Chapter 19

Financial Management: Principles and Applications, 11e (Titman)
Chapter 19 International Business Finance

19.1 Foreign Exchange Markets and Currency Exchange Rates
1) Trading in foreign exchange markets is dominated by:
A) Russian rubles, Indian rupees and Indonesian rupeas.
B) Spanish pesetas, German marks, French francs.
C) Chinese renminbis, Indian rupees and pesos of various Latin American countries.
D) U. S. dollars, the British pound, the euro and the yen.
Answer: D
Diff: 2
Topic: 19.1 Foreign Exchange Markets and Currency Exchange Rates
Keywords: foreign exchange markets
Principles: Principle 3: Cash Flows Are the Source of Value
2) Participants in foreign exchange trading include:
A) importers and exporters.
B) investors and portfolio managers.
C) currency traders.
D) all of the above.
Answer: D
Diff: 2
3) Suppose International Trading Enterprises purchased 25,000 kilograms of Belgian chocolate
for a price of 100,000 euros. If the current exchange rate is .69368 euros to the U.S. dollar, what
is the purchase price of the chocolate in dollars?
A) $14,416
B) $693,368
C) $69,368
D) $144,159
Answer: D
Diff: 2
Keywords: exchange rate
1
Copyright 2011 Pearson Education, Inc.
4) A spot transaction occurs when one currency is:

A) deposited in a foreign bank.
B) immediately exchanged for another currency.
C) exchanged for another currency at a specified price.
D) traded for another at an agreed-upon future price.
Answer: B
Diff: 2
Keywords: spot rates
5) Forward rates are quoted:
A) in direct form.
B) in indirect form.
C) at a premium or discount.
Answer: D
Diff: 2
Keywords: forward rates
6) If the quote for a forward exchange contract is greater than the computed price, the forward
contract is:
A) overvalued.
B) undervalued.
C) a good buy.
D) at equilibrium.
Answer: A
Diff: 2
7) Buying and selling in more than one market to make a riskless profit is called:
A) profit maximization.
B) arbitrage.
C) international trading.
D) cannot be determined from the above information.
Answer: B
Diff: 2
Keywords: arbitrage
2
8) After the U.S. dollar, the most widely traded currency is:
A) the Saudi riyal.
B) the euro.
C) the Swiss franc.
D) the Canadian dollar.
Answer: B
Diff: 2
9) Which of the following statements about exchange rates is true?
A) Exchange rates are fixed by international agreements.
B) Exchange fluctuate between currencies but are fixed in terms of gold.
C) Exchange rates fluctuate constantly.
D) Are regulated by a special committee of the United Nations.
Answer: C
Diff: 2
Keywords: exchange rate risk
10) What keeps foreign exchange quotes in two different countries in line with each other?
A) Cross rates
B) Forward rates
C) Arbitrage
D) Spot rates
Answer: C
Diff: 2
Keywords: arbitrage
11) An attempt to profit by converting dollars to yen, yen to euros, and euros back to dollars
would be an example of:
A) arbitrage.
B) speculation.
C) hedging.
D) intervention.
Answer: A
Diff: 2
Keywords: arbitrage
3
12) An investor purchased 200,000,000 Japanese yen at an exchange rate of 93 yen to the dollar.
the yen cost her ________.
A) $18,600
B) $10,752.70
C) $21,505.30
D) $186,000
Answer: C
Diff: 2
13) An investor purchased 1,000,000 Canadian dollars at an exchange rate of 1.0309 Canadian
dollars to the U.S. dollar. The Canadian dollars cost her ________.
A) $103,090
B) $970,026
C) $1,030,927
D) $97,000
Answer: B
Diff: 2
14) An investor purchased Canadian dollars at an exchange rate of $0.97 U.S. to 1 Canadian
dollar. The Canadian dollars cost her $1,000,000 (U.S. dollars). How many Canadian dollars did
she buy?
A) $103,090
B) $970,026
C) $1,030,927
D) $97,000
Answer: C
Diff: 2
4
15) Assume that an investor purchased 200,000,000 Japanese yen in New York at an exchange
rate of 93 yen to the dollar and simultaneously sold the yen in Tokyo at an exchange rate of 91
Japanese yen to the dollar. Further assume that there was no cost associated with this transaction.
What profit or loss did the investor make?
A) ($43,010) loss
B) $47,272 profit
C) ($47,272) loss
D) $43,956 profit
Answer: B
Diff: 2
Keywords: arbitrage
16) Transactions carried out in the foreign exchange markets include:
A) spot transactions.
B) forward exchange contracts which allow the exchange of one currency for another today.
C) swaps.
D) both A and B.
Answer: D
Diff: 2
17) Assume that an investor owned 5,000 shares of Anheuser-Busch Corporation common stock
prior to the acquisition by InBev of Belgium. At the time of the acquisition, the dollar was
worth .77 euros. Further assume that the purchase price was equal to 54 euros per share. What
was the sales price of Anheuser Busch common stock per share in U.S. dollars?
A) $41.58
B) $54
C) $77
D) $70.13
Answer: D
Diff: 2
18) One U.S. dollar buys 92.61 yen and 12.707 Mexican pesos. What is price of pesos in yen?
A) 7.2881
B) .1372
C) .0787
D) 1.0798
Answer: A
Diff: 2
Keywords: cross rate
5

