Butler / Multinational Finance – Sample Exam / Part I

True/False
Chapter 3
1. Capital markets are markets for long-term financial assets and liabilities, typically considered to be
greater than one year in maturity.
2. Liquidity refers to the ease with which you can exchange one asset for another of equal value.
3. Eurobonds are denominated in one or more currencies but are traded in external markets outside the
borders of the countries issuing those currencies.
4. If the current spot rate is S0$/DM = $0.5839/DM and the one-year forward rate is F1$/DM = $0.5754/DM,
then the deutsche mark is selling at a forward premium.
5. Daily volume in the inter-bank foreign exchange market is nearly one billion dollars.
6. You expect to receive a cash flow denominated in a foreign currency in six months. You can hedge
this exposure by buying the foreign currency in the forward market.
Chapter 4
7. Empirical evidence indicates that relative purchasing power parity can be used to successfully predict
short-term changes in spot exchange rates.
Multiple choice: Pick the best alternative
Chapter 3
8. The Irish punt depreciates 28.57 percent against the dollar. By how much has the dollar appreciated
against the punt?
a. 10%
b. 20%
c. 30%
d. 40%
e. 50%
9. The value of the Hong Kong dollar against the U.S. dollar on December 31, 1978 was $4.80/HK$. By
year-end 1998, the exchange rate was $7.75/HK$. What was the average annual change in the value
of the Hong Kong dollar over this 20-year period?
a. less than or equal to 0%
* b. more than 0% and less than or equal to 5%
c. more than 5% and less than or equal to 10%
d. more than 10% and less than or equal to 15%
e. more than 15%
10. The spot rate is $1.00/€ and the one-year forward rate is $1.10/€. What is the percentage forward
premium (or discount) on the dollar?
* a. less than 0%
b. 0%
c. 10 percent
d. more than 10%
e. none of the above
11. S0$/SFr = $1.27/SFr and F1$/SFr = $1.26/SFr. These prices indicate that ____.
a. nominal interest rates are lower in the U.S. than in Switzerland
b. the inflation rate in Switzerland is increasing
c. the Swiss franc has recently depreciated against the dollar
d. the Swiss franc is expected to appreciate against the dollar
e. it is not possible to claim that any of the above are true without additional information

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Chapter 4
12. Annual inflation rates in Israel and Mexico are expected to be 8% and 20%, respectively, over the
next several years. The current spot rate is 2 Mexican new pesos (NPeso) per Israeli shekel (Shk).
Relative purchasing power parity suggests that the exchange rate in 4 years will be approximately
____.
a. NPeso 1.31/Shk
b. NPeso 1.80/Shk
c. NPeso 2.00/Shk
d. NPeso 2.22/Shk
e. NPeso 3.05/Shk
13. Annual interest rates are 1% in Swiss francs and 2.5% in dollars. The current spot rate is $0.3512/SFr.
What is the 4-year forward rate?
a. $0.3311/SFr
b. $0.3461/SFr
c. $0.3564/SFr
d. $0.3512/SFr
e. $0.3725/SFr
14. The exchange rate changes from €1.04/$ at the beginning of the year to €1.05/$ at the end of the year.
Inflation during the year is 5% in dollars and 4% in euros. What is the percentage real appreciation or
depreciation of the euro during the year, x$/€?
a. x$/€ ≤ -2%
b. -2% < x$/€ < -1%
c. -1% ≤ x$/€ ≤ +1%
d. +1% < x$/€ < +2%
e. x$/€ ≥ +2%

Chapter 4 Covered interest arbitrage problem - Show your work

You can trade at the following prices:
Spot rate, euro (€) per British pounds sterling (£) €1.4876/£
One-year forward exchange rate €1.4906/£
One-year euro interest rate 4.10%
One-year pounds sterling interest rate 3.55%
Is covered interest arbitrage worthwhile?
If so, explain the steps and compute the profit based on an initial transaction of £1,000,000.
SHOW YOUR WORK: Use time lines to indicate the size and timing of all cash flows.

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Key
True/False
1. True.
2. True.
3. True.
4. False. The mark (in the denominator of the quote) is selling at a forward discount.
5. False. Trading volume averages well over one trillion dollars daily.
6. False. Sell the foreign currency (and buy the domestic currency) at the forward rate.
7. False. In the short run, inflation differentials are not very good predictors of actual changes in spot
exchange rates.

Multiple choice
8. d.. 40%
9. b. more than 0% and less than or equal to 5%
10. a. less than 0%
11. a. nominal interest rates are lower in the U.S. than in Switzerland
12. e. NPeso 3.05/Shk
13. e. $0.3725/SFr
14. b. -2% < x$/€ < -1%

Covered interest arbitrage problem (50 points)

F1€/£/S0€/£ = (€1.4906/£)/(€1.4876/£) = 1.002017 < 1.005311 ≈ (1.0410)/(1.0355) = (1+ i€)/(1+i£).

- Borrow £1 million to yield £1,035,500. +£1m

-£1.0355m
- Buy €1,487,600 and sell £1 million at the spot exchange rate. +€1.4876m
-£1m
- Invest €1,487,600 to earn €1,548,592 in one year. +€1.548592m
-€1.4876m
- Buy £1,035,500 forward at a cost of €1,543,516.
+£1.0355m
-€1.543516m

Profit = €1,548,592-€1,543,516 = €5,075 at time t=1,

or (€5,075)/(1.041) = €4,875 in present value.

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