year forward rate of a currency will be ____ the predicted spot rate of the currency in one year according to the international Fisher effect. a. greater than b. less than c. equal to d. answer is dependent on whether the forward rate has a discount or premium ANS: C

PTS: 1

19. The Fisher effect is used to determine the: a. real inflation rate. b. real interest rate. c. real spot rate. d. real forward rate.

ANS: B

PTS: 1

20. Latin American countries have historically experienced relatively high inflation, and their currencies have weakened. This information is somewhat consistent with the concept of: a. interest rate parity. b. locational arbitrage. c. purchasing power parity. d. the exchange rate mechanism.

ANS: C

PTS: 1

21. Assume that the inflation rate in Singapore is 3%, while the inflation rate in the U.S. is 8%. According to PPP, the Singapore dollar should ____ by ____%. © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

a. b. c. d.

appreciate; 4.85 depreciate; 3,11 appreciate; 3.11 depreciate; 4.85

ANS: A SOLUTION:

(1.08/1.03)  1 = 4.85%.

PTS: 1 22. The inflation rate in the U.S. is 3%, while the inflation rate in Japan is 10%. The current exchange rate for the Japanese yen (¥) is $0.0075. After supply and demand for the Japanese yen has adjusted in the manner suggested by purchasing power parity, the new exchange rate for the yen will be: a. $0.0076. b. $0.0073. c. $0.0070. d. $0.0066.

ANS: C SOLUTION:

(1.03/1.10)  $.0075 = $.0070

PTS: 1 23. Assume that the U.S. inflation rate is higher than the New Zealand inflation rate. This will cause U.S. consumers to ____ their imports from New Zealand and New Zealand consumers to ____ their imports from the U.S. According to purchasing power parity (PPP), this will result in a(n) ____ of the New Zealand dollar (NZ$). a. reduce; increase; appreciation b. increase; reduce; appreciation c. reduce; increase; depreciation d. reduce; increase; appreciation ANS: B

PTS: 1

24. The following regression analysis was conducted for the inflation rate information and exchange rate of the British pound:

Regression results indicate that a0 = 0 and a1 = 2. Therefore: a. purchasing power parity holds. b. purchasing power parity overestimated the exchange rate change during the period under examination. c. purchasing power parity underestimated the exchange rate change during the period under examination. d. purchasing power parity will overestimate the exchange rate change of the British pound in the future.

ANS: C

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

25. Which of the following is indicated by research regarding purchasing power parity (PPP)? a. PPP clearly holds in the short run. b. Deviations from PPP are reduced in the long run. c. PPP clearly holds in the long run. d. There is no relationship between inflation differentials and exchange rate movements in the short run or long run.

ANS: B

PTS: 1

26. The interest rate in the U.K. is 7%, while the interest rate in the U.S. is 5%. The spot rate for the British pound is $1.50. According to the international Fisher effect (IFE), the British pound should adjust to a new level of: a. $1.47. b. $1.53. c. $1.43. d. $1.57.

ANS: A SOLUTION:

(1.05/1.07)  (1.50) = $1.47.

PTS: 1 27. If nominal British interest rates are 3% and nominal U.S. interest rates are 6%, then the British pound (£) is expected to ____ by about ____%, according to the international Fisher effect (IFE). a. depreciate; 2.9 b. appreciate; 2.9 c. depreciate; 1.0 d. appreciate; 1.0 e. none of the above ANS: B SOLUTION:

(1.06/1.03)  1 = 2.9%.

PTS: 1 28. There is much evidence to suggest that Japanese investors invest in U.S. Treasury securities when U.S. interest rates are higher than Japanese interest rates. These investors most likely believe in the international Fisher effect. a. True b. False ANS: F

PTS: 1

29. Which of the following is not true regarding IRP, PPP, and the IFE? a. IRP suggests that a currency's spot rate will change according to interest rate differentials. b. PPP suggests that a currency's spot rate will change according to inflation differentials. c. The IFE suggests that a currency's spot rate will change according to interest rate differentials. d. All of the above are true.

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

ANS: A

PTS: 1

30. The relative form of purchasing power parity (PPP) accounts for the possibility of market imperfections such as transportation costs, tariffs, and quotas in establishing a relationship between inflation rates and exchange rate changes. a. True b. False ANS: T

PTS: 1

31. According to the international Fisher effect (IFE), the exchange rate percentage change should be approximately equal to the differential in income levels between two countries. a. True b. False ANS: F

PTS: 1

32. Research indicates that deviations from purchasing power parity (PPP) are reduced over the long run. a. True b. False ANS: T

PTS: 1

33. The IFE theory suggests that foreign currencies with relatively high interest rates will appreciate because the high nominal interest rates reflect expected inflation. a. True b. False ANS: F

PTS: 1

34. If the IFE theory holds, that means that covered interest arbitrage is not feasible. a. True b. False ANS: F

PTS: 1

35. If interest rate parity holds, and the international Fisher effect (IFE) holds, foreign currencies with relatively high interest rates should have forward discounts and those currencies would be expected to depreciate. a. True b. False ANS: T

PTS: 1

36. Interest rate parity can only hold if purchasing power parity holds. a. True b. False ANS: F

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

37. If interest rate parity holds, then the international Fisher effect must hold. a. True b. False ANS: F

PTS: 1

38. Which of the following theories suggests that the percentage change in spot exchange rate of a currency should be equal to the inflation differential between two countries? a. purchasing power parity (PPP). b. triangular arbitrage. c. international Fisher effect (IFE). d. interest rate parity (IRP).

ANS: A

PTS: 1

39. Which of the following theories suggests that the percentage difference between the forward rate and the spot rate depends on the interest rate differential between two countries? a. purchasing power parity (PPP). b. triangular arbitrage. c. international Fisher effect (IFE). d. interest rate parity (IRP).

ANS: D

PTS: 1

40. Which of the following theories can be assessed using data that exists at one specific point in time? a. purchasing power parity (PPP) b. international Fisher effect (IFE). c. A and B d. interest rate parity (IRP).

ANS: D

PTS: 1

41. Which of the following theories suggests the percentage change in spot exchange rate of a currency should be equal to the interest rate differential between two countries? a. absolute form of PPP. b. relative form of PPP. c. international Fisher effect (IFE). d. interest rate parity (IRP).

ANS: C

PTS: 1

42. The following regression analysis was conducted for the inflation rate information and exchange rate of the British pound:

Regression results indicate that a0 = 0 and a1 = 1. Therefore: a. purchasing power parity holds. © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

b. purchasing power parity overestimated the exchange rate change during the period under examination. c. purchasing power parity underestimated the exchange rate change during the period under examination. d. purchasing power parity will overestimate the exchange rate change of the British pound in the future.

ANS: A

PTS: 1

43. The following regression analysis was conducted for the inflation rate information and exchange rate of the British pound:

Regression results indicate that a0 = 0 and a1 = 0.4. Therefore: a. purchasing power parity holds. b. purchasing power parity overestimated the exchange rate change during the period under examination. c. purchasing power parity underestimated the exchange rate change during the period under examination. d. purchasing power parity will overestimate the exchange rate change of the British pound in the future.

ANS: B

PTS: 1

44. Assume that the one-year interest rate in the U.S. is 7% and in the U.K. is 5%. According to the international Fisher effect, British pound's spot exchange rate should ____ by about ____ over the year. a. depreciate; 1.9% b. appreciate; 1.9% c. depreciate; 3.94% d. appreciate; 3.94% ANS: B SOLUTION:

(1 + .07)/(1 + .05)  1 = 1.9%

PTS: 1 45. According to the international Fisher effect (IFE): a. the nominal rate of return on a foreign investment should be equal to the nominal rate of return on the domestic investment. b. the exchange rate adjusted rate of return on a foreign investment should be equal to the interest rate on a local money market investment. c. the percentage change in the foreign spot exchange rate will be positive if the foreign interest rate is higher than the local interest rate. d. the percentage change in the foreign spot exchange rate will be negative if foreign interest rate is lower than the local interest rate.

ANS: B

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

46. Assume that the U.S. one-year interest rate is 5% and the one-year interest rate on euros is 8%. You have $100,000 to invest and you believe that the international Fisher effect (IFE) holds. The euro's spot exchange rate is $1.40. What will be the yield on your investment if you invest in euros? a. 8% b. 5% c. 3% d. 2.78% ANS: B

PTS: 1

47. Assume that the U.S. one-year interest rate is 3% and the one-year interest rate on Australian dollars is 6%. The U.S. expected annual inflation is 5%, while the Australian inflation is expected to be 7%. You have $100,000 to invest for one year and you believe that PPP holds. The spot exchange rate of an Australian dollar is $0.689. What will be the yield on your investment if you invest in the Australian market? a. 6% b. 3% c. 4% d. 2% ANS: C SOLUTION:

(1 + .05)/(1 + .07)  $0.689 = $0.676. ($100,000/A$0.689)  (1 + .06) = A$153,846  $0.676 = $104,000. ($104,000  $100,000)/$100,000 = 4%

PTS: 1 48. Assume that the international Fisher effect (IFE) holds between the U.S. and the U.K. The U.S. inflation is expected to be 5%, while British inflation is expected to be 3%. The interest rates offered on pounds are 7% and U.S. interest rates are 7%. What does this say about real interest rates expected

by British investors? a. real interest rates expected by British investors are equal to the interest rates expected by U.S. investors. b. real interest rates expected by British investors are 2 percentage points lower than the real interest rates expected by U.S. investors. c. real interest rates expected by British investors are 2 percentage points above the real interest rates expected by U.S. investors. d. IFE doesn't hold in this case because the U.S. inflation is higher than the British inflation, but the interest rates offered in both countries are equal.

ANS: C

PTS: 1

49. The international Fisher effect (IFE) suggests that the currencies with relatively high interest rates will appreciate because those high rates will attract investment and increase the demand for that currency. a. True b. False ANS: F

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

50. If purchasing power parity holds, then the Fisher effect must also hold. a. True b. False ANS: F

PTS: 1

51. If the international Fisher effect (IFE) holds, the local investors are expected to earn the same return from investing internationally as they would from investing in their local markets. a. True b. False ANS: T

PTS: 1

52. Assume that inflation in the U.S. is expected to be 9%, while inflation in Australia is expected to be 5% over the next year. Today you receive an offer to purchase a one-year put option for $.03 per unit on Australian dollars at a strike price of $0.72. Today the Australian dollar is quoted at $0.70. You believe that purchasing power parity holds. You should accept the offer. a. True b. False ANS: F SOLUTION:

Spot rate in a year = (1.09/1.05)  $0.70 = $0.73

PTS: 1 53. Assume that the interest rate offered on pounds is 5% and the pound is expected to depreciate by 1.5%.

For the international Fisher effect (IFE) to hold between the U.K. and the U.S., the U.S. interest rate should be ____. a. 3.43% b. 5.68% c. 6.5% d. 7.3% ANS: A SOLUTION:

(1 + .05)  (1 + .015)  1 = 3.43%

PTS: 1 54. Purchasing power parity (PPP) focuses on the relationship between nominal interest rates and exchange rates between two countries. a. True b. False ANS: F

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

55. According to the international fisher effect (IFE), the exchange rate percentage change should be approximately equal to the differential in income levels between two countries. a. True b. False ANS: F

PTS: 1

56. According to purchasing power parity (PPP), if a foreign country's inflation rate is below the inflation rate at home, home country consumers will increase their imports from the foreign country and foreign consumers will lower their demand for home country products. These market forces cause the foreign currency to appreciate. a. True b. False ANS: T

PTS: 1

57. According to the IFE, when the nominal interest rate at home exceeds the nominal interest rate in the foreign country, the home currency should depreciate. a. True b. False ANS: T

PTS: 1

58. The inflation rate in the U.S. is 4%, while the inflation rate in Japan is 1.5%. The current exchange rate for the Japanese yen (¥) is $0.0080. After supply and demand for the Japanese yen has adjusted according to purchasing power parity, the new exchange rate for the yen will be a. $0.0078. b. $0.0082. c. $0.0111. d. $0.00492. e. None of the above ANS: B

PTS: 1

59. Assume that the New Zealand inflation rate is higher than the U.S. inflation rate. This will cause U.S. consumers to ____ their imports from New Zealand and New Zealand consumers to ____ their imports from the U.S. According to purchasing power parity (PPP), this will result in a(n) ____ of the New Zealand dollar (NZ$). a. reduce; increase; appreciation b. increase; reduce; depreciation c. reduce; increase; depreciation d. reduce; increase; appreciation ANS: C

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

60. The following regression was conducted for the exchange rate of the Cyprus pound (CYP):

Regression results indicate that a0 = 0 and a1 = 2. Therefore, a. purchasing power parity holds. b. purchasing power parity overestimated the exchange rate change during the period under examination. c. purchasing power parity underestimated the exchange rate change during the period under examination. d. purchasing power parity will overestimate the exchange rate change of the Cyprus pound in the future.

ANS: C

PTS: 1

61. Among the reasons that purchasing power parity (PPP) does not consistently occur are: a. exchange rates are affected by interest rate differentials. b. exchange rates are affected by national income differentials and government controls. c. supply and demand may not adjust if no substitutable goods are available. d. all of the above are reasons that PPP does not consistently occur.

ANS: D

PTS: 1

62. Which of the following is not true regarding IRP, PPP, and the IFE? a. IRP suggests that a currency's spot rate will change according to interest rate differentials. b. PPP suggests that a currency's spot rate will change according to inflation differentials. c. The IFE suggests that a currency's spot rate will change according to interest rate differentials. d. All of the above are true.

ANS: A

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Chapter 9—Forecasting Exchange Rates 1. Which of the following forecasting techniques would best represent the use of today's forward exchange rate to forecast the future exchange rate? a. fundamental forecasting. b. market-based forecasting. c. technical forecasting. d. mixed forecasting.

ANS: B

PTS: 1

2. Which of the following forecasting techniques would best represent sole use of today's spot exchange rate of the euro to forecast the euro's future exchange rate? a. fundamental forecasting. b. market-based forecasting. c. technical forecasting. d. mixed forecasting.

ANS: B

PTS: 1

3. Which of the following forecasting techniques would best represent the use of relationships between economic factors and exchange rate movements to forecast the future exchange rate? a. fundamental forecasting. b. market-based forecasting. c. technical forecasting. d. mixed forecasting.

ANS: A

PTS: 1

4. Which of the following forecasting techniques would best represent the sole use of the pattern of historical currency values of the euro to predict the euro's future currency value? a. fundamental forecasting. b. market-based forecasting. c. technical forecasting. d. mixed forecasting.

ANS: C

PTS: 1

5. If a particular currency is consistently declining substantially over time, then a market-based forecast will usually have: a. underestimated the future exchange rates over time. b. overestimated the future exchange rates over time. c. forecasted future exchange rates accurately. d. forecasted future exchange rates inaccurately but without any bias toward consistent underestimating or overestimating.

ANS: B

PTS: 1

6. According to the text, the analysis of currencies forecasted with use of the forward rate suggests that: a. currencies exhibited about the same mean forecast errors as a percent of the realized value. b. the Canadian dollar can be forecasted by U.S. firms with greater accuracy than other © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

currencies. c. the Swiss franc can be forecasted by U.S. firms with greater accuracy than other currencies. d. none of the above ANS: B

PTS: 1

7. Assume the following information:

Period 1 2 3 4

Predicted Value of New Zealand Dollar $.52 .54 .44 .51

Realized Value of New Zealand Dollar $.50 .60 .40 .50

Given this information, the mean absolute forecast error as a percentage of the realized value is about: a. 1.5%. b. 26%. c. 6%. d. 6.5%. e. none of the above ANS: D SOLUTION:

[|$.52  $.50|/$.50 + |$.54  $.60|/$.60 + |$.44  $.40|/$.40 + |$.51  $.50|/$.50)]/4 = [.04 + .10 + .10 + .02]/4 = .065 = 6.50%

PTS: 1 8. If it was determined that the movement of exchange rates was not related to previous exchange rate values, this implies that a ____ is not valuable for speculating on expected exchange rate movements. a. technical forecast technique b. fundamental forecast technique c. all of the above d. none of the above ANS: A

PTS: 1

9. Which of the following is true? a. Forecast errors cannot be negative. b. Forecast errors are negative when the forecasted rate exceeds the realized rate. c. Absolute forecast errors are negative when the forecasted rate exceeds the realized rate. d. None of the above.

ANS: D

PTS: 1

10. Which of the following is true according to the text? a. Forecasts in recent years have been very accurate. b. Use of the absolute forecast error as a percent of the realized value is a good measure to use in detecting a forecast bias. © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

c. Forecasting errors are smaller when focused on longer term periods. d. None of the above.

ANS: D

PTS: 1

11. A fundamental forecast that uses multiple values of the influential factors is an example of: a. sensitivity analysis. b. discriminant analysis. c. technical analysis. d. factor analysis.

ANS: A

PTS: 1

12. When the value from the prior period of an influential factor affects the forecast in the future period, this is an example of a(n): a. lagged input. b. instantaneous input. c. simultaneous input. d. B and C ANS: A

PTS: 1

13. Assume a forecasting model uses inflation differentials and interest rate differentials to forecast the exchange rate. Assume the regression coefficient of the interest rate differential variable is .5, and the coefficient of the inflation differential variable is .4. Which of the following is true? a. The interest rate variable is inversely related to the exchange rate, and the inflation variable is directly (positively) related to the interest rate variable. b. The interest rate variable is inversely related to the exchange rate, and the inflation variable is directly related to the exchange rate. c. The interest rate variable is directly related to the exchange rate, and the inflation variable is directly related to the exchange rate. d. The interest rate variable is directly related to the exchange rate, and the inflation variable is directly related to the interest rate variable.

ANS: B

PTS: 1

14. Which of the following is not a limitation of fundamental forecasting? a. uncertain timing of impact. b. forecasts are needed for factors that have a lagged impact. c. omission of other relevant factors from the model. d. possible change in sensitivity of the forecasted variable to each factor over time. e. none of the above ANS: B

PTS: 1

15. Assume that interest rate parity holds. The U.S. five-year interest rate is 5% annualized, and the Mexican five-year interest rate is 8% annualized. Today's spot rate of the Mexican peso is $.20. What is the approximate five-year forecast of the peso's spot rate if the five-year forward rate is used as a forecast? a. $.131. b. $.226. c. $.262. © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

d. $.140. e. $.174.

ANS: E SOLUTION:

(1.05)5/(1.08)5  1 = 13%; $.20[1 + (13%)] = $.174

PTS: 1 16. Assume that the forward rate is used to forecast the spot rate. The forward rate of the Canadian dollar contains a 6% discount. Today's spot rate of the Canadian dollar is $.80. The spot rate forecasted for one year ahead is: a. $.860. b. $.848. c. $.740. d. $.752. e. none of the above ANS: D SOLUTION:

$.80  [1 + (6%)] = $.752

PTS: 1 17. If today's exchange rate reflects all relevant public information about the euro's exchange rate, but not all relevant private information, then ____ would be refuted. a. weak-form efficiency b. semistrong-form efficiency c. strong-form efficiency d. A and B e. B and C ANS: D

PTS: 1

18. According to the text, research generally supports ____ in foreign exchange markets. a. weak-form efficiency b. semistrong-form efficiency c. strong-form efficiency d. A and B e. B and C ANS: D

PTS: 1

19. Assume that the U.S. interest rate is 11 percent, while Australia's one-year interest rate is 12 percent.

Assume interest rate parity holds. If the one-year forward rate of the Australian dollar was used to forecast the future spot rate, the forecast would reflect an expectation of: a. depreciation in the Australian dollar's value over the next year. b. appreciation in the Australian dollar's value over the next year. c. no change in the Australian dollar's value over the next year. d. information on future interest rates is needed to answer this question.

ANS: A

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

20. If the forward rate was expected to be an unbiased estimate of the future spot rate, and interest rate parity holds, then: a. covered interest arbitrage is feasible. b. the international Fisher effect (IFE) is supported. c. the international Fisher effect (IFE) is refuted. d. the average absolute error from forecasting would equal zero.

ANS: B

PTS: 1

21. Which of the following is not a forecasting technique mentioned in your text? a. accounting-based forecasting. b. technical forecasting. c. fundamental forecasting. d. market-based forecasting.

ANS: A

PTS: 1

22. The following regression model was estimated to forecast the value of the Malaysian ringgit (MYR): MYRt = a0 + a1INCt  1 + a2INFt  1 + t, where MYR is the quarterly change in the ringgit, INF is the previous quarterly percentage change in the inflation differential, and INC is the previous quarterly percentage change in the income growth differential. Regression results indicate coefficients of a0 = .005; a1 = .4; and a2 = .7. The most recent quarterly percentage change in the inflation differential is 5%, while the most recent quarterly percentage change in the income differential is 3%. Using this information, the forecast for the percentage change in the ringgit is: a. 4.60%. b. 1.80%. c. 5.2%. d. 4.60%. e. none of the above ANS: B SOLUTION:

MYRt = .005 + (.4)(.03) + (.7)(.05) = 1.80%

PTS: 1 23. The following regression model was estimated to forecast the value of the Indian rupee (INR): INRt = a0 + a1INTt + a2INFt  1 + t, where INR is the quarterly change in the rupee, INT is the real interest rate differential in period t between the U.S. and India, and INF is the inflation rate differential between the U.S. and India in the previous period. Regression results indicate coefficients of a0 = .003; a1 = .5; and a2 = .8. Assume that INFt  1 = 2%. However, the interest rate differential is not known at the beginning of period t and must be estimated. You have developed the following probability distribution:

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Probability 30% 40% 30%

Possible Outcome 2% 3% 4%

The expected change in the Indian rupee in period t is: a. 3.40%. b. 0.40%. c. 3.10%. d. 1.70%. e. none of the above ANS: A SOLUTION:

E[INTt] = (.02)(.3) + (.03)(.4) + (.04)(.3) = 3.00% INRt = .003 + (.5)(.03) + (.8)(.02) = 3.40%

PTS: 1 24. Huge Corporation has just initiated a market-based forecast system using the forward rate as an estimate of the future spot rate of the Japanese yen (¥) and the Australian dollar (A$). Listed below are the forecasted and realized values for the last period: Currency Australian dollar Japanese yen

Forecasted Value $.60 $.0067

Realized Value $.55 $.0069

According to this information and using the absolute forecast error as a percentage of the realized value, the forecast of the yen by Huge Corp. is ____ the forecast of the Australian dollar. a. more accurate than b. less accurate than c. more biased than d. the same as ANS: A SOLUTION:

Absolute forecast error for the Australian dollar = (|.60  .55|)/.55 = 9.09% Absolute forecast error for the Japanese yen = (|.0067  .0069|)/.0069 = 2.90% Therefore, Huge Corp. has estimated the Japanese yen more accurately by approximately 6.19%.

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

25. Gamma Corporation has incurred large losses over the last ten years due to exchange rate fluctuations of the Egyptian pound (EGP), even though the company has used a market-based forecast based on the forward rate. Consequently, management believes its forecasts to be biased. The following regression model was estimated to determine if the forecasts over the last ten years were biased: St = a0 + a1Ft  1 + t, where St is the spot rate of the pound in year t and Ft  1 is the forward rate of the pound in year t  1.

Regression results reveal coefficients of a0 = 0 and a1 = 1.3. Thus, Gamma has reason to believe that its past forecasts have ____ the realized spot rate. a. overestimated b. underestimated c. correctly estimated d. none of the above ANS: B

PTS: 1

26. Which of the following is not a method of forecasting exchange rate volatility? a. using the absolute forecast error as a percentage of the realized value. b. using the volatility of historical exchange rate movements as a forecast for the future. c. using a time series of volatility patterns in previous periods. d. deriving the exchange rate's implied standard deviation from the currency option pricing model.

ANS: A

PTS: 1

27. If a foreign currency is expected to ____ substantially against the parent's currency, the parent may prefer to ____ the remittance of subsidiary earnings. a. weaken; delay b. weaken; expedite c. appreciate; expedite d. none of the above ANS: B

PTS: 1

28. If an MNC invests excess cash in a foreign county, it would like the foreign currency to ____; if an MNC issues bonds denominated in a foreign currency, it would like the foreign currency to ____. a. appreciate; depreciate b. appreciate; appreciate c. depreciate; depreciate d. depreciate; appreciate ANS: A

PTS: 1

29. Severus Co. has to pay 5 million Canadian dollars for supplies it recently received from Canada.

Today, the Canadian dollar has appreciated by 2 percent against the U.S. dollar. Severus has determined that whenever the Canadian dollar appreciates against the U.S. dollar by more than 1 percent, it experiences a reversal of 40 percent on the following day. Based on this information, the Canadian dollar is expected to ____ tomorrow, and Severus would prefer to make payment ____. a. depreciate by .8%; today b. depreciate by .8%; tomorrow © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

c. appreciate by .8%; today d. appreciate by .8%; tomorrow ANS: B SOLUTION:

et + 1 = (2%)  (40%) = 0.8%

PTS: 1 30. Corporations tend to make only limited use of technical forecasting because it typically focuses on the near future, which is not very helpful for developing corporate policies. a. True b. False ANS: T

PTS: 1

31. Sulsa Inc. uses fundamental forecasting. Using regression analysis, it has determined the following equation for the euro: eurot

= b0 + b1INFt  1 + b2INCt  1 = .005 + .9INFt  1 + 1.1INCt  1

The most recent quarterly percentage change in the inflation differential between the U.S. and Europe was 2 percent, while the most recent quarterly percentage change in the income growth differential between the U.S. and Europe was 1 percent. Based on this information, the forecast for the euro is a(n) ____ of ____%. a. appreciation; 3.4 b. depreciation; 3.4 c. appreciation; 0.7 d. appreciation; 1.2 ANS: D SOLUTION:

eurot = .005 + .9(.02) + 1.1(.01) = 1.2%

PTS: 1 32. The U.S. inflation rate is expected to be 4 percent over the next year, while the European inflation rate is expected to be 3 percent. The current spot rate of the euro is $1.03. Using purchasing power parity, the expected spot rate at the end of one year is $____. a. 1.02 b. 1.03 c. 1.04 d. none of the above ANS: C SOLUTION: E(St + 1) = $1.03(1.0097) = $1.04 PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

33. If the one-year forward rate for the euro is $1.07, while the current spot rate is $1.05, the expected percentage change in the euro is ____%. a. 1.90 b. 2.00 c. 1.87 d. none of the above ANS: A SOLUTION:

E(e) = 1.07/1.05  1 = 1.90%

PTS: 1 34. If both interest rate parity and the international Fisher effect hold, then between the forward rate and the spot rate, the ____ rate should provide more accurate forecasts for currencies in ____-inflation countries. a. spot; high b. spot; low c. forward; high d. forward; low ANS: C

PTS: 1

35. If a foreign country's interest rate is similar to the U.S. rate, the forward rate premium or discount will be ____, meaning that the forward rate and spot rate will provide ____ forecasts. a. substantial; similar b. substantial; very different c. close to zero; similar d. close to zero; very different ANS: C

PTS: 1

36. Factors such as economic growth, inflation, and interest rates are an integral part of ____ forecasting. a. technical b. fundamental c. market-based d. none of the above ANS: B

PTS: 1

37. Silicon Co. has forecasted the Canadian dollar for the most recent period to be $0.73. The realized value of the Canadian dollar in the most recent period was $0.80. Thus, the absolute forecast error as a percentage of the realized value was ____%. a. 9.6 b. 9.6 c. 8.8 d. 8.8 ANS: C

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

SOLUTION: PTS: 1 38. The absolute forecast error of a currency is ____, on average, in periods when the currency is more ____. a. lower; volatile b. higher; stable c. lower; stable d. none of the above ANS: C

PTS: 1

39. If the foreign exchange market is ____ efficient, then historical and current exchange rate information is not useful for forecasting exchange rate movements. a. weak-form b. semistrong-form c. strong form d. all of the above ANS: D

PTS: 1

40. Foreign exchange markets are generally found to be at least ____ efficient. a. weak-form b. semistrong-form c. strong form d. none of the above ANS: B

PTS: 1

41. MNCs can forecast exchange rate volatility to determine the potential range surrounding their exchange rate forecast. a. True b. False ANS: T

PTS: 1

42. If the pattern of currency values over time appears random, then technical forecasting is appropriate. a. True b. False ANS: F

PTS: 1

43. Inflation and interest rate differentials between the U.S. and foreign countries are examples of variables that could be used in fundamental forecasting. a. True b. False ANS: T

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

44. A regression analysis of the Australian dollar value on the inflation differential between the U.S. and Australia produced a coefficient of .8. Thus, for every 1% increase in the inflation differential, the Australian dollar is expected to depreciate by .8%. a. True b. False ANS: F

PTS: 1

45. The most sophisticated forecasting techniques provide consistently accurate forecasts. a. True b. False ANS: F

PTS: 1

46. If the forward rate is used as an indicator of the future spot rate, the spot rate is expected to appreciate or depreciate by the same amount as the forward premium or discount, respectively. a. True b. False ANS: T

PTS: 1

47. Research indicates that currency forecasting services almost always outperform forecasts based on the forward rate. a. True b. False ANS: F

PTS: 1

48. When measuring forecast performance of different currencies, it is often useful to adjust for their relative sizes. Thus, percentages, rather than nominal amounts, are often used to compute forecast errors. a. True b. False ANS: T

PTS: 1

49. The closer graphical points are to the perfect forecast line, the better is the forecast. a. True b. False ANS: T

PTS: 1

50. Foreign exchange markets appear to be strong-form efficient. a. True b. False ANS: F

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

51. A motivation for forecasting exchange rate volatility is to obtain a range surrounding the forecast. a. True b. False ANS: T

PTS: 1

52. Two methods to assess exchange rate volatility are the volatility of historical exchange rate movements and the exchange rate's implied standard deviation from the currency option pricing model. a. True b. False ANS: T

PTS: 1

53. Market-based forecasting involves the use of historical exchange rate data to predict future values. a. True b. False ANS: F

PTS: 1

54. Fundamental models examine moving averages over time and thus allow the development of a forecasting rule. a. True b. False ANS: F

PTS: 1

55. A forecasting technique based on fundamental relationships between economic variables and exchange rates, such as inflation, is referred to as technical forecasting. a. True b. False ANS: F

PTS: 1

56. Usually, fundamental forecasting is used for short-term forecasts, while technical forecasting is used for longer-term forecasts. a. True b. False ANS: F

PTS: 1

57. If points are scattered evenly on both sides of the perfect forecast line, then the forecast appears to be very accurate. a. True b. False ANS: F

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

58. If foreign exchange markets are strong-form efficient, then all relevant public and private information is already reflected in today's exchange rates. a. True b. False ANS: T

PTS: 1

59. Exchange rates one year in advance are typically forecasted with almost perfect accuracy for the major currencies, but not for currencies of smaller countries. a. True b. False ANS: F

PTS: 1

60. The potential forecast error is larger for currencies that are more volatile. a. True b. False ANS: T

PTS: 1

61. A forecast of a currency one year in advance is typically more accurate than a forecast one week in advance since the currency reverts to equilibrium over a longer term period. a. True b. False ANS: F

PTS: 1

62. In general, any key managerial decision that is based on forecasted exchange rates should rely completely on one forecast rather than alternative exchange rate scenarios. a. True b. False ANS: F

PTS: 1

63. Monson Co., based in the U.S., exports products to Japan denominated in yen. If the forecasted value of the yen is substantially ____ than the forward rate, Monson Co. will likely decide ____ the payments. a. higher; to hedge b. lower; not to hedge c. higher; not to hedge d. none of the above ANS: C

PTS: 1

64. When a U.S.-based MNC wants to determine whether to establish a subsidiary in a foreign country, it will always accept that project if the foreign currency is expected to appreciate. a. True b. False ANS: F

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

65. The following is not a limitation of technical forecasting: a. It's not suitable for long-term forecasts of exchange rates. b. It doesn't provide point estimates or a range of possible future values. c. It cannot be applied to currencies that exhibit random movements. d. It cannot be applied to currencies that exhibit a continuous trend for short-term forecast.

ANS: D

PTS: 1

66. The following regression model was estimated to forecast the percentage change in the Australian Dollar (AUD): AUDt = a0 + a1INTt + a2INFt  1 + t, where AUD is the quarterly change in the Australian Dollar, INT is the real interest rate differential in period t between the U.S. and Australia, and INF is the inflation rate differential between the U.S. and Australia in the previous period. Regression results indicate coefficients of a0 = .001; a1 = .8; and a2 = .5. Assume that INFt  1 = 4%. However, the interest rate differential is not known at the beginning of period t and must be estimated. You have developed the following probability distribution: Probability 20% 80%

Possible Outcome 3% 4%

There is a 20% probability that the Australian dollar will change by ____, and an 80% probability it will change by ____. a. 4.5%; 6.1%; b. 6.1%; 4.5% c. 4.5%; 5.3% d. None of the above ANS: C SOLUTION:

Probability 20% = .001 + (.8)(.03) + (.5)(.04) = 4.5% Probability 80% = .001 + (.8)(.04) + (.5)(.04) = 5.3%

PTS: 1 67. Purchasing power parity is used in: a. technical forecasting. b. fundamental forecasting. c. market-based accounting. d. all of the above.