19) Assume that an importer of wine were to purchase 5,000 cases of premium French Bordeaux
for 700,000 euros. Further assume that the quoted exchange rates are as follows: spot rate = .70
euros to the U.S. dollar; 30-day forward rate = .705 euros to the U.S. dollar; and 90-day forward
rate = .710 euros to the U.S. dollar. If the actual currency exchange rate at the time payment is
due in 90 days is equal to the forward rate of .710 euros to the U.S. dollar, how much would the
wine cost the importer in U.S. dollars if payment is made in 90 days? Round to the nearest dollar.
A) $704,225
B) $355,000
C) $497,000
D) $985,915
Answer: D
Diff: 2
20) You are leaving Mexico and have 3,000 pesos to change into dollars. The exchange rate is
10.2 pesos to the dollar. How many dollars will you receive?
A) You will receive 30,600 US$.
B) You will receive 294.12 US$.
C) You will lose money converting back into dollars.
D) This is not enough information to find the number of dollars.
Answer: B
Diff: 2
21) You are on your way to a beautiful Mexican resort. The current exchange rate is 12 pesos to
the dollar. When you arrive, you convert 1,000 US$ for how many pesos?
A) 12,000 pesos
B) 1,200 pesos
C) 8,333 pesos
D) 83.33 pesos
Answer: A
Diff: 2
6
22) Assume that a buyer of Italian wine saw the following quotes: spot rate of .75 euros to the
U.S. dollar; 30-day forward rate of .747 euros to the U.S. dollar; 90-day forward rate of .744
euros to the U.S. dollar. What does this information imply?
A) The forward euro is selling at a premium as compared with the spot euro.
B) The dollar is expected to maintain the same value in the near future relative to the euro.
C) The forward euro is selling at a discount as compared with the spot euro.
D) None of the above.
Answer: A
Diff: 2
Use the following information to answer the following question(s).
Below is an excerpt from Table 19.1, Foreign Exchange Ratrd (January 8, 2010) that appears in
your text. (Sources The Wall Street Journal and Reuters)
U.S. $ equivalent
Currency per U.S. $
Country
Mon.
Mon.
India (Rupee)
0.02199
45.4752
Britain (Pound)
1.6028
.6239
30-day Forward
1.6024
.6241
90-day Forward
1.6019
.6243
180-day Forward
1.6008
.6247
Canada (Dollar)
0.9700
1.0309
30-day Forward
0.9700
1.0309
90-day Forward
0.9700
1.0309
180-day Forward
0.9698
1.30311
Switzerland franc
0.9772
1.0233
30-day Forward
0.9773
1.0232
90-day Forward
0.9777
1.0228
180-day Forward
0.9783
1.0222
23) To buy one Indian Rupee you would need:
A) 2.199 cents.
B) 45.4752 dollars.
C) 21.99 cents.
D) 4.54752 dollars.
Answer: A
Diff: 2
7
24) The number of pounds you can purchase per U.S. dollar is:
A) 1.6008.
B) 6.239.
C) 0.6239.
D) 1.6028.
Answer: C
Diff: 2
25) Assume that your firm must pay 10,000,000 rupees to an Indian firm. How much will you
have to pay in U.S. dollars.
A) $2,199,000
B) $219,900
C) $454,752,000
D) $$454,752
Answer: B
Diff: 2
26) Assume that your firm must pay $4,000 to a Swiss firm. In Swiss francs Swiss firm will
receive:
A) 3,908.80 Swiss francs.
B) 3,913 Swiss francs.
C) 39,088 Swiss francs.
D) 4,093.20 Swiss francs.
Answer: D
Diff: 2
27) The Swiss franc to British pound exchange rate is:
A) 1.64 Swiss francs to the pound.
B) 1.5663 Swiss francs to the pound.
C) .6097 Swiss francs to the pound.
D) .9772 Swiss francs to the pound.
Answer: A
Diff: 2
8
28) The British pound to Swiss franc exchange rate is:

A) 1.64 British pounds to the Swiss franc.
B) 1.5663 British pounds to the Swiss franc.
C) .6097 British pounds to the Swiss franc.
D) .9772 British pounds to the Swiss franc.
Answer: C
Diff: 2
29) The 90-day forward rate for Canadian dollars is:
A) 10.309.
B) 9.7000.
C) 0.9700.
D) 01.0309.
Answer: C
Diff: 2
30) Based on the forward rates in table 19.1, the British pound is expected to:
A) stay the same against the dollar.
B) weaken against the dollar.
C) fluctuate randomly against the dollar.
D) strengthen against the dollar.
Answer: D
Diff: 2
31) The following are the prices in the foreign exchange market between the U.S. dollar and a
foreign currency (fc). Spot 0.6335US$/fc; three-month forward 0.6375US$/fc. What was the
discount or premium on three-month forward for the foreign currency?
A) 0.63% premium
B) 0.40% premium
C) 0.63% discount
D) 0.40% discount
Answer: A
Diff: 2
9
32) Assume that a firm purchases foreign currency in order to complete the purchase of raw
material from an overseas supplier. The currency is purchased today at an exchange rate that is
good only for today. This transaction is referred to as a(n) ________ transaction.
A) forward
B) arbitrage
C) spot
D) hedge
Answer: C
Diff: 2
33) Forward exchange rates:
A) reduce uncertainty about future value of currencies.
B) are always slightly lower than the spot rate.
C) reflect expectations about the future value of currencies.
D) both A and C.
Answer: D
Diff: 2
34) A trader who simultaneously bought Swiss francs in New York for .9772 and sold them in
Zurich for .9774 would be practicing:
A) simple arbitrage.
B) inside trading.
C) compound arbitrage.
D) parity exploitation.
Answer: A
Diff: 2
Keywords: arbitrage
35) A dealer in New York offers to buy U.K. pounds for $1.60 and sell them for $1.605. The
different prices are due to:
A) arbitrage.
B) a tax on currency transactions.
C) the bid-ask spread.
D) supply and demand.
Answer: C
Diff: 2
Keywords: bid-ask
10
36) The exchange rate that represents the number of units of a home currency that is required to
purchase one unit of a foreign currency is referred to as a(n) ________ quote.
A) forward
B) direct
C) market
D) indirect
E) arbitrage
Answer: B
Diff: 2
Keywords: direct, indirect quotes
37) The exchange rate that represents the number of units of a foreign currency that can be
purchased with one unit of a home currency is referred to as a(n) ________ quote.
A) forward
B) direct
C) market
D) indirect
Answer: D
Diff: 2
38) A foreign exchange dealer in New York posts an ask price of .02201 for Indian rupees and a
bid price of .02197. What is the dealer's profit on the simultaneous purchase and sale of 1 million
rupees?
A) $40 profit
B) ($40 )loss
C) $400 profit
D) ($4) loss
Answer: A
Diff: 2
Keywords: bid-ask
39) The international currency system that presently exists is best described as a ________ rate
currency system.
A) parity
B) fixed
C) multinational
D) floating
Answer: D
Diff: 2
11

40) A cross rate is the computation of an exchange rate for a currency from the exchange rates of
two other countries.
Answer: TRUE
Diff: 2
41) The asked rate is the price a customer will receive from a foreign currency trader when
selling a foreign currency.
Answer: FALSE
Diff: 2
Keywords: bid-ask
42) The foreign exchange market is similar in form to the New York Stock Exchange.
Answer: FALSE
Diff: 2
43) Arbitrage eliminates forward discounts and premiums across the markets of a single
currency.
Answer: FALSE
Diff: 2
Keywords: arbitrage
44) Arbitrage is the process of buying and selling in one market in order to make a riskless profit.
Answer: TRUE
Diff: 2
Keywords: arbitrage
45) The efficiency of foreign currency markets is ensured, in large measure, by the process of
arbitrageurs.
Answer: TRUE
Diff: 2
Keywords: arbitrage
46) A direct quote in Bombay tells one how many British pounds can buy one Indian rupee.
12
Answer: FALSE
Diff: 2
47) The bid rate (also called the offer rate) is the number of units of home currency paid to a
customer in exchange for their foreign currency.
Answer: FALSE
Diff: 2
Keywords: bid-ask
48) The foreign exchange market provides a physical entity that transfers the purchasing power
from one currency to another.
Answer: FALSE
Diff: 2
49) Foreign exchange transactions carried out in the spot market entails an agreement today to
deliver a specific number of units of currency on a future date in return for a specified number of
units of another currency.
Answer: FALSE
Diff: 2
50) Transactions carried out in the foreign exchange markets can include direct or indirect
exchange rate quotes.
Answer: TRUE
Diff: 2
51) Spot transactions are made immediately in the market place at the market price.
Answer: TRUE
Diff: 2
13
52) Spot exchange markets are efficient due to arbitrage forces.

