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CHAPTER 31
INTERNATIONAL ASPECTS
OF CORPORATE FINANCE
SUGGESTED ANSWERS TO THE REVIEW QUESTIONS AND PROBLEMS
I. Questions
1. The U.S. dollar. The primary reason why the dollar was used is that it
provided a relatively stable benchmark, and it was accepted universally
for transaction purposes.
2. Under the fixed exchange rate system, the fluctuations were limited to
+1% and 1%. Under the floating exchange rate system, there are no
agreed-upon limits.
3. A dollar will buy more French francs.
4. There will be an excess supply of dollars in the foreign exchange
markets, and thus, will tend to drive down the value of the dollar. Foreign
investments in the United States will increase.
5. Taking into account differential labor costs abroad, transportation, tax
advantages, and so forth, Philippine corporations can maximize long-run
profits. There are also nonprofit behavioral and strategic considerations,
such as maximizing market share and enhancing the prestige of corporate
officers.
6. The foreign projects cash flows have to be converted to local currency,
since the shareholders of the Philippine corporation (assuming they are
mainly Philippine residents) are interested in peso returns. This subjects
them to exchange rate risk, and therefore requires an additional risk
premium. There is also a risk premium for political risk (mainly the risk
of expropriation).
7. A Eurodollar is a dollar deposit in a foreign bank, normally a European
bank. The foreign bank need not be owned by foreigners it only has to
be located in a foreign country. For example, a Citibank subsidiary in
Paris accepts Eurodollar deposits. The Frenchmans deposit at Chase
Manhattan Bank in New York is not a Eurodollar deposit. However, if he
transfers his deposit to a bank in London or Paris, it would be. The
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Chapter 31
Forwardexchangerate 1 rh
.
Spotexchangerate
1 rf
Interest rate parity shows why a particular currency might be at a forward
premium or discount. A currency is at a forward premium whenever
domestic interest rates are higher than foreign interest rates. Discounts
prevail if domestic interest rates are lower than foreign interest rates. If
these conditions do not hold, then arbitrage will soon force interest rates
back to parity.
11. Purchasing power parity assumes there are neither transactions costs nor
regulations that limit the ability to buy and sell goods across different
countries. In many cases, these assumptions are incorrect, which
explains why PPP is often violated. An additional complication, when
empirically testing to see whether PPP holds, is that products in different
countries are rarely identical. Frequently, there are real or perceived
differences in quality, which can lead to price differences in different
countries.
II. Multiple Choice Questions
1.
2.
3.
A
B
C
6.
7.
8.
B
B
C
11.
12.
13.
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D
C
B
16.
17.
18.
A
D
A
4. A
5. D
III. Problems
9.
10.
C
C
14.
15.
A
C
19.
Chapter 31
Problem 1
Dollars should sell for 1/1.50, or 0.6667 pound per dollar.
Problem 2
$1 = 4.0 Israeli shekels; $1 = 90 Japanese yen;
Cross-exchange rate, yen/shekel = ?
Cross Rate:
Dollars
Yen
Yen
.
Shekel Dollar Shekel
Note that an indirect quotation is given for Israeli shekel; however, the cross
rate formula requires a direct quotation. The indirect quotation is the
reciprocal of the direct quotation. Since $1 = 4.0 shekels, then 1 shekel =
$0.25.
Yen/Shekel = $0.25 per shekel 90 yen per dollar
= 22.50 yen per shekel
Problem 3
rNOM, 6-month T-bills = 4%; rNOM of similar default-free 6-month Japanese bonds
= 2.5%; Spot exchange rate: 1 yen = $0.010; 6-month forward exchange rate = ?
.
Spot exchange rate
1 rf
rf = 2.5% / 2
= 1.25%
rh = 4% / 2
= 2%
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Chapter 31
1.02
1.0125
= Pf (Spot rate)
$500
= Spot rate
1 euro
= $1.60
or
$1
= 0.625 euro
Problem 5
The dollars required to purchase 1,000 units for each of the following currency is
as follows:
Currency
British pound
Canadian dollar
EMU euro
Japanese yen
U.S. Dollars
Required to
Buy One Unit of
Foreign Currency
1.5282
0.9569
1.2893
0.011437
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1,000 =
1,000 =
1,000 =
1,000 =
1,000 =
Purchase Price
in Dollars
$1,528.20
956.90
1,289.30
11.44
Mexican peso
Swedish krona
0.0782
0.1359
1,000 =
1,000 =
Chapter 31
78.20
135.90
Problem 6
The price of krones is $0.15 today. A 10% appreciation will make it worth
$0.1650 tomorrow. A dollar will buy 1 / 0.1650 = 6.0606 krones tomorrow.
Problem 7
The exchange rate between Swedish kronas and pounds is:
kronas / dollar dollars / pound
Kronas / pound =
=
7.5 1.5
Problem 8
Spot rate: 1 yen = $0.0114; Forward rate: 1 yen = $0.0114; r NOM of 90-day
Japanese risk-free securities = 2%; r NOM of 90-day U.S. risk-free securities = ?
rf = 2.0% / 4
= 0.50%
rh = ?
1 rh
Forwardexchangerate
=
Spotexchangerate
1 rf
$0.0114
1 rh
=
$0.0114
1.005
1 =
1 rh
1.005
1 + rh = 1.005
rh = 0.005
rNOM = 0.50% 4
= 2%
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Chapter 31
Problem 9
a. rNOM of 90-day U.S. risk-free securities = 3%; rNOM of 90-day British risk-free
securities = 3.5%; Spot rate: 1 pound = $1.50; forward rate selling at
premium or discount = ?
Forwardexchangerate
=
Spotexchangerate
1 rh
1 rf
rh = 3% / 4
= 0.75%
rf = 3.5% / 4
= 0.875%
Spot rate = $1.50
Forwardexchangerate
1.0075
=
$1.50
1.00875
Forwardexchangerate
= 0.99876
$1.50
Chapter 31
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Chapter 31
P0 =
D1
rs g
3 $1.50
(0.13 0.047619
)
$4.50
0.082381
= $54.62424588
Total equity
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