ANS: B

PTS: 1

68. If speculators expect the spot rate of the yen in 60 days to be ____ than the 60-day forward rate on the yen, they will ____ the yen forward and put ____ pressure on the yen's forward rate. a. higher; buy; upward

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

b. higher; sell; downward c. higher; sell; upward d. lower; buy; upward ANS: A

PTS: 1

69. If speculators expect the spot rate of the Canadian dollar in 30 days to be ____ than the 30-day forward rate on Canadian dollars, they will ____ Canadian dollars forward and put ____ pressure on the Canadian dollar forward rate. a. lower; sell; upward b. lower; sell; downward c. higher; sell; upward d. higher; sell; downward ANS: B

PTS: 1

70. Assume that U.S. annual inflation equals 8%, while Japanese annual inflation equals 5%. If purchasing power parity is used to forecast the future spot rate, the forecast would reflect an expectation of: a. appreciation of yen's value over the next year. b. depreciation of yen's value over the next year. c. no change in yen's value over the next year. d. information about interest rates is needed to answer this question.

ANS: A

PTS: 1

71. Assume that U.S. interest rates are 6%, while British interest rates are 7%. If the international Fisher effect holds and is used to determine the future spot rate, the forecast would reflect an expectation of: a. appreciation of pound's value over the next year. b. depreciation of pound's value over the next year. c. no change in pound's value over the next year. d. not enough information to answer this question.

ANS: B

PTS: 1

72. If the foreign exchange market is ____ efficient, then technical analysis is not useful in forecasting exchange rate movements. a. weak-form b. semistrong-form c. strong form d. all of the above ANS: D

PTS: 1

73. If today's exchange rate reflects any historical trends in Canadian dollar exchange rate movements, but not all relevant public information, then the Canadian dollar market is: a. weak-form efficient. b. semistrong-form efficient.

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

c. strong-form efficient. d. all of the above.

ANS: A

PTS: 1

74. Leila Corporation used the following regression model to determine if the forecasts over the last ten years were biased: St = a0 + a1Ft  1 + t, where St is the spot rate of the yen in year t and Ft  1 is the forward rate of the yen in year t  1.

Regression results reveal coefficients of a0 = 0 and a1 = .30. Thus, Leila Corporation has reason to believe that its past forecasts have ____ the realized spot rate. a. overestimated b. underestimated c. correctly estimated d. none of the above ANS: A

PTS: 1

75. Assume that U.S. interest rate for the next three years is 5%, 6%, and 7% respectively. Also assume that Canadian interest rates for the next three years are 3%, 6%, 9%. The current Canadian spot rate is $.840. What is the approximate three-year forecast of Canadian dollar spot rate if the three-year forward rate is used as a forecast? a. $.840 b. $.890 c. $.856 d. $.854 ANS: C SOLUTION:

{[(1.05)(1.06)(1.07)]/[(1.03)(1.05)(1.08)]}  $.84 = $.856

PTS: 1 76. Which of the following is not one of the major reasons for MNCs to forecast exchange rates? a. to decide in which foreign market to invest the excess cash. b. to decide where to borrow at the lowest cost. c. to determine whether to require the subsidiary to remit the funds or invest them locally. d. to speculate on the exchange rate movements.

ANS: D

PTS: 1

77. Sensitivity analysis allows for all of the following except: a. accountability for uncertainty. b. focus on a single point estimate of future exchange rates. c. development of a range of possible future values. d. consideration of alternative scenarios.

ANS: B

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

78. If graphical points lie above the perfect forecast line, than the forecast overestimated the future value. a. True b. False ANS: F

PTS: 1

79. A regression model was applied to explain movements in the Canadian dollar's value over time. The coefficient for the inflation differential between the U.S. and Canada was 0.2. The coefficient of the interest rate differential between the U.S. and Canada produced a coefficient of 0.8. Thus, the Canadian dollar depreciates when the inflation differential ____ and the interest rate differential ____. a. increases; increases b. decreases; increases c. increases; decreases d. increases; decreases ANS: C

PTS: 1

80. If the pattern of currency values over time appears random, then technical forecasting is appropriate. a. True b. False ANS: F

PTS: 1

81. Market-based forecasting is based on fundamental relationships between economic variables and exchange rates. a. True b. False ANS: F

PTS: 1

82. In market-based forecasting, a forward rate quoted for a specific date in the future can be used as the forecasted spot rate on that future date. a. True b. False ANS: T

PTS: 1

83. Since the forward rate does not capture the nominal interest rate between two countries, it should provide a less accurate forecast for currencies in high-inflation countries than the spot rate. a. True b. False ANS: F

PTS: 1

84. Inflation and interest rate differentials between the U.S. and foreign countries are examples of variables that could be used in fundamental forecasting. a. True b. False ANS: T

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

85. If a foreign country's interest rate is similar to the U.S. rate, the forward rate premium or discount will be close to zero, meaning that the forward rate and spot rate will provide similar forecasts. a. True b. False ANS: T

PTS: 1

86. Using the inflation differential between two countries to forecast their exchange rates is not always accurate because of such factors as the uncertain timing of the impact of inflation and barriers to trade. a. True b. False ANS: T

PTS: 1

87. When measuring forecast performance of different currencies, it is often useful to adjust for their relative sizes. Thus, percentages rather than nominal amounts are often used to compute forecast errors. a. True b. False ANS: T

PTS: 1

88. Forecast errors tend to be large for short forecast horizons. a. True b. False ANS: F

PTS: 1

89. A motivation for forecasting exchange rate volatility is to obtain a range surrounding the forecast. a. True b. False ANS: T

PTS: 1

90. Two methods to assess exchange rate volatility are the volatility of historical exchange rate movements and the exchange rate's implied standard deviation from the currency option pricing model. a. True b. False ANS: T

PTS: 1

91. Which of the following is not a forecasting technique mentioned in your text? a. Accounting-based forecasting b. Technical forecasting c. Fundamental forecasting d. Market-based forecasting e. Mixed forecasting ANS: A

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

92. The following regression model was estimated to forecast the value of the Malaysian ringgit (MYR): MYRt = a0 + a1INCt  1 + a2INFt  1 + t, where MYR is the quarterly change in the ringgit, INF is the previous quarterly percentage change in the inflation differential, and INC is the previous quarterly percentage change in the income growth differential. Regression results indicate coefficients of a0 = 0.005; a1 = 0.4; and a2 = 0.7. The most recent quarterly percentage change in the inflation differential is 5%, while the most recent quarterly percentage change in the income differential is 3%. Using this information, the forecast for the percentage change in the ringgit is a. 4.60%. b. 1.80%. c. 5.2%. d. 4.60%. e. None of the above ANS: B

PTS: 1

93. Pro Corp, a U.S.-based MNC, uses purchasing power parity to forecast the value of the Thai baht (THB), which has a current exchange rate of $0.022. Inflation in the U.S. is expected to be 3% during the next year, while inflation in Thailand is expected to be 10%. Under this scenario, Pro Corp would forecast the value of the baht at the end of the year to be: a. $0.023. b. $0.021. c. $0.020. d. None of the above ANS: B

PTS: 1

94. Small Corporation would like to forecast the value of the Cyprus pound (CYP) five years from now using forward rates. Unfortunately, Small is unable to obtain quotes for five-year forward contracts.

However, Small observes that the five-year interest rate in the U.S. is 11%, while the Cyprus five-year interest rate is 15%. Based on this information, the Cyprus pound should ____ by ____% over the next five years. a. appreciate; 16.22 b. depreciate; 16.22 c. appreciate; 6.66 d. depreciate; 6.66 e. none of the above ANS: B

PTS: 1

95. The one-year forward rate of the British pound is $1.55, while the current spot rate is $1.60. Based on the forward rate, what is the expected percentage change in the British pound over the next year? a. +5.0% b. 3.1% c. +3.1% d. +3.2% e. None of the above ANS: B

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

96. Which of the following is not a method of forecasting exchange rate volatility? a. Using the absolute forecast error as a percentage of the realized value to improve your forecast. b. Using the volatility of historical exchange rate movements as a forecast for the future. c. Using a time series of volatility patterns in previous periods. d. Deriving the exchange rate's implied standard deviation from the currency option pricing model.

ANS: A

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Chapter 10—Measuring Exposure to Exchange Rate Fluctuations 1. Translation exposure reflects: a. the exposure of a firm's international contractual transactions to exchange rate fluctuations. b. the exposure of a firm's local currency value to transactions between foreign exchange traders. c. the exposure of a firm's financial statements to exchange rate fluctuations. d. the exposure of a firm's cash flows to exchange rate fluctuations.

ANS: C

PTS: 1

2. Transaction exposure reflects: a. the exposure of a firm's international contractual transactions to exchange rate fluctuations. b. the exposure of a firm's local currency value to transactions between foreign exchange traders. c. the exposure of a firm's financial statements to exchange rate fluctuations. d. the exposure of a firm's cash flows to exchange rate fluctuations.

ANS: A

PTS: 1

3. Economic exposure refers to: a. the exposure of a firm's international contractual transactions to exchange rate fluctuations. b. the exposure of a firm's local currency value to transactions between foreign exchange traders. c. the exposure of a firm's financial statements to exchange rate fluctuations. d. the exposure of a firm's cash flows to exchange rate fluctuations. e. the exposure of a country's economy (specifically GNP) to exchange rate fluctuations.

ANS: D

PTS: 1

4. Diz Co. is a U.S.-based MNC with net cash inflows of euros and net cash inflows of Swiss francs.

These two currencies are highly correlated in their movements against the dollar. Yanta Co. is a U.S.-based MNC that has the same level of net cash flows in these currencies as Diz Co. except that its euros represent net cash outflows. Which firm has a higher exposure to exchange rate risk? a. Diz Co. b. Yanta Co. c. the firms have about the same level of exposure. d. neither firm has any exposure.

ANS: A

PTS: 1

5. Jacko Co. is a U.S.-based MNC with net cash inflows of euros and net cash inflows of Sunland francs.

These two currencies are highly negatively correlated in their movements against the dollar. Kriner Co. is a U.S.-based MNC that has the same exposure as Jacko Co. in these currencies, except that its Sunland francs represent cash outflows. Which firm has a high exposure to exchange rate risk? a. Jacko Co. b. Kriner Co. c. the firms have about the same level of exposure. © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

d. neither firm has any exposure.

ANS: B

PTS: 1

6. According to the text, currency variability levels ____ perfectly stable over time, and currency correlations ____ perfectly stable over time. a. are; are not b. are; are c. are not; are not d. are not; are ANS: C

PTS: 1

7. Which of the following operations benefits from appreciation of the firm's local currency? a. borrowing in a foreign currency and converting the funds to the local currency prior to the appreciation. b. receiving earnings dividends from foreign subsidiaries. c. purchasing supplies locally rather than overseas. d. exporting to foreign countries.

ANS: A

PTS: 1

8. Which of the following operations benefit(s) from depreciation of the firm's local currency? a. borrowing in a foreign country and converting the funds to the local currency prior to the depreciation. b. purchasing foreign supplies. c. investing in foreign bank accounts denominated in foreign currencies prior to depreciation of the local currency. d. A and B ANS: C

PTS: 1

9. Economic exposure can affect: a. MNCs only. b. purely domestic firms only. c. A and B d. none of the above ANS: C

PTS: 1

10. Under FASB 52: a. translation gains and losses are included in the reported net income. b. translation gains and losses are included in stockholder's equity. c. A and B d. none of the above ANS: B

PTS: 1

11. Assume that the British pound and Swiss franc are highly correlated. A U.S. firm anticipates the equivalent of $1 million cash outflows in francs and the equivalent of $1 million cash outflows in pounds. During a ____ cycle, the firm is ____ affected by its exposure. a. strong dollar; favorably © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

b. weak dollar; not c. strong dollar; not d. weak dollar; favorably ANS: A

PTS: 1

12. A U.S. MNC has the equivalent of $1 million cash outflows in each of two highly negatively correlated currencies. During ____ dollar cycles, cash outflows are ____. a. weak; somewhat stable b. weak; favorably affected c. weak; adversely affected d. none of the above ANS: A

PTS: 1

13. Magent Co. is a U.S. company that has exposure to the Swiss francs (SF) and Danish kroner (DK). It has net inflows of SF200 million and net outflows of DK500 million. The present exchange rate of the SF is about $.40 while the present exchange rate of the DK is $.10. Magent Co. has not hedged these positions. The SF and DK are highly correlated in their movements against the dollar. If the dollar weakens, then Magent Co. will: a. benefit, because the dollar value of its SF position exceeds the dollar value of its DK position. b. benefit, because the dollar value of its DK position exceeds the dollar value of its SF position. c. be adversely affected, because the dollar value of its SF position exceeds the dollar value of its DK position. d. be adversely affected, because the dollar value of its DK position exceeds the dollar value of its SF position.

ANS: A

PTS: 1

14. Generally, MNCs with less foreign costs than foreign revenues will be ____ affected by a ____ foreign currency. a. favorably; stronger b. not; stronger c. favorably; weaker d. not; weaker e. B and D ANS: A

PTS: 1

15. When the dollar strengthens, the reported consolidated earnings of U.S.-based MNCs are ____ affected by translation exposure. When the dollar weakens, the reported consolidated earnings are ____ affected. a. favorably; favorably affected but by a smaller degree b. favorably; favorably affected by a higher degree c. unfavorably; favorably affected d. favorably; unfavorably affected ANS: C

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

16. A firm produces goods for which substitute goods are produced in all countries. Appreciation of the firm's local currency should: a. increase local sales as it reduces foreign competition in local markets. b. increase the firm's exports denominated in the local currency. c. increase the returns earned on the firm's foreign bank deposits. d. increase the firm's cash outflow required to pay for imported supplies denominated in a foreign currency. e. none of the above ANS: E

PTS: 1

17. A firm produces goods for which substitute goods are produced in all countries. Depreciation of the firm's local currency should: a. decrease local sales as foreign competition in local markets is reduced. b. decrease the firm's exports denominated in the local currency. c. decrease the returns earned on the firm's foreign bank deposits. d. decrease the firm's cash outflow required to pay for imported supplies denominated in a foreign currency. e. none of the above ANS: E

PTS: 1

18. If a U.S. firm's cost of goods sold exposure is much greater than its sales exposure in Switzerland, there is a ____ overall impact of the Swiss franc's depreciation against the dollar on ____. a. positive; interest expenses b. positive; gross profit c. negative; gross profit d. negative; interest expenses ANS: B

PTS: 1

19. Assume that your firm is an importer of Mexican chairs denominated in pesos. Your competition is mainly U.S. producers of chairs. You wish to assess the relationship between the percentage change in its stock price (SPt) and the percentage change in the peso's value relative to the dollar (PESOt). SPt is the dependent variable. You apply the regression model to an earlier subperiod and a more recent subperiod. In the recent subperiod, you increased your importing volume. You should expect that the regression coefficient in the PESOt variable would be ____ in the first subperiod and ____ in the second subperiod. a. negative; positive b. positive; positive c. positive; negative d. negative; negative ANS: D

PTS: 1

20. A set of currency cash inflows is more volatile if the correlations are low. a. True b. False ANS: F

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

21. Which of the following is not a form of exposure to exchange rate fluctuations? a. transaction exposure. b. credit exposure. c. economic exposure. d. translation exposure.

ANS: B

PTS: 1

22. Subsidiary A of Mega Corporation has net inflows in Australian dollars of A$1,000,000, while Subsidiary B has net outflows in Australian dollars of A$1,500,000. The expected exchange rate of the Australian dollar is $.55. What is the net inflow or outflow as measured in U.S. dollars? a. $500,000 outflow. b. $500,000 inflow. c. $275,000 inflow. d. $275,000 outflow.

ANS: D SOLUTION:

A$1,000,000  A$1,500,000 = A$500,000  $.55 = $275,000

PTS: 1 23. Dubas Co. is a U.S.-based MNC that has a subsidiary in Germany and another subsidiary in Greece.

Both subsidiaries frequently remit their earnings back to the parent company. The German subsidiary generated a net outflow of €2,000,000 this year, while the Greek subsidiary generated a net inflow of €1,500,000. What is the net inflow or outflow as measured in U.S. dollars this year? The exchange rate for the euro is $1.05. a. $3,675,000 outflow b. $525,000 outflow c. $525,000 inflow d. $210,000 outflow ANS: B SOLUTION:

€2,000,000 + €1,500,000 = €500,000  $1.05 = $525,000

PTS: 1 24. One argument for exchange rate irrelevance is that: a. MNCs can hedge exchange rate exposure much more effectively than individual investors. b. investors can invest in a diversified stock portfolio of MNCs that have different exposures to exchange rates. c. purchasing power parity does not hold very well. d. MNCs are typically not diversified across numerous countries.

ANS: B

PTS: 1

25. ____ exposure is the degree to which the value of contractual transactions can be affected by exchange rate fluctuations. a. Transaction

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

b. Economic c. Translation d. None of the above ANS: A

PTS: 1

26. If an MNC expects cash inflows of equal amounts in two currencies, and the two currencies are ____ correlated, the MNC's transaction exposure is relatively ____. a. negatively; high b. negatively; low c. positively; low d. none of the above ANS: B

PTS: 1

27. If an MNC has a net inflow in one currency and a net outflow of about the same amount in another currency, then the MNCs' transaction exposure is ____ if the two currencies are ____ correlated. a. high; positively b. low; negatively c. high; negatively d. none of the above ANS: C

PTS: 1

Exhibit 10-1 Cerra Co. expects to receive 5 million euros tomorrow as a result of selling goods to the Netherlands.

Cerra estimates the standard deviation of daily percentage changes of the euro to be 1 percent over the last 100 days. Assume that these percentage changes are normally distributed. Use the value-at-risk (VAR) method based on a 95% confidence level for the following question(s).

28. Refer to Exhibit 10-1. What is the maximum one-day loss if the expected percentage change of the euro tomorrow is 0.5%? a. 0.5% b. 2.2% c. 1.5% d. 1.2% ANS: D SOLUTION:

0.5%  (1.65  1%) = 1.2%

PTS: 1 29. Refer to Exhibit 10-1. What is the maximum one-day loss in dollars if the expected percentage change of the euro tomorrow is 0.5%? The current spot rate of the euro (before considering the maximum one-day loss) is $1.01. a. $75,750. b. $60,600. c. $111,100. d. $25,250. © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

ANS: B SOLUTION:

0.5%  (1.65  1%) = 1.2% $1.01  (.012)  5,000,000 = $60,600

PTS: 1 30. The maximum one-day loss computed for the value-at-risk (VAR) method does not depend on: a. the expected percentage change in the currency for the next day. b. the standard deviation of the daily percentage changes in the currency over a previous period. c. the current level of interest rates. d. the confidence level used.

ANS: C

PTS: 1

Exhibit 10-2 Volusia, Inc. is a U.S.-based exporting firm that expects to receive payments denominated in both euros and Canadian dollars in one month. Based on today's spot rates, the dollar value of the funds to be received is estimated at $500,000 for the euros and $300,000 for the Canadian dollars. Based on data for the last fifty months, Volusia estimates the standard deviation of monthly percentage changes to be 8 percent for the euro and 3 percent for the Canadian dollar. The correlation coefficient between the euro and the Canadian dollar is 0.30.

31. Refer to Exhibit 10-2. What is the portfolio standard deviation? a. 3.00%. b. 5.44%. c. 17.98%. d. none of the above ANS: B SOLUTION:

PTS: 1 32. Refer to Exhibit 10-2. Assuming an expected percentage change of 0 percent for each currency during the next month, what is the maximum one-month loss of the currency portfolio? Use a 95 percent confidence level and assume the monthly percentage changes for each currency are normally distributed. a. 9.00%. b. 30.00%. c. 5.00%. d. none of the above ANS: A

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

SOLUTION:

0%  (1.65  5.44%) = 9.00% PTS: 1 33. Appreciation in a firm's local currency causes a(n) ____ in cash inflows and a(n) ____ in cash outflows. a. reduction; reduction b. increase; increase c. increase; reduction d. reduction; increase ANS: A

PTS: 1

34. In general, a firm that concentrates on local sales, has very little foreign competition, and obtains foreign supplies (denominated in foreign currencies) will likely ____ a(n) ____ local currency. a. be hurt by; appreciated b. benefit from; depreciated c. be hurt by; depreciated d. none of the above ANS: C

PTS: 1

35. The ____ the percentage of an MNC's business conducted by its foreign subsidiaries, the ____ the percentage of a given financial statement item that is susceptible to translation exposure. a. greater; smaller b. smaller; greater c. greater; greater d. none of the above ANS: C

PTS: 1

36. Under FASB 52, consolidated earnings are sensitive to the functional currency's weighted average exchange rate. a. True b. False ANS: T

PTS: 1

37. If the U.S. dollar appreciates, an MNC's: a. U.S. sales will probably decrease. b. exports denominated in U.S. dollars will probably increase. c. interest owed on foreign funds borrowed will probably increase. d. exports denominated in foreign currencies will probably increase. e. all of the above ANS: A

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

38. Assume that Mill Corporation, a U.S.-based MNC, has applied the following regression model to estimate the sensitivity of its cash flows to exchange rate movements: PCFt = a0 + a1et + t where the term on the left-hand side is the percentage change in inflation-adjusted cash flows measured in the firm's home currency over period t, and et is the percentage change in the exchange rate of the currency over period t. The regression model estimates a coefficient of a1 of 2. This indicates that: a. if the foreign currency appreciates by 1%, Mill's cash flows will decline by 2%. b. if the foreign currency appreciates by 1%, Mill's cash flows will decline by .2%. c. if the foreign currency depreciates by 1%, Mill's cash flows will increase by 2%. d. if the foreign currency depreciates by 1%, Mill's cash flows will decline by 2%. e. none of the above ANS: B

PTS: 1

39. ____ is (are) not a determinant of translation exposure. a. The MNC's degree of foreign involvement b. The locations of foreign subsidiaries c. The local (domestic) earnings of the MNC d. The accounting methods used ANS: C

PTS: 1

40. The following regression model was run by a U.S.-based MNC to determine its degree of economic exposure as it relates to the Australian dollar and Sudanese dinar (SDD): PCFt = a0 + a1et + t where the term on the left-hand side is the percentage change in inflation-adjusted cash flows measured in the firm's home currency over period t, and et is the percentage change in the exchange rate of the currency over period t. The regression was run over two subperiods for each of the two currencies, with the following results:

Currency Australian dollar (A$) Sudanese dinar (SDD)

Regression Coefficient (a1) Earlier Subperiod .80 .20

Regression Coefficient (a1) Recent Subperiod .10 .25

Based on these results, which of the following statements is probably not true? a. The MNC was more sensitive to movements in the Australian dollar than in the dinar in the earlier subperiod. b. The MNC was more sensitive to movements in the dinar than in the Australian dollar in the more recent subperiod.

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

c. The MNC probably had more outflows than inflows in Australian dollars in the earlier subperiod. d. The MNC probably had more inflows than outflows denominated in dinar in the more recent subperiod. e. All of the above are true.

ANS: C

PTS: 1

41. Consider an MNC that is exposed to the Taiwan dollar (TWD) and the Egyptian pound (EGP). 25% of the MNC's funds are Taiwan dollars and 75% are pounds. The standard deviation of exchange movements is 7% for Taiwan dollars and 5% for pounds. The correlation coefficient between movements in the value of the Taiwan dollar and the pound is .7. Based on this information, the standard deviation of this two-currency portfolio is approximately: a. 5.13%. b. 2.63%. c. 4.33%. d. 5.55%.

ANS: A SOLUTION:

PTS: 1 42. Consider an MNC that is exposed to the Bulgarian lev (BGL) and the Romanian leu (ROL). 30% of the MNC's funds are lev and 70% are leu. The standard deviation of exchange movements is 10% for lev and 15% for leu. The correlation coefficient between movements in the value of the lev and the leu is .85. Based on this information, the standard deviation of this two-currency portfolio is approximately: a. 17.28%. b. 13.15%. c. 14.50%. d. 12.04%.

ANS: B SOLUTION:

PTS: 1 43. One argument why exchange rate risk is irrelevant to corporations is that shareholders can deal with this risk individually. a. True b. False ANS: T

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

44. Because creditors may prefer that firms maintain low exposure to exchange rate risk, exchange rate movements may cause earnings to be more volatile, and because investors may prefer corporations to perform hedging for them, exchange rate risk is probably relevant. a. True b. False ANS: T

PTS: 1

45. A firm's transaction exposure in any foreign currency is based solely on the size of its open position in that currency. a. True b. False ANS: F

PTS: 1

46. Two highly negatively correlated currencies move in tandem almost as if they are the same currency. a. True b. False ANS: F

PTS: 1

47. The transaction exposure of two inflow currencies is offset when the correlation between the currencies is high. a. True b. False ANS: F

PTS: 1

48. The Canadian dollar consistently appears to move almost independently of other currencies. That is it exhibits low correlations with the other currencies. a. True b. False ANS: T

PTS: 1

49. U.S. exporters may not necessarily benefit from weak-dollar periods if foreign competitors are willing to reduce their profit margin. a. True b. False ANS: T

PTS: 1

50. If the functional currencies for reporting purposes are highly correlated, translation exposure is magnified. a. True b. False ANS: T

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

51. An MNC can avoid translation exposure if its earnings are not remitted by the foreign subsidiary to the parent. a. True b. False ANS: F

PTS: 1

52. Assume a regression model in which the dependent variable is the firm's stock price percentage change, and the independent variable is percentage change in the foreign currency. The coefficient is negative. This implies that the company's stock price increases if the foreign currency appreciates. a. True b. False ANS: F

PTS: 1

53. A company may become more exposed or sensitive to an individual currency's movements over time for several reasons, including a reduction in hedging, a greater involvement in the foreign country, or an increased use of the foreign currency. a. True b. False ANS: T

PTS: 1

54. Regression analysis cannot be used to assess the sensitivity of a company's performance to economic conditions because economic conditions are unpredictable. a. True b. False ANS: T

PTS: 1

55. A high correlation between two currencies would be desirable for achieving low exchange rate risk if one is an inflow currency and the other is an outflow currency. a. True b. False ANS: T

PTS: 1

56. Firms with more in foreign costs than in foreign revenues will be favorably affected by a stronger foreign currency. a. True b. False ANS: F

PTS: 1

57. The exposure of an MNC's consolidated financial statements to exchange rate fluctuations is known as transaction exposure. a. True b. False ANS: F

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

58. In general, translation exposure is larger with MNCs that have a larger proportion of earnings generated by foreign subsidiaries. a. True b. False ANS: T

PTS: 1

59. A reduction in hedging will probably reduce transaction exposure. a. True b. False ANS: F

PTS: 1

60. The VAR method presumes that the distribution of exchange rate movements is normal. a. True b. False ANS: T

PTS: 1

61. The VAR method assumes that the volatility (standard deviation) of exchange rate movements changes over time. a. True b. False ANS: F

PTS: 1

62. If exchange rate movements are less volatile in the past than in the future, the estimated maximum expected loss derived from the VAR method will be underestimated. a. True b. False ANS: T

PTS: 1

63. Some MNCs are subject to economic exposure without being subject to transaction exposure. a. True b. False ANS: T

PTS: 1

64. If positions in a specific currency among an MNC's subsidiaries offset each other, the decision by one subsidiary to hedge its position in that currency would increase the MNC's overall exposure. a. True b. False ANS: T

PTS: 1

65. Vada, Inc. exports computers to Australia invoiced in U.S. dollars. Its main competitor is located in Japan. Vada is subject to: a. economic exposure. © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

b. transaction exposure. c. translation exposure. d. economic and transaction exposure.

ANS: A

PTS: 1

66. Jenco Co. imports raw materials from Japan, invoiced in U.S. dollars. The price it pays is not expected to change for the next several years. If the Japanese yen appreciates, its imports from Japan will probably ____ and if the Japanese yen depreciates, its imports from Japan will probably ____. a. increase; decrease b. decrease; increase c. increase; stay the same d. stay the same; stay the same ANS: D

PTS: 1

67. Yomance Co. is a U.S. company that has exposure to Japanese yen and British pounds. It has net inflows of 5,000,000 yen and net outflows of 60,000 pounds. The present exchange rate of the Japanese yen is $.012 while the present exchange rate of the British pound is $1.50. Yomance Co. has not hedged its positions. The yen and pound movements against the dollar are highly and positively correlated. If the dollar strengthens, then Yomance Co. will: a. benefit, because the dollar value of its pound position exceeds the dollar value of its yen position. b. benefit, because the dollar value of its yen position exceeds the dollar value of its pound position. c. be adversely affected, because the dollar value of its pound position exceeds the dollar value of its yen position. d. be adversely affected, because the dollar value of its yen position exceeds the dollar value of its pound position.

ANS: A

PTS: 1

68. Generally, MNCs with less foreign revenues than foreign costs will be ____ affected by a ____ foreign currency. a. favorably; stronger b. favorably; weaker c. not; stronger d. not; weaker ANS: B

PTS: 1

69. If a U.S. firm's cost of goods sold in Switzerland is much greater than its sales in Switzerland, the appreciation of the Swiss franc has a ____ impact on the firm's ____. a. positive; interest expenses b. positive; gross profit c. negative; gross profit d. negative; interest expenses ANS: C

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

70. If a U.S. firm's sales in Australia are much greater than its cost of goods sold in Australia, the appreciation of the Australian dollar has a ____ impact on the firm's ____. a. positive; interest expenses b. positive; gross profit c. negative; interest expenses d. negative; gross profit ANS: B

PTS: 1

71. U.S. based Majestic Co. sells products to U.S. consumers and purchases all of materials from U.S. suppliers. Its main competitor is located in Belgium. Majestic Co. is subject to: a. economic exposure. b. translation exposure. c. transaction exposure. d. no exposure to exchange rate fluctuations.

ANS: A

PTS: 1

72. Vermont Co. has one foreign subsidiary. Its translation exposure is directly affected by each of the following, except: a. the interest rate in the country of the subsidiary. b. proportion of business conducted by the subsidiary. c. its accounting method. d. the exchange rate movements of the subsidiary's currency.

ANS: A

PTS: 1

73. Treck Co. expects to pay €200,000 in one month for its imports from Greece. It also expects to receive €250,000 for its exports to Italy in one month. Treck Co. estimates the standard deviation of monthly percentage changes of the euro to be 3 percent over the last 40 months. Assume that these percentage changes are normally distributed. Using the value-at-risk (VAR) method based on a 95% confidence level, what is the maximum one-month loss in dollars if the expected percentage change of the euro during next month is 2%? Assume that the current spot rate of the euro (before considering the maximum one-month loss) is $1.23. a. $38,468 b. $21,371 c. $17,097 d. $4,274 ANS: D SOLUTION:

Net exposure = €250,000  €200,000 = €50,000 Maximum one-month loss: 2%  (1.65  3%) = 6.95% $1.23  (.0695%)  €50,000 = $4,274

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

74. Jensen Co. expects to pay €50,000 in one month for its imports from France. It also expects to receive €200,000 for its exports to Belgium in one month. Jensen estimates the standard deviation of monthly percentage changes of the euro to be 2.5 percent over the last 50 months. Assume that these percentage changes are normally distributed. Using the value-at-risk (VAR) method based on a 97.5% confidence level, what is the maximum one month loss in dollars if the expected percentage change of the euro during next month is 2%? Assume that current spot rate of the euro (before considering the maximum one-month loss) is $1.35. a. $4,303 b. $7,830 c. $5,873 d. $1,958 ANS: C SOLUTION:

Net exposure = €200,000  €50,000 = €150,000 Maximum one-month loss: 2%  (1.96  2.5%) = 2.9% €150,000  $1.35  (0.029) = $5,873

PTS: 1 75. Lazer Co. is a U.S. firm that exports computers to Belgium invoiced in euros and to Italy invoiced in dollars. Additionally, Lazer Co. has a subsidiary in Korea that produces computers in South Korea and sells them there. Lazer also has competitors in different countries. Lazer Co. is subject to: a. transaction exposure. b. economic exposure. c. translation exposure. d. all of the above.