Answer: TRUE
Diff: 2
53) When banks transact in foreign currencies, the direct bid quote is greater than the direct
asked quote.
Answer: FALSE
Diff: 2
Keywords: bid-ask
54) The forward rate is the same as the spot rate that will prevail in the future.
Answer: FALSE
Diff: 2
55) The major advantage of the forward market is risk reduction.
Answer: TRUE
Diff: 2
56) Spot exchange markets have the potential for arbitrage opportunities for a long period of
time.
Answer: FALSE
Diff: 2
57) The difference between the asked price and the bid price is known as the spread.
Answer: TRUE
Diff: 2
Keywords: bid-ask
14
58) A narrow spread indicates efficiency in the spot exchange market.

Answer: TRUE
Diff: 2
Keywords: bid-ask
59) Forward contracts are usually quoted for periods greater than one year.
Answer: FALSE
Diff: 2
60) Forward rates, like spot rates, are quoted in both direct and indirect form.
Answer: TRUE
Diff: 2
61) Forward contracts benefit only the customer due to a reduction in uncertainty.
Answer: FALSE
Diff: 2
62) What is the role of arbitrage in the foreign exchange markets?
Answer: Foreign exchange quotes should be consistent with each other so that the exchange
rates in all markets will be the same. If a currency could be purchased for one price in, for
example, Paris and sold at a higher price in another market, say New York, then arbitrageurs
would buy aggressively in Paris, increasing demand, and sell in New York, increasing supply.
The increased buying activity in one market and selling activity in the other would soon
eliminate the price differential.
Diff: 2
Keywords: arbitrage
63) A dealer in London posts an ask rate of .6238 and a bid rate of .6237. How much, in U.K.
pounds, would it cost to purchase $100,000. For how much in pounds could you sell $100,000?
Answer: $100,000 could be purchased for 62,380 British pounds and sold for 62,370 British
pounds.
Diff: 2
15
64) What is the difference between forward rates and spot rates? What is the purpose of forward
contracts?
Answer: The spot rate for a currency is the price that is paid for immediate delivery "on the
spot." Forward rates are the prices paid for currency that is to be delivered at some point in the
future, such as 30, 60 or 90 days. Forward transactions are useful for importers and exporters
because they allow buyers and sellers to fix the value of payments in advance, in their own
currencies.
Diff: 2
65) What is the difference between and "ask" quote and a "bid" quote.
Answer: Currency traders make a small (in percentage terms) profit by purchasing at a slightly
lower price, the "bid" rate and selling at a slightly higher price, the "ask" rate.
Diff: 2
Keywords: bid-ask
66) As of January 8, 2010, the spot rate for Swiss francs was .9772. The 180 day forward rate
was .9783. Compute the annualized percentage rate premium or discount for Swiss francs.
Answer: (.9783 - .9772)/.9772 365/180 = .002283. The annualized premium is 0.2283%.
Diff: 2
67) One U.S. dollar buys 12.706 Mexican pesos and .6936 euros. What is the peso/euro
exchange rate.
Answer: 12.706/1 1/.6936 = 18.319 pesos per euro.
Diff: 2
16
19.2 Interest Rate and Purchasing-Power Parity