ANS: D

PTS: 1

76. Lampon Co. is a U.S. firm that has a subsidiary in Hong Kong that produces light fixtures and sells them to Japan, denominated in Japanese yen. Its subsidiary pays all of its expenses, including the cost of goods sold, in U.S. dollars. The Hong Kong dollar is pegged to the U.S. dollar. If the Japanese yen appreciates against the U.S. dollar, the Hong Kong subsidiary's revenue will ____, and its expenses will ____. a. increase; decrease b. decrease; remain unchanged c. decrease; increase d. increase; remain unchanged ANS: D

PTS: 1

77. Assume that the Japanese yen is expected to depreciate substantially over the next year. The U.S.-based MNC has a subsidiary in Japan, where its costs exceed revenues. The overall value of MNC will ____ because of the yen's depreciation. a. decrease b. increase c. remain unchanged d. A and C are possible ANS: B

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

78. If the net inflow of one currency is about the same amount as a net outflow in another currency, the firm will benefit if these two currencies are negatively correlated because the transaction exposure is offset. a. True b. False ANS: F

PTS: 1

79. A purely domestic firm is never exposed to exchange rate fluctuations. a. True b. False ANS: F

PTS: 1

80. The transaction exposure of two inflow currencies is offset when the correlation between the currencies is high. a. True b. False ANS: F

PTS: 1

81. Currency correlations are generally negative. a. True b. False ANS: F

PTS: 1

82. Dollar cash flows associated with two foreign inflow currencies will normally be less volatile if the standard deviations of the individual currencies are lower. a. True b. False ANS: T

PTS: 1

83. The maximum one-day loss estimated using the value-at-risk (VAR) method is independent of the confidence level used. a. True b. False ANS: F

PTS: 1

84. The degree to which a firm's present value of future cash flows can be influenced by exchange rate fluctuations is referred to as transaction exposure. a. True b. False ANS: F

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

85. Purely domestic firms are never affected by economic exposure. a. True b. False ANS: F

PTS: 1

86. U.S. exporters may not necessarily benefit from weak-dollar periods if foreign competitors are willing to reduce their profit margin. a. True b. False ANS: T

PTS: 1

87. Firms with more foreign costs than foreign revenues will generally be favorably affected by a stronger foreign currency. a. True b. False ANS: F

PTS: 1

88. Translation exposure affects an MNC's cash flows. a. True b. False ANS: F

PTS: 1

89. Since earnings can affect stock prices, many MNCs are concerned about translation exposure. a. True b. False ANS: T

PTS: 1

90. A company may become more exposed or sensitive to an individual currency's movements over time for several reasons, including a reduction in hedging, a greater involvement in the foreign country, or an increased use of the foreign currency. a. True b. False ANS: T

PTS: 1

91. Which of the following is not a form of exposure to exchange rate fluctuations? a. Transaction exposure b. Credit exposure c. Economic exposure d. Translation exposure ANS: B

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

92. Which of the following is not true regarding currency correlations? a. Two highly positively correlated currencies act almost as if they are the same currency. b. If two inflow currencies are highly positively correlated transaction exposure is somewhat offset. c. If two inflow currencies are negatively correlated transaction exposure is somewhat offset. d. If two currencies, one an inflow currency and the other an outflow currency, are highly positively correlated, transaction exposure is somewhat offset.

ANS: B

PTS: 1

93. If the U.S. dollar appreciates, a. an MNC's U.S. sales will probably decrease. b. an MNC's exports denominated in U.S. dollars will probably increase. c. an MNC's interest owed on foreign funds borrowed will probably increase. d. an MNC's exports denominated in foreign currencies will probably increase. e. all of the above ANS: A

PTS: 1

94. Which of the following is not true regarding economic exposure? a. Even purely domestic firms can be affected by economic exposure. b. In general, depreciation of the firm's local currency causes a decrease in both cash inflows and outflows. c. The degree of economic exposure will likely be much greater for a firm involved in international business than for a purely domestic firm. d. The impact of a change in the local currency on inflow and outflow variables can sometimes be indirect and therefore different from what is expected. e. All of the above are true.

ANS: B

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Chapter 11—Managing Transaction Exposure 1. Assume zero transaction costs. If the 90-day forward rate of the euro is an accurate estimate of the spot rate 90 days from now, then the real cost of hedging payables will be: a. positive. b. negative. c. positive if the forward rate exhibits a premium, and negative if the forward rate exhibits a discount. d. zero.

ANS: D

PTS: 1

2. Assume zero transaction costs. If the 180-day forward rate overestimates the spot rate 180 days from now, then the real cost of hedging payables will be: a. positive. b. negative. c. positive if the forward rate exhibits a premium, and negative if the forward rate exhibits a discount. d. zero.

ANS: A

PTS: 1

3. Assume the following information: U.S. deposit rate for 1 year U.S. borrowing rate for 1 year Swiss deposit rate for 1 year Swiss borrowing rate for 1 year Swiss forward rate for 1 year Swiss franc spot rate

= = = = = =

11% 12% 8% 10% $.40 $.39

Also assume that a U.S. exporter denominates its Swiss exports in Swiss francs and expects to receive SF600,000 in 1 year.

Using the information above, what will be the approximate value of these exports in 1 year in U.S. dollars given that the firm executes a forward hedge? a. $234,000. b. $238,584. c. $240,000. d. $236,127.

ANS: C SOLUTION:

SF600,000  $.40 = $240,000

PTS: 1 4. Assume the following information: U.S. deposit rate for 1 year U.S. borrowing rate for 1 year New Zealand deposit rate for 1 year

= = =

11% 12% 8%

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

New Zealand borrowing rate for 1 year New Zealand dollar forward rate for 1 year New Zealand dollar spot rate

= = =

10% $.40 $.39

Also assume that a U.S. exporter denominates its New Zealand exports in NZ$ and expects to receive NZ$600,000 in 1 year. You are a consultant for this firm.

Using the information above, what will be the approximate value of these exports in 1 year in U.S. dollars given that the firm executes a money market hedge? a. $238,584. b. $240,000. c. $234,000. d. $236,127.

ANS: D SOLUTION: 1. Borrow NZ$545,455 (NZ$600,000/1.1) = NZ$545,455.

2.

Convert NZ$545,455 to $212,727 (at $.39 per NZ$).

3.

Invest $212,727 to accumulate $236,127 ($212,727  1.11) = $236,127.

PTS: 1 5. An example of cross-hedging is: a. find two currencies that are highly positively correlated; match the payables of the one currency to the receivables of the other currency. b. use the forward market to sell forward whatever currencies you will receive. c. use the forward market to buy forward whatever currencies you will receive. d. B and C ANS: A

PTS: 1

6. Which of the following reflects a hedge of net receivables in British pounds by a U.S. firm? a. purchase a currency put option in British pounds. b. sell pounds forward. c. borrow U.S. dollars, convert them to pounds, and invest them in a British pound deposit. d. A and B ANS: D

PTS: 1

7. Which of the following reflects a hedge of net payables on British pounds by a U.S. firm? a. purchase a currency put option in British pounds. b. sell pounds forward. c. sell a currency call option in British pounds. d. borrow U.S. dollars, convert them to pounds, and invest them in a British pound deposit. e. A and B ANS: D

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

8. If Lazer Co. desired to lock in the maximum it would have to pay for its net payables in euros but wanted to be able to capitalize if the euro depreciates substantially against the dollar by the time payment is to be made, the most appropriate hedge would be: a. a money market hedge. b. purchasing euro put options. c. a forward purchase of euros. d. purchasing euro call options. e. selling euro call options.

ANS: D

PTS: 1

9. If Salerno Inc. desired to lock in a minimum rate at which it could sell its net receivables in Japanese yen but wanted to be able to capitalize if the yen appreciates substantially against the dollar by the time payment arrives, the most appropriate hedge would be: a. a money market hedge. b. a forward sale of yen. c. purchasing yen call options. d. purchasing yen put options. e. selling yen put options.

ANS: D

PTS: 1

10. The real cost of hedging payables with a forward contract equals: a. the nominal cost of hedging minus the nominal cost of not hedging. b. the nominal cost of not hedging minus the nominal cost of hedging. c. the nominal cost of hedging divided by the nominal cost of not hedging. d. the nominal cost of not hedging divided by the nominal cost of hedging.

ANS: A

PTS: 1

11. From the perspective of Detroit Co., which has payables in Mexican pesos and receivables in Canadian dollars, hedging the payables would be most desirable if the expected real cost of hedging payables is ____, and hedging the receivables would be most desirable if the expected real cost of hedging receivables is ____. a. negative; positive b. zero; positive c. zero; zero d. positive; negative e. negative; negative ANS: E

PTS: 1

12. Use the following information to calculate the dollar cost of using a money market hedge to hedge 200,000 pounds of payables due in 180 days. Assume the firm has no excess cash. Assume the spot rate of the pound is $2.02, the 180-day forward rate is $2.00. The British interest rate is 5%, and the U.S. interest rate is 4% over the 180-day period. a. $391,210. b. $396,190. c. $388,210. d. $384,761. e. none of the above © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

ANS: E SOLUTION: 1. Need to invest £190,476 (£200,000/1.05) = £190,476.

2.

Need to exchange $384,762 to obtain the £190,476 (£190,476  $2.02) = $384,762.

3.

At the end of 180 days, need $400,152 to repay loan ($384,762  1.04) = $400,152.

PTS: 1 13. Assume that Cooper Co. will not use its cash balances in a money market hedge. When deciding between a forward hedge and a money market hedge, it ____ determine which hedge is preferable before implementing the hedge. It ____ determine whether either hedge will outperform an unhedged strategy before implementing the hedge. a. can; can b. can; cannot c. cannot; can d. cannot; cannot ANS: B

PTS: 1

14. Foghat Co. has 1,000,000 euros as receivables due in 30 days, and is certain that the euro will depreciate substantially over time. Assuming that the firm is correct, the ideal strategy is to: a. sell euros forward. b. purchase euro currency put options. c. purchase euro currency call options. d. purchase euros forward. e. remain unhedged.

ANS: A

PTS: 1

15. Spears Co. will receive SF1,000,000 in 30 days. Use the following information to determine the total dollar amount received (after accounting for the option premium) if the firm purchases and exercises a put option: Exercise price Premium Spot rate Expected spot rate in 30 days 30-day forward rate a. b. c. d. e.

= = = = =

$.61 $.02 $.60 $.56 $.62

$630,000. $610,000. $600,000. $590,000. $580,000.

ANS: D SOLUTION:

($.61  $.02)  SF1,000,000 = $590,000

PTS: 1 © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

16. A ____ involves an exchange of currencies between two parties, with a promise to re-exchange currencies at a specified exchange rate and future date. a. long-term forward contract b. currency option contract c. parallel loan d. money market hedge ANS: C

PTS: 1

17. If interest rate parity exists and transactions costs are zero, the hedging of payables in euros with a forward hedge will ____. a. have the same result as a call option hedge on payables b. have the same result as a put option hedge on payables c. have the same result as a money market hedge on payables d. require more dollars than a money market hedge e. A and D ANS: C

PTS: 1

18. Assume that Parker Company will receive SF200,000 in 360 days. Assume the following interest rates:

360-day borrowing rate 360-day deposit rate

U.S. 7% 6%

Switzerland 5% 4%

Assume the forward rate of the Swiss franc is $.50 and the spot rate of the Swiss franc is $.48. If Parker Company uses a money market hedge, it will receive ____ in 360 days. a. $101,904 b. $101,923 c. $98,769 d. $96,914 e. $92,307 ANS: D SOLUTION: 1. Borrow SF190,476 (SF200,000/1.05) = SF190,476.

2.

Convert SF190,476 to $91,428 (SF190,476  $.48) = $91,428.

3.

Invest $91,428 at 6% to accumulate $96,914 ($91,428  1.06) = $96,914.

PTS: 1 19. The forward rate of the Swiss franc is $.50. The spot rate of the Swiss franc is $.48. The following interest rates exist:

360-day borrowing rate 360-day deposit rate

U.S. 7% 6%

Switzerland 5% 4%

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

You need to purchase SF200,000 in 360 days. If you use a money market hedge, the amount of dollars you need in 360 days is: a. $101,904. b. $101,923. c. $98,770. d. $96,914. e. $92,307.

ANS: C SOLUTION: 1. Need to invest SF192,308 (SF200,000/1.04) = SF192,308.

2.

Need to borrow $92,308 to exchange for SF192,308 (SF192,308  $.48) = $92,308.

3.

At the end of 360 days, need $98,769 to repay the loan ($92,308  1.07) = $98,770.

PTS: 1 20. Your company will receive C$600,000 in 90 days. The 90-day forward rate in the Canadian dollar is $.80. If you use a forward hedge, you will: a. receive $750,000 today. b. receive $750,000 in 90 days. c. pay $750,000 in 90 days. d. receive $480,000 today. e. receive $480,000 in 90 days.

ANS: E SOLUTION:

C$600,000  $0.80 = $480,000

PTS: 1 21. A call option exists on British pounds with an exercise price of $1.60, a 90-day expiration date, and a premium of $.03 per unit. A put option exists on British pounds with an exercise price of $1.60, a 90-day expiration date, and a premium of $.02 per unit. You plan to purchase options to cover your future receivables of 700,000 pounds in 90 days. You will exercise the option in 90 days (if at all).

You expect the spot rate of the pound to be $1.57 in 90 days. Determine the amount of dollars to be received, after deducting payment for the option premium. a. $1,169,000. b. $1,099,000. c. $1,106,000. d. $1,143,100. e. $1,134,000.

ANS: C SOLUTION:

($1.60  $.02)  £700,000 = $1,106,000

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

22. Assume that Smith Corporation will need to purchase 200,000 British pounds in 90 days. A call option exists on British pounds with an exercise price of $1.68, a 90-day expiration date, and a premium of $.04. A put option exists on British pounds, with an exercise price of $1.69, a 90-day expiration date, and a premium of $.03. Smith Corporation plans to purchase options to cover its future payables. It will exercise the option in 90 days (if at all). It expects the spot rate of the pound to be $1.76 in 90 days. Determine the amount of dollars it will pay for the payables, including the amount paid for the option premium. a. $360,000. b. $338,000. c. $332,000. d. $336,000. e. $344,000.

ANS: E SOLUTION:

($1.68 + $.04)  £200,000 = $344,000

PTS: 1 23. Assume that Kramer Co. will receive SF800,000 in 90 days. Today's spot rate of the Swiss franc is $.62, and the 90-day forward rate is $.635. Kramer has developed the following probability distribution for the spot rate in 90 days: Possible Spot Rate in 90 Days $.61 $.63 $.64 $.65

Probability 10% 20% 40% 30%

The probability that the forward hedge will result in more dollars received than not hedging is: a. 10%. b. 20%. c. 30%. d. 50%. e. 70%.

ANS: C SOLUTION:

The forward hedge will result in more dollars if the spot rate is less than the forward rate, which is true in the first two cases.

PTS: 1 24. Assume that Jones Co. will need to purchase 100,000 Singapore dollars (S$) in 180 days. Today's spot rate of the S$ is $.50, and the 180-day forward rate is $.53. A call option on S$ exists, with an exercise price of $.52, a premium of $.02, and a 180-day expiration date. A put option on S$ exists, with an exercise price of $.51, a premium of $.02, and a 180-day expiration date. Jones has developed the following probability distribution for the spot rate in 180 days:

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Possible Spot Rate in 90 Days $.48 $.53 $.55

Probability 10% 60% 30%

The probability that the forward hedge will result in a higher payment than the options hedge is ____ (include the amount paid for the premium when estimating the U.S. dollars required for the options hedge). a. 0% b. 10% c. 30% d. 40% e. 70% ANS: B SOLUTION:

There is a 10% probability that the call option will not be exercised. In that case, Jones will pay $.48  S$100,000 = $48,000, which is less than the amount paid with the forward hedge ($.53  S$100,000 = $53,000).

PTS: 1 25. Assume that Patton Co. will receive 100,000 New Zealand dollars (NZ$) in 180 days. Today's spot rate of the NZ$ is $.50, and the 180-day forward rate is $.51. A call option on NZ$ exists, with an exercise price of $.52, a premium of $.02, and a 180-day expiration date. A put option on NZ$ exists with an exercise price of $.51, a premium of $.02, and a 180-day expiration date. Patton Co. has developed the following probability distribution for the spot rate in 180 days: Possible Spot Rate in 90 Days $.48 $.49 $.55

Probability 10% 60% 30%

The probability that the forward hedge will result in more U.S. dollars received than the options hedge is ____ (deduct the amount paid for the premium when estimating the U.S. dollars received on the options hedge). a. 10% b. 30% c. 40% d. 70% e. none of the above ANS: D SOLUTION:

The put option will be exercised in the first two cases, resulting in an amount received per unit of $.51  $.02 = $.49. Thus, the forward hedge will result in more U.S. dollars received ($.51 per unit).

PTS: 1 © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

26. The ____ hedge is not a technique to eliminate transaction exposure discussed in your text. a. index b. futures c. forward d. money market e. currency option ANS: A

PTS: 1

27. Money Corp. frequently uses a forward hedge to hedge its Malaysian ringgit (MYR) receivables. For the next month, Money has identified its net exposure to the ringgit as being MYR1,500,000. The 30-day forward rate is $.23. Furthermore, Money's financial center has indicated that the possible values of the Malaysian ringgit at the end of next month are $.20 and $.25, with probabilities of .30 and .70, respectively. Based on this information, the revenue from hedging minus the revenue from not hedging receivables is____. a. $0. b. $7,500. c. $7,500. d. none of the above ANS: C SOLUTION:

RCH(1) RCH(2) E[RCH]

= (MYR1,500,000  $0.20)  (MYR1,500,000  $0.23) = $45,000 = (MYR1,500,000  $0.25)  (MYR1,500,000  $0.23) = $30,000 = (.30)(45,000) + (.7)(30,000) = 7,5000

PTS: 1 28. Hanson Corp. frequently uses a forward hedge to hedge its British pound (£) payables. For the next quarter, Hanson has identified its net exposure to the pound as being £1,000,000. The 90-day forward rate is $1.50. Furthermore, Hanson's financial center has indicated that the possible values of the British pound at the end of next quarter are $1.57 and $1.59, with probabilities of .50 and .50, respectively. Based on this information, what is the expected real cost of hedging payables? a. $80,000. b. $80,000. c. $1,570,000. d. $1,580,000.

ANS: B SOLUTION:

RCH(1) = (£1,000,000  $1.50)  (£1,000,000  $1.57) = $70,000 RCH(2) = (£1,000,000  $1.50)  (£1,000,000  $1.59) = $90,000 E[RCH] = (.50)(70,000) + (.50)($90,000) = $80,000

PTS: 1 Exhibit 11-1

360-day borrowing rate 360-day deposit rate

U.S. 6% 5%

Jordan 5% 4%

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

29. Refer to Exhibit 11-1. Perkins Corp. will receive 250,000 Jordanian dinar (JOD) in 360 days. The current spot rate of the dinar is $1.48, while the 360-day forward rate is $1.50. How much will Perkins receive in 360 days from implementing a money market hedge (assume any receipts before the date of the receivable are invested)? a. $377,115. b. $373,558. c. $363,019. d. $370,000.

ANS: D SOLUTION: 1. Borrow JOD238,095.24 (JOD250,000/1.05) = JOD238,095.24.

2.

Convert JOD238,095.24 to $352,380.95 (JOD238,095.24  $1.48) = $352,380.95.

3.

Invest $352,380.95 at 5% to accumulate $370,000 ($352,280.95  1.05) = $370,000.

PTS: 1 30. Refer to Exhibit 11-1. Pablo Corp. will need 150,000 Jordanian dinar (JOD) in 360 days. The current spot rate of the dinar is $1.48, while the 360-day forward rate is $1.46. What is Pablo's cost from implementing a money market hedge (assume Pablo does not have any excess cash)? a. $224,135. b. $226,269. c. $224,114. d. $223,212.

ANS: B SOLUTION: 1. Need to invest JOD144,230.76 (JOD150,000/1.04) = JOD144,230.76.

2.

Need to convert $213,461.52 to obtain the JOD144,230.76 dinar (JOD144,230.76  $1.48) = $213,461.52.

3.

At the end of 360 days, need $226,269.22 ($213,461.52  1.06) = $226,269.21.

PTS: 1 31. Lorre Company needs 200,000 Canadian dollars (C$) in 90 days and is trying to determine whether or not to hedge this position. Lorre has developed the following probability distribution for the Canadian dollar: Possible Value of Canadian Dollar in 90 Days $0.54 0.57 0.58 0.59

Probability 15% 25% 35% 25%

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

The 90-day forward rate of the Canadian dollar is $.575, and the expected spot rate of the Canadian dollar in 90 days is $.55. If Lorre implements a forward hedge, what is the probability that hedging will be more costly to the firm than not hedging? a. 40%. b. 60%. c. 15%. d. 85%.

ANS: A SOLUTION:

Since Lorre locks into the $.575 with a forward contract, the first two cases would have been cheaper had Lorre not hedged (15% + 25% = 40%).

PTS: 1 32. Quasik Corporation will be receiving 300,000 Canadian dollars (C$) in 90 days. Currently, a 90-day call option with an exercise price of $.75 and a premium of $.01 is available. Also, a 90-day put option with an exercise price of $.73 and a premium of $.01 is available. Quasik plans to purchase options to hedge its receivable position. Assuming that the spot rate in 90 days is $.71, what is the net amount received from the currency option hedge? a. $219,000. b. $222,000. c. $216,000. d. $213,000.

ANS: C SOLUTION:

($.73  $.01)  300,000 = $216,000.

PTS: 1 33. FAB Corporation will need 200,000 Canadian dollars (C$) in 90 days to cover a payable position.

Currently, a 90-day call option with an exercise price of $.75 and a premium of $.01 is available. Also, a 90-day put option with an exercise price of $.73 and a premium of $.01 is available. FAB plans to purchase options to hedge its payable position. Assuming that the spot rate in 90 days is $.71, what is the net amount paid, assuming FAB wishes to minimize its cost? a. $144,000. b. $148,000. c. $152,000. d. $150,000.

ANS: A SOLUTION:

($.71 + $.01)  200,000 = $144,000. Note: the call option is not exercised since the spot rate is less than the exercise price.

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

34. You are the treasurer of Arizona Corporation and must decide how to hedge (if at all) future receivables of 350,000 Australian dollars (A$) 180 days from now. Put options are available for a premium of $.02 per unit and an exercise price of $.50 per Australian dollar. The forecasted spot rate of the Australian dollar in 180 days is: Future Spot Rate $.46 $.48 $.52

Probability 20% 30% 50%

The 90-day forward rate of the Australian dollar is $.50.

What is the probability that the put option will be exercised (assuming Arizona purchased it)? a. 0%. b. 80%. c. 50%. d. none of the above ANS: C SOLUTION:

Arizona will exercise when the exercise price is greater than the future spot (20% + 30% = 50%).

PTS: 1 35. If interest rate parity exists, and transaction costs do not exist, the money market hedge will yield the same result as the ____ hedge. a. put option b. forward c. call option d. none of the above ANS: B

PTS: 1

36. Which of the following is the least effective way of hedging exposure in the long run? a. long-term forward contract. b. currency swap. c. parallel loan. d. money market hedge.

ANS: D

PTS: 1

37. When a perfect hedge is not available to eliminate transaction exposure, the firm may consider methods to at least reduce exposure, such as ____. a. leading b. lagging c. cross-hedging d. currency diversification e. all of the above ANS: E

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

38. Sometimes the overall performance of an MNC may already be insulated by offsetting effects between subsidiaries and it may not be necessary to hedge the position of each individual subsidiary. a. True b. False ANS: T

PTS: 1

39. To hedge a ____ in a foreign currency, a firm may ____ a currency futures contract for that currency. a. receivable; purchase b. payable; sell c. payable; purchase d. none of the above ANS: C

PTS: 1

40. A forward contract hedge is very similar to a futures contract hedge, except that ____ contracts are commonly used for ____ transactions. a. forward; small b. futures; large c. forward; large d. none of the above ANS: C

PTS: 1

41. Celine Co. will need €500,000 in 90 days to pay for German imports. Today's 90-day forward rate of the euro is $1.07. There is a 40 percent chance that the spot rate of the euro in 90 days will be $1.02, and a 60 percent chance that the spot rate of the euro in 90 days will be $1.09. Based on this information, the expected value of the real cost of hedging payables is $____. a. 35,000 b. 25,000 c. 1,000 d. 1,000 ANS: D SOLUTION:

E[RCHp] = $35,000  0.40 + $25,000  0.60 = $1,000

PTS: 1 42. In a forward hedge, if the forward rate is an accurate predictor of the future spot rate, the real cost of hedging payables will be: a. highly positive. b. highly negative. c. zero. d. none of the above ANS: C

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

43. If an MNC is hedging various currencies, it should measure the real cost of hedging in each currency as a dollar amount for comparison purposes. a. True b. False ANS: F

PTS: 1

44. Samson Inc. needs €1,000,000 in 30 days. Samson can earn 5 percent annualized on a German security. The current spot rate for the euro is $1.00. Samson can borrow funds in the U.S. at an annualized interest rate of 6 percent. If Samson uses a money market hedge, how much should it borrow in the U.S.? a. $952,381. b. $995,851. c. $943,396. d. $995,025.

ANS: B SOLUTION:

1,000,000/[1 + (5%  30/360) = $995,851

PTS: 1 45. Blake Inc. needs €1,000,000 in 30 days. It can earn 5 percent annualized on a German security. The current spot rate for the euro is $1.00. Blake can borrow funds in the U.S. at an annualized interest rate of 6 percent. If Blake uses a money market hedge to hedge the payable, what is the cost of implementing the hedge? a. $1,000,000. b. $1,055,602. c. $1,000,830. d. $1,045,644.

ANS: C SOLUTION: 1. Borrow $995,851 from a U.S. bank (€1,000,000  $1.00  [1 + (.05  30/360)] 2.

Convert $995,851 to €995,851, given the exchange rate of $1.00 per euro.

3.

Use the euros to purchase a German security that offers 0.42% interest over 30 days.

4.

Repay the U.S. loan in 30 days, plus interest; the amount owed is $1,000,830 (computed as $995,851  [1 + (.06  30/360)]).

PTS: 1 46. Since the results of both a money market hedge and a forward hedge are known beforehand, an MNC can implement the one that is more feasible. a. True b. False ANS: T

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

47. If interest rate parity exists, the forward hedge will always outperform the money market hedge. a. True b. False ANS: F

PTS: 1

48. To hedge a contingent exposure, in which an MNC's exposure is contingent on a specific event occurring, the appropriate hedge would be a(n) ____ hedge. a. money market b. futures c. forward d. options ANS: D

PTS: 1

49. A ____ is not normally used for hedging long-term transaction exposure. a. long-term forward contact b. futures contract c. currency swap d. parallel loan ANS: B

PTS: 1

50. The ____ does not represent an obligation. a. long-term forward contract b. currency swap c. parallel loan d. currency option ANS: D

PTS: 1

51. Hedging the position of individual subsidiaries is generally necessary, even if the overall performance of the MNC is already insulated by the offsetting positions between subsidiaries. a. True b. False ANS: F

PTS: 1

52. If an MNC is extremely risk-averse, it may decide to hedge even though its hedging analysis indicates that remaining unhedged will probably be less costly than hedging. a. True b. False ANS: T

PTS: 1

53. A money market hedge involves taking a money market position to cover a future payables or receivables position. a. True b. False ANS: T

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

54. To hedge a payable position with a currency option hedge, an MNC would write a call option. a. True b. False ANS: F

PTS: 1

55. MNCs generally do not need to hedge because shareholders can hedge their own risk. a. True b. False ANS: F

PTS: 1

56. Currency futures are very similar to forward contracts, except that they are standardized and are more appropriate for firms that prefer to hedge in smaller amounts. a. True b. False ANS: T

PTS: 1

57. To hedge payables with futures, an MNC would sell futures; to hedge receivables with futures, an MNC would buy futures. a. True b. False ANS: F

PTS: 1

58. When the real cost of hedging is positive, this implies that hedging was more favorable than not hedging. a. True b. False ANS: F

PTS: 1

59. A futures hedge involves taking a money market position to cover a future payables or receivables position. a. True b. False ANS: F

PTS: 1

60. If interest rate parity (IRP) exists, then the money market hedge will yield the same result as the options hedge. a. True b. False ANS: F

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

61. The price at which a currency put option allows the holder to sell a currency is called the settlement price. a. True b. False ANS: F

PTS: 1

62. A put option essentially represents two swaps of currencies, one swap at the inception of the loan contract and another swap at a specified date in the future. a. True b. False ANS: F

PTS: 1

63. The hedging of a foreign currency for which no forward contract is available with a highly correlated currency for which a forward contract is available is referred to as cross-hedging. a. True b. False ANS: T

PTS: 1

64. The exact cost of hedging with call options (as measured in the text) is not known with certainty at the time that the options are purchased. a. True b. False ANS: T

PTS: 1

65. The tradeoff when considering alternative call options to hedge a currency position is that an MNC can obtain a call option with a higher exercise price, but would have to pay a higher premium. a. True b. False ANS: F

PTS: 1

66. When comparing the forward hedge to the options hedge, the MNC can easily determine which hedge is more desirable, because the cost of each hedge can be determined with certainty. a. True b. False ANS: F

PTS: 1

67. When comparing the forward hedge to the money market hedge, the MNC can easily determine which hedge is more desirable, because the cost of each hedge can be determined with certainty. a. True b. False ANS: T

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

68. Assume zero transaction costs. If the 90-day forward rate of the euro underestimates the spot rate 90 days from now, then the real cost of hedging payables will be: a. positive. b. negative. c. positive if the forward rate exhibits a premium, and negative if the forward rate exhibits a discount. d. zero.

ANS: B

PTS: 1

69. Johnson Co. has 1,000,000 euros as payables due in 30 days, and is certain that euro is going to appreciate substantially over time. Assuming the firm is correct, the ideal strategy is to: a. sell euros forward b. purchase euro currency put options. c. purchase euro currency call options. d. purchase euros forward. e. remain unhedged.

ANS: D

PTS: 1

70. Linden Co. has 1,000,000 euros as payables due in 90 days, and is certain that euro is going to depreciate substantially over time. Assuming the firm is correct, the ideal strategy is to: a. sell euros forward b. purchase euro currency put options. c. purchase euro currency call options. d. purchase euros forward. e. remain unhedged ANS: E

PTS: 1

71. Mender Co. will be receiving 500,000 Australian dollars in 180 days. Currently, a 180-day call option with an exercise price of $.68 and a premium of $.02 is available. Also, a 180-day put option with an exercise price of $.66 and a premium of $.02 is available. Mender plans to purchase options to hedge its receivables position. Assuming that the spot rate in 180 days is $.67, what is the amount received from the currency option hedge (after considering the premium paid)? a. $330,000 b. $325,000 c. $320,000 d. $340,000 ANS: B

PTS: 1

72. You are the treasurer of Montana Corporation and must decide how to hedge (if at all) future payables of 1,000,000 Japanese yen 90 days from now. Call options are available with a premium of $.01 per unit and an exercise price of $.01031 per Japanese yen. The forecasted spot rate of the Japanese yen in 90 days is: Future Spot Rate $.01035 $.01032 $.01030 $.01029

Probability 20% 20% 30% 30%

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

The 90-day forward rate of the Japanese yen is $.01033.

What is the probability that the call option will be exercised (assuming Montana purchased it)? a. 30% b. 60% c. 20% d. 40% ANS: D

PTS: 1

73. If an MNC assesses net transaction exposure, this refers to the consolidation of all expected inflows for a particular time and currency. a. True b. False ANS: F

PTS: 1

74. Most MNCs do not perceive their foreign exchange management as a profit center. Rather, their main responsibility is to assess potential exposure and determine how and if the exposure should be hedged. a. True b. False ANS: T

PTS: 1

75. If a firm is hedging payables with futures contracts, it may end up paying more for the payable than it would have had it remained unhedged if the foreign currency depreciates. a. True b. False ANS: T

PTS: 1

76. A money market hedge involves taking a money market position to cover a future payables or receivables position. a. True b. False ANS: T

PTS: 1

77. To hedge a payable position in a foreign currency with a money market hedge, the MNC would borrow the foreign currency, convert it to dollars, and invest that amount in the U.S. until the payable is due. a. True b. False ANS: F

PTS: 1

78. If interest rate parity exists, and transaction costs do not exist, the option hedge will yield the same results as no hedge. a. True b. False © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

ANS: F

PTS: 1

79. To hedge a payable position with a currency option hedge, an MNC would write a call option. a. True b. False ANS: F

PTS: 1

80. An advantage of using options to hedge is that the MNC can let the option expire. However, a disadvantage of using options is that a premium must be paid for it. a. True b. False ANS: T

PTS: 1

81. To hedge a receivable position with a currency option hedge, an MNC would buy a put option. a. True b. False ANS: T

PTS: 1

82. Futures, forward, and money market hedges all lock into a certain price to be received from hedging a receivable. For a currency option hedge with a put option, however, the exact amount received is not known until the option is (or is not) exercised. a. True b. False ANS: T

PTS: 1

83. If hedging projections cause a firm to believe that it will definitely be adversely affected by its transaction exposure, a currency option hedge is more appropriate than other methods. a. True b. False ANS: F

PTS: 1

84. Overhedging refers to the hedging of a larger amount in a currency than the actual transaction amount. a. True b. False ANS: T

PTS: 1

85. Most MNCs can completely hedge all of their transactions. a. True b. False ANS: F

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

86. When a parent company tries to convince a subsidiary to hedge its transaction exposure, this is called leading. a. True b. False ANS: F

PTS: 1

87. Lagging refers to the delay of payment by a subsidiary if the currency denominating the payable is expected to depreciate. a. True b. False ANS: T

PTS: 1

88. Cross-hedging may involve taking a forward position in a currency that is highly correlated with the currency an MNC needs to hedge. a. True b. False ANS: T

PTS: 1

89. Since forward contracts are easy to use for hedging, any exposure to exchange rate movements should be hedged. a. True b. False ANS: F

PTS: 1

90. The ____ hedge is not a technique to eliminate transaction exposure discussed in your text. a. index b. futures c. forward d. money market e. currency option ANS: A

PTS: 1

91. A money market hedge on payables would involve, among others, borrowing ____ and investing in the ____. a. the foreign currency; U.S. b. the foreign currency; foreign country c. dollars; foreign country d. dollars; U.S. ANS: C

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

92. FAI Corporation will be receiving 300,000 Canadian dollars (C$) in 90 days. Currently, a 90-day call option with an exercise price of $0.75 and a premium of $0.01 is available. Also, a 90-day put option with an exercise price of $0.73 and a premium of $0.01 is available. FAI plans to purchase options to hedge its receivable position. Assuming that the spot rate in 90 days is $0.71, what is the net amount received from the currency option hedge? a. $219,000 b. $222,000 c. $216,000 d. $213,000 ANS: C

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Chapter 12—Managing Economic Exposure and Translation Exposure 1. Depreciation of the euro relative to the U.S. dollar will cause a U.S.-based multinational firm's reported earnings (from the consolidated income statement) to ____. If a firm desired to protect against this possibility, it could stabilize its reported earnings by ____ euros forward in the foreign exchange market. a. be reduced; purchasing b. be reduced; selling c. increase; selling d. increase; purchasing ANS: B

PTS: 1

2. Springfield Co., based in the U.S., has a cost from orders of foreign material that exceeds its foreign revenue. All foreign transactions are denominated in the foreign currency of concern. This firm would ____ a stronger dollar and would ____ a weaker dollar. a. benefit from; be unaffected by b. benefit from; be adversely affected by c. be unaffected by; be adversely affected by d. be unaffected by; benefit from e. benefit from; benefit from ANS: B

PTS: 1

3. Whitewater Co. is a U.S. company with sales to Canada amounting to C$8 million. Its cost of materials attributable to the purchase of Canadian goods is C$6 million. Its interest expense on Canadian loans is C$4 million. Given these exact figures above, the dollar value of Whitewater's "earnings before interest and taxes" would ____ if the Canadian dollar appreciates; the dollar value of Whitewater's cash flows would ____ if the Canadian dollar appreciates. a. increase; increase b. decrease; increase c. decrease; decrease d. increase; decrease e. increase; be unaffected ANS: D

PTS: 1

4. Sycamore (a U.S. firm) has no subsidiaries and presently has sales to Mexican customers amounting to MXP98 million, while its peso-denominated expenses amount to MXP41 million. If it shifts its material orders from its Mexican suppliers to U.S. suppliers, it could reduce peso-denominated expenses by MXP12 million and increase dollar-denominated expenses by $800,000. This strategy would ____ the Sycamore's exposure to changes in the peso's movements against the U.S. dollar.

Regardless of whether the firm shifts expenses, it is likely to perform better when the peso is valued ____ relative to the dollar. a. reduce; high b. reduce; low c. increase; low d. increase; high ANS: D

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

5. Which of the following is an example of economic exposure but not an example of transaction exposure? a. An increase in the dollar's value hurts a U.S. firm's domestic sales because foreign competitors are able to increase their sales to U.S. customers. b. An increase in the pound's value increases the U.S. firm's cost of British pound payables. c. A decrease in the peso's value decreases a U.S. firm's dollar value of peso receivables. d. A decrease in the Swiss franc's value decreases the dollar value of interest payments on a Swiss deposit sent to a U.S. firm by a Swiss bank.

ANS: A

PTS: 1

6. Rockford Co. is a U.S. manufacturing firm that produces goods in the U.S. and sells all products to retail stores in the U.K.; the goods are denominated in pounds. It finances a small portion of its business with pound-denominated loans from British banks. Which of the following is true? (Assume that the amount of products to be sold is guaranteed by contracts.) a. The dollar value of sales is higher if the pound depreciates against the dollar. b. The dollar value of sales is unaffected by the pound's exchange rate. c. A and B d. None of the above ANS: D

PTS: 1

7. If a U.S. firm's expenses are more susceptible to exchange rate movements than revenue, the firm will ____ if the dollar ____. a. benefit; weakens b. be unaffected; weakens c. be unaffected; strengthens d. benefit; strengthens ANS: D

PTS: 1

8. Laketown Co. has some expenses and revenue in euros. If its expenses are more sensitive to exchange rate movements than revenue, it could reduce economic exposure by ____. If its revenues are more sensitive than expenses, it could reduce economic exposure by ____. a. decreasing foreign revenues; decreasing foreign expenses b. decreasing foreign revenues; increasing foreign expenses c. increasing foreign revenues; decreasing foreign revenues d. decreasing foreign expenses; increasing foreign revenues ANS: D

PTS: 1

9. Any restructuring of operations that ____ the difference between a foreign currency's inflows and outflows may ____ economic exposure. a. reduces; increase b. increases; reduce c. reduces; reduce d. A and B e. none of the above ANS: C

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

10. It is generally least difficult to effectively hedge various types of: a. translation exposure. b. transaction exposure. c. economic exposure. d. A and C ANS: B

PTS: 1

11. With regard to hedging translation exposure, translation losses ____, and gains on forward contracts used to hedge translation exposure ____. a. are not tax deductible; are taxed b. are tax deductible; are taxed c. are not tax deductible; are not taxed d. are tax deductible; are not taxed ANS: A

PTS: 1

12. If a firm does not have foreign subsidiaries, it is not subject to ____. a. transaction exposure b. economic exposure c. A and B d. translation exposure ANS: D

PTS: 1

13. If the Singapore dollar appreciates against the U.S. dollar over this year, the consolidated earnings of a U.S. company with a subsidiary in Singapore will be ____ as a result of the exchange rate movement. a. negative b. adversely affected c. favorably affected d. unaffected ANS: C

PTS: 1

14. Assume a U.S. firm uses a forward contract to hedge all of its translation exposure. Also assume that the firm underestimated what its foreign earnings would be. Assume that the foreign currency depreciated over the year. The firm would generate a translation ____, which would be ____ than the gain generated by the forward contract. a. loss; smaller b. loss; larger c. gain; larger d. gain; smaller ANS: B

PTS: 1

15. A perfect hedge (full coverage) on translation exposure can usually be achieved when: a. using the money market hedge. b. using the forward hedge. c. using the futures hedge. d. none of the above, since a perfect hedge is nearly impossible.

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

ANS: D

PTS: 1

16. Assume that a Japanese car manufacturer exports cars to U.S. dealerships, which are priced in yen. The demand for those cars declines when the yen is strong. The manufacturer also produces some cars in the U.S. with U.S. materials and those cars are priced in dollars. The manufacturer could reduce its economic exposure by: a. closing down most of its plants in the U.S. b. producing more automobiles in the U.S. c. relying completely on Japanese suppliers for its parts. d. pricing its exports in dollars.

ANS: B

PTS: 1

17. Wisconsin Inc. conducts business in Zambia. Years ago, Wisconsin established a subsidiary in Zambia that has consistently generated very large profits denominated in Zambian kwacha. Wisconsin wishes to restructure its operations to reduce economic exposure. Which of the following is not a feasible way of accomplishing this? a. increase Zambian supply orders. b. increase Zambian sales. c. restructure debt to increase debt payments in Zambia. d. reduce Zambian sales.

ANS: B

PTS: 1

18. Which of the following firms is not exposed to translation exposure? a. Firm X, with a fully owned subsidiary that periodically remits earnings generated in Great Britain to the U.S.-based parent. b. Firm Y, with a fully owned subsidiary that periodically generates foreign losses in Sweden. The parent covers at least some of these losses. c. Firm Z, with a fully owned subsidiary that generates substantial earnings in Germany. The subsidiary never remits earnings but reinvests them in Germany. d. All of the above firms are exposed to translation exposure.

ANS: D

PTS: 1

19. ____ represents any impact of exchange rate fluctuations on a firm's future cash flows. a. Translation exposure b. Economic exposure c. Transaction exposure d. None of the above ANS: B

PTS: 1

20. An effective way for an MNC to assess its economic exposure is to review the firm's: a. income statement. b. liquidity. c. retained earnings. d. level of stockholders' equity.

ANS: A

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

21. If revenues and costs are equally sensitive to exchange rate movements, MNCs may reduce their economic exposure by restructuring their operations to shift the sources of costs or revenues to other locations so that: a. cash inflows exceed cash outflows in each foreign currency. b. cash outflows exceed cash inflows in each foreign currency. c. cash inflows match cash outflows in each foreign currency. d. none of the above ANS: C

PTS: 1

22. Managing economic exposure is generally perceived to be ____ managing transaction exposure. a. more difficult than b. less difficult than c. just as difficult as d. none of the above ANS: A

PTS: 1

23. As opposed to transaction exposure, managing economic exposure involves developing a(n) ____ solution. a. short-term b. long-term c. immediate d. none of the above ANS: B

PTS: 1

24. Cierra, Inc. is attempting to assess its degree of economic exposure in euros. In order to do so, it has applied regression analysis to determine whether the percentage change in its total cash flow is related to the percentage change in the euro. A ____ and statistically significant slope coefficient resulting from this analysis implies that the cash flows are ____ related to the percentage changes in the euro. a. positive; positively b. positive; negatively c. negative; positively d. B and C e. none of the above ANS: A

PTS: 1

25. Assume that an MNC's cash flows are positively related to the movements in a foreign currency. If the MNC expects the foreign currency to weaken, it could purchase the currency forward to reduce its degree of economic exposure. a. True b. False ANS: F

PTS: 1

26. An MNC is attempting to reduce its economic exposure by financing a portion of its business with loans in the foreign currency. If the foreign currency weakens, the MNC will need ____ of the foreign currency to cover the loan payment, while the MNC's foreign currency revenues will convert to ____ dollars. a. more; fewer © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

b. more; more c. less; fewer d. less; more ANS: C

PTS: 1

27. An MNC expects to sell fixed assets it utilizes in Europe in the distant future. In order to hedge the sale of these assets in the distant future, the MNC could create a(n) ____ that ____ the expected value of the assets in the future. a. asset; matches b. asset; exceeds c. liability; matches d. liability; is less than ANS: C

PTS: 1

28. Long-term forward contracts are a possible way to hedge the distant sale of fixed assets in foreign countries, but they may not be available for many emerging market currencies. a. True b. False ANS: T

PTS: 1

29. ____ exposure occurs when an MNC translates each subsidiary's financial data to its home currency for consolidated financial statements. a. Translation b. Transaction c. Economic d. None of the above ANS: A

PTS: 1

30. ____ is (are) not a limitation of hedging translation exposure. a. Inaccurate stock price forecasts b. Inadequate forward contracts for some currencies c. Taxation on gains from forward contracts d. Increased transaction exposure ANS: A

PTS: 1

31. To hedge translation exposure, MNCs could ____ that their foreign subsidiaries receive as earnings to create a cash outflow in the currency to offset the earnings received in that currency. a. purchase the currency forward b. sell the currency forward c. purchase futures contracts of the currency d. A or C e. none of the above ANS: B

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

32. Translation losses are ____, while gains on forward contracts used to hedge translation exposure are ____. a. tax deductible; not taxed b. not tax deductible; not taxed c. not tax deductible; taxed d. tax deductible; taxed ANS: D

PTS: 1

33. In general, it is more difficult to effectively hedge economic or translation exposure than to hedge transaction exposure. a. True b. False ANS: T

PTS: 1

34. A foreign subsidiary with more susceptible expenses than revenue to exchange rate movements will be favorably affected by an appreciation of the foreign currency. a. True b. False ANS: F

PTS: 1

35. U.S. firms can attempt to hedge their translation exposure of their European subsidiaries with a forward purchase of euros. a. True b. False ANS: F

PTS: 1

36. Hedging translation exposure with forward contracts can backfire if the currency being hedged depreciates. a. True b. False ANS: F

PTS: 1

37. A limitation of hedging translation exposure is that translation losses are not tax deductible, whereas gains on forward contracts used to hedge translation exposure are taxed. a. True b. False ANS: T

PTS: 1

38. The translation gain (or loss) is simply a paper gain (or loss). Conversely, the gain (or loss) resulting from a hedge strategy is a real gain (or loss). a. True b. False ANS: T

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

39. All MNCs are subject to translation exposure. a. True b. False ANS: F

PTS: 1

40. U.S.-based MNCs invoicing in Asian currencies and incurring expenses in Asian currencies were probably less affected by the weakness of Asian currencies than U.S.-based MNCs that invoice in Asian currencies but do not incur expenses in those currencies. a. True b. False ANS: T

PTS: 1

41. The management of economic exposure is normally focused completely on transactions that will occur in the next three months. a. True b. False ANS: F

PTS: 1

42. Transaction exposure results when an MNC translates each subsidiary's financial data to its home currency for consolidated financial statements. a. True b. False ANS: F

PTS: 1

43. Although forward contracts may reduce translation exposure at the expense of increasing transaction exposure, they are sometimes used to hedge translation exposure. a. True b. False ANS: T

PTS: 1

44. Vermont Co. has foreign expenses denominated in euros that exceed foreign revenues. Appreciation of the euro relative to the U.S. dollar will cause this firm's reported earnings (from the consolidated income statement) to ____. If a firm desired to protect against this possibility, it could stabilize its reported earnings by ____ euros forward in the foreign exchange market. a. decrease; purchasing b. decrease; selling c. increase; selling d. increase; purchasing ANS: A

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

45. Sarakose Co. is a U.S. company with sales to Canada amounting to C$5 million. Its cost of materials attributable to the purchase of Canadian goods is C$7 million. Its interest expense on Canadian loans is C$5 million. The dollar value of Sarakose's "earnings before interest and taxes" would ____ if the Canadian dollar appreciates; the dollar value of its cash flows would ____ if the Canadian dollar appreciates. a. increase; increase b. decrease; increase c. decrease; decrease d. increase; decrease e. increase; be unaffected ANS: C

PTS: 1

46. If a U.S. firm has much more revenue than expenses denominated in euros, the firm will likely ____ if the euro ____. a. benefit; weakens b. be unaffected; weakens c. be unaffected; strengthens d. benefit; strengthens ANS: D

PTS: 1

47. Assume that Atlanta Co. is producing motorcycles and selling them to U.S. customers. Atlanta Co. obtains all of its supplies from American firms and has no competition in the U.S. It has one major competitor in Japan. Now assume that Phoenix Co. is producing office furniture and obtains its supplies from a Canadian firm. Based on this information, Atlanta Co. has ____ exposure and Phoenix Co. has ____ exposure. a. transaction; translation b. translation; transaction c. economic; transaction d. economic; translation ANS: C

PTS: 1

48. Orlando Co. produces home appliances and sells them in the U.S. It outsources the production of the appliances to a Chinese manufacturer, and the imported appliances are priced in dollars. Its major competitor for appliances is located in Mexico. Based on this information, Orlando Co. is subject to ____ exposure. a. economic b. transaction c. translation d. economic and transaction ANS: A

PTS: 1

49. Tennessee Co. conducts business in the U.S. and Canada. The net cash flows from Canadian operations are expected to be C$500,000 next year. The Canadian dollar is valued at about $.90. The net cash flows from U.S. operations are supposed to be $200,000. To reduce sensitivity of its net cash flows without reducing its volume of business in Canada, Tennessee Co. could: a. purchase Canadian supplies. b. increase its borrowings in U.S. c. decrease prices on Canadian goods. © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

d. decrease its borrowed funds in Canada.

ANS: A

PTS: 1

50. Mercury Co. has a subsidiary based in Italy and is exposed to translation exposure. Mercury forecasts that its earnings next year will be €10 million. Mercury decides to hedge the expected earnings by selling €10 million forward. During the next year, the euro appreciated. Mercury's consolidated earnings were ____ affected by the euro's movement, and Mercury's hedge position was ____ affected by the euro's movement. a. favorably; favorably b. favorably; adversely c. adversely; favorably d. adversely; adversely ANS: B

PTS: 1

51. All MNCs are subject to transaction exposure. a. True b. False ANS: F

PTS: 1

52. A foreign subsidiary with more revenue than expenses denominated in a foreign currency will be favorably affected by appreciation of the foreign currency. a. True b. False ANS: T

PTS: 1

53. Economic exposure represents any impact of exchange rate fluctuations on a firm's future cash flows and thus includes transaction exposure. a. True b. False ANS: T

PTS: 1

54. In general, it is more difficult to effectively hedge economic or translation exposure than to hedge transaction exposure. a. True b. False ANS: T

PTS: 1

55. To reduce economic exposure when a foreign currency has a greater impact on cash inflows, an MNC could reduce its level of foreign sales, increase its foreign supply orders, or restructure debt to increase debt payments in the foreign currency. a. True b. False ANS: T

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

56. When a foreign currency has a greater impact on cash outflows than on cash inflows, one possibility in restructuring operations is to reduce foreign sales. a. True b. False ANS: F

PTS: 1

57. Even if translation exposure does not affect cash flows, it is a concern of many MNCs. a. True b. False ANS: T

PTS: 1

58. Translation exposure results when an MNC translates each subsidiary's financial data to its home currency for consolidated financial statements. a. True b. False ANS: T

PTS: 1

59. Implementing a forward or money market hedge to hedge translation exposure may increase transaction exposure. a. True b. False ANS: T

PTS: 1

60. Which of the following statements is incorrect? a. Transaction exposure represents only the exchange rate risk when converting net foreign cash inflows to U.S. dollars or when purchasing foreign currencies to send payments. b. Economic exposure represents any impact of exchange rate fluctuations on a firm's future cash flows. c. Firms can simply focus on hedging their foreign currency payables and/or receivables to hedge economic exposure. d. The management of economic exposure tends to serve as a long-term solution rather than just a short-term solution.

ANS: C

PTS: 1

61. Thornton Corporation has extensive liabilities denominated in Cyprus pounds resulting from imports from Cyprus. However, Thornton's revenues are denominated solely in U.S. dollars. Which of the following is probably not true? a. Thornton would benefit from a depreciation of the Cyprus pound. b. Thornton has at least some transaction exposure. c. Thornton has at least some economic exposure. d. Thornton has at least some translation exposure. e. All of the above are true.

ANS: D

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

62. A U.S.-based MNC has a subsidiary in Barbados that generates substantial net cash inflows denominated in Barbados dollars. Given this information, the MNC would ____ from a(n) ____ of the Barbados dollar. a. benefit; appreciation b. benefit; depreciation c. not benefit; appreciation d. none of the above ANS: A

PTS: 1

63. Campbell Company has a subsidiary located in Jamaica. The subsidiary has generated losses for the last five years and is expected to generate losses for the next ten years. Campbell is reluctant to divest of this subsidiary, however. Given this information, Campbell would ____ from a(n) ____ of the Jamaican dollar. a. benefit; appreciation b. benefit; depreciation c. not benefit; appreciation d. not benefit; depreciation e. B and C ANS: E

PTS: 1

64. ____ is (are) a limitation of hedging translation exposure. a. Inaccurate earnings forecasts b. Inadequate forward contracts for some currencies c. Accounting distortions d. Increased transaction exposure e. All of the above ANS: E

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Chapter 13—Direct Foreign Investment 1. Based on the text, it should be obvious that markets are ____ in reality, and consequently, monopolistic advantages ____ be exploited. a. perfect; may possibly b. perfect; cannot c. imperfect; may possibly d. imperfect; cannot ANS: C

PTS: 1

2. When a firm analyzes the feasibility of a project, it should consider the: a. variability of the project's cash flow. b. correlation of the project's cash flow relative to the prevailing cash flows of the MNC. c. A and B d. none of the above ANS: C

PTS: 1

3. The ____ a project's variability in cash flows, and the ____ the positive correlation between the project's cash flow and the MNC's cash flow, the lower the risk of the project. a. higher; higher b. higher; lower c. lower; lower d. lower; higher ANS: C

PTS: 1

4. The most important cost-related motive for direct foreign investment is diversification across product markets. a. True b. False ANS: F

PTS: 1

5. Consider Firm A and Firm B that both produce the same product. Firm A would more likely have more stable cash flows if its percentage of foreign sales were ____ and the number of foreign countries it sold products to was ____. a. higher; large b. higher; small c. lower; small d. higher; large ANS: A

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

6. According to the text, a firm may be able to achieve a "more efficient" project portfolio if it: a. focuses solely on one product. b. focuses solely on one location to market what it produces. c. A and B d. none of the above ANS: D

PTS: 1

7. According to information in the text, a host government would be least likely to provide incentives for direct foreign investment (DFI) into its country if the firm planning DFI: a. would compete with local firms of the host country. b. would produce a good not currently available in the host country. c. would produce a good and export it to other countries. d. B and C ANS: A

PTS: 1

8. If countries are highly influential upon each other, the correlations of their economic growth levels would likely be ____. A firm would benefit ____ by diversifying sales among these countries relative to another set of countries that were not influential upon each other. a. high and positive; more b. close to zero; more c. high and positive; less d. close to zero; less ANS: C

PTS: 1

9. A firm will likely benefit most from diversifying if: a. the correlations between country economies are high. b. the correlations between country economies are low. c. the variability of all country economy levels is high. d. B and C ANS: B

PTS: 1

10. When a foreign currency is perceived by a firm to be undervalued, the firm may consider direct foreign investment in that country, as the initial outlay should be relatively low. a. True b. False ANS: T

PTS: 1

11. Consider a country that presently has a high level of unemployment because of weak economic conditions. Its income levels are very low. This country may be an attractive target as a result of ____ motives by U.S. firms that engage in direct foreign investment. a. revenue-related b. cost-related c. A and B d. none of the above ANS: B

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

12. Which of the following is a reason to consider international business? a. economies of scale. b. exploit monopolistic advantages. c. diversification. d. all of the above ANS: D

PTS: 1

13. From the concept of an "efficient frontier," the point on a frontier that is optimal for all firms: a. is the top point. b. is the point closest to the vertical axis. c. is the point half way between the two end points. d. cannot be determined since firms vary in their willingness to accept risk.

ANS: D

PTS: 1

14. Direct foreign investment is perceived by foreign governments to: a. be a cause of national problems. b. be a remedy for national problems. c. either A or B is possible. d. have no impact on national problems.

ANS: C

PTS: 1

15. Direct foreign investment would typically be welcomed if: a. the products to be produced are substitutes for other locally produced products. b. people from the country of the company's headquarter are transferred to the foreign country to work at the subsidiary. c. the products to be produced are going to be exported. d. all of the above ANS: C

PTS: 1

16. Assume a U.S. firm initiates direct foreign investment in the U.K. If the British pound is expected to appreciate against the dollar, the dollar value of earnings remitted to the parent should ____. The parent may request that the subsidiary ____ in order to benefit from the expectation about the pound. a. increase; postpone remitting earnings until the pound strengthens b. decrease; postpone remitting earnings until the pound strengthens c. decrease; remit earnings immediately before the pound strengthens d. increase; remit earnings immediately before the pound strengthens ANS: A

PTS: 1

17. Assume the British pound appreciates against the dollar while the Japanese yen depreciates against the dollar. Which of the following is true? a. Japanese exporters can increase American sales by shifting operations from their British subsidiaries to Japan. b. British exporters can increase American sales by shifting operations from their Japanese subsidiaries to Britain. c. American exporters can increase sales to Japan by shifting operations from Japanese subsidiaries to American subsidiaries. © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

d. B and C ANS: A

PTS: 1

18. Even if production costs are higher in a foreign country, a U.S. firm may establish a manufacturing plant in the foreign country now if: a. the host government of that country eliminates all quotas. b. the host government of that country reduces all quotas. c. the host government of that country increases all quotas. d. the host government of that country eliminates all tariffs.

ANS: C

PTS: 1

19. A country with high unemployment could best increase its employment by: a. encouraging foreign firms to establish subsidiaries that produce the same products local firms produce. b. encouraging foreign firms to establish licensing arrangements for products local firms produce. c. encouraging foreign firms to establish subsidiaries that produce products local firms do not produce. d. none of the above would reduce employment.

ANS: C

PTS: 1

20. According to your text, ____ is a country that has been perceived as one of the most attractive sources of new demand. a. Paraguay b. Morocco c. Sweden d. China ANS: D

PTS: 1

21. ____ is not a disadvantage of direct foreign investment. a. The expense of establishing a foreign subsidiary b. The uncertainty of inflation and exchange rate movements c. Political risk d. All of the above are disadvantages of direct foreign investment ANS: D

PTS: 1

22. Assume the correlation coefficient between the return on the existing project and the return on a proposed foreign project is 1. Also assume the returns on the existing project and the new project are equal, and that the existing project has a lower standard deviation than the proposed project. Under this scenario, undertaking the proposed project will ____ the variance of the firm's overall returns. a. decrease b. increase c. decrease or increase, depending on the exact size of the returns and standard deviations d. none of the above ANS: B

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

23. Which of the following is not true regarding host government attitudes towards direct foreign investment (DFI)? a. Host governments may offer incentives to MNCs in the form of subsidies in certain circumstances. b. Host governments generally perceive DFI as a remedy to eliminate a country's political problems. c. The ability of a host government to attract DFI is dependent on the country's markets and resources. d. Some types of DFI will be more attractive to some governments than to others. e. All of the above are true.

ANS: B

PTS: 1

24. Which of the following is not true regarding the efficient frontier considered by MNCs? a. There is exactly one point on the efficient frontier that is optimal for every MNC, regardless of its degree of risk aversion. b. The efficient frontier for international projects will probably lie to the left of the efficient frontier for domestic projects. c. Each point on the efficient frontier represents a portfolio of projects as opposed to an individual project. d. All of the above are true. e. A and C are false.

ANS: A

PTS: 1

25. Which of the following is not a cost-related motive of direct foreign investment? a. International diversification. b. Low labor costs. c. Land can be purchased at a low price. d. Manufacturing plants can be built for a low price.

ANS: A

PTS: 1

26. MNCs commonly consider direct foreign investment because it can improve their profitability and enhance shareholder wealth. a. True b. False ANS: T

PTS: 1

27. ____ is not a revenue-related motive for direct foreign investment. a. Attracting new sources of demand b. Fully benefiting from economies of scale c. Exploiting monopolistic advantages d. Entering profitable markets ANS: B

PTS: 1

28. ____ is not a cost-related motive for direct foreign investment. a. Exploiting monopolistic advantages b. Fully benefiting from economies of scale c. Using foreign factors of production © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

d. Using foreign raw materials ANS: A

PTS: 1

29. When a firm perceives that a foreign currency is ____, the firm may attempt direct foreign investment in that country, as the initial outlay should be relatively ____. a. overvalued; high b. overvalued; low c. undervalued; high d. undervalued; low ANS: D

PTS: 1

30. Developing countries are mostly targeted because they have advanced technology. a. True b. False ANS: F

PTS: 1

31. Direct foreign investment is normally completed first, and then capital budgeting can be applied later. a. True b. False ANS: F

PTS: 1

32. The best means to accomplish the revenue-related motive of attracting new sources of demand is to: a. acquire a competitor that has controlled its local market. b. establish a subsidiary or acquire a competitor in a new market. c. establish a subsidiary in a market where tougher trade restrictions will adversely affect the firm's export volume. d. establish subsidiaries in markets whose business cycles differ from those where existing subsidiaries are based.

ANS: B

PTS: 1

33. To enter markets where superior profits are possible, an MNC should: a. acquire a competitor that has controlled its local market. b. establish a subsidiary or acquire a competitor in a new market. c. establish a subsidiary in a market where tougher trade restrictions will adversely affect the firm's export volume. d. establish subsidiaries in markets whose business cycles differ from those where existing subsidiaries are based.

ANS: A

PTS: 1

34. To exploit monopolistic advantages, an MNC should: a. acquire a competitor that has controlled its local market. b. establish a subsidiary or acquire a competitor in a new market.

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

c. establish a subsidiary in a market where tougher trade restrictions will adversely affect the firm's export volume. d. establish subsidiaries in markets where competitors are unable to produce the identical product.

ANS: D

PTS: 1

35. To fully benefit from economies of scale, an MNC should: a. establish a subsidiary in a new market that can sell products produced elsewhere. b. establish a subsidiary in a market that has relatively low costs of labor or land. c. establish a subsidiary in a market where raw materials are cheap and accessible. d. participate in a joint venture in order to learn about a production process or other operations.

ANS: A

PTS: 1

36. To use foreign factors of production, an MNC should: a. establish a subsidiary in a new market that can sell products produced elsewhere. b. establish a subsidiary in a market that has relatively low costs of labor or land. c. establish a subsidiary in a market where raw materials are cheap and accessible. d. participate in a joint venture in order to learn about a production process or other operations.

ANS: B

PTS: 1

37. They key to international diversification is selecting foreign projects whose performance levels are highly correlated over time. a. True b. False ANS: F

PTS: 1

38. When economic conditions of two countries are ____, then a firm would ____ its risk by operating in both countries instead of concentrating just in one. a. highly correlated; reduce b. not highly correlated; not reduce c. not highly correlated; reduce d. none of the above ANS: C

PTS: 1

39. Along the frontier of efficient project portfolios, exactly one portfolio can be singled out as "optimal" for all MNCs. a. True b. False ANS: F

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

40. Some governments restrict foreign ownership of local firms. Such restrictions may limit or prevent international acquisitions. a. True b. False ANS: T

PTS: 1

41. Direct foreign investment (DFI) represents investment in real assets (such as land, buildings, or even existing plants) in foreign countries. a. True b. False ANS: T

PTS: 1

42. Although direct foreign investment is sometimes conducted, benefits are rarely realized. a. True b. False ANS: F

PTS: 1

43. MNCs often attempt to set up production in locations where land and labor are expensive, because expensive factors of production indicate high demand. a. True b. False ANS: F

PTS: 1

44. Due to market imperfections, the cost of factors of production (such as labor) may differ substantially across countries. a. True b. False ANS: T

PTS: 1

45. In assessing the risk of an individual project, the expected correlation of the new project's returns with those of the prevailing business should be considered. a. True b. False ANS: T

PTS: 1

46. Managers of MNCs may attempt to expand their divisions internationally if their compensation may be increased as a result of expansion. This goal is consistent with the goals of shareholders. a. True b. False ANS: F

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

47. Countries in eastern Europe are more appealing to MNCs that seek relatively low costs of land and labor than countries in western Europe. a. True b. False ANS: T

PTS: 1

48. Assume a U.S. firm initiates direct foreign investment in Italy. If the euro is expected to depreciate against the dollar, the dollar value of earnings remitted to the parent should ____. The parent may request that the subsidiary ____. a. increase; postpone remitting earnings until the euro weakens b. decrease; postpone remitting earnings until the euro weakens c. decrease; remit earnings immediately before the euro weakens d. increase; remit earnings immediately before the euro weakens ANS: C

PTS: 1

49. To diversify internationally for the purpose of reducing risk, which strategy is appropriate? a. Establish subsidiaries in markets whose business cycles are the same as those where existing subsidiaries are based. b. Establish a subsidiary in a market that has relatively low cost of labor or land. c. Establish a subsidiary in a market where the local currency is weak but is expected to appreciate over time. d. Establish subsidiaries in markets whose business cycles differ from those where existing subsidiaries are based.

ANS: D

PTS: 1

50. To fully benefit from use of foreign raw materials: a. establish a subsidiary in a market where raw materials are cheap and accessible. b. sell the finished product to countries where the raw materials are more expensive. c. establish a subsidiary in a new market that can sell products produces elsewhere. d. A and B ANS: D

PTS: 1

51. Procedural and documentation requirements imposed by the foreign government are referred to as: a. regulatory barriers. b. industry barriers. c. protective barriers. d. "Red Tape" barriers.

ANS: D

PTS: 1

52. Constraints pertaining to taxes, currency convertibility, earnings remittance, and employee rights are best described as: a. ethical differences. b. regulatory barriers. c. quota barriers. d. "Red Tape" barriers.

ANS: B

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

53. Assume that the government of Krusho requires bribes to approve certain projects. MNCs that attempt to do business in Krusho must deal with: a. protective barriers. b. "red tape" barriers. c. ethical differences. d. regulatory barriers.

ANS: C

PTS: 1

54. The overall variability of a firm's returns depends on the expected return of each individual project, percentage of funds invested in each individual project, and correlation coefficient of returns between the investments. a. True b. False ANS: T

PTS: 1

55. MNCs can probably achieve more desirable risk-return characteristics from their project portfolios if they sufficiently diversify among products and geographical markets. a. True b. False ANS: T

PTS: 1

56. Once a decision to establish a foreign subsidiary has been made, it is irreversible. Therefore, no periodic monitoring of the project is necessary. a. True b. False ANS: F

PTS: 1

57. Direct foreign investment is commonly considered by MNCs because it allows the MNC to: a. attract new sources of demand. b. enter profitable markets. c. react to exchange rate movements. d. react to trade restrictions. e. all of the above ANS: E

PTS: 1

58. Which of the following is not true regarding host government attitudes towards direct foreign investment (DFI)? a. Host governments may offer incentives to MNCs in the form of subsidies in certain circumstances. b. Host governments generally perceive DFI as a remedy for their national problems.

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

c. The ability of a host government to attract DFI is dependent on the country's markets and resources. d. Some types of DFI will be more attractive to some governments than to others. e. All of the above are true.

ANS: B

PTS: 1

59. ____ is not a cost-related motive for direct foreign investment (DFI). a. Using foreign factors of production b. Using foreign raw materials c. Using foreign technology d. Reacting to trade restrictions e. Fully benefiting from economies of scale ANS: D

PTS: 1

60. When a foreign currency is perceived by a firm to be ____, the firm will probably ____ direct foreign investment in that country. a. undervalued; consider b. undervalued; not consider c. overvalued; not consider d. A and C e. B and C ANS: D

PTS: 1

61. The best means of using direct foreign investment (DFI) to fully benefit from cheap foreign factors of production is probably to: a. acquire a competitor that has controlled its local market. b. establish a subsidiary in a new market that can sell products produced elsewhere; this allows for increased production and possibly greater production efficiency. c. establish a subsidiary in a market that has relatively low costs of labor and land; sell the finished product to countries where the cost of production is higher. d. establish a subsidiary in a market in which raw materials are cheap and accessible; sell the finished product to countries in which the raw materials are more expensive.