1) A theory that relates the ratios of spot and forward exchange to differences in interest rates in
two countries or currency zones is known as:
A) interest rate parity.
B) purchasing power parity.
C) market efficiency.
D) forward/spot equivalence hypothesis.
Answer: A
Diff: 2
Topic: 19.2 Interest Rate and Purchasing-Power Parity
Keywords: interest rate parity
2) The interplay between interest rate differentials and exchange rates such that both adjust until
the foreign exchange market and the money market reach equilibrium is called the:
A) purchasing power parity theory.
B) balance of payments quantum theory.
C) interest rate parity theory.
D) arbitrage markets theory.
Answer: C
Diff: 2
3) Which of the following statements is true?
A) The forward rate is the same as the spot rate that will prevail in the future.
B) Only the forward rate is known.
C) An indirect quote is the exchange rate that indicates the number of units of the home currency
required to buy one unit of foreign currency.
D) Both B and C.
Answer: B
Diff: 2
4) The purchasing power parity theory is least likely to apply to the price of:
A) oral surgery.
B) smart phones.
C) crude oil.
D) cane sugar.
Answer: A
Diff: 2
Keywords: purchasing power parity
17

5) The 1 year interest rate in the U.S. is 1%. The spot exchange rate for yen is 92.61 to the dollar.
The 6 months forward rate is 92.57 to the dollar. These prices indicate that interest rates in Japan,
on an annualized basis, are about:
A) .08% lower.
B) .08% higher.
C) .04% higher.
D) .8% lower.
Answer: B
Diff: 2
6) The 1 year interest rate in the U.S. is 2%. The spot exchange rate for Canadian dollars .97 to
the U.S.dollar. The 6 months forward rate is .9698 to the U.S. dollar. These prices indicate that
interest rates in Canada, on an annualized basis, are about:
A) .08% lower.
B) .08% higher.
C) .04% higher.
D) .8% lower.
Answer: C
Diff: 2
7) The spot exchange rate for Canadian dollars is .97 to the U.S.dollar. The 6 months forward
rate is .9698 to the U.S. dollar. The interest rate in Canada (annual) is 2.04%. What is the U. S.
Interest rate?
A) 2.02%
B) 4.04%
C) 1.08%
D) .9982%
Answer: A
Diff: 2
18
8) A barrel of oil currently costs $85 in U.S. dollars. The current exchange rate is $1.40 U. S. to
the euro. If purchasing power parity prevails what is the price of a barrel of oil in euros?
A) 71.43 euros
B) 140 euros
C) 119 euros
D) 60.71 euros
Answer: D
Diff: 2
9) 10,000 bushels of corn currently sells in the U. S. for $57,300. The current exchange rate is
45.5 rupees to the dollar. If purchasing power parity prevails, what is the price of 10,000 bushels
of corn in rupees?
A) 2,607,150 rupees
B) 12,593.34 rupees
C) 45,500 rupees
D) 260,715 rupees
Answer: A
Diff: 2
10) The current spot exchange rate between the Japanese yen and the U.S. dollar is 92.61 Y/US$.
The yen is expected to appreciate by 4% against the dollar over the next year. What do you
expect the spot exchange rate between the yen and the dollar to be one year from now?
A) 92.61 Y/US$
B) 98.18 Y/US$
C) 89.05 Y/US$
D) 103.08 Y/US$
Answer: C
Diff: 2
11) According to the domestic Fisher effect, if the inflation rate is 3% and the real rate of interest
is 2%, the nominal rate of interest will be:
A) 5.06%.
B) 5.00%.
C) 6%.
D) 8.15%.
Answer: A
Diff: 2
19