ANS: C

PTS: 1

62. The ____ the correlation in project returns is over time, the ____ will be the project portfolio risk as measured by the portfolio variance. a. lower; lower b. higher; lower c. lower; higher d. none of the above ANS: A

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Chapter 14—Multinational Capital Budgeting 1. If a U.S. parent is setting up a French subsidiary, and funds from the subsidiary will be periodically sent to the parent, the ideal situation from the parent's perspective is a ____ after the subsidiary is established. a. strengthening euro b. stable euro c. weak euro d. B and C are both ideal.

ANS: A

PTS: 1

2. According to the text, in order to develop a distribution of possible net present values from international projects, a firm should use: a. a risk-adjusted discount rate. b. a payback period. c. certainty equivalents. d. simulation.

ANS: D

PTS: 1

3. When evaluating international project cash flows, which of the following factors is relevant? a. future inflation. b. blocked funds. c. exchange rates. d. all of the above ANS: D

PTS: 1

4. In general, increased investment by the parent in the foreign subsidiary causes more exchange rate exposure to the parent over time because the cash flows remitted to the parent will be larger. a. True b. False ANS: T

PTS: 1

5. Blocked funds may penalize a project if the return on the forced reinvestment in the foreign country is less than the required rate of return on the project. a. True b. False ANS: T

PTS: 1

6. When assessing a German project administered by a German subsidiary of a U.S.-based MNC solely from the German subsidiary's perspective, which variable will most likely influence the capital budgeting analysis? a. the withholding tax rate.

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

b. c. d. e.

the euro's exchange rate. the U.S. tax rate on earnings remitted to the U.S. the German government's tax rate.

A and C

ANS: D

PTS: 1

7. In capital budgeting analysis, the use of a cumulative NPV is useful for: a. determining a probability distribution of NPVs. b. determining the time required to achieve a positive NPV. c. determining how the required rate of return changes over time. d. determining how the cost of capital changes over time. e. A and B ANS: B

PTS: 1

8. Assume the parent of a U.S.-based MNC plans to completely finance the establishment of its British subsidiary with existing funds from retained earnings in U.S. operations. According to the text, the discount rate used in the capital budgeting analysis on this project should be most affected by: a. the cost of borrowing funds in the U.K. b. the economic conditions in the U.K. c. the parent's cost of capital. d. A and B ANS: C

PTS: 1

9. Assume a U.S.-based MNC has a Chilean subsidiary that annually remits 30 million Chilean pesos to the U.S. If the peso ____, the dollar amount of remitted funds ____. a. appreciates; decreases b. depreciates; is unaffected c. appreciates; is unaffected d. depreciates; decreases e. B and C ANS: D

PTS: 1

10. Assume an MNC establishes a subsidiary where it has no other existing business. The present value of parent cash flows from this subsidiary is more sensitive to exchange rate movements when: a. the subsidiary finances the entire investment by local borrowing. b. the subsidiary finances most of the investment by local borrowing. c. the parent finances most of the investment. d. the parent finances the entire investment.

ANS: D

PTS: 1

11. If an MNC exports to a country, then establishes a subsidiary to produce and sell the same product in the country, then cash flows from prevailing operations would likely be ____ affected by the project. If an MNC establishes a foreign manufacturing subsidiary that buys components from the parent, the cash flows from prevailing operations would likely be ____ affected by the project. a. adversely; adversely © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

b. favorably; adversely c. favorably; favorably d. adversely; favorably ANS: D

PTS: 1

12. An MNC is considering establishing a two-year project in New Zealand with a $30 million initial investment. The firm's cost of capital is 12%. The required rate of return on this project is 18%. The project is expected to generate cash flows of NZ$12 million in Year 1 and NZ$30 million in Year 2, excluding the salvage value. Assume no taxes, and a stable exchange rate of $.60 per NZ$ over the next two years. All cash flows are remitted to the parent. What is the break-even salvage value? a. about NZ$11 million. b. about NZ$15 million. c. about NZ$31 million. d. about NZ$37 million. e. about NZ$25 million.

ANS: E SOLUTION: 1. NZ$12,000,000  $.60 = $7,200,000 2. NZ$30,000,000  $.60 = $18,000,000

Break-even salvage value

$7,200,000/(1.18) $18,000,000/(1.18)2

= =

$6,101,695 $12,927,320 $19,029,015

= [Initial outlay  PV of cash flows] (1 + k) m = [$30,000,000  $19,029,015] (1.18)2 = $15,276,000

Break-even salvage value in NZ$

= $15,276,000/$.60 = NZ$25,459,999

PTS: 1 13. A firm considers an exporting project and will invoice the exports in dollars. The expected cash flows in dollars would be more difficult if the currency of the foreign country is ____. a. fixed b. volatile c. stable d. none of the above, as the firm is not exposed ANS: B

PTS: 1

14. If the parent charges the subsidiary administrative fees, the earnings from the project will appear low to the parent and high to the subsidiary. a. True b. False ANS: F

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

15. Other things being equal, a blocked funds restriction is more likely to have a significant adverse effect on a project if the currency of that country is expected to ____ over time, and if the interest rate in that country is relatively ____. a. appreciate; low b. appreciate; high c. depreciate; high d. depreciate; low ANS: D

PTS: 1

16. If a multinational project is assessed from the subsidiary's perspective, withholding taxes are ignored for project assessment. a. True b. False ANS: T

PTS: 1

17. Other things being equal, firms from a particular home country will engage in more international acquisitions if they expect foreign currencies to ____ against their home currency, and if their cost of capital is relatively ____. a. appreciate; low b. appreciate; high c. depreciate; high d. depreciate; low ANS: A

PTS: 1

18. The discrepancy between the feasibility of a project in a host country from the perspective of the U.S. parent versus the subsidiary administering the project is likely to be greater for projects in countries where: a. the taxes are the same as in the U.S. b. there are no blocked fund restrictions. c. the currency of the host country is expected to depreciate consistently. d. none of the above; a discrepancy is not possible.

ANS: C

PTS: 1

19. The break-even salvage value of a particular project is the salvage value necessary to: a. offset any losses incurred by the subsidiary in a given year. b. offset any losses incurred by the MNC overall in a given year. c. make the project have zero profits. d. make the project's return equal the required rate of return.

ANS: D

PTS: 1

20. The impact of blocked funds on the net present value of a foreign project will be greater if interest rates are ____ in the host country and there are ____ investment opportunities in the host country. a. very high; limited

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

b. very low; limited c. very low; numerous d. very high; numerous ANS: B

PTS: 1

21. One foreign project in Hungary and another in Japan had the same perceived value from the U.S. parent's perspective. Then, the exchange rate expectations were revised, upward for the value of the Hungarian forint and downward for the Japanese yen. The break-even salvage value for the project in Japan would now be ____ from the parent's perspective. a. negative b. higher than that for the Hungarian project c. lower than that for the Hungarian project d. the same as that for the Hungarian project e. A and C ANS: B

PTS: 1

22. Exchange rates for purposes of multinational capital budgeting: a. are very difficult to forecast. b. can be easily hedged with currency swaps. c. are unimportant, as they do not affect the cash flows of the multinational project. d. all of the above ANS: A

PTS: 1

23. A U.S.-based MNC has just established a subsidiary in Algeria. Shortly after the plant was built, the MNC determines that its exchange rate forecasts, which had previously indicated a slight appreciation in the Algerian dinar, were probably false. Instead of a slight appreciation, the MNC now expects that the dinar will depreciate substantially due to political turmoil in Algeria. This new development would likely cause the MNC to ____ its estimate of the previously computed net present value. a. lower b. increase c. lower, but not necessarily if the MNC invests enough in Algeria to offset the decrease in NPV d. increase, but not necessarily if the MNC reduces its investment in Algeria by an offsetting amount e. none of the above ANS: A

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Exhibit 14-1 Assume that Baps Corporation is considering the establishment of a subsidiary in Norway. The initial investment required by the parent is $5,000,000. If the project is undertaken, Baps would terminate the project after four years. Baps' cost of capital is 13%, and the project is of the same risk as Baps' existing projects. All cash flows generated from the project will be remitted to the parent at the end of each year. Listed below are the estimated cash flows the Norwegian subsidiary will generate over the project's lifetime in Norwegian kroner (NOK): Year 1 NOK10,000,000

Year 2 NOK15,000,000

Year 3 NOK17,000,000

Year 4 NOK20,000,000

The current exchange rate of the Norwegian kroner is $.135. Baps' exchange rate forecast for the Norwegian kroner over the project's lifetime is listed below: Year 1 $.13

Year 2 $.14

Year 3 $.12

Year 4 $.15

24. Refer to Exhibit 14-1. What is the net present value of the Norwegian project? a. $803,848. b. $5,803,848. c. $1,048,829. d. none of the above ANS: C SOLUTION: Cash flow to parent PV of parent cash flow Cumulative NPV

Year 0 $5,000,000

Year 1 $1,300,000 1,150,442 3,849,558

Year 2 $2,100,000 1,644,608 2,204,950

Year 3 $2,040,000 1,413,822 791,128

Year 4 $3,000,000 1,839,956 1,048,828

PTS: 1 25. Refer to Exhibit 14-1. Assume that NOK8,000,000 of the cash flow in year 4 represents the salvage value. Baps is not completely certain that the salvage value will be this amount and wishes to determine the break-even salvage value, which is $____. a. 510,088.04 b. 1,710,088 c. 1,040,000 d. none of the above ANS: D SOLUTION:

Even if there is no salvage value, the NPV would still be positive, as shown below:

Cash flow to parent PV of parent cash flow Cumulative NPV

Year 0 $5,000,000

Year 1 $1,300,000 1,150,442 3,849,558

Year 2 $2,100,000 1,644,608 2,204,950

Year 3 $2,040,000 1,413,822 791,128

Year 4 $1,800,000 1,103,974 312,846

PTS: 1 © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

26. Refer to Exhibit 14-1. Baps is also uncertain regarding the cost of capital. Recently, Norway has been involved in some political turmoil. What is the net present value (NPV) of this project if a 16% cost of capital is used instead of 13%? a. $17,602.62. b. $8,000,000. c. $1,048,829. d. $645,147.

ANS: D SOLUTION: Year 0 $5,000,000

Cash flow to parent PV of parent cash flow Cumulative NPV

Year 1 $1,300,000 1,120,690 3,879,310

Year 2 $2,100,000 1,560,642 2,318,668

Year 3 $2,040,000 1,306,942 1,011,726

Year 4 $3,000,000 1,656,873 645,147

PTS: 1 27. Petrus Company has a unique opportunity to invest in a two-year project in Australia. The project is expected to generate 1,000,000 Australian dollars (A$) in the first year and 2,000,000 Australian dollars in the second. Petrus would have to invest $1,500,000 in the project. Petrus has determined that the cost of capital for similar projects is 14%. What is the net present value of this project if the spot rate of the Australian dollar for the two years is forecasted to be $.55 and $.60, respectively? a. $2,905,817. b. $94,183. c. $916,128. d. none of the above ANS: B SOLUTION: Cash flow to parent PV of parent cash flow Cumulative NPV

Year 0 $1,500,000

Year 1 $550,000 482,456 1,017,544

Year 2 $1,200,000 923,361 94,183

PTS: 1 28. Which of the following is not a characteristic of a country to be considered within an MNC's international tax assessment? a. corporate income taxes. b. withholding taxes. c. provisions for carrybacks and carryforwards. d. tax treaties. e. all of the above are characteristics to be considered.

ANS: E

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

29. Like income tax treaties, ____ help to avoid double taxation and stimulate direct foreign investment. a. withholding taxes b. excise taxes c. tax credits d. carryforwards ANS: C

PTS: 1

30. If the parent's government imposes a ____ tax rate on funds remitted from a foreign subsidiary, a project is less likely to be feasible from the ____ point of view. a. high; subsidiary's b. high; parent's c. low; parent's d. A and C e. none of the above ANS: B

PTS: 1

31. If a subsidiary project is assessed from the subsidiary's perspective, then an expected appreciation in the foreign currency will affect the feasibility of the project ____. a. positively b. negatively c. either positively or negatively, depending on the percentage appreciation d. none of the above ANS: D

PTS: 1

32. When a foreign subsidiary is not wholly owned by the parent and a foreign project is partially financed with retained earnings of the parent and of the subsidiary, then: a. the parent's perspective should be used to evaluate a foreign project. b. the subsidiary's perspective should be used to evaluate a foreign project. c. the foreign project should enhance the value of both the parent and the subsidiary. d. none of the above ANS: C

PTS: 1

33. The ____ is (are) likely the major source of funds to support a particular project. a. initial investment b. variable costs c. fixed costs d. none of the above ANS: A

PTS: 1

34. Because before-tax cash flows are necessary for an adequate capital budgeting analysis, international tax effects need not be determined on a proposed foreign project. a. True b. False ANS: F

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

35. The required rate of return of a project is ____ the MNC's cost of capital. a. greater than b. less than c. the same as d. any of the above, depending on the specific project ANS: D

PTS: 1

36. An international project's NPV is ____ related to the size of the initial investment and ____ related to the project's required rate of return. a. positively; positively b. positively; negatively c. negatively; positively d. negatively; negatively ANS: D

PTS: 1

37. An international project's NPV is ____ related to consumer demand and ____ related to the project's salvage value. a. positively; positively b. positively; negatively c. negatively; positively d. negatively; negatively ANS: A

PTS: 1

38. Everything else being equal, the ____ the depreciation expense is in a given year, the ____ a foreign project's NPV will be. a. higher; lower b. higher; higher c. lower; higher d. none of the above ANS: B

PTS: 1

39. A foreign project generates a negative cash flow in year 1 and positive cash flows in years 2 through 5.

The NPV for this project will be higher if the foreign currency ____ in year 1 and ____ in years 2 through 5. a. depreciates; depreciates b. appreciates; appreciates c. depreciates; appreciates d. appreciates; depreciates ANS: C

PTS: 1

40. If an MNC sells a product in a foreign country and imports partially manufactured components needed for production to that country from the U.S., then the local economy's inflation will have: a. a more pronounced impact on revenues than on costs. b. a less pronounced impact on revenues than on costs. c. the same impact on revenues as on costs. d. none of the above

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

ANS: A

PTS: 1

41. When conducting a capital budgeting analysis and attempting to account for effects of exchange rate movements for a foreign project, inflation ____ included explicitly in the cash flow analysis, and debt payments by the subsidiary ____ included explicitly in the cash flow analysis. a. should be; should be b. should definitely not be; should definitely not be c. should definitely not be; should be d. should be; should definitely not be ANS: A

PTS: 1

42. As the financing of a foreign project by the parent ____ relative to the financing provided by the subsidiary, the parent's exchange rate exposure ____. a. increases; decreases b. decreases; increases c. increases; increases d. none of the above ANS: C

PTS: 1

43. In conducting a multinational capital budgeting analysis, the subsidiary's perspective should always be used. a. True b. False ANS: F

PTS: 1

44. The feasibility of a multinational project from the parent's perspective is dependent not on the subsidiary cash flows but on the cash flows that it ultimately receives. a. True b. False ANS: T

PTS: 1

45. The required rate of return used to discount the relevant cash flows from a foreign project may differ from the MNC's cost of capital because of that particular project's risk. a. True b. False ANS: T

PTS: 1

46. In multinational capital budgeting, depreciation is treated as a cash outflow. a. True b. False ANS: F

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

47. No matter what the probability distribution of future exchange rates is, as long as one out of several scenarios results in a negative net present value (NPV), a project should not be accepted. a. True b. False ANS: F

PTS: 1

48. If a foreign project is financed with a subsidiary's retained earnings, the subsidiary's investment could be viewed as an opportunity cost, since the funds could be remitted to the parent rather than invested in the foreign project. a. True b. False ANS: T

PTS: 1

49. If a host government restricts the remittances from a foreign subsidiary, a possible solution is to let the subsidiary obtain partial financing for the project. a. True b. False ANS: T

PTS: 1

50. When managers use NPV analysis, agency costs are eliminated, and governance is not needed to monitor MNC decisions regarding projects. a. True b. False ANS: F

PTS: 1

51. Sometimes, a multinational project may appear feasible from the subsidiary's perspective but not from the parent's perspective and vice versa. a. True b. False ANS: T

PTS: 1

52. The feasibility of a multinational project from the parent's perspective is dependent not on the subsidiary cash flows but on the cash flows that it ultimately receives. a. True b. False ANS: T

PTS: 1

53. Assuming that a subsidiary is wholly owned, a subsidiary's perspective is appropriate in attempting to determine whether a project will enhance the firm's value. a. True b. False ANS: F

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

54. The required rate of return used to discount the relevant cash flows from a foreign project may differ from the MNC's cost of capital because of that particular project's risk. a. True b. False ANS: T

PTS: 1

55. If a parent's perspective is used in analyzing a multinational project, the relevant cash flows are the dollars ultimately received by the parent as a result of the project; the relevant initial outlay is the investment by the parent. a. True b. False ANS: T

PTS: 1

56. If partial financing is provided by the foreign subsidiary, including foreign interest payments in the cash flow analysis may avoid overstatement of the estimated foreign cash flows. a. True b. False ANS: T

PTS: 1

57. Three common methods to incorporate an adjustment for risk into the capital budgeting analysis are the use of risk-adjusted discount rates, sensitivity analysis, and simulation. a. True b. False ANS: T

PTS: 1

58. The greater the uncertainty about a project's forecasted cash flows, the larger should be the discount rate applied to cash flows, other things being equal. a. True b. False ANS: T

PTS: 1

59. The objective of sensitivity analysis in capital budgeting is to determine how sensitive the NPV is to alternative values of the input variables. a. True b. False ANS: T

PTS: 1

60. ____ can cause the parent's after-tax cash flows to differ from the subsidiary's after-tax cash flows. a. The number of units sold by the subsidiary b. The subsidiary's earnings before income and taxes (EBIT) c. The tax rate the subsidiary is subject to in the host country d. Withholding taxes imposed by the host government ANS: D

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

61. ____ is an input required for a multinational capital budgeting analysis, given that it is conducted from the parent's viewpoint. a. Salvage value b. Price per unit sold c. Initial investment d. Consumer demand e. All of the above are inputs required for capital budgeting analysis.

ANS: E

PTS: 1

62. ____ is not a method of incorporating an adjustment for risk into the capital budgeting analysis. a. Discriminant analysis b. Risk-adjusted discount rate c. Sensitivity analysis d. Simulation ANS: A

PTS: 1

63. Which of the following is not true regarding simulation? a. It can be used to generate a probability distribution of NPVs. b. It generates a probability distribution of NPVs by randomly drawing values for the input variable(s). c. It can only be used for one variable at a time. d. It can be used to develop probability distributions of all variables with uncertain future values.

ANS: C

PTS: 1

64. Which of the following is not a factor that should be considered in multinational capital budgeting? a. Blocked funds b. Exchange rate fluctuations c. Inflation d. Financing arrangements e. All of the above should be considered.

ANS: E

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Chapter 15—International Corporate Governance and Control 1. International governance is achieved by all of the following except: a. poison pills. b. board of directors. c. institutional investors. d. blockholders. e. All of the above achieve governance.

ANS: A

PTS: 1

2. Which of the following is not an advantage of international acquisitions over the establishment of a new subsidiary? a. The firm can immediately expand its international business. b. An international acquisition typically generates quicker cash flows than the establishment of a new subsidiary. c. International acquisitions are generally cheaper than the establishment of a new subsidiary. d. An international acquisition typically generates larger cash flows than the establishment of a new subsidiary. e. All of the above are advantages of international acquisitions.

ANS: C

PTS: 1

3. According to your text, U.S. firms pursue more international acquisitions in ____ than in other countries. a. the U.K. b. Mexico c. Japan d. Germany e. France ANS: A

PTS: 1

4. Which of the following is not true regarding a target's previous cash flows? a. They may serve as an initial base from which future cash flows may be estimated after accounting for other factors. b. It may be easier to estimate the cash flows to be generated by a target than to estimate the cash flows to be generated from a new foreign subsidiary. c. They are always good indicators of future cash flows. d. All of the above are true.

ANS: C

PTS: 1

5. As far as the managerial talent of the target is concerned: a. the manner in which the acquirer plans to deal with the managerial talent will affect the estimated cash flows to be generated by the target. b. downsizing will reduce expenses and increase productivity and revenues. c. governments of some countries are likely to intervene and prevent the acquisition if downsizing is anticipated. d. all of the above © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

e. A and C only ANS: E

PTS: 1

6. Based on information in your text, all of the following factors should be considered in an international acquisition, except: a. the target's willingness to be acquired. b. the target's previous acquisition history. c. the target's previous cash flows. d. the target's local economic conditions.

ANS: B

PTS: 1

7. Which of the following tax-related factors need not be considered in assessing a foreign target? a. corporate tax rates in the host country. b. withholding tax rates in the host country. c. withholding tax rates in the home country. d. corporate tax rates in the home country. e. all of the above must be considered in assessing a foreign target.

ANS: C

PTS: 1

Exhibit 15-1 Klimewsky, Inc., a U.S.-based MNC, has screened several targets. Based on economic and political considerations, only one eligible target remains in Malaysia. Klimewsky would like you to value this target and has provided you with the following information: 

Klimewsky expects to keep the target for three years, at which time it expects to sell the firm for 500 million Malaysian ringgit (MYR) after deducting the amount for any taxes paid.



Klimewsky expects a strong Malaysian economy. Consequently, the estimates for revenues for the next year are MYR300 million. Revenues are expected to increase by 9% over the following two years.



Cost of goods sold are expected to be 60% of revenues.



Selling and administrative expenses are expected to be MYR40 million in each of the next three years.



The Malaysian tax rate on the target's earnings is expected to be 30%.



Depreciation expenses are expected to be MYR15 million per year for each of the next three years.



The target will need MYR9 million in cash each year to support existing operations.



The target's current stock price is MYR35 per share. The target has 11 million shares outstanding.



Any cash flows remaining after taxes are remitted by the target to Klimewsky, Inc.

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Klimewsky uses the prevailing exchange rate of the Malaysian ringgit as the expected exchange rate for the next three years. This exchange rate is currently $.23. 

Klimewsky's required rate of return on similar projects is 13%.

8. Refer to Exhibit 15-1. Based on the information provided above, the net present value of the Malaysian target is $____ million. a. 155.9 b. 111.5 c. 138.0 d. 143.0 e. none of the above ANS: B SOLUTION: Valuation of Bulgarian Target Based on the Assumptions Provided (numbers are in millions)

Revenue Cost of Goods Sold Gross Profit

Year 1 MYR300 MYR180 MYR120

Year 2 MYR327 MYR196.2 MYR130.8

Year 3 MYR356.4 MYR213.8 MYR142.6

Selling & Admin. Exp. Depreciation Earnings Before Taxes

MYR40 MYR15 MYR65

MYR40 MYR15 MYR75.8

MYR40 MYR15 MYR87.6

Tax (30%) Earnings After Taxes

MYR19.5 MYR45.5

MYR22.7 MYR53.1

MYR26.3 MYR61.3

+Depreciation Funds to Reinvest

MYR15 MYR9

MYR15 MYR9

MYR15 MYR9

Sale of Firm Cash Flows in MYR Exchange Rate of MYR Cash Flows in $ PV (13% disc. rate) Cumulative PV

MYR500 MYR51.5 $.23 $11.8

MYR59.1 $.23 $13.6

MYR567.3 $.23 $130.5

$10.4 $10.4

$10.7 $21.1

$90.4 $111.5

The value of the Malaysian target based on the information provided is $111.5 million.

PTS: 1 9. Refer to Exhibit 15-1. The Malaysian target's value based on its stock price is $____ million. a. 1.4 b. 1,673.9 c. 111.5 © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

d. 88.6 e. none of the above ANS: D SOLUTION:

Since the Malaysian target has 11 million shares outstanding, each of which is worth MYR35 per share, its market value is 11,000,000  35 = MYR385 million  $.23 = $88.6 million.

PTS: 1 10. Refer to Exhibit 15-1. The target's board has indicated that it finds a premium of 30 percent appropriate. You have been asked to negotiate for Klimewsky with the Malaysian target. What is the maximum percentage premium you should be willing to offer? a. 30.0%. b. 25.9%. c. you should not offer any premium because the market's valuation is below Klimewsky's valuation. d. none of the above ANS: B SOLUTION:

Since your valuation of the target is $111.5 million and the market's valuation of the target is $88.55 million, you should be willing to offer a maximum premium of $111.5/$88.55  1 = 25.9%.

PTS: 1 11. Which of the following would probably not cause the stock price of a foreign target to decrease? a. Its expected cash flows decline. b. General stock market conditions in the foreign country are deteriorating. c. Investors anticipate that the target will be acquired. d. All of the above will cause the target's stock price to decrease.

ANS: C

PTS: 1

12. Which of the following factors is least likely to cause the required rate of return to vary among MNCs assessing the same foreign target? a. differences in the timing of remittances from the target to the parent. b. differences in the desired use of the target. c. differences in the local risk-free interest rate. d. differences in the ability to use financial leverage.

ANS: A

PTS: 1

13. Which of the following types of international corporate control transaction is probably the most difficult to value by an MNC? a. international acquisition. b. newly privatized foreign business. c. international alliance. d. international divestiture.

ANS: B

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

14. A previously undertaken project in a foreign country may no longer be feasible because: a. interest rates have declined. b. the MNC's cost of capital has decreased. c. the host government has increased its tax rates substantially. d. exchange rate projections changed from a depreciation to an appreciation of the foreign currency.

ANS: C

PTS: 1

15. An international alliance typically requires a ____ initial outlay than an international acquisition, and the cash flows to be received will typically be ____ than the cash flow resulting from an international acquisition. a. smaller; larger b. smaller; smaller c. larger; smaller d. larger; larger ANS: B

PTS: 1

16. Even if an existing business adds value to an MNC, it may be worthwhile to assess whether the business would generate more value to the MNC if it was restructured. a. True b. False ANS: T

PTS: 1

17. At present, U.S. firms acquire more targets in the former Soviet Union than in any other country. a. True b. False ANS: F

PTS: 1

18. The U.S. is one of the few countries with agencies that monitor mergers and acquisitions. a. True b. False ANS: F

PTS: 1

19. The government of a country may prevent a foreign firm from acquiring local targets and downsizing the targets. a. True b. False ANS: T

PTS: 1

20. Since the cash flows generated by a foreign target will eventually be converted to the parent's currency, there is no need to consider the foreign exchange rate in the capital budgeting process. a. True b. False ANS: F

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

21. From an acquirer's perspective, the ideal conditions would be a weak foreign currency at the time of acquisition and a strengthening of the foreign currency over time as funds are remitted back to the parent. a. True b. False ANS: T

PTS: 1

22. Premiums required to entice a target's board of directors to approve an acquisition are usually between 1 and 3 percent of the target's market price. a. True b. False ANS: F

PTS: 1

23. A foreign target's expected future cash flows generally vary among different MNCs valuing the target. a. True b. False ANS: T

PTS: 1

24. An acquirer based in a low-tax country may be able to generate higher cash flows from acquiring a foreign target than an acquirer based in a high-tax country. a. True b. False ANS: T

PTS: 1

25. The valuation of a target (from the parent's perspective) should increase when the potential acquirer's cost of capital increases. a. True b. False ANS: F

PTS: 1

26. If potential acquirers are based in different countries, their required rates of return when considering a specific target will only vary if the desired use of the target is different. a. True b. False ANS: F

PTS: 1

27. Acquirers may have different required rates of return because of differences in the ability to use financial leverage. a. True b. False ANS: T

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

28. An international acquisition is different from the establishment of a new subsidiary in that the MNC can immediately expand its international business since the target is already in place. a. True b. False ANS: T

PTS: 1

29. An MNC that plans to acquire a target would prefer to time its bid for the target when the local stock market prices in the target's country are generally high. a. True b. False ANS: F

PTS: 1

30. Privatization involves the sale of previously government-owned businesses by the government. a. True b. False ANS: T

PTS: 1

31. An MNC should periodically reassess its investments to determine whether to divest them. a. True b. False ANS: T

PTS: 1

32. The initial outlay for a project in a foreign country may decline if property values in that country decline. a. True b. False ANS: T

PTS: 1

33. The valuation of newly privatized businesses is generally more difficult than the valuation of a foreign target that has operated privately for several years. a. True b. False ANS: T

PTS: 1

34. Other things being equal, a foreign subsidiary in China would more likely be divested by the U.S. parent if new information caused the parent to suddenly anticipate that: a. the Chinese yuan would depreciate in the future. b. the Chinese yuan would appreciate in the future. c. the Chinese yuan would remain somewhat stable in the future. d. none of the above; the value of the Chinese yuan has no impact on the feasibility of a divestiture.

ANS: A

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

35. Which of the following is not directly considered in the decision by a U.S.-based MNC to divest a subsidiary? a. the required rate of return on the subsidiary. b. forecasted exchange rates of the subsidiary's currency relative to the dollar. c. the initial outlay on the project. d. the possible selling price of the project.

ANS: C

PTS: 1

36. Regarding the valuation of privatized businesses in less developed countries, ____ can normally be estimated with a high degree of accuracy. a. future cash flows b. future exchange rate movements c. the proper discount rate d. none of the above ANS: D

PTS: 1

37. U.S. firms acquire more target firms in ____ than in any other country. a. Spain b. Italy c. Belgium d. United Kingdom ANS: D

PTS: 1

38. Firms based in ____ tend to acquire more U.S. target firms than the other countries listed here. a. Canada b. Japan c. Germany d. Mexico ANS: A

PTS: 1

39. The sale of a subsidiary by an MNC is referred to as a divestiture. a. True b. False ANS: T

PTS: 1

40. An MNC's parent would consider investing in a target only if the estimated present value of the cash flows it would ultimately receive from the target over time ____ the initial outlay necessary to purchase the target. a. is less than b. is the same as c. is greater than d. none of the above ANS: C

PTS: 1

41. Which of the following would not enhance the value of a target from the acquirer's perspective? a. Expected sales of the target have increased. © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

b. The subsidiary's currency is expected to strengthen after the acquisition. c. The required rate of return from investing in the target has increased. d. All of the above would enhance the value of the target.

ANS: C

PTS: 1

42. An international acquisition will typically require that the acquirer pay a premium of 30 percent or more for a public target. a. True b. False ANS: T

PTS: 1

43. A target's previous cash flows are typically an accurate indicator of future cash flows, especially when the target's cash flows would have to be converted into the acquirer's home currency as they are remitted to the parent. a. True b. False ANS: F

PTS: 1

44. Potential targets in countries where economic conditions are ____ are more likely to experience strong demand for their products in the future and may generate ____ cash flows. a. strong; lower b. weak; higher c. weak; lower d. strong; higher ANS: D

PTS: 1

45. When an MNC assesses targets among countries, it would prefer a country where the growth potential for its industry is ____ and the competition within the industry is ____. a. low; not excessive b. high; excessive c. high; not excessive d. low; excessive ANS: C

PTS: 1

46. An MNC that plans to acquire a target would prefer to make a bid at a time when the local stock market prices are generally ____. Assume that economic conditions are held constant when completing this statement. a. low b. high c. volatile d. none of the above ANS: A

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

47. If a target is privately held, general stock market conditions will not affect the amount that an acquirer has to pay for a foreign target. a. True b. False ANS: F

PTS: 1

48. The earnings of a private European firm are €5 million, and the average P/E ratio of publicly traded European firms in the same industry is 12. This firm is considering the possibility of going public in which it would issue one million shares. If the private firm has similar growth potential and other characteristics similar to other publicly traded firms in the industry, its value can be estimated as ____ million euros. a. 2.4 b. 60.0 c. 41.7 d. 12 ANS: B SOLUTION:

Market valuation = €5 million  12 = €60 million

PTS: 1 49. If the foreign currency ____ by the time the acquirer makes payment, the acquisition will be more costly, and the cost of the acquisition changes ____ the change in the exchange rate. a. appreciates; by a lesser percentage then b. depreciates; in the same proportion as c. appreciates; in the same proportion as d. appreciates; by a greater percentage than ANS: C

PTS: 1

50. If an MNC targets a successful foreign company with plans to continue the target's local business in a more efficient manner, the risk of the business will be relatively ____, and therefore the MNC's required return from acquiring the target will be relatively ____. a. high; high b. high; low c. low; high d. low; low ANS: D

PTS: 1

51. Even after an MNC's accept/reject decision of a foreign acquisition has been made, it should be reassessed at various times. In fact, this analysis may indicate that a previously accepted project should be divested. a. True b. False ANS: T

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

52. An international acquisition may be preferable to the establishment of a new subsidiary because the firm can immediately expand its international business and benefit from existing customer relationships. a. True b. False ANS: T

PTS: 1

53. The Sarbanes-Oxley Act requires more accountability by executives and the board of directors when assessing acquisitions. a. True b. False ANS: T

PTS: 1

54. When viewed as a project, the international acquisition usually generates quicker and larger cash flows than the establishment of a new subsidiary, but it also requires a larger initial outlay. a. True b. False ANS: T

PTS: 1

55. Downsizing reduces expenses but may also reduce productivity and revenue. a. True b. False ANS: T

PTS: 1

56. Economic conditions in the host country are probably more important for an MNC that intends to use the target to generate revenues in the host country than an MNC that intends to focus on exporting from the target's home country. a. True b. False ANS: T

PTS: 1

57. When an MNC assesses targets among countries, it would prefer a country in which the growth potential for its respective industry is high and the competition within the industry is not excessive. a. True b. False ANS: T

PTS: 1

58. Because of errors in cash flow or exchange rate estimates, the estimated net present value of acquiring a foreign target could be underestimated. a. True b. False ANS: T

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

59. A foreign target's expected future cash flows generally vary among different MNCs valuing the target. a. True b. False ANS: T

PTS: 1

60. An acquirer based in a low-tax country may be able to generate higher cash flows from acquiring a foreign target than an acquirer based in a high-tax country. a. True b. False ANS: T

PTS: 1

61. The value of an MNC (from the parent's perspective) is independent of the MNC's desired scheduling of remitted funds from the target. a. True b. False ANS: F

PTS: 1

62. If potential acquirers are based in different countries, their required rates of return when considering a specific target will only vary if the desired use of the target is different. a. True b. False ANS: F

PTS: 1

63. While acquisitions of privatized businesses may be attractive because of the potential for MNCs to increase their efficiency, the valuation of these businesses is generally more difficult. a. True b. False ANS: T

PTS: 1

64. It is always the best course of action to divest of a foreign project if the expected cash flows from the project decline substantially. a. True b. False ANS: F

PTS: 1

65. The valuation of a proposed international divestiture can be determined by comparing the present value of the cash flows if the project is continued to the proceeds that would be received (after taxes) if the project is divested. a. True b. False ANS: T

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

66. The stock price of a target may decrease if investors anticipate that the target will be acquired, since they are aware that stock prices of targets fall abruptly after a bid by the acquiring firm. a. True b. False ANS: F

PTS: 1

67. A simple method of valuing a private company is to apply the price-earnings ratios of publicly traded firms in the same industry to the private company's earnings. a. True b. False ANS: T

PTS: 1

68. The ideal time to purchase a foreign company is when the spot rate of that company's currency is perceived to be very high and is expected to decrease over time. a. True b. False ANS: F

PTS: 1

69. Which of the following is not an advantage of international acquisitions over the establishment of a new subsidiary? a. The firm can immediately expand its international business. b. The firm benefits from existing customer relationships. c. International acquisitions are generally cheaper than the establishment of a new subsidiary. d. An international acquisition typically generates quicker and larger cash flows than the establishment of a new subsidiary. e. All of the above are advantages of international acquisitions.

ANS: C

PTS: 1

70. An MNC valuing a foreign target for acquisition purposes must account for all of the following, except: a. the foreign exchange rate. b. withholding taxes imposed by the host government. c. blocked-funds restrictions. d. income taxes imposed by the U.S. government. e. An MNC must account for all of the above.

ANS: E

PTS: 1

71. According to your text, all of the following are factors to be considered in an international acquisition, except a. the target's willingness to be acquired. b. the target's previous acquisition history. c. the target's previous cash flows. d. the target's local economic conditions.

ANS: B

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

72. Which of the following would probably not cause the stock price of a foreign target to decrease? a. Its expected cash flows decline. b. General stock market conditions in the foreign country are deteriorating. c. Investors anticipate that the target will be acquired. d. All of the above will cause the target's stock price to decrease.

ANS: C

PTS: 1

73. Which of the following is not a reason why the valuation of a foreign target may vary among MNCs? a. Differences in estimated cash flows to be generated by the foreign target b. Differences in estimated exchange rates c. Differences in required rates of return d. All of the above are possible reasons why the valuation of a foreign target may vary among MNCs ANS: D

PTS: 1

74. The valuation of a newly privatized business is generally more difficult than the valuation of a publicly traded firm because: a. It has previously operated in environments of very high competition. b. Interest rates in the countries where privatization takes place are extremely high. c. The stock markets in the countries where privatization takes place are overvalued. d. Economic conditions in the countries where privatization takes place are very uncertain. e. None of the above ANS: D

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Chapter 16—Analysis of Country Risk 1. A macro-assessment of country risk: a. is adjusted for the particular business of the firm involved. b. excludes all aspects relevant to a particular firm or project. c. A and B d. none of the above ANS: B

PTS: 1

2. A micro-assessment of country risk: a. is adjusted for the particular business of the firm involved. b. excludes all aspects relevant to a particular firm or project. c. A and B d. none of the above ANS: A

PTS: 1

3. The Delphi technique: a. is a method of purchasing information about inspections of the country being evaluated. b. requires the use of discriminant analysis to assess country risk. c. involves the collection of independent opinions on country risk. d. none of the above ANS: C

PTS: 1

4. The checklist approach: a. requires several inspections of the country being evaluated. b. requires the use of discriminant analysis to assess country risk. c. requires ratings and weights to be assigned to all factors relevant in assessing country risk. d. involves the collection of independent opinions on country risk.

ANS: C

PTS: 1

5. The most important variable in determining a country's degree of overall country risk: a. is political risk. b. is financial risk. c. is the probability of a host government takeover. d. may often vary with the country of concern.

ANS: D

PTS: 1

6. According to the text, country risk analysis has: a. almost always detected problems before they occur. b. been effectively used in place of capital budgeting to determine whether a project should be accepted. c. been perfected as a result of the development of discriminant analysis. d. none of the above ANS: D

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

7. To best reduce exposure to a host government takeover, a subsidiary could: a. use a long-run profit perspective for business in that country. b. hire people from its own country (where the parent is located). c. attempt to obtain supplies from its parent for which substitutes are not available. d. borrow funds from its parent rather than from the host country's creditors.

ANS: C

PTS: 1

8. Insurance purchased to cover the risk of expropriation ____, and will typically cover ____. a. will be the same for all firms; only a portion of the firm's total exposure. b. will be the same for all firms; all of the firm's total exposure. c. will be dependent on the firm's risk; all of the firm's total exposure. d. will be dependent on the firm's risk; only a portion of the firm's total exposure.

ANS: D

PTS: 1

9. Country risk assessment should be used when: a. determining whether to establish a subsidiary in a foreign country. b. determining whether to continue business in a foreign country. c. A and B d. none of the above ANS: C

PTS: 1

10. When determining whether a particular proposed project in a foreign country is feasible: a. a country risk rating can adequately substitute for a capital budgeting analysis. b. country risk analysis should be incorporated within the capital budgeting analysis. c. the effect of country risk on sales revenue is more important than the effect on cash flows. d. the project with the highest country risk rating (lowest country risk) should be accepted. e. B and D ANS: B

PTS: 1

11. The primary purpose of country risk analysis when applied to capital budgeting is usually to: a. measure the effect of country risk on sales. b. measure the effect of country risk on cash flows. c. measure the effect of country risk on the consolidated balance sheet. d. measure the effect of country risk on the consolidated income statement.

ANS: B

PTS: 1

12. If a foreign country's consumers tend to only purchase products that are produced locally, the least effective strategy for a U.S. firm is to: a. use a licensing arrangement with a local firm in that country. b. enter into a joint venture in that country. c. develop a subsidiary (under the U.S. name) that manufactures and sells products in that country. d. develop a subsidiary (under the U.S. name) that manufactures products in that country and exports them to border countries.

ANS: C

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

13. An MNC considers direct foreign investment in Germany. It is mainly concerned with the subsidiary's ability to generate sufficient sales there. The country risk characteristic that would best address this concern is: a. the host government's tax rates charged on remitted earnings. b. the possibility of blocked funds. c. the state of the economy in Germany. d. the possibility of a withholding tax imposed by the German government.

ANS: C

PTS: 1

14. An MNC has a foreign manufacturing plant to capitalize on cheap production costs; the MNC exports all the goods produced. It should be most concerned about the country's: a. growth in gross domestic product. b. government policies designed to increase tariffs on imported goods. c. local consumer purchasing habits. d. government environmental regulations and taxes on the lease or purchase of a production site.

ANS: D

PTS: 1

15. A firm may incorporate a country risk rating into the capital budgeting analysis by: a. adjusting the NPV upward if the country risk rating has fallen (implying increased risk) below a benchmark level. b. adjusting the discount rate upward as the country risk rating decreases (implying increased risk). c. A and B d. none of the above ANS: B

PTS: 1

16. According to the text, the most appropriate method of incorporating country risk into capital budgeting analysis is to: a. compare each form of a country risk rating to a benchmark level. b. estimate the effect of each form of country risk on cash flows. c. estimate the effect of each form of country risk on the income statement and balance sheet. d. adjust the discount rate to reflect the level of country risk using the conventional adjustment formula that is used by virtually all MNCs. ANS: B

PTS: 1

17. The Multilateral Investment Guarantee Agency can provide MNCs implementing direct foreign investment in less developed countries with: a. insurance that covers losses on multilateral netting procedures. b. exchange rate risk insurance. c. political risk insurance. d. guarantees that MNCs will receive the same taxation treatment by the host government as local firms. e. guarantees of lines of credit provided by the World Bank if the MNC experiences liquidity problems.

ANS: C

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

18. Country risk analysis is important because it: a. focuses on whether to hedge contractual transactions. b. focuses on the competitor firms in its industry. c. can be used to improve the analysis used to make long-term investing decisions. d. all of the above ANS: C

PTS: 1

19. ____ is (are) not a form of political risk. a. Exchange rate movements b. Attitude of consumers in the host country c. Actions of the host government d. Blockage of fund transfers e. All of the above are forms of political risk ANS: A

PTS: 1

20. Eurenasia is a country that has frequently been assigned low macro-assessment ratings of country risk in the recent past due to its tendency to war with neighboring nations. MNC A is considering the establishment of a subsidiary to manufacture personal computers, while MNC B is considering the establishment of a subsidiary to manufacture tanks. Which of the two MNCs is likely to be less affected by the low macro-assessment? a. MNC A. b. MNC B. c. both will be equally affected, since the macro-assessment does not vary. d. none of the above ANS: B

PTS: 1

21. Which of the following is not a technique to assess country risk? a. Gamma technique. b. Delphi technique. c. checklist approach. d. inspection visits.

ANS: A

PTS: 1

22. The ____ involves the collection of independent opinions on country risk without group discussion by the assessors who provide these opinions. a. checklist approach b. discriminant analysis c. regression analysis d. Delphi technique ANS: D

PTS: 1

23. When quantifying country risk: a. weights should be equally allocated among factors. b. weights should be assigned to the political and financial factors according to their perceived importance. c. it is not generally necessary to construct separate ratings for political and financial risk © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

since these will be equally weighed in the final analysis. d. the derived factors will be identical for all MNCs conducting business in that country.

ANS: B

PTS: 1

24. Which of the following is not a strategy that could be used by an MNC to reduce its exposure to a host government takeover? a. Attempt to recover cash flows from a foreign investment as quickly as possible b. Rely on unique supplies and/or technology c. Hire local labor d. Borrow local funds e. All of the above are strategies to reduce an MNC's exposure to a host government takeover.

ANS: E

PTS: 1

25. MNCs can purchase insurance to cover the risk of expropriation. Which of the following is not a source of this type of insurance? a. the World Bank. b. the Overseas Private Investment Corporation (OPIC). c. the International Monetary Fund (IMF). d. all of the above are sources for insurance against expropriation.

ANS: C

PTS: 1

26. Which of the following is not a way in which country risk analysis can be used? a. to monitor countries where an MNC is currently doing business. b. as a screening device to avoid conducting business in countries with excessive risk. c. to revise an MNC's financing decisions. d. to determine the degree to which the MNC is exposed to exchange rate movements.

ANS: D

PTS: 1

27. An MNC must assess country risk not only in countries where it currently does business but also in those where it expects to export or establish subsidiaries. a. True b. False ANS: T

PTS: 1

28. ____ is not a political risk factor. a. High interest rates in a foreign country b. Currency inconvertibility c. War d. Corruption ANS: A

PTS: 1

29. A mild form of political risk is a tendency of residents to purchase only: a. imported products. b. locally produced products. c. products produced by MNCs. © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

d. none of the above ANS: B

PTS: 1

30. To make an MNC's operations coincide with its own goal, a host government could do all of the following, except: a. require the use of local employees for managerial positions. b. require social facilities. c. subsidize the MNC. d. require environmental controls.

ANS: C

PTS: 1

31. When a country's currency is inconvertible, the earnings generated by a subsidiary in that country cannot be remitted to the parent through currency conversion. a. True b. False ANS: T

PTS: 1

32. When the war in Iraq began in 2003, some MNCs feared that oil prices would ____ and that U.S. inflation and interest rates would ____. a. rise; rise b. fall; fall c. rise; fall d. fall; rise ANS: A

PTS: 1

33. Higher interest rates in a foreign country tend to ____ the growth of an economy and ____ demand for the MNC's product. a. increase; increase b. reduce; reduce c. increase; reduce d. reduce; increase ANS: B

PTS: 1

34. A ____ currency may ____ the volume of products imported by the country and therefore reduce the country's production and national income. a. weak; increase b. weak; reduce c. strong; increase d. strong; reduce ANS: C

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

35. Risk assessors almost always arrive at the same opinion after completing a macro-assessment of country risk. a. True b. False ANS: F

PTS: 1

36. ____ involve(s) the collection of independent opinions on country risk without group discussion by the assessors who provide these opinions. a. The checklist approach b. The Delphi technique c. Quantitative analysis d. Inspection visits ANS: B

PTS: 1

37. Perhaps the most appropriate method for incorporating forms of country risk in a capital budgeting analysis is to estimate how the ____ would be affected by each form of risk. a. discount rate b. cash flows c. opportunity cost d. none of the above ANS: B

PTS: 1

38. Since country risk is constantly changing and events in other parts of the world are largely unpredictable, country risk analysis is not important for MNCs. a. True b. False ANS: F

PTS: 1

39. A blockage of fund transfers imposed by a host government usually forces a subsidiary to donate the funds to the host government. a. True b. False ANS: F

PTS: 1

40. Higher interest rates tend to increase the growth of an economy and increase the demand for an MNC's products. a. True b. False ANS: F

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

41. When using a checklist approach to assess country risk, factors should be converted to some numerical forms and assigned equal weights. a. True b. False ANS: F

PTS: 1

42. Unlike project risk, country risk cannot be incorporated into the capital budgeting analysis of a proposed project by adjustment of the discount rate or by adjustment of the estimated cash flows. a. True b. False ANS: F

PTS: 1

43. After a project is accepted and implemented, country risk does not need to be monitored; since the project is already established, no further changes can be made. a. True b. False ANS: F

PTS: 1

44. While an overall risk rating of a country can be useful, it cannot always detect upcoming crises. a. True b. False ANS: T

PTS: 1

45. Country risk can affect an MNC's cash flows but cannot affect its cost of capital. a. True b. False ANS: F

PTS: 1

46. To reduce the exposure to a host government takeover, an MNC may attempt to recover cash flows from the foreign project more quickly or hire local labor. a. True b. False ANS: T

PTS: 1

47. The weights assigned to factors when assessing country risk should always be higher for the political risk factors than the financial factors. a. True b. False ANS: F

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

48. A micro-assessment of country risk involves consideration of all variables that affect country risk except for those unique to a particular firm or industry. a. True b. False ANS: F

PTS: 1

49. Delphi analysis examines the financial and political factors of various countries and attempts to identify which factors help to distinguish between tolerable-risk and intolerable-risk countries. a. True b. False ANS: F

PTS: 1

50. U.S.-based MNCs could avoid country risk by simply avoiding international business. a. True b. False ANS: T

PTS: 1

51. If an MNC diversifies its operations internationally to reduce its exposure to any individual country's problems, country risk analysis becomes irrelevant. a. True b. False ANS: F

PTS: 1

52. Macro-assessment of country risk refers to an overall risk assessment of a country without consideration of the MNC's business. a. True b. False ANS: T

PTS: 1

53. Adjustments to incorporate country risk into the capital budgeting analysis would involve either the addition of a risk premium to the discount rate or a reduction of the cash flows. a. True b. False ANS: T

PTS: 1

54. Country risk analysis is important because it: a. can be used by MNCs as a screening device to avoid countries with excessive risk.

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

b. can be used by MNCs to monitor countries where the MNC is presently engaged in international business. c. can be used to improve the analysis used to make long-term investing or financing decisions. d. all of the above ANS: D

PTS: 1

55. Which of the following is not a form of financial risk? a. Exchange rate movements b. Inflation rates c. Blockage of fund transfers d. All of the above are forms of financial risk.

ANS: C

PTS: 1

56. Which of the following is not an example of political risk? a. The Japanese government requires an MNC's subsidiary to install exercise rooms for its employees. b. The Swiss government requires an MNC's subsidiary to install filters in its manufacturing plants to reduce pollution. c. Country X, considered for expansion, frequently goes to war with its neighbors. d. Country Y's government has recently taken over the subsidiary of one of your competitors, another U.S.-based MNC. e. All of the above are examples of political risk.

ANS: E

PTS: 1

57. Which of the following is probably the best method of incorporating country risk into a capital budgeting analysis? a. Adjusting the discount rate upward b. Adjusting the input variables to estimate the sensitivity of the project's NPV c. Adjusting the political risk rating to obtain a more favorable NPV d. Country risk should be ignored in capital budgeting, since it is a subjective analysis.

ANS: B

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Chapter 17—Multinational Cost of Capital and Capital Structure 1. An argument for MNCs to have a debt-intensive capital structure is: a. they are well diversified. b. they can reduce the chance of bankruptcy. c. it spreads the shareholder base. d. it forces subsidiaries to pay dividends to shareholders.

ANS: A

PTS: 1

2. According to the text, there is evidence that the debt ratios (debt/capital) of MNCs based in: a. the U.S. tend to be generally higher than MNCs headquartered in Japan and Germany. b. China tend to be generally higher than MNCs headquartered in other non-U.S. countries. c. the U.S. tend to be generally lower than MNCs headquartered in Japan and Germany. d. A and B ANS: C

PTS: 1

3. According to the text, the cost of capital for an international project will: a. always be greater than the firm's cost of capital. b. always be less than the firm's cost of capital. c. always be the same as the firm's cost of capital. d. none of the above ANS: D

PTS: 1

4. Which of the following factors is not expected to generally have a favorable impact on the firm's cost of capital according to the text? a. easy access to international capital markets. b. high degree of international diversification. c. high exposure to exchange rate fluctuations. d. all of the above ANS: C

PTS: 1

5. The capital asset pricing theory is based on the premise that: a. only unsystematic variability in cash flows is relevant. b. only systematic variability in cash flows is relevant. c. both systematic and unsystematic variability in cash flows are relevant. d. neither systematic nor unsystematic variability in cash flows is relevant.

ANS: B

PTS: 1

6. According to the text, MNCs can: a. use only debt financing in foreign countries to support foreign subsidiaries. b. use only equity financing in foreign countries to support foreign subsidiaries. c. use only parent financing in foreign countries to support foreign subsidiaries. d. none of the above ANS: D

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

7. The term "global" target capital structure for an MNC represents the MNC's capital structure: a. in the U.S. b. relative to competitors across all countries. c. where it has its largest subsidiary. d. when consolidating all of its subsidiaries.

ANS: D

PTS: 1

8. According to the text, an MNC's "global" target capital structure is: a. always debt-intensive. b. always equity-intensive. c. sometimes different from an MNC's "local" capital structures (at subsidiaries). d. none of the above ANS: C

PTS: 1

9. One argument for why subsidiaries should be wholly-owned by the parent is that the potential conflict of interests between the MNC's ____ is avoided. a. managers and shareholders b. majority shareholders and minority shareholders c. existing creditors d. managers and creditors ANS: B

PTS: 1

10. One argument for why subsidiaries should be only partly-owned by the parent is: a. that the potential conflict of interests between the MNC's managers and shareholders is avoided. b. that the potential conflict of interests between the MNC's majority shareholders and minority shareholders is avoided. c. that the potential conflict of interests between the MNC's existing creditors is avoided. d. to motivate subsidiary managers by allowing them partial ownership.

ANS: D

PTS: 1

11. The cost of capital incurred by U.S.-based MNCs is primarily driven by the global stock market volatility. a. True b. False ANS: F

PTS: 1

12. Other things being equal, countries with relatively ____ populations and ____ inflation are more likely to have a low cost of capital. a. young; high b. old; high c. old; low d. young; low ANS: C

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

13. Other things being equal, the financial leverage of MNCs will be higher if the governments of their home countries are ____ likely to rescue them (in the event of failure), and if their home countries are ____ likely to experience a recession. a. more; more b. less; more c. less; less d. more; less ANS: D

PTS: 1

14. Based on the factors that influence a country's cost of capital, the cost of capital in less developed countries is likely to be ____ than that of the U.S. and ____ than that of Japan. a. higher; higher b. higher; lower c. lower; lower d. lower; higher ANS: A

PTS: 1

15. According to the text, the cost of debt: a. for each country is somewhat stable over time. b. among countries changes over time, and these changes are negatively correlated. c. among countries changes over time, and these changes are positively correlated. d. among countries changes over time, and are not correlated.

ANS: C

PTS: 1

16. The term "local target capital structure" is used in the text to represent the: a. average capital structure of local firms where the MNC's subsidiary is based. b. average capital structure of local firms where the MNC's parent is based. c. capital structure of a subsidiary of a particular MNC. d. capital structure of a particular MNC overall (including all subsidiaries).

ANS: C

PTS: 1

17. The term "global capital structure" is used in the text to represent the: a. average capital structure of all MNCs across countries. b. average capital structure of all domestic firms across countries. c. capital structure of a subsidiary of a particular MNC. d. capital structure of a particular MNC overall (including all subsidiaries).

ANS: D

PTS: 1

18. An MNC may deviate from its target capital structure in each country where financing is obtained, yet still achieve its target capital structure on a consolidated basis. a. True b. False ANS: T

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

19. Assume that the risk-free interest rate in the U.S. is the same as that in Country M. Assume that the government of Country M is more likely to rescue local firms that experience financial problems.

Other things being equal, Country M's firms are likely to use a ____ degree of financial leverage than U.S. firms. If a firm based in Country M had the same degree of financial leverage and the same operating characteristics as a U.S. firm, its cost of capital would be ____ than that of the U.S. firm. a. higher; higher b. higher; lower c. lower; lower d. lower; higher ANS: B

PTS: 1

20. When a country's risk-free rate rises, the cost of equity to an MNC in that country _____, and the cost of debt to an MNC in that country ____, other things held constant. a. increases; increases b. increases; is not affected c. is not affected; increases d. is not affected; is not affected ANS: A

PTS: 1

21. Which of the following is not a factor that favorably affects an MNC's cost of capital, according to your text? a. exchange rate risk. b. size. c. access to international capital markets. d. international diversification.

ANS: A

PTS: 1

22. According to your text, which of the following is not a factor that increases an MNC's cost of capital? a. higher exposure to exchange rate risk. b. higher exposure to country risk. c. an increase in the risk-free interest rate. d. an increase in the size of the MNC. ANS: D

PTS: 1

23. The ____ an MNC, the ____ its cost of capital is likely to be. a. larger; higher b. larger; lower c. smaller; lower d. A and C ANS: B

PTS: 1

24. Zoro Corporation has a beta of 2.0. The risk-free rate of interest is 5%, and the return on the stock market overall is expected to be 13%. What is the required rate of return on Zoro stock? a. 21%. b. 41%. c. 16%. d. 13%. © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

e. none of the above ANS: A SOLUTION:

5% + 2 (13%  5%) = 21%.

PTS: 1 25. Which of the following is not a reason provided in the text regarding why the cost of debt can vary across countries? a. differences in the risk-free rate. b. a high price-earnings multiple. c. differences in the credit risk premium. d. differences in demographics.

ANS: B

PTS: 1

26. In general, MNCs probably prefer to use ____ foreign debt when their foreign subsidiaries are subject to ____ local interest rates. a. more; low b. more; high c. less; low d. B and C e. none of the above ANS: A

PTS: 1

27. In general, MNCs probably prefer to use ____ foreign debt when their foreign subsidiaries are subject to potentially ____ local currencies. a. more; strong b. more; weak c. less; strong d. less; weak e. B and D ANS: B

PTS: 1

28. A firm's cost of ____ reflects an opportunity cost: what the existing shareholders could have earned if they had received the earnings as dividends and invested the funds themselves. a. debt b. retained earnings c. short-term loans d. none of the above ANS: B

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

29. The ____ the MNC's cost of capital, the ____ will be a project's net present value for its proposed project with a given set of expected cash flows. a. lower; higher b. higher; higher c. lower; lower d. none of the above ANS: A

PTS: 1

30. To the extent that individual economies are ____ each other, net cash flows from a portfolio of subsidiaries should exhibit ____ variability, which may reduce the probability of bankruptcy. a. dependent on; less b. dependent on; more c. independent of; less d. independent of; more ANS: C

PTS: 1

31. In general, a firm ____ exposed to exchange rate fluctuations will usually have a ____ distribution of possible cash flows in future periods. a. more; narrower b. less; wider c. more; wider d. none of the above ANS: C

PTS: 1

32. According to the CAPM, the required rate of return on stock is a positive function of all of the following, except: a. the risk-free rate of interest. b. the market rate of return. c. the stock's beta. d. the company's earnings.

ANS: D

PTS: 1

33. The lower a project's beta, the ____ is the project's ____ risk. a. lower; systematic b. lower; unsystematic c. higher; systematic d. higher; unsystematic ANS: A

PTS: 1

34. Capital asset pricing theory suggests that ____ risk of projects can be ignored and that ____ is relevant. a. unsystematic; unsystematic b. unsystematic; systematic c. systematic; unsystematic d. systematic; systematic

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

ANS: B

PTS: 1

35. Capital asset pricing theory would most likely suggest that the cost of capital is generally ____ for ____. a. higher; MNCs b. lower; domestic firms c. lower; MNCs d. none of the above ANS: C

PTS: 1

36. When assuming that investors in the U.S. are most concerned with their exposure to the U.S. stock market, it is acceptable to use the U.S. market when measuring a U.S.-based MNC's project's beta. a. True b. False ANS: T

PTS: 1

37. Assume the following information for Pexi Co., a U.S.-based MNC that needs funding for a project in Germany: U.S. risk-free rate = 4% German risk-free rate = 5% Risk premium on dollar-denominated debt provided by U.S. creditors = 3% Risk premium on euro-denominated debt provided by German creditors = 4% Beta of project = 1.2 Expected U.S. market return = 10% U.S. corporate tax rate = 30% German corporate tax rate = 40% What is Pexi's cost of dollar-denominated equity? a. 12.0%. b. 11.2%. c. 10.0%. d. 7.2%.

ANS: B SOLUTION:

4% + 1.2(10%  4%) = 11.2%

PTS: 1 38. Assume the following information for Brama Co., a U.S.-based MNC that needs funding for a project in Germany: U.S. risk-free rate = 4% German risk-free rate = 5% Risk premium on dollar-denominated debt provided by U.S. creditors = 3% Risk premium on euro-denominated debt provided by German creditors = 4% Beta of project = 1.2 Expected U.S. market return = 10% U.S. corporate tax rate = 30% © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

German corporate tax rate = 40% What is Brama's after-tax cost of dollar-denominated debt? a. 7.0%. b. 4.9%. c. 8.0%. d. 5.6%.

ANS: B SOLUTION:

(4%  3%) x (1- 0.3) = 4.9%

PTS: 1 39. Assume that an MNC has very stable cash flows and uses very little debt. Its cost of debt should be: a. lower than its cost of equity. b. higher than its cost of equity. c. lower than the country's risk-free rate. d. lower than its credit risk premium.

ANS: A

PTS: 1

40. Normally, each subsidiary of an MNC will issue its own stock where it does business. a. True b. False ANS: F

PTS: 1

41. In general, an MNC's size, its access to international capital markets, and international diversification are unfavorable to an MNC's cost of capital. a. True b. False ANS: F

PTS: 1

42. Country differences, such as differences in the risk-free interest rate and differences in risk premiums across countries, can cause the cost of capital to vary across countries. a. True b. False ANS: T

PTS: 1

43. Because their economies have lower growth, the cost of debt in industrialized countries is much higher than the cost of debt in many less developed countries. a. True b. False ANS: F

PTS: 1

44. In the United States, government rescues are not as common as in other countries. Assuming that this is expected to continue in the future, the risk premium on a given level of debt would be higher for U.S. firms than for firms of other countries, everything else being equal. © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

a. True b. False ANS: T

PTS: 1

45. The MNC's cost of equity is unrelated to the local risk-free rate. a. True b. False ANS: F

PTS: 1

46. Assume a subsidiary is forced to borrow in excess of the MNC's optimal capital structure. Also assume that the parent company reduces its debt financing by an offsetting amount. Under this scenario, the cost of capital for the MNC overall could not have changed. a. True b. False ANS: F

PTS: 1

47. Because increased external financing by a foreign subsidiary reduces the external financing needed by the parent, such an action will not affect the overall MNC's cost of capital. a. True b. False ANS: F

PTS: 1

48. Since the cost of funds can vary among markets, the MNC's access to the international capital markets may allow it to attract funds at a lower cost than that paid by domestic firms. a. True b. False ANS: T

PTS: 1

49. Capital asset pricing theory would most likely suggest that the MNC's cost of capital is lower than that of domestic firms. a. True b. False ANS: T

PTS: 1

50. If an MNC's cash flows are more stable, it can probably handle more debt than an MNC with erratic cash flows. a. True b. False ANS: T

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

51. When MNCs pursue international projects that have a high potential for return, but also increase their risk, this increases the return to the bondholders that provided credit to the MNCs. a. True b. False ANS: F

PTS: 1

52. There is an advantage to using equity rather than debt financing because dividend payments are tax deductible. a. True b. False ANS: F

PTS: 1

53. An MNC's cost of capital may differ from that of domestic firms because of their access to international capital markets, their exposure to exchange rate risk, and other characteristics. a. True b. False ANS: T

PTS: 1

54. An MNC's size, its access to international capital markets, and international diversification are unfavorable to an MNC's cost of capital. a. True b. False ANS: F

PTS: 1

55. The capital asset pricing model (CAPM) suggests that the required return on a firm's stock is a positive function of the risk-free rate of interest and the market rate of return and a negative function of the stock's beta. a. True b. False ANS: F

PTS: 1

56. Country differences, such as differences in the risk-free interest rate and differences in risk premiums across countries, can cause the cost of capital to vary across countries. a. True b. False ANS: T

PTS: 1

57. It is always advantageous to use foreign debt to finance a foreign project, particularly in developing countries. a. True b. False ANS: F

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

58. It is probably easier to estimate the cost of equity than it is to estimate the cost of debt. a. True b. False ANS: F

PTS: 1

59. An MNC may deviate from its target capital structure in each country where financing is obtained, yet still achieve its target capital structure on a consolidated basis. a. True b. False ANS: T

PTS: 1

60. If a parent company backs the debt of a foreign subsidiary, the borrowing capacity of the parent might be reduced as creditors are not willing to provide as many funds to the parent if those funds may possibly be needed to rescue a parent's subsidiary. a. True b. False ANS: T

PTS: 1

61. Based on the CAPM, the ____ the beta of a project, the ____ the required rate of return on that project. a. higher; higher b. lower; higher c. higher; lower d. B and C e. none of the above ANS: A

PTS: 1

62. The capital asset pricing model suggests that the required return on a firm's stock is a positive function of: a. the risk-free rate of interest. b. the market rate of return. c. the stock's beta. d. all of the above ANS: D

PTS: 1

63. The capital asset pricing model suggests that the required return on a firm's stock is a negative function of: a. the risk-free rate of interest. b. the market rate of return. c. the stock's beta. d. none of the above ANS: D

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

64. An MNC can obtain equity by all of the following except: a. retained earnings. b. a global equity offering. c. a domestic equity offering. d. none of the above.

ANS: D

PTS: 1

65. Werner Corporation has a target capital structure that consists of 40% debt and 60% equity. Werner can borrow at an interest rate of 10%. Also, Werner has determined its cost of equity to be 14%.

Werner's tax rate is 40%. What is Werner's weighted average cost of capital? a. 10.80% b. 12.40% c. 9.20% d. None of the above ANS: A

PTS: 1

66. The U.S. risk-free rate is currently 3%. The expected U.S. market return is 10%. Solso, Inc. is considering a project that has a beta of 1.2. What is the cost of dollar-denominated equity? a. 8.4% b. 11.4% c. 10% d. None of the above ANS: B

PTS: 1

67. Which of the following is least likely to influence an MNC's capital structure? a. The stability of MNC's cash flows b. The MNC's credit risk c. The MNC's access to earnings d. The MNC's decision to invest excess cash in a Treasury bill rather than in a bank ANS: D

PTS: 1

68. Which of the following is not a host country characteristic than can affect an MNC's capital structure decision? a. The strength of host country currencies b. The country risk in host countries c. Political decisions to increase penalties for criminals d. Tax laws in host countries ANS: C

PTS: 1

69. If the parent ____ the debt of the subsidiary, the subsidiary's borrowing capacity might be ____. a. does not back; increased b. backs; reduced c. does not back; reduced d. backs; increased e. C and D

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

ANS: E

PTS: 1

70. ____ are beneficial because they may reduce transaction costs. However, MNCs may not be able to obtain all the funds that they need. a. Private placements b. Domestic equity offerings c. Global equity offerings d. Global debt offerings ANS: A

PTS: 1

71. Most MNCs obtain equity funding: a. in foreign countries. b. in their home country. c. through global offerings. d. through private placements.