12) According to the domestic Fisher effect, if the inflation rate is 5%, and the nominal rate of
interest is 7%, the real rate of interest is:
A) 2.00%.
B) 1.904%.
C) 4.65%.
D) 0.5252%.
Answer: B
Diff: 2
13) According to the international Fisher effect, if the nominal interest rate in Russia is 9.5% and
the inflation rate is 8%, the real rate of interest is approximately:
A) 18.26%.
B) 6.5%.
C) 1.5%.
D) -1.5%.
Answer: C
Diff: 2
14) The nominal rate of interest in Russia is 9.5% and the inflation rate is 8%. The nominal rate
of interest in Spain is 3% and the inflation rate is 1%. Which country has the higher real rate of
interest?
A) Russia
B) Spain
C) There is no difference.
D) There is not enough information
Answer: B
Diff: 2
20
15) The nominal rate of interest in Russia is 9.5% and the inflation rate is 8%. The nominal rate
of interest in Canada is 2.5% and the inflation rate is zero. We would expect:
A) the ruble to strengthen against the dollar.
B) the exchange rate between the Canadian dollar and the ruble to stay the same because of
interest rate parity.
C) the exchange rate between the Canadian dollar and the ruble to stay the same because of
purchasing price parity.
D) the Canadian dollar to strengthen against the ruble.
Answer: D
Diff: 2
16) Which of the following statements is true?
A) Interest rate parity indicates that the forward premium or discount should be greater than the
differences in the national interest rates for securities of the same maturity.
B) Purchasing power parity indicates that, in the long run, exchange rates adjust to reflect
international differences in inflation so that the purchasing power of each currency tends to
remain the same.
C) The International Fisher Effect indicates that the nominal interest rate should be the same all
over the world at all times if the market is efficient.
D) Both B and C.
Answer: B
Diff: 2
17) Which of the following is a conceptual method for keeping the foreign currency market in
equilibrium?
A) The purchasing power parity mechanisms
B) The balance of trade mechanisms
C) Government intervention through central banks
D) The interest rate parity mechanisms
Answer: D
Diff: 2
21
18) Assume that a Toyota sold for 1,476,000 yen in 1990. If the price for this automobile was
$8,200 in 1985, and the car still sells for the same amount of yen today, but the current exchange
rate is 90 yen per dollar, what is the car selling for today in U.S. dollars?
A) $ 14,760
B) $16,400
C) $18,204
D) $12,062
Answer: B
Diff: 2
19) If a currency's forward price in U. S. dollars is higher than the spot price, interest rates are
higher in the foreign country than they are in the U.S.
Answer: FALSE
Diff: 2
20) If a currency's forward price in U. S. dollars is lower than the spot price, interest rates are
higher in the foreign country than they are in the U.S.
Answer: TRUE
Diff: 2
21) Purchasing price parity is more likely to be the case for common commodities than for
personal services.
Answer: TRUE
Diff: 2
22) If a country is has high interest rates because of inflation, the forward price of its currency
will be higher than the spot price.
Answer: FALSE
Diff: 2
22
23) Prices differences of identical items in different currencies can best be explained by the
international Fisher effect.
Answer: FALSE
Diff: 2
Keywords: international Fisher effect
24) The forward price of currencies can be either higher, lower or even the same as the spot
price.
Answer: TRUE
Diff: 2
25) The price of a Big Mac is more or less the same everywhere in the world.
Answer: FALSE
Diff: 2
26) What is meant by interest rate parity?
Answer: Interest rate parity is the theory that explains the differences between spot rates and
forward rates by relating them to differing interest rates in the two countries. Interest rate parity
can be expressed by the following identity: Difference in interest rates=ratio of the forward and
the spot rates.
Diff: 2
27) Assume that the interest rate in India is 10% while in Europe it is 3% and that the exchange
rate is 65.50 rupees to the euro. What would we expect the 6 month exchange rate to be?
Answer: The higher interest rate in India implies that the the rupee will weaken against the euro.
Specifically, (1 + .03/2)/(1 + .10/2)=Forward Exchange Rate/65.50 so the 6 month forward
exchange rate should be 67.76 rupees to the euro.
Diff: 2
23
28) What is the law of one price? How does it apply to foreign exchange rates?
Answer: The law of one price states that under certain conditions, the same item should sell for
the equivalent price in different currencies. It should not be possible to make a profit by buying a
barrel of oil in dollars and simultaneously selling it in euros or yen, or the reverse.
Diff: 2
29) Jean-Marc lives in Besanon, a French city near the Swiss border. The exchange rate is 1.47
Swiss francs to the euro. If Jean-Marc's shopping cart of groceries typically costs him 80 euros,
what should it cost him if he drives across the border to Switzerland? Do you think that purchase
price parity would apply in this situation?
Answer: If purchase price parity applies, Jean-Marc's groceries should cost him approximately
80 x 1.47 =118 Swiss francs. Although some items might be priced differently because of taxes
or brand preferences, it is unlikely that a grocery cart of diverse items would be priced very
differently when it is easily possible for customers to drive from one location to the other. If
groceries were significantly less expensive on one or the other side of the border, local merchants
in the more expensive country would be unable to compete or survive.
Diff: 2
19.3 Capital Budgeting for Direct Foreign Investment
1) Which of the following international business activities constitutes a foreign direct
investment? All firms mentioned are U.S. based.
A) Yanqui Spirits imports a 1000 cases of rum from the Dominican Republic.
B) WMT Inc. opens a big-box retail facility in Nicaragua.
C) Condor University runs training sessions for Indonesian civil servants on its California
Campus.
D) Merkizer Pharmaceuticals licenses an Indian company to manufacture a drug under its
patents.
Answer: B
Diff: 2
Topic: 19.3 Capital Budgeting for Direct Foreign Investment
Keywords: direct foreign investment
24
2) One reason for international investment is that:

A) the economies of many countries are growing faster than the U.S.
B) price-earnings (P/E) ratios are higher in foreign countries.
C) doing business in foreign countries is simpler than in the U. S.
D) raw materials are typically cheaper in other countries than in the U. S.
Answer: A
Diff: 2
3) In 2010, the U. S. A. comprised ________ of the world's stock market capitalization.
A) 20%
B) just under 50%
C) 75%
D) 90%
Answer: B
Diff: 2
Keywords: multinational corporation
4) The spot exchange rate for the Thai bhat is 33.135 bhat to the dollar. The 1 year forward rate is
34.175. Ramo Corp. has undertaken a capital project in Bangkok that is expected to produce a
cash flow of 17,087,500 bhat at the end of the first year. The company will discount cash flows at
a rate of 14%. What is the present value of the first year cash flow in U.S. dollars.
A) $14,989,035
B) $500,000
C) $438,596
D) $452,363
Answer: C
Diff: 2
5) The spot exchange rate for the Thai bhat is 33.135 bhat to the dollar or .00318 dollar to the
bhat. For capital budgeting purposes, Ramo Corp needs to estimate the exchange rate 5 years
from now. The U.S. interest rate is 4%; the interest rate in Thailand is 8%. The estimated 5 year
forward rate is:
A) 27.44 bhat to the dollar.
B) 40.02 bhat to the dollar.
C) 31.90 bhat to the dollar.
D) 34.41 bhat to the dollar.
Answer: B
Diff: 2
25

6) RAH Inc., a U.S. corporation is evaluating a proposal to construct and lease an office building
in Kiev. RAH's weighted average cost of capital is 11%. The risk free rate in the U.S. is 3.75%.
RAH believes that conditions in Kiev warrant a required rate of return that is 12% above the
risk-free rate. Cash flows from the hotel project should be discounted at:
A) 23%.
B) 14.75%.
C) 15.75%.
D) 12%.
Answer: C
Diff: 2
7) Some complexities of conducting international business include:
A) multiple currencies.
B) differing legal requirements.
C) restrictions on repatriating earnings.
Answer: D
Diff: 2
Keywords: political risk
8) When multinational companies evaluate capital investments in foreign countries, they
discount:
A) pre-tax earnings of the foreign subsidiary.
B) foreign earnings at home country discount rates.
C) only earnings that are expected to be transferred back to the parent company.
D) all cash flows in the foreign currency at the host country discount rates.
Answer: C
Diff: 2
9) Exchange rate risk:
A) arises from the fact that the spot exchange rate on a future date is a random variable.
B) applies only to certain types of international businesses.
C) has been phased out due to recent international legislation.
D) is not a significant factor in foreign investment decisions.
Answer: A
Diff: 2
26

10) Exchange rate risk:
A) exists when the contract is written in terms of the foreign currency.
B) exists also in direct foreign investments and foreign portfolio investments.
C) does not exist if the international trade contract is written in terms of the domestic currency.
Answer: D
Diff: 2
11) Risks of foreign direct investment potentially include:
A) exchange rate fluctuations.
B) political instability.
C) competition from foreign competitors.
Answer: D
Diff: 2
12) An important (additional) consideration for a direct foreign investment is:
A) political risk.
B) maximizing the firm's profits.
C) attaining a high international P/E ratio.
Answer: A
Diff: 2
13) If the net present value of a direct foreign investment is negative, the multinational firm
should:
A) reject any proposals.
B) consider establishing a sales office.
C) consider licensing.
D) both A and C.
Answer: C
Diff: 2
27
14) Foreign countries claim that multinational corporations:

A) cause stability in their currencies in foreign exchange markets.
B) exploit local labor with low wages.
C) have no political or cultural loyalty.
D) both B and C.
Answer: D
Diff: 2
15) Capital markets in foreign countries:
A) offer lower returns than those obtainable in the domestic capital markets.
B) provide international diversification.
C) in general are becoming less integrated due to the widespread availability of interest rate and
currency swaps.
D) increase portfolio betas.
Answer: B
Diff: 2
16) Expropriation of plant and equipment without compensation is an example of financial risk
from direct foreign investments.
Answer: FALSE
Diff: 2
17) Economic exposure refers to the overall impact of exchange rate changes on the value of the
firm.
Answer: TRUE
Diff: 2
18) The cost of debt used in the international investment decision is the lesser of the parent's or
the subsidiary's cost of debt.
Answer: FALSE
Diff: 2
28
19) Because a large part of a subsidiary's equity funds comes from the parent, the subsidiary
should use the same cost of equity as the parent.
Answer: FALSE
Diff: 2
20) Millheim Electronics is an American firm operating in India, whose government refuses to
allow Millheim to send its earnings out of the country. This is an example of repatriation of
profits.
Answer: FALSE
Diff: 2
21) Multinational corporations can have lower cost of capital and more continuous access to
external finance compared to a domestic firm.
Answer: TRUE
Diff: 2
22) The relevant sources of risk for direct foreign investment capital budgeting decisions are the
same as those faced when making domestic capital budgeting decisions.
Answer: FALSE
Diff: 2
29
23) The interest rate in the U.S. is 4%, in Switzerland it is 3%. The spot rate is 1.0232 USD to
the Swiss franc. A U.S. based hotel chain needs to project forward exchange rates for the next
five years. Complete the table below.
Year Spot
x rate
Rate
differential
Forward Rate
0
1
2
3
4
5
Answer: The interest rate in the U.S. is 4%, in Switzerland it is 3%. The spot rate is .9700 Swiss
francs to the dollar. A U.S. based hotel chain needs to project forward exchange rates for the next
five years. Complete the table below.
Year Spot
x rate
Rate
differential
Forward Rate
0 $0.9700/SF 1
$0 .9700/SF
1
$0.9700/SF 1.00977
$0.9794/SF
2
$0.9700/SF (1.00977)2
$0.9890/SF
3
$0.9700/SF (1.00977)3
$0.9987/SF
4
$0.9700/SF (1.00977)4
$1.0085/SF
5
$0.9700/SF (1.00977)5
$1.01832/SF
Diff: 2
24) The spot exchange rate for the Thai bhat is 33.135 bhat to the dollar. The Host Hotel
Company will be able to repatriate profits from its luxury resort hotel in Phuket in 5 years. It has
estimated the 5 year forward rate at 38 bhat to the dollar. The risk-free rate in the U.S. is 4% and
Host uses an 11 % risk premium for investments of this type. If the expected accumulated profits
after 5 years are 100 million bhat, what is their present value in U.S. dollars.
Answer: Present value in bhats is 100,000,000/(1 + .04 + .11)5=49,717,674. Dividing the PV in
bhats by the forward price of 38 bhats to the dollar, we obtain $1,308,360.
Diff: 2
30
25) What are some of the potential risks, other than exchange rate risk, that need to be considered
in foreign direct investment decisions.
Answer: Business risks involve issues such as product acceptance in foreign markets,
competitive practices, legal protections for physical and intellectual property and the like.
Financial risk could arise from the way in which the investment is financed. Political risk
involves possible expropriation of property, locked up funds that cannot be converted into parent
company currency, price controls, unexpected changes in tax rates, restrictive employment
policies and the like. Unfortunately, these risks tend to be greater in the areas of greatest
opportunity.
Diff: 2
26) Briefly discuss the factors that multinational firms consider in arriving at capital structure
decisions.
Answer: Multinational firms should consider several factors in arriving at capital structure
decisions. First, firms should consider how the capital structure of its local affiliates is influenced
by the local norms of the industry and in that country. It is noted that norms will vary from
country to country. Second, the local affiliate capital structure needs to reflect corporate attitudes
toward exchange rate and political risk in that country. These risks would normally lead to higher
levels of debt and other local capital. Third, the capital structure of the local affiliate must reflect
home country requirements with regard to the company's consolidated capital structure. Last, the
optimal capital structure should reflect wider access to financial markets as well as the ability to
diversify economic and political risks.
Diff: 2
31

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Chapter 19

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Financial Management: Principles and Applications, 11e (Titman)

Chapter 19 International Business Finance

4) A spot transaction occurs when one currency is:

Principles: Principle 3: Cash Flows Are the Source of Value

28) The British pound to Swiss franc exchange rate is:

Principles: Principle 3: Cash Flows Are the Source of Value

52) Spot exchange markets are efficient due to arbitrage forces.

58) A narrow spread indicates efficiency in the spot exchange market.

19.2 Interest Rate and Purchasing-Power Parity

Principles: Principle 3: Cash Flows Are the Source of Value

Principles: Principle 3: Cash Flows Are the Source of Value

2) One reason for international investment is that:

Principles: Principle 3: Cash Flows Are the Source of Value

Principles: Principle 3: Cash Flows Are the Source of Value

14) Foreign countries claim that multinational corporations:

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