ANS: B

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Chapter 18— Financing in the Long-Term 1. If an MNC financed with a currency different from its invoice currency, it would prefer that the loan be denominated in a currency that: a. exhibits a low interest rate and is expected to appreciate. b. exhibits a low interest rate and is expected to depreciate. c. exhibits a high interest rate and is expected to depreciate. d. exhibits a high interest rate and is expected to appreciate.

ANS: B

PTS: 1

2. Floating-rate bonds are often issued with a floating coupon rate that is tied to LIBOR. a. True b. False ANS: T

PTS: 1

3. A U.S. firm could issue bonds denominated in euros and partially hedge against exchange rate risk by: a. invoicing its exports in U.S. dollars. b. requesting that any imports ordered by the firm be invoiced in U.S. dollars. c. invoicing its exports in euros. d. requesting that any imports ordered by the firm be invoiced in the currency denominating the bonds.

ANS: C

PTS: 1

4. Lantana Co. conducts pays for many imports denominated in Canadian dollars. It is a major exporter to France, and invoices the exports in euros. It also has much business in U.S. dollars. It has no other international business and does not hedge its transactions. It is about to obtain a small loan. It could reduce its exchange rate risk if its loan is denominated in: a. U.S. dollars. b. euros. c. Canadian dollars d. none of the above ANS: B

PTS: 1

5. Simulation is useful in the bond-denomination decision since it can: a. precisely compute the cost of financing with bonds denominated in a single foreign currency. b. precisely compute the cost of financing with bonds denominated in a portfolio of foreign currencies. c. assess the probability that a bond denominated in a foreign currency will be less costly than a bond denominated in the home currency. d. A and B ANS: C

PTS: 1

6. An interest rate swap between two firms of different countries enables the exchange of ____ for ____. a. fixed-rate payments; floating-rate payments b. stock; interest deductions on taxes © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

c. interest payments on loans; ownership of debt of less developed countries d. interest payments on loans; stock ANS: A

PTS: 1

7. If U.S. firms issue bonds in ____, the dollar outflows to cover fixed coupon payments increase as the dollar ____. a. a foreign currency; weakens b. dollars; strengthens c. a foreign currency; strengthens d. dollars; weakens ANS: A

PTS: 1

8. The yields offered on newly issued bonds tend to be: a. lower in less developed countries where labor costs are low. b. relatively high in countries such as Japan and the U.S. because the credit risk premium is much higher there than in other countries. c. the same across countries at a give point in time. d. none of the above ANS: D

PTS: 1

9. When a U.S.-based MNC has a subsidiary in Mexico that needs financing, the MNC's exposure to exchange rate risk can be minimized if: a. the parent issues dollar-denominated equity and provides the proceeds to the subsidiary. b. the parent provides its retained earnings to the Mexican subsidiary. c. the subsidiary obtains a dollar-denominated loan from a financial institution. d. the subsidiary obtains a peso-denominated loan from a financial institution.

ANS: D

PTS: 1

10. A U.S. firm has received a large amount of cash inflows periodically in Swiss francs as a result of exporting goods to Switzerland. It has no other business outside the U.S. It could best reduce its exposure to exchange rate risk by: a. issuing Swiss franc-denominated bonds. b. purchasing Swiss franc-denominated bonds. c. purchasing U.S. dollar-denominated bonds. d. issuing U.S. dollar-denominated bonds.

ANS: A

PTS: 1

11. A U.S. firm has a Canadian subsidiary that remits a large amount of its earnings to the parent on an annual basis. It also imports supplies from China, invoiced in Chinese yuan. The firm has no other foreign business, and needs a small loan. The firm could best reduce its exposure to exchange rate risk by borrowing: a. U.S. dollars. b. Canadian dollars. c. Chinese yuan. d. a combination of Canadian dollars and Chinese yuan.

ANS: B

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

12. If the currency denominating a foreign bond depreciates against the firm's home currency, the funds needed to make coupon payments will increase. a. True b. False ANS: F

PTS: 1

13. An interest rate swap is commonly used by an issuer of fixed-rate bonds to: a. convert to floating-rate debt. b. hedge exchange rate risk. c. lock in the interest payments on debt. d. remove the default risk of its debt.

ANS: A

PTS: 1

14. A currency swap between two firms of different countries enables the exchange of ____ for ____ at periodic intervals. a. stock; one currency b. stock; a portfolio of foreign currencies c. one currency; stock options d. one currency; another currency ANS: D

PTS: 1

15. Assume a U.S.-based subsidiary wants to raise $1,000,000 by issuing a bond denominated in Pakistani rupees (PKR). The current exchange rate of the rupee is $.02. Thus, the MNC needs ____ rupees to obtain the $1,000,000 needed. a. 50,000,000 b. 20,000 c. 1,000,000 d. none of the above ANS: A SOLUTION:

$1,000,000/$.02 = PKR50,000,000

PTS: 1 16. An MNC issues ten-year bonds denominated in 500,000 Philippines pesos (PHP) at par. The bonds have a coupon rate of 15%. If the peso remains stable at its current level of $.025 over the lifetime of the bonds and if the MNC holds the bonds until maturity, the financing cost to the MNC will be: a. 10.0%. b. 12.5%. c. 15.0%. d. none of the above ANS: C SOLUTION:

Since the bonds are issued at par, and since the exchange rate remains stable over the life of the bonds and the bonds are held until maturity, the financing cost will be exactly the coupon rate of the bond.

PTS: 1 © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

17. New Hampshire Corp. has decided to issue three-year bonds denominated in 5,000,000 Russian rubles at par. The bonds have a coupon rate of 17%. If the ruble is expected to appreciate from its current level of $.03 to $.032, $.034, and $.035 in years 1, 2,and 3, respectively, what is the financing cost of these bonds? a. 17%. b. 23.18%. c. 22.36%. d. 23.39%.

ANS: D SOLUTION:

Payments in rubles Forecasted exchange rate of ruble Payments in dollars

Year 1 850,000 $.032 $27,200

Year 2 850,000 $.034 $28,900

Year 3 5,850,000 $.035 $204,750

Annual Cost of Financing

23.39%

PTS: 1 18. In a(n) ____ swap, two parties agree to exchange payments associated with bonds; in a(n) ____ swap, two parties agree to periodically exchange foreign currencies. a. interest rate; currency b. currency; interest rate c. interest rate; interest rate d. currency; currency ANS: A

PTS: 1

19. Good Company prefers variable to fixed rate debt. Bad Company prefers fixed to variable rate debt.

Assume the following information for Good and Bad Companies:

Good Company Bad Company

Fixed Rate Bond 10% 12%

Variable Rate Bond LIBOR + 1% LIBOR + 1.5%

Given this information: a. an interest rate swap will probably not be advantageous to Good Company because it can issue both fixed and variable debt at more attractive rates than Bad Company. b. an interest rate swap attractive to both parties could result if Good Company agreed to provide Bad Company with variable rate payments at LIBOR + 1% in exchange for fixed rate payments of 10.5%. c. an interest rate swap attractive to both parties could result if Bad Company agreed to provide Good Company with variable rate payments at LIBOR + 1% in exchange for fixed rate payments of 10.5%. d. none of the above ANS: B

PTS: 1

20. A callable swap gives the ____ payer the right to terminate the swap; the MNC would exercise this right if interest rates ____ substantially. © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

a. b. c. d. e.

floating-rate; rise floating-rate; fall fixed-rate; rise fixed-rate; fall none of the above

ANS: D

PTS: 1

21. When an MNC needs to finance a portion of a foreign project within the foreign country, the best method to account for a foreign project's risk is to: a. apply a required return that is based on the CAPM. b. apply a required return based on unsystematic risk. c. derive the net present value of the equity investment. d. apply the required return equal to the risk-free rate in the foreign country.

ANS: C

PTS: 1

22. Assume that a yield curve's shape is caused by liquidity. An MNC may be tempted to finance with a maturity that is less than the expected life of the project when the yield curve is: a. flat. b. inverted. c. upward-sloping. d. downward sloping.

ANS: C

PTS: 1

23. If the foreign currency that was borrowed appreciates over time, an MNC will need fewer funds to cover the coupon or principal payments. [Assume the MNC has no other cash flows in that currency.] a. True b. False ANS: F

PTS: 1

24. U.S.-based MNCs whose foreign subsidiary generates large earnings may be able to offset exposure to exchange rate risk by issuing bonds denominated in the subsidiary's local currency. a. True b. False ANS: T

PTS: 1

25. Countries in emerging markets such as in Latin America tend to have ____ interest rates, and so the yields offered on bonds issued in those countries is ____. a. low; high b. high; low c. high; high d. none of the above ANS: C

PTS: 1

26. MNCs can use ____ to reduce exchange rate risk. This occurs when two parties provide simultaneous loans with an agreement to repay at a specified point in the future. a. forward contracts © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

b. currency swaps c. parallel loans d. none of the above ANS: C

PTS: 1

27. An upward-sloping yield curve for a foreign country means that annualized yields there are ____ for short-term debt than for long-term debt. The yield curve in this country reflects ____. a. higher; several periods b. lower; several periods c. higher; a specific point in time d. lower; a specific point in time ANS: D

PTS: 1

28. The ____ for a given country represents the annualized yield offered on debt for various maturities. a. LIBOR b. yield curve c. parallel loan d. interest rate swap ANS: B

PTS: 1

29. When an MNC finances with a floating-rate loan in a currency that matches its long-term cash inflows, the MNC is exposed to ____ risk. a. short; interest rate b. long; interest rate c. short; exchange rate d. none of the above ANS: B

PTS: 1

30. Some MNCs use a country's yield curve to compare annualized rates among debt maturities, so that they can choose a maturity that has a relatively low rate. a. True b. False ANS: T

PTS: 1

31. As a(n) ____ to an interest rate swap, a financial institution simply arranges a swap between two parties. a. ultraparty b. broker c. counterparty d. none of the above ANS: B

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

32. In general, the ____ rate payer in a plain vanilla swap believes interest rates are going to ____. a. fixed; decline b. floating; decline c. floating; increase d. none of the above ANS: B

PTS: 1

33. In a(n) ____ swap, the fixed rate payer has the right to terminate the swap. a. callable b. putable c. amortizing d. zero-coupon ANS: A

PTS: 1

34. In a(n) ____ swap, the notional value is increased over time. a. amortizing b. basis c. zero-coupon d. accretion ANS: D

PTS: 1

35. A ____ gives its owner the right to enter into a swap. a. basis swap b. swaption c. callable swap d. putable swap ANS: B

PTS: 1

36. Foreign subsidiaries of U.S. MNCs can finance projects with dollars in order to avoid exchange rate risk. a. True b. False ANS: F

PTS: 1

37. The actual financing cost of a U.S. corporation issuing a bond denominated in euros is affected by the euro's value relative to the U.S. dollar during the financing period. a. True b. False ANS: T

PTS: 1

38. A floating coupon rate is an advantage to the bond issuer during periods of increasing interest rates. a. True b. False ANS: F

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

39. An MNC issuing pound-denominated bonds may be completely insulated from exchange rate risk associated with the bond if its foreign subsidiary makes the coupon and principal payments of the bond with its pound receivables. a. True b. False ANS: T

PTS: 1

40. If an MNC uses a long-term forward contract to hedge the exchange rate risk associated with a bond denominated in euros, it would sell euros forward. a. True b. False ANS: F

PTS: 1

41. Currency swaps, whereby two parties exchange currencies at a specified point in time for a specified price, are often used by MNCs to hedge against interest rate risk. a. True b. False ANS: F

PTS: 1

42. A limitation of interest rate swaps is that there is a risk to each swap participant that the counterparticipant could default on his payments. a. True b. False ANS: T

PTS: 1

43. Many MNCs simultaneously swap interest payments and currencies. a. True b. False ANS: T

PTS: 1

44. A parallel loan represents simultaneous loans provided by two parties with an agreement to repay at a specified point in the future. a. True b. False ANS: T

PTS: 1

45. Since yield curves are identical across countries, MNCs rarely consider them when deciding on the maturity of bonds denominated in a foreign currency. a. True b. False ANS: F

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

46. Fixed-rate loans have interest rates that are fixed for each year but adjust at the end of each year in response to prevailing interest rates. a. True b. False ANS: F

PTS: 1

47. If the currency denominating a foreign bond depreciates against the firm's home currency over the lifetime of the bond, the funds needed to make coupon payments will increase. a. True b. False ANS: F

PTS: 1

48. Even if the interest rate associated with a foreign country is higher than the domestic interest rate, the financing costs of a foreign bond will always be lower than the financing rate of a domestic bond as long as the currency depreciates over the lifetime of a bond. a. True b. False ANS: F

PTS: 1

49. If the currency of a foreign currency-denominated bond ____, the funds needed to make coupon payments will ____. a. appreciates; increase b. depreciates; decrease c. appreciates; decrease d. depreciates; increase e. A and B ANS: E

PTS: 1

50. Generally, the financing costs associated with a foreign currency-denominated bond will be ____ volatile than the financing costs of a domestic bond because of ____. a. more; exchange rate movements b. less; exchange rate movements c. less; global economic conditions d. none of the above ANS: A

PTS: 1

51. ____ swaps are often used by companies to hedge against ____ rate risk. a. Currency; interest b. Interest; interest c. Interest; exchange d. Currency; exchange e. B and D ANS: E

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

52. ____ are commonly used to hedge interest rate risk. a. Currency swaps b. Parallel loans c. Interest rate swaps d. Forward contracts e. None of the above ANS: C

PTS: 1

53. In a(n) ____ swap, the notional value is reduced over time. a. accretion b. amortizing c. forward d. zero-coupon e. putable ANS: B

PTS: 1

54. A(n) ____ swap is entered into today, but the swap payments start at a specific future point in time. a. accretion b. amortizing c. forward d. zero-coupon e. putable ANS: C

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Chapter 19—Financing International Trade 1. Which of the following is a reason why commercial banks can facilitate international trade? a. The exporter may not wish to accept credit risk of the importer. b. The government may impose exchange contracts that prevent payment by the importer to the exporter. c. The exporter may need financing until payment for the goods is received. d. All of the above ANS: D

PTS: 1

2. Consider an exporter that sells its accounts receivables off to another firm that becomes responsible for obtaining cash from the various importers. This reflects: a. accounts receivable financing. b. consignment. c. factoring. d. a letter of credit.

ANS: C

PTS: 1

3. Consider a bank that acknowledges that it will make payments on behalf of a computer importer after the computers are delivered to the importer. This reflects: a. accounts receivable financing. b. forfaiting. c. factoring. d. a letter of credit.

ANS: D

PTS: 1

4. Consider an importer that issues a promissory note to pay for the imported capital goods over a period of five years. The notes are extended to an exporter who sells them at a discount to a bank. This reflects: a. accounts receivable financing. b. forfaiting. c. factoring. d. a letter of credit.

ANS: B

PTS: 1

5. Consider an exporter that is willing to send goods to the importer without a guaranteed payment by the bank. The bank provides a loan to the exporter that is backed by the value of the exported goods. This reflects: a. accounts receivable financing. b. forfaiting. c. factoring. d. a letter of credit.

ANS: A

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

6. The all-in-rate a bank charges its customer(s) for accepting drafts includes both the discount rate and the acceptance commission. a. True b. False ANS: T

PTS: 1

7. MNCs can use ____ to sell their existing accounts receivable as a means of obtaining cash. a. factoring b. a bill of lading c. a banker's acceptance d. a letter of credit ANS: A

PTS: 1

8. The ____ was established in 1934 with the intention to facilitate Soviet-American trade. a. Domestic International Sales Corporation (DISC) b. Private Export Funding Corporation (PEFCO) c. Export-Import Bank d. Foreign Credit Insurance Association (FCIA) ANS: C

PTS: 1

9. A ____ provides a summary of freight charges and conveys title to the merchandise. a. letter of credit b. banker's acceptance c. bill of lading d. bill of exchange ANS: C

PTS: 1

10. According to the text, international trade activity has generally ____ over time. This should cause the popularity of trade finance techniques to ____ over time. a. increased; increase b. increased; decrease c. decreased; increase d. decreased; decrease ANS: A

PTS: 1

11. Which of the following payment terms provides the supplier with the greatest degree of protection? a. letters of credit. b. consignment. c. prepayment. d. drafts (sight/time).

ANS: C

PTS: 1

12. With ____, the exporter ships the goods to the importer while still retaining actual title to the merchandise. a. a letter of credit arrangement © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

b. an open account arrangement c. a draft arrangement d. a consignment arrangement ANS: D

PTS: 1

13. With ____, a bank purchases a receivable without recourse to the exporter. a. accounts receivable financing b. factoring c. a banker's acceptance d. a letter of credit ANS: B

PTS: 1

14. In ____, a bank arranges to fund a loan to pay the exporter instead of charging the importer's account immediately. a. refinancing of a sight letter of credit b. a banker's acceptance c. a short-term bank loan d. accounts receivable financing ANS: A

PTS: 1

15. A bill of exchange requesting the bank to pay the face amount upon presentation of documents is a: a. banker's acceptance. b. time draft. c. letter of credit. d. sight draft.

ANS: D

PTS: 1

16. A bill of exchange requesting the bank to pay the face amount at a future date is a: a. banker's acceptance. b. time draft. c. letter of credit. d. sight draft.

ANS: B

PTS: 1

17. An exchange of goods between two parties under two distinct contracts expressed in monetary terms is: a. compensation. b. counterpurchase. c. factoring. d. accounts receivable financing.

ANS: B

PTS: 1

18. Which of the following is not a program of the Export-Import Bank of the U.S.? a. working capital guarantee program. b. project finance loan program.

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

c. direct loan program. d. the foreign sales corporation program.

ANS: D

PTS: 1

19. Who bears the payment risk in a letter of credit? a. the exporter. b. the importer. c. the issuing bank. d. both the exporter and importer.

ANS: C

PTS: 1

20. Countertrade represents foreign trade: a. restrictions imposed by the government on imports from another country. b. restrictions imposed by the government on exports sent from the country. c. transactions that force the sales of goods of one country to be linked to the purchase or exchange of goods from the country. d. financing provided to an exporter in exchange for goods provided to the creditor by the exporter.

ANS: C

PTS: 1

21. All types of foreign trade transactions in which the sale of goods to one country is linked to the purchase or exchange of goods from that same country are called countertrade. a. True b. False ANS: T

PTS: 1

22. The exchange of goods between two parties without the use of any currency as a medium of exchange is called factoring. a. True b. False ANS: F

PTS: 1

23. A draft drawn on and accepted by a bank is called a banker's acceptance. a. True b. False ANS: T

PTS: 1

24. The Direct Loan Program is administered by the: a. Private Export Funding Corporation (PEFCO). b. Overseas Private Investment Corporation (OPIC). c. Ex-Imbank. d. Foreign Credit Insurance Association (FCIA).

ANS: C

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

25. The Working Capital Guarantee Program is administered by the: a. Private Export Funding Corporation (PEFCO). b. Overseas Private Investment Corporation (OPIC). c. Ex-Imbank. d. Foreign Credit Insurance Association (FCIA).

ANS: C

PTS: 1

26. Which of the following is not a payment method used for international trade? a. consignment. b. open account. c. factoring. d. draft. e. letter of credit.

ANS: C

PTS: 1

27. Under a letter of credit arrangement, the bank issuing the letter of credit is known as the ____ bank, the correspondent bank in the beneficiary's country to which the issuing bank sends the letter of credit is known as the ____ bank, and the bank that agrees to examine documents under the letter of credit and pay the beneficiary is called the ____ bank. a. issuing; negotiating; advising b. issuing; advising; negotiating c. advising; issuing; negotiating d. negotiating; issuing; advising e. advising; negotiating; issuing ANS: B

PTS: 1

28. A(n) ____ letter of credit is not a trade-related letter of credit. a. commercial b. import/export c. revocable d. irrevocable e. all of the above are trade-related letters of credit ANS: E

PTS: 1

29. Which of the following is not true regarding letters of credit? a. They are issued by banks on behalf of the importer promising to pay the exporter. b. A revocable letter of credit can be cancelled or revoked at any time without prior notification to the beneficiary. c. They guarantee that the goods shipped are the goods purchased. d. All of the above are true.

ANS: C

PTS: 1

30. A banker's acceptance is a draft drawn on and accepted by a(n) ____. a. bank b. importer c. exporter © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

d. none of the above ANS: A

PTS: 1

31. Which of the following is not true regarding a banker's acceptance? a. It can be beneficial to the exporter, as he does not have to worry about the credit risk of the importer. b. It can be beneficial to the importer, as he may have greater access to foreign markets when purchasing supplies. c. It can be beneficial to the bank accepting the draft in that it earns a commission for creating an acceptance. d. It is a sight draft. e. All of the above are true.

ANS: D

PTS: 1

32. ____ is not a type of program offered by Ex-Imbank. a. Guarantees b. Loans c. Currency swap insurance d. Bank insurance ANS: C

PTS: 1

33. As part of Ex-Imbank's export credit insurance programs, a(an) ____ policy is generally issued to an administrator, such as a bank, trading company, insurance broker, or government agency, who then administers the policy for multiple exporters. a. multiple-buyer b. single-buyer c. small business d. umbrella ANS: D

PTS: 1

34. The ____ is a private corporation owned by a consortium of commercial banks and industrial companies, but the ____ is a self-sustaining government agency. a. Overseas Private Investment Corporation (OPIC); Private Export Funding Corporation (PEFCO) b. Private Export Funding Corporation (PEFCO); Overseas Private Investment Corporation (OPIC) c. Private Export Funding Corporation (PEFCO); Ex-Imbank d. Overseas Private Investment Corporation (OPIC); Ex-Imbank ANS: B

PTS: 1

35. The risk to the exporter is highest with the ____ method. a. prepayment b. letter of credit c. consignment d. open account ANS: D

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

36. A ____ is an unconditional promise drawn by one party, instructing the buyer to pay the face amount upon presentation. a. draft b. bill of lading c. trade acceptance d. letter of credit ANS: A

PTS: 1

37. Under a(n) ____ arrangement, the exporter ships the goods to the importer while still retaining actual title to the merchandise. a. draft b. consignment c. prepayment d. open account ANS: B

PTS: 1

38. In ____, the exporter sells accounts receivable without recourse. a. accounts receivable financing b. factoring c. working capital financing d. countertrade ANS: B

PTS: 1

39. An irrevocable L/C obligates the issuing bank to honor all drawings presented in conformity with the terms of the L/C. a. True b. False ANS: T

PTS: 1

40. ____ promises to pay the beneficiary if they buyer fails to pay as agreed. a. A standby L/C b. A transferable L/C c. Assignment of proceeds d. None of the above ANS: A

PTS: 1

41. The interest rate the bank charges the customer in a banker's acceptance is referred to as the all-in rate; it entirely consists of the acceptance commission. a. True b. False ANS: F

PTS: 1

42. ____ refers to the purchase of financial obligations, such as bills of exchange or promissory notes, without recourse to the original holder, usually the exporter. a. Factoring © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

b. Accounts receivable financing c. Forfaiting d. None of the above ANS: C

PTS: 1

43. The term counterpurchase denotes the exchange of goods between two parties under two distinct contracts expressed in monetary terms. a. True b. False ANS: T

PTS: 1

44. The Working Capital Guarantee Program and the Medium-term Guarantee Program are offered by the: a. Export-Import Bank of the United States b. Private Export Funding Corporation c. Overseas Private Investment Corporation d. none of the above ANS: A

PTS: 1

45. The ____ is a self-sustaining federal agency responsible for insuring direct U.S. investments in foreign countries against the risk of currency inconvertibility, expropriation, and other political risks. a. Export-Import Bank of the United States b. Private Export Funding Corporation c. Overseas Private Investment Corporation d. none of the above ANS: C

PTS: 1

46. Under a letter of credit, the exporter will not ship the goods until the buyer has remitted payment to the exporter. a. True b. False ANS: F

PTS: 1

47. In an open account transaction, the exporter ships the goods to the importer but retains title to the goods until they have been sold. a. True b. False ANS: F

PTS: 1

48. When using factoring to finance international trade, a bank will provide a loan to the exporter secured by an assignment of the account receivable. a. True b. False ANS: F

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

49. From a bank's viewpoint, issuing a letter of credit is analogous to making a loan as far as risk is concerned. a. True b. False ANS: T

PTS: 1

50. There is an active secondary market for banker's acceptances. a. True b. False ANS: T

PTS: 1

51. The commission earned by the bank for accepting a draft is reflected in the all-in-rate. a. True b. False ANS: T

PTS: 1

52. The Working Capital Guarantee Program of the Private Export Funding Corporation (PEFCO) encourages commercial banks to extend short-term export financing to eligible exporters by providing a comprehensive guarantee that covers 100 percent of the loan's principal and interest. a. True b. False ANS: F

PTS: 1

53. The objectives of the Export-Import Bank of the United States include the assumption of underlying credit risk and country risk to encourage private lenders to finance export trade and the provision of direct loans to foreign buyers when private lenders are unwilling to do so. a. True b. False ANS: T

PTS: 1

54. The Overseas Private Investment Corporation (OPIC) is owned by a consortium of commercial banks and industrial companies; it cooperates closely with the Export-Import Bank. a. True b. False ANS: F

PTS: 1

55. Under prepayment, the exporter will not ship the goods until the buyer has remitted payment to the exporter. a. True b. False ANS: T

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

56. A letter of credit does not guarantee that the goods purchased will be those invoiced and shipped. a. True b. False ANS: T

PTS: 1

57. If shipment is made under a forfaiting draft, the exporter is paid once shipment has been made and the draft is presented to the buyer for payments. a. True b. False ANS: F

PTS: 1

58. In a countertrade transaction, banks on both ends act as intermediaries in the processing of shipping documents and the collection of payment. a. True b. False ANS: F

PTS: 1

59. Under a countertrade arrangement, the exporter ships the goods to the importer while retaining title to the merchandise until it is sold. a. True b. False ANS: F

PTS: 1

60. The sale of accounts receivable to a third party for a discount is called factoring. a. True b. False ANS: T

PTS: 1

61. Under a letter of credit, the exporter will not ship the goods until the buyer has remitted payment to the exporter. a. True b. False ANS: F

PTS: 1

62. The payment method that affords the supplier the greatest degree of protection is the prepayment method. a. True b. False ANS: T

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

63. A bank issuing a letter of credit on behalf of an importer is obligated to honor the letter of credit regardless of the buyer's willingness or ability to pay. a. True b. False ANS: T

PTS: 1

64. If shipment is made under a time draft, the exporter is paid once shipment has been made and the draft is presented to the buyer for payment. a. True b. False ANS: F

PTS: 1

65. In an open account transaction, the exporter ships the goods to the importer but retains title to the goods until they have been sold. a. True b. False ANS: F

PTS: 1

66. When using factoring to finance international trade, a bank will provide a loan to the exporter secured by an assignment of the account receivable. a. True b. False ANS: F

PTS: 1

67. An irrevocable letter of credit can be cancelled or amended if the beneficiary consents to it. a. True b. False ANS: T

PTS: 1

68. The bill of exchange serves as a receipt for shipment and a summary of freight charges; most importantly, it conveys title to the merchandise. a. True b. False ANS: F

PTS: 1

69. Which of the following is not a payment method used for international trade? a. Supplier credit b. Bill of exchange c. Bill of lading d. Letter of credit e. All of the above are payment methods used.

ANS: C

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

70. Under a ____, the exporter is paid once shipment has been made and the draft is presented to the buyer for payment; under a ____, the exporter provides instructions to the buyer's bank to release shipping documents against acceptance, by the buyer, of the draft. a. sight draft; time draft b. sight draft; banker's acceptance c. bill of lading; banker's acceptance d. time draft; sight draft ANS: A

PTS: 1

71. Which of the following is not a trade financing method used in international trade from an exporter's perspective? a. Accounts receivable financing b. Letter of credit c. Barter d. Open account ANS: D

PTS: 1

72. Of all the payment methods available in international trade, ____ probably affords the most protection to the exporter, while ____ probably affords the least protection. a. prepayment; consignment b. prepayment; open account c. open account; prepayment d. consignment; prepayment ANS: B

PTS: 1

73. Which of the following is not true regarding letters of credit? a. They are issued by banks on behalf of the importer promising to pay the exporter. b. A revocable letter of credit can be cancelled or revoked at any time without prior notification to the beneficiary. c. They guarantee that the goods shipped are the goods purchased. d. All of the above are true.

ANS: C

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Chapter 20— Financing in the Short-Term 1. MNCs may be able to lock in a lower cost from financing in a low interest rate foreign currency if they: a. have future cash inflows in that foreign currency. b. have future cash outflows in that foreign currency. c. have offsetting future cash inflows and outflows in that foreign currency. d. have no other cash flows in that foreign currency.

ANS: A

PTS: 1

2. Assume that the Swiss franc has an annual interest rate of 8% and is expected to depreciate by 6% against the dollar. From a U.S. perspective, the effective financing rate from borrowing francs is: a. 8%. b. 14.48%. c. 2%. d. 1.52%.

ANS: D SOLUTION:

(1 + 8%)[1 + (6%)]  1 = 1.52%.

PTS: 1 3. Assume that the U.S. interest rate is 11% while the interest rate on the euro is 7%. If euros are borrowed by a U.S. firm, they would have to ____ against the dollar by ____ in order to have the same effective financing rate from borrowing dollars. a. depreciate; about 3.74% b. appreciate; about 3.74% c. appreciate; about 4.53% d. depreciate; about 4.53% ANS: B SOLUTION:

(1.11/1.07)  1 = 3.74%. Euros have to appreciate since borrowing in euros is currently cheaper.

PTS: 1 4. When a U.S. firm borrows a foreign currency and has no offsetting position in this currency, it will incur an effective financing rate that is always above the ____ if the currency ____. a. foreign currency's interest rate; appreciates b. foreign currency's interest rate; depreciates c. domestic interest rate; depreciates d. domestic interest rate; appreciates ANS: A

PTS: 1

5. A firm without any exposure to foreign exchange rates would likely increase this exposure the most by: a. borrowing domestically. b. borrowing a portfolio of foreign currencies that are not highly correlated. c. borrowing a portfolio of foreign currencies that are highly correlated. © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

d. borrowing two foreign currencies that are negatively correlated.

ANS: C

PTS: 1

6. If a firm repeatedly borrows a foreign currency portfolio, the variability of the portfolio's effective financing rate will be highest if the correlations between currencies in the portfolio are ____ and the individual variability of each currency is ____. a. high; low b. high; high c. low; low d. low; high ANS: B

PTS: 1

7. Assume the annual British interest rate is above the annual U.S. interest rate. Also assume the pound's forward rate of $1.75 equals the pound's spot rate. Given this information, interest rate parity ____ exist, and the U.S. firm ____ lock in a lower financing cost by borrowing pounds for one year. a. does; could b. does; could not c. does not; could not d. does not; could ANS: C

PTS: 1

8. A risk-averse firm would prefer to borrow ____ when the expected financing costs are similar in a foreign country as in the local country. a. locally b. in the foreign country c. either A or B d. part of the funds locally, and part from the foreign country ANS: A

PTS: 1

9. A firm forecasts the euro's value as follows for the next year: Possible Percentage Change 2% 3% 6%

Probability 10% 50% 40%

The annual interest rate on the euro is 7%. The expected value of the effective financing rate from a U.S. firm's perspective is about: a. 8.436%. b. 10.959%. c. 11.112%. d. 11.541%.

ANS: B

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

SOLUTION: Effective Financing Rate = 4.86% (1.07)( .98)  1 = 10.21% (1.07)(1.03)  1 = 13.42% (1.07)(1.06)  1

Probability 10% 50% 40%

Computation of Expected Value .486% 5.105% 5.368% 10.959%

PTS: 1 10. The effective financing rate: a. adjusts the nominal interest rate for inflation over the period of concern. b. adjusts the nominal interest rate for the change in the spot exchange rate over the period of concern. c. adjusts the nominal rate for a change in foreign interest rates over the period of concern. d. adjusts the nominal rate for the forward discount (or premium) over the period of concern.

ANS: B

PTS: 1

11. If interest rate parity exists and transactions costs are zero, foreign financing with a simultaneous forward purchase of the currency borrowed will result in an effective financing rate that is: a. less than the domestic interest rate. b. greater than the domestic interest rate. c. equal to the domestic interest rate. d. greater than the domestic interest rate if the forward rate exhibits a premium and less than the domestic interest rate if the forward rate exhibits a discount.

ANS: C

PTS: 1

12. If interest rate parity exists, transactions costs are zero, and the forward rate is an accurate predictor of the future spot rate, then the effective financing rate on a foreign currency: a. would be equal to the U.S. interest rate. b. would be less than the U.S. interest rate. c. would be more than the U.S. financing rate. d. would be less than the U.S. interest rate if the forward rate exhibited a discount and more than the U.S. interest rate of the forward rate exhibited a premium.

ANS: A

PTS: 1

13. Assume that interest rate parity exists, and there are zero transactions costs. If the forward rate consistently underestimates the future spot rate, then: a. on average, the foreign effective financing rate is greater than the domestic interest rate. b. on average, the foreign effective financing rate is less than the domestic rate.

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

c. the foreign effective financing rate exceeds the U.S. interest rate when its forward rate exhibits a discount and is less than the U.S. interest rate when its forward rate exhibits a premium. d. the foreign effective financing rate is less than the U.S. interest rate when its forward rate exhibits a discount and exceeds the U.S. interest rate when its forward rate exhibits a discount.

ANS: A

PTS: 1

14. Assume the U.S. one-year interest rate is 8%, and the British one-year interest rate is 6%. The one-year forward rate of the pound is $1.97. The spot rate of the pound at the beginning of the year is $1.95. By the end of the year, the pound's spot rate is $2.05. Based on the information, what is the effective financing rate for a U.S. firm that takes out a one-year, uncovered British loan? a. about 12.4%. b. about 7.1%. c. about 13.5%. d. about 10.3%. e. about 11.3%.

ANS: E SOLUTION: Effective financing rate = (1 + 6%)(1 + 5.1%)  1 = 11.4% PTS: 1 15. The variance in financing costs over time is ____ for foreign financing than domestic financing. The variance when financing with foreign currencies is lower when those currencies exhibit ____ correlations, assuming the firm has no other business in those currencies. a. lower; low b. lower; high c. higher; high d. higher; low ANS: D

PTS: 1

16. Euronotes are underwritten by: a. European central banks. b. commercial banks. c. the International Monetary Fund. d. the Federal Reserve System.

ANS: B

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

17. Assume the U.S. interest rate is 7.5%, the New Zealand interest rate is 6.5%, the spot rate of the NZ$ is $.52, and the one-year forward rate of the NZ$ is $.50. At the end of the year, the spot rate is $.48.

Based on this information, what is the effective financing rate for a U.S. firm that takes out a one-year, uncovered NZ$ loan? a. about 1.7%. b. about 0.0%. c. about 14.7%. d. about 15.4%. e. about 8.3%.

ANS: A SOLUTION: Effective financing rate = (1 + 6.5%)[1 + (7.7%)]  1 = about 1.7% PTS: 1 18. A negative effective financing rate for a U.S. firm implies that the firm: a. will incur a loss on the project financed with the funds. b. paid more interest on the funds than what it would have paid if it had borrowed dollars. c. will be unable to repay the loan. d. none of the above ANS: D

PTS: 1

19. A U.S. firm plans to borrow Swiss francs today for a one-year period. The Swiss interest rate is 9%. It uses today's spot rate as a forecast for the franc's spot rate in one year. The U.S. one-year interest rate is 10%. The expected effective financing rate on Swiss francs is: a. equal to the U.S. interest rate. b. less than the U.S. interest rate, but more than the Swiss interest rate. c. equal to the Swiss interest rate. d. less than the Swiss interest rate. e. more than the U.S. interest rate.

ANS: C

PTS: 1

20. Assume that interest rates of most industrialized countries are similar to the U.S. interest rate. In the last few months, the currencies of all industrialized countries weakened substantially against the U.S. dollar. If non-U.S. firms based in these countries financed with U.S. dollars during this period (even when they had no receivables in dollars), their effective financing rate would have been: a. negative. b. zero. c. positive, but lower than the interest rate of their respective countries. d. higher than the interest rate of their respective countries.

ANS: D

PTS: 1

21. ____ typically have maturities of less than one year. a. Eurobonds b. Euro-commercial paper © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

c. Euronotes d. ADRs ANS: B

PTS: 1

22. MNCs can use short-term foreign financing to reduce their exposure to exchange rate fluctuations. For example, if an American-based MNC has ____ in euros, it could borrow ____, resulting in an offsetting effect. a. payables; euros b. receivables; euros c. payables; dollars d. receivables; dollars ANS: B

PTS: 1

23. Assume Jelly Corporation, a U.S.-based MNC, obtains a one-year loan of 1,500,000 Malaysian ringgit (MYR) at a nominal interest rate of 7%. At the time the loan is extended, the spot rate of the ringgit is $.25. If the spot rate of the ringgit in one year is $.28, the dollar amount initially obtained from the loan is $____, and $____ are needed to repay the loan. a. 375,000; 449,400 b. 449,400; 375,000 c. 6,000,000; 5,357,143 d. 5,357,143; 6,000,000 ANS: A SOLUTION:

MYR1,500,000  $.25 = $375,000 (MYR1,500,000  1.07)  $.28 = $449,400

PTS: 1 24. Morton Company obtains a one-year loan of 2,000,000 Japanese yen at an interest rate of 6%. At the time the loan is extended, the spot rate of the yen is $.005. If the spot rate of the yen at maturity of the loan is $.0035, what is the effective financing rate of borrowing yen? a. 37.8%. b. 51.43%. c. 25.8%. d. 6%. e. none of the above ANS: C SOLUTION:

Depreciation of dinar: $.0035/$.005  1 = 30% Effective financing rate: (1.06)  [1 + (30%)]  1 = 25.80%.

PTS: 1 25. ____ are free of default risk. a. Euronotes b. Eurobonds c. Euro-commercial paper d. None of the above ANS: D

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Exhibit 20-1 Assume a U.S.-based MNC is borrowing Romanian leu (ROL) at an interest rate of 8% for one year.

Also assume that the spot rate of the leu is $.00012 and the one-year forward rate of the leu is $.00010.

The expected spot rate of the leu one-year from now is $.00011.

26. Refer to Exhibit 20-1. What is the effective financing rate for the MNC assuming it borrows leu on a covered basis? a. 10%. b. 10%. c. 1%. d. 1%. e. none of the above ANS: B SOLUTION:

Forward discount: .00010/.00012  1 = 16.67% Effective financing rate: (1.08)  [1 + (16.67%)] 1 = 10.00%.

PTS: 1 27. Refer to Exhibit 20-1. What is the effective financing rate for the MNC assuming it borrows leu on an uncovered basis? a. about 10%. b. about 10%. c. about 1%. d. about 2%. e. none of the above ANS: D SOLUTION:

Depreciation of leu: .00010/.00011  1 = 9.09% Effective financing rate: (1.08)  [1 + (9.09%)]  1 = 1.82%.

PTS: 1 28. Assume that interest rate parity holds between the U.S. and Cyprus. The U.S. one-year interest rate is 7% and the Cyprus one-year interest rate is 6%. What is the approximate effective financing rate of a one-year loan denominated in Cyprus pounds assuming that the MNC covered its exposure by purchasing pounds one year forward? a. 6%. b. 7%. c. 1%. d. cannot answer without more information ANS: B SOLUTION:

When interest rate parity holds, the foreign financing cost (when covering with a forward hedge) is approximately equal to the domestic financing cost.

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

29. Maston Corporation has forecasted the value of the Russian ruble as follows for the next year: Percentage Change 5% 3% 1%

Probability of Occurrence 20% 50% 30%

If the Russian interest rate is 30%, the expected cost of financing a one-year loan in rubles is: a. 27.14%. b. 32.86%. c. 26.10%. d. none of the above ANS: A SOLUTION: Effective Financing Rate = 23.50% (1.30)( .95)  1 = 26.10% (1.30)( .97)  1 = 31.30% (1.30)(1.01)  1

Probability 20% 50% 30%

Computation of Expected Value 4.70% 13.05% 9.39% 27.14%

PTS: 1 Exhibit 20-2 To benefit from the low correlation between the Canadian dollar (C$) and the Japanese yen (¥), Luzar Corporation decides to borrow 50% of funds needed in Canadian dollars and the remainder in yen. The domestic financing rate for a one-year loan is 7%. The Canadian one-year interest rate is 6% and the Japanese one-year interest rate is 10%. Luzar has determined the following possible percentage changes in the two individual currencies as follows: Currency Canadian dollar Canadian dollar

Percentage Change 2.0% 4.0%

Probability 30% 70%

Japanese yen Japanese yen

3.0% 1.0%

60% 40%

30. Refer to Exhibit 20-2. What is the expected effective financing rate of the portfolio Luzar is contemplating (assume the two currencies move independently from one another)? a. 9.03%. b. 7.00%. c. 10.00%. d. 7.59%. e. none of the above ANS: A

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

SOLUTION: Determine effective financing rate for each currency under each possible scenario.

Step 1.

Step 2.

Currency Canadian dollar Canadian dollar

Percentage Change 2.0% 4.0%

Probability 30% 70%

Effective Rate (1.06)(1.02)  1 = 8.12% (1.06)(1.04)  1 = 10.24%

Japanese yen Japanese yen

3.0% 1.0%

60% 40%

(1.10)( .97)  1 = 6.70% (1.10)(1.01)  1 = 11.10%

Determine joint probabilities and effective financing rate of portfolio for each scenario.

Canadian Dollar 8.12% 8.12% 10.24% 10.24%

Japanese Yen 6.70% 11.10% 6.70% 11.10%

Joint Probability (.3)(.6) = .18 (.3)(.4) = .12 (.7)(.6) = .42 (.7)(.4) = .28

Portfolio Effective Rate (.5)( 8.12%) + (.5)( 6.70%) = 7.41% (.5)( 8.12%) + (.5)(11.10%) = 9.61% (.5)(10.24%) + (.5)( 6.70%) = 8.47% (.5)(10.24%) + (.5)(11.10%) = 10.67%

1.00

Step 3.

Determine effective financing rate of portfolio. (.18)(7.41%) + (.12)(9.61%) + (.42)(8.47%) + (.28)(10.67%) = 9.03%

PTS: 1 31. Refer to Exhibit 20-2. What is the probability that the financing rate of the two-currency portfolio is less than the domestic financing rate? a. 12%. b. 30%. c. 100%. d. 0%. e. none of the above ANS: D SOLUTION:

Since the domestic financing rate is 7%, the table above shows that there is no possibility that foreign financing with the portfolio of currencies is cheaper than domestic financing.

PTS: 1 Exhibit 20-3 Cameron Corporation would like to simultaneously borrow Japanese yen (¥) and Sudanese dinar (SDD) for a six-month period. Cameron would like to determine the expected financing rate and the variance of a portfolio consisting of 30% yen and 70% dinar. Cameron has gathered the following information: © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Mean effective financing rate of Japanese yen for six months Mean effective financing rate of Sudanese dinar for six months Standard deviation of Japanese yen's effective financing rate Standard deviation of Sudanese dinar's effective financing rate Correlation coefficient of effective financing rates of these two currencies

4% 1% .10 .20 .23

32. Refer to Exhibit 20-3. What is the expected financing rate of the portfolio contemplated by Cameron Corporation? a. 3.10%. b. 1.90%. c. 17.00%. d. 13.00%. e. none of the above ANS: B SOLUTION:

(.3)(4%) + (.7)(1%) = 1.90%.

PTS: 1 33. Refer to Exhibit 20-3. What is the expected standard deviation of the portfolio contemplated by Cameron? a. 2.24%. b. 14.98%. c. 2.89%. d. 17.00%. e. none of the above ANS: B SOLUTION: PTS: 1 34. If interest rate parity exists, financing with a foreign currency may still be feasible, but it would have to be conducted on an uncovered basis (i.e., without use of a forward hedge). a. True b. False ANS: T

PTS: 1

35. Firms that believe the forward rate is an unbiased predictor of the future spot rate will prefer borrowing the foreign currency. a. True b. False ANS: F

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

36. Euronotes are unsecured debt securities whose interest rate is based on the London Interbank Offer Rate (LIBOR) with typical maturities of one, three, and six months. a. True b. False ANS: T

PTS: 1

37. One reason an MNC may consider foreign financing is that the proceeds could be used to offset a foreign net payables position. a. True b. False ANS: F

PTS: 1

38. A negative effective financing rate implies that the U.S. firm actually paid fewer dollars in total loan repayment than the number of dollars borrowed. a. True b. False ANS: T

PTS: 1

39. If all currencies in a financing portfolio are not correlated with each other, financing with such a portfolio would not be very different from financing with a single foreign currency. a. True b. False ANS: F

PTS: 1

40. The interest rate of euronotes is based on the T-bill rate. a. True b. False ANS: F

PTS: 1

41. Countries with a ____ rate of inflation tend to have a ____ interest rate. a. high; low b. low; high c. high; high d. A and B are correct ANS: C

PTS: 1

42. Kushter Inc. would like to finance in euros. European interest rates are currently 4%, and the euro is expected to depreciate by 2% over the next year. What is Kushter's effective financing rate next year? a. 1.92% b. 2.00% c. 6.08% d. none of the above ANS: A © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

SOLUTION:

(1.04)(.98)  1 = 1.92%

PTS: 1 43. A negative effective financing rate indicates that an MNC: a. paid only a small amount in interested over and above the amount borrowed. b. has been negatively affected by a large appreciation of the foreign currency. c. actually paid fewer dollars to repay the loan than it borrowed. d. would have been better off borrowing in the U.S. ANS: C

PTS: 1

44. If interest rate parity exists, the attempt to finance with a foreign currency while covering the position to avoid exchange rate risk will result in an effective financing rate that is ____ the domestic interest rate. a. lower than b. greater than c. similar to d. none of the above ANS: C

PTS: 1

45. If interest rate parity exists, and the forward rate is an accurate estimator of the future spot rate, the foreign financing rate will be ____ the home financing rate. a. lower than b. greater than c. similar to d. none of the above ANS: C

PTS: 1

46. Assume the U.S. financing rate is 10 percent and that the financing rate in Germany is 9 percent. An MNC would be indifferent between financing in dollars and financing in euros next year if the euro is expected to ____. a. appreciate by 0.92%. b. depreciate by 0.92%. c. appreciate by 1.00%. d. depreciate by 1.00%.

ANS: A SOLUTION:

1.10/1.09  1 = 0.92%

PTS: 1 47. Foreign financing costs in a single foreign currency ____ financing costs in dollars, and the variance of foreign financing costs over time is ____ than the variance of financing in dollars. a. are higher than; higher than b. can be lower or higher than; higher than c. can be lower or higher than; lower than d. are lower than; higher than ANS: B

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

48. The degree of volatility of financing with a currency portfolio depends on only the standard deviations of effective financing rates of the individual currencies within the portfolio. a. True b. False ANS: F

PTS: 1

49. An MNC's parent or subsidiary in need for funds commonly determines whether there are any available internal funds before searching for outside funding. a. True b. False ANS: T

PTS: 1

50. A large firm may finance in a foreign currency to offset a net payable position in that foreign country. a. True b. False ANS: F

PTS: 1

51. If movements of two currencies with low interest rates are highly negatively correlated, then financing in a portfolio of currencies would not be very beneficial. That is, financing with such a portfolio would not be very different from financing with a single foreign currency. a. True b. False ANS: F

PTS: 1

52. Which of the following is probably not a scenario under which a U.S.-based MNC would consider short-term foreign financing? a. Canadian dollars offer a lower interest rate than available in the U.S. and are expected to appreciate over the maturity of the loan. b. Australian dollars offer a lower interest rate than available in the U.S. and are expected to depreciate over the maturity of the loan. c. A U.S. firms has net receivables in Cyprus pounds. d. A and C. e. None of the above ANS: A

PTS: 1

53. Which of the following statement is false? a. If interest rate parity holds, foreign financing a simultaneous hedge of that position in the forward market will result in financing costs similar to those in domestic financing. b. If interest rate parity holds, and the forward rate is an accurate forecast of the future spot rate, uncovered foreign financing will result in financing costs similar to those in domestic financing.

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

c. If interest rate parity holds, and the forward rate is expected to overestimate the future spot rate, uncovered foreign financing is expected to result in lower financing costs than those in domestic financing. d. If interest rate parity holds, and the forward rate is expected to underestimate the future spot rate, uncovered foreign financing is expected to result in lower financing costs than those in domestic financing.

ANS: D

PTS: 1

54. If interest rate parity does not hold, and the forward ____ is ____ the interest rate differential, then foreign financing with a simultaneous hedge of that position in the forward market results in higher financing costs than those of domestic financing a. premium; higher than b. discount; higher than c. premium; less than d. A and B ANS: A

PTS: 1

55. Assume the U.S. one-year interest rate is 9%, while the Chilean one-year interest rate is 13%. If the Chilean peso ____ by ____%, a U.S.-based MNC would incur the same financing cost in dollars versus Chilean pesos over a one year period. a. depreciates; 3.54 b. appreciates; 3.54 c. depreciates; 3.67 d. appreciates; 3.67 ANS: A

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Chapter 21—International Cash Management 1. The Mexican one-year interest rate is 27 percent, while the U.S. one-year interest rate is 9 percent. If a U.S. firm creates a one-year deposit in Mexico, the Mexican peso would have to ____ against the U.S. dollar by ____ in order to make that investment have an effective yield that is achievable in the U.S. a. appreciate; 18% b. depreciate; 36% c. depreciate; 14% d. appreciate; 14% e. depreciate; 8.5% ANS: C SOLUTION:

1.09/1.27  1 = 14.2%

PTS: 1 2. Assume that Subsidiaries X and Y often trade with each other. Assume that Subsidiary X has excess cash while Subsidiary Y is short on cash. How can Subsidiary X help out Subsidiary Y? a. X should lag its payments sent to Y to pay for imports from Y. b. X should request that Y lead its payments to be sent for goods that Y sent to X. c. A and B d. None of the above ANS: D

PTS: 1

3. Netting can achieve all but one of the following: a. Cross border transactions between subsidiaries are reduced. b. Transactions costs are reduced. c. Currency conversion costs are reduced. d. Transaction exposure is eliminated.

ANS: D

PTS: 1

4. Which of the following is true? a. Some countries may prohibit netting. b. Some countries may prohibit forms of leading and lagging. c. A and B d. None of the above ANS: C

PTS: 1

5. According to the text: a. banks in the U.S. are prohibited from facilitating cash transfers for MNCs. b. banks in most non-U.S. countries are more advanced than the U.S. in facilitating cash transfers for MNCs. c. an MNC with subsidiaries in several different countries has no problems in coordinating its cash transfers since a uniform global banking system exists. d. none of the above ANS: D

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

6. In what is known as dynamic hedging, banks always hedge open positions in any foreign currencies. a. True b. False ANS: F

PTS: 1

7. Assume the U.S. one-year interest rate is 11% and the French one-year interest rate is 18%. The break-even level of depreciation in the euro at which the U.S. and French investments would exhibit the same return to a U.S. investor is: a. about 5.1%. b. about 6.8%. c. about 6.3%. d. about 5.9%.

ANS: D SOLUTION:

1.11/1.18  1 = 5.9%

PTS: 1 8. Assume that a U.S. investor invests in a British CD offering a six-month interest rate of 5%. Over this six-month period, the pound depreciates by 9%. The effective yield on the British CD for the U.S. investor is: a. 14.45%. b. 4.45%. c. 14.00%. d. 4.00%.

ANS: B SOLUTION:

(1 + 6%)[1 + (9%)]  1 = 4.45%

PTS: 1 9. Assume that there are several foreign currencies that exhibit a higher interest rate than the U.S. interest rate. The U.S. firm has a higher probability of generating a higher effective yield on a portfolio of currencies (relative to the domestic yield) if: a. the foreign currency movements against the U.S. dollar are highly correlated. b. the foreign currency movements against the U.S. dollar are perfectly positively correlated. c. the foreign currency movements against the U.S. dollar exhibit low correlations. d. none of the answers above would have any impact on the probability of a foreign cash investment generating a higher effective yield than a U.S. investment.

ANS: C

PTS: 1

10. If the international Fisher effect (IFE) exists, then a U.S. firm that has access to banks offering high interest rates in deposits denominated in foreign currencies should: a. invest in the foreign deposits since they will, on average, generate higher effective yields than a U.S. deposit. b. invest in the U.S. deposits since they will, on average, generate higher effective yields than a foreign deposit. c. invest in the U.S. deposits since they will, on average, generate similar effective yields as a foreign deposit. © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

d. invest in the foreign deposits since they will, on average, generate similar effective yields as a U.S. deposit.

ANS: C

PTS: 1

11. The most useful measure of an MNC's liquidity is its: a. cash balance. b. amount of securities held as investments. c. political risk rating. d. potential access to funds.

ANS: D

PTS: 1

12. Generally, if interest rate parity holds and the forward rate is an unbiased predictor of the future spot rate, then the international Fisher effect will also hold. a. True b. False ANS: T

PTS: 1

13. According to the international Fisher effect: a. exchange rates adjust to compensate for income differentials between countries. b. interest rates adjust to compensate for income differentials between countries. c. exchange rates adjust to compensate for interest rate differentials between countries. d. exchange rates adjust to compensate for risk differentials between countries.

ANS: C

PTS: 1

14. The international Fisher effect suggests that: a. the effective yield on short-term foreign securities should, on average, equal the yield on short-term domestic securities. b. the effective yield on short-term securities of high inflation countries is greater than the yield on short-term domestic securities. c. if domestic income grows faster than foreign income, the effective yield on short-term foreign securities is higher than short-term domestic securities. d. if foreign tax rates equal domestic tax rates, the exchange rates of different currencies will change by the same degree.

ANS: A

PTS: 1

15. If a foreign currency consistently depreciated against the dollar over several periods and had lower interest rates at the beginning of those periods than the U.S. interest rates, then: a. U.S. firms could have achieved a higher effective yield on foreign deposits than on U.S. deposits during those periods. b. the international Fisher effect is supported by the results. c. A and B d. none of the above ANS: D

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

16. In a bilateral netting system, transactions between the parent and a subsidiary or between two subsidiaries are consolidated over a specific period of time. a. True b. False ANS: T

PTS: 1

17. A common purpose of inter-subsidiary leading or lagging strategies is to: a. allow subsidiaries with excess funds to provide financing to subsidiaries with deficient funds. b. assure that the inventory levels at subsidiaries are maintained within tolerable ranges. c. change the prices a high-tax rate subsidiary charges a low-tax rate subsidiary. d. measure the performance of subsidiaries according to how quickly subsidiaries remit dividend payments to the parent.

ANS: A

PTS: 1

18. Assume that a U.S. firm considers investing in British one-year Treasury securities. The interest rate on these securities is 12%, while the interest rate on the same securities in the U.S. is 10%. The firm believes that today's spot rate is an appropriate forecast for the spot rate of the pound in one year.

Based on this information, the effective yield on British securities from the U.S. firm's perspective is: a. equal to the U.S. interest rate. b. equal to the British interest rate. c. lower than the U.S. interest rate. d. higher than the British interest rate. e. lower than the British interest rate, but higher than the U.S. interest rate.

ANS: B

PTS: 1

19. Assume that in recent months, most currencies of industrialized countries depreciated substantially against the dollar. Assume that their interest rates were similar to the U.S. interest rate. If non-U.S. firms invested in U.S. Treasury securities during this period, their effective yield would have been: a. negative. b. zero. c. positive, but less than the interest rate of their respective countries. d. more than the interest rate of their respective countries.

ANS: D

PTS: 1

20. According to ____, the effective yield earned by U.S. investors will be the same as the effective yield earned by non-U.S. investors in any given period. a. interest rate parity (IRP) b. the international Fisher effect (IFE) c. purchasing power parity (PPP) d. none of the above ANS: D

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

21. Assume Costner Corporation, a U.S.-based MNC, invests 2,500,000 Zambian kwacha (ZMK) for a one-year period at a nominal interest rate of 9%. At the time the loan is extended, the spot rate of the kwacha is $.00060. If the spot rate of the kwacha in one year is $.00056, the dollar amount initially invested in Zambia is $____, and $____ are paid out after one year. a. 1,500; 1,526 b. 1,526; 1,500 c. 1,500; 1,400 d. 1,400; 1,500 ANS: A SOLUTION:

ZMK2,500,000  $.0006 = $1,500 (ZMK2,500,000  1.09)  $.00056 = $1,526

PTS: 1 22. Bullock Corporation invests 1,500,000 South African rand at a nominal interest rate of 10%. At the time the investment is made, the spot rate of the rand is $.205. If the spot rate of the rand at maturity of the investment is $.203, what is the effective yield of investing in rand? a. 11.08%. b. 8.92%. c. 10.00%. d. none of the above ANS: B SOLUTION:

Depreciation of rand: .203/.205  1 = .98% Effective yield: (1 + 10%) + [1 + (.98%)]  1 = 8.92%.

PTS: 1 23. Assume that interest rate parity holds. The U.S. one-year interest rate is 10% and the Australian one-year interest rate is 8%. What will the approximate effective yield be for an Australian citizen of a one-year deposit denominated in U.S. dollars? Assume the deposit is covered by a forward sale of dollars. a. 10%. b. 8%. c. 2%. d. cannot answer without more information ANS: B SOLUTION:

If interest rate parity holds, the Australian citizen will be able to earn approximately his or her domestic interest rate.

PTS: 1 24. Assume that you forecast the value of the euro as follows for the next year: Percentage Change 2% 3% 5%

Probability of Occurrence 30% 40% 30%

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

If the interest rate on the euro is 12%, the expected effective yield from a euro-denominated deposit is: a. 15.36%. b. 15.70%. c. 12.00%. d. 14.35%. e. none of the above ANS: D SOLUTION: Effective Financing Rate = 9.76% (1.12)( .98)  1 = 15.36% (1.12)(1.03)  1 = 17.60% (1.12)(1.05)  1

Computation of Expected Value 2.93% 6.14% 5.28% 14.35%

Probability 30% 40% 30%

PTS: 1 Exhibit 21-1 To benefit from the low correlation between the Trinidad dollar and the Japanese yen (¥), Sciorra Corporation decides to invest 50% of total funds invested in Trinidad dollars and the remainder in yen.

The domestic yield on a one-year deposit is 8%. The Trinidad one-year interest rate is 10% and the Japanese one-year interest rate is 7%. Sciorra has determined the following possible percentage changes in the two individual currencies as follows: Currency Trinidad dollar Trinidad dollar

Percentage Change 1.0% 2.0%

Probability 35% 65%

Japanese yen Japanese yen

2.0% 1.0%

45% 55%

25. Refer to Exhibit 21-1. What is the expected effective yield of the portfolio Sciorra is contemplating (assume the two currencies move independently from one another)? a. 6.47%. b. 8.84%. c. 8.50%. d. none of the above ANS: B SOLUTION: Determine effective yield for each currency under each possible scenario.

Step 1.

Currency Trinidad dollars Trinidad dollars

Percentage Change 1.0% 2.0%

Probability 35% 65%

Effective Yield (1.10)( .99)  1 = 8.90% (1.10)(1.02)  1 = 12.20%

Japanese yen Japanese yen

2.0% 1.0%

45% 55%

(1.07)( .98)  1 = 4.86% (1.07)(1.01)  1 = 8.07%

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

Step 2.

Determine joint probabilities and effective yield of portfolio for each scenario.

Trinidad Dollar 8.90% 8.90% 12.20% 12.20%

Japanese Yen 4.86% 8.07% 4.86% 8.07%

Joint Probability (.35)(.45) = .1575 (.35)(.55) = .1925 (.65)(.45) = .2925 (.65)(.55) = .3575

Portfolio Effective Rate (.5)( 8.90%) + (.5)(4.86%) = 6.88% (.5)( 8.90%) + (.5)(8.07%) = 8.49% (.5)(12.20%) + (.5)(4.86%) = 8.53% (.5)(12.20%) + (.5)(8.07%) = 10.14%

1.0000

Step 3.

Determine effective yield of portfolio. (.1575)(6.88%) + (.1925)(8.49%) + (.2925)(8.53%) + (.3575)(10.14%) = 8.84%

PTS: 1 26. Refer to Exhibit 21-1. What is the probability that the yield of the two-currency portfolio is less than the domestic yield? a. .1575. b. .35. c. .6425. d. 1. e. none of the above ANS: A SOLUTION:

Since the domestic financing rate is 8%, the table above shows that there is a .1575 chance that foreign investment with the portfolio of currencies will yield a higher rate than investing domestically.

PTS: 1 Exhibit 21-2 Moore Corporation would like to simultaneously invest in Malaysian ringgit (MYR) and Romanian leu (ROL) for a three-month period. Moore would like to determine the expected yield and the variance of a portfolio consisting of 40% ringgit and 60% leu. Moore has identified the following information: Mean effective financing rate of Malaysian ringgit for three months Mean effective financing rate of Romanian leu for three months Standard deviation of Malaysian ringgit's effective financing rate Standard deviation of Romanian leu's effective financing rate Correlation coefficient of effective financing rates of these two currencies

3% 2% .15 .07 .19

27. Refer to Exhibit 21-2. What is the expected effective yield of the portfolio contemplated by Moore Corporation? a. 2.50%. b. 2.60%. c. 2.40%. d. none of the above © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

ANS: C SOLUTION:

(.4)(3%) + (.6)(2%) = 2.40%.

PTS: 1 28. Refer to Exhibit 21-2. What is the standard deviation of the portfolio contemplated by Moore Corporation? a. .624%. b. 7.950%. c. 1.040%. d. 10.200%. e. none of the above ANS: B SOLUTION: PTS: 1 29. Lockboxes are post office box numbers assigned to employees for picking up their paychecks. a. True b. False ANS: F

PTS: 1

30. Preauthorized payment is an arrangement that allows a corporation to charge a customer's bank account up to some limit. a. True b. False ANS: T

PTS: 1

31. Although netting typically increases the need for foreign exchange conversion, it generally reduces the number of cross border transactions between subsidiaries. a. True b. False ANS: F

PTS: 1

32. Leading refers to the payment of supplies earlier than necessary; lagging refers to the payment of supplies later than allowed. a. True b. False ANS: T

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

33. Since exchange rate forecasts are not always accurate, a probability distribution of possible exchange rates may be preferable to a single point estimate. a. True b. False ANS: T

PTS: 1

34. When investing in a portfolio of foreign currencies, the currencies represented within the portfolio are ideally highly positively correlated. a. True b. False ANS: F

PTS: 1

35. A subsidiary will normally have a more difficult time forecasting future outflow payments if its purchases are international rather than domestic. a. True b. False ANS: T

PTS: 1

36. To ____, MNCs can use preauthorized payments. a. accelerate cash inflows b. minimize currency conversion costs c. manage blocked funds d. manage intersubsidiary cash transfers ANS: A

PTS: 1

37. ____ may complicate cash flow optimization. a. The use of a zero-balance account b. Government restrictions c. Leading and lagging d. None of the above ANS: B

PTS: 1

38. MNCs often use ____ to invest excess cash while retaining liquidity. a. international bond markets b. international equity markets c. international money markets d. the market for acquisitions ANS: C

PTS: 1

39. Centralized cash management is more complicated when the MNC uses multiple currencies. a. True b. False ANS: T

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

40. In general, exchange rate fluctuations cause cash flows to be more volatile and uncertain. a. True b. False ANS: T

PTS: 1

41. Since each subsidiary may be more concerned with its own operations than with the overall operations of the MNC, a centralized management group may need to monitor the parent-subsidiary and intersubsidiary cash flows. a. True b. False ANS: T

PTS: 1

42. A currency portfolio's variability depends on the standard deviations and paired correlations of effective yields of the individual currencies within the portfolio. a. True b. False ANS: T

PTS: 1

43. An MNC has determined that the degree of appreciation for the Singapore dollar that equates the foreign and domestic yield is 2%. If the Singapore dollar appreciates by less than 2%, the investment in Singapore will be more attractive. a. True b. False ANS: F

PTS: 1

44. When investing in a portfolio of foreign currencies, the currencies represented within the portfolio are ideally highly positively correlated if the goal is to reduce exchange rate risk. a. True b. False ANS: F

PTS: 1

45. The effective yield of investing in a foreign currency depends on both the ____ and the ____ of the foreign currency. a. inflation rate; exchange rate movements b. income level; interest rates c. interest rates; exchange rate movements d. interest rates; amount invested ANS: C

PTS: 1

46. Zanada Corporation invests 1,500,000 South African rand (ZAR) at a nominal interest rate of 10%. At the time the investment is made, the spot rate of the rand is $0.205. If the spot rate of the rand at maturity of the investment is $0.203, what is the effective yield of investing in rand? a. 11.08% b. 8.93% © 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.

c. 10.00% d. None of the above ANS: B

PTS: 1

47. Which of the following statements is false? a. If interest rate parity exists, covered interest arbitrage is not worthwhile. b. If interest rate parity holds and the forward rate is an accurate forecast of the future spot rate, an uncovered investment in a foreign security is not worthwhile. c. If interest rate parity exists and the forward rate is an unbiased forecast of the future spot rate, an uncovered investment in a foreign security will on average earn an effective yield similar to an investment in a domestic security. d. If interest rate parity exists and the forward rate is expected to underestimate the future spot rate, an uncovered investment in a foreign security is expected to earn a lower effective yield than an investment in a domestic security.

ANS: D

PTS: 1

48. If interest rate parity does not hold, and the forward ____ is greater than the interest rate differential, then covered interest arbitrage is feasible for investors residing in the ____ country. a. premium; home b. discount; home c. premium; foreign d. B and C ANS: A

PTS: 1

49. Assume the U.S. one-year interest rate is 15%, while the South African one-year interest rate is 13%.

If the South African rand ____ by ____%, a U.S.-based MNC is indifferent between investing in dollars and investing in rand. a. depreciates; 1.77 b. appreciates; 1.74 c. appreciates; 1.77 d. depreciates; 1.74 ANS: C

PTS: 1

50. Which of the following is not a technique to optimize cash flows? a. Accelerate cash inflows b. Minimize currency conversion costs c. Manage blocked funds d. All of the above are techniques to optimize cash flows ANS: D

PTS: 1

51. A ____ allows customers to send payments to a post office box number. a. bilateral netting system b. multilateral netting system c. lockbox d. preauthorized payment ANS: C

PTS: 1

© 2012 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.