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Department
Business
Course
BUSI 2504
Professor
Robert Riordan
Semester
Fall

Description
CHAPTER 21 INTERNATIONAL CORPORATE FINANCE Learning Objectives LO1 The different terminologies used in international finance. LO2 How exchange rates are quoted, what they mean, and the difference between spot and forward exchange rates. LO3 Purchasing power parity, interest rate parity, unbiased forward rates, uncovered interest rate parity, and the generalized Fisher effect and their implications for exchange rate changes. LO4 How to estimate NPV using home and foreign currency approach. LO5 The different types of exchange rate risk and ways firms manage exchange rate risk. LO6 The impact of political risk on international business investing. Answers to Concepts Review and Critical Thinking Questions 2. (LO3) The exchange rate will increase, as it will take progressively more euros to purchase a dollar. This is the relative PPP relationship. 4. (LO1) A Yankee bond is most accurately described by d. 6. (LO5, 6) Additional advantages include being closer to the final consumer and, thereby, saving on transportation, significantly lower wages, and less exposure to exchange rate risk. Disadvantages include political risk and costs of supervising distant operations. 8. (LO3) a. False. If prices are rising faster in Great Britain, it will take more pounds to buy the same amount of goods that one dollar can buy; the pound will depreciate relative to the dollar. b. False. The forward market would already reflect the projected deterioration of the euro relative to the dollar. Only if you feel that there might be additional, unanticipated weakening of the euro that isn’t reflected in forward rates today will the forward hedge protect you against additional declines. c. True. The market would only be correct on average, while you would be correct all the time. 10. (LO3) IRP is the most likely to hold because it presents the easiest and least costly means to exploit any arbitrage opportunities. Relative PPP is least likely to hold since it depends on the absence of market imperfections and frictions in order to hold strictly. Solutions to Questions and Problems Basic For the 1st printing of the textbook, please note the following amendments to the question printed in the textbook: 1 d. ‘New Zealand dollar’ should read ‘Australian dollar’. 1 e. ‘Chilean peso’ should read ‘Russian rouble’. 1 f. ‘Mexican pesos’ should read ‘Swiss francs’. 1. (LO2) Using the quotes from the table, we get: 21-1 a. $100(1/($1.6725 /€1.00)) = €59.79 b. $1.6725 CDN c. €5M($1.6725/€) = $8,362,500 2. (LO2) a. You would prefer £100, since: (£100)($1.7908/£1) = $179.08 Canadian b. You would still prefer £100: (€100)($1.6725/€) = $167.25 Canadian c. Swiss Francs per British pounds = SFr 1.6305/£1; British pounds per Swiss Franc = £0.6133/SFr1 3. (LO2) a. F6 = ¥79.00 (per $). The yen is selling at a premium because it is more expensive in the forward market than in the spot market ($0.012658/¥ versus $0.012639/¥). b. F3 = $0.8133US/$1.00Can. The US dollar is selling at a premium because it is more expensive in the forward market than in the spot market ($0.8133US/$Can versus $0.8120/$). c. The value of the dollar will fall relative to the yen, since it takes more dollars to buy one yen in the future than it does today. The value of the dollar will fall relative to the US dollar, because it takes more Canadian dollars to buy one US dollar in the future than it does today. 4. (LO2) a. The U.S. dollar, since one Canadian dollar will buy: (Can$1)/(Can$1.06/$1US) = $0.9434 US b. The cost in U.S. dollars is: (Can$2.50)/(Can$1.06/$1US) = $2.36 US Among the reasons that absolute PPP doesn’t hold are tariffs and other barriers to trade, transactions costs, taxes, and different tastes. c. The U.S. dollar is selling at a discount in the table, because it is less expensive in the 3 month forward market than in the spot market (Can$1.2296 versus Can$1.2315). d. The Canadian dollar is expected to appreciate in value relative to the dollar, because it takes less Canadian dollars to buy one U.S. dollar in the future than it does today. e. Interest rates in the United States are probably lower than they are in Canada. This fuels additional investment in the Canada relative to the US and a strengthening Canadian dollar. 5. (LO2) a. The cross rate in ¥/£ terms is: (¥112/$1)($1.93/£1) = ¥216.16/£1 b. The yen is quoted too low relative to the pound. Take out a loan for $1 and buy ¥112. Use the ¥112 to purchase pounds at the cross-rate, which will give you: 21-2 ¥112(£1/¥209) = £0.53589 Use the pounds to buy back dollars and repay the loan. The cost to repay the loan will be: £0.53589($1.93/£1) = $1.0343 You arbitrage profit is $0.0343 per dollar used. For the 1st printing of the textbook, please note the following amendment to the question printed in the textbook: 6. ‘In Switzerland?’ should read ‘In the European Union?’. 6. (LO3) We can rearrange the interest rate parity condition to answer this question. The equation we will use is: F/t 0 (1 + R ) FC(1 + R CDN) [(F/S ) / (1 + R )] - 1 = R t 0 CDN FC Using this relationship with t = 6 months, we find: Great Britain: R = (£0.5599 / £0.5584) / (1 + .022) – 1 = -.0188 or -1.88% FC Japan: R FC(¥79.00 / ¥79.12) / (1 + .022) – 1 = -.0230 or -2.30% European Union: R = (€0.FC93 / €0.5979) / (1 + .022) – 1 = -.0192 or -1.92% The interest rate parity condition suggests that the risk free interest rates in Great Britain, Japan, and the European Union are negative. Such a condition could occur if nominal interest rates were below the inflation rates in those countries, which might happen if the central banks of those countries were using very low interest rates to stimulate the economy. 8. (LO3) Using the relative purchasing power parity equation: t F t S ×0[1 + (h – FC)] US We find: Z2.26 = Z2.17[1 + (h – hFC] US 3 1/3 h FCh = US2.26/Z2.17) – 1 h FCh = US136 or 1.36% Inflation in Poland is expected to exceed that in Canada by 1.36% over this period. 9. (LO5) The profit will be the quantity sold, times the sales price minus the cost of production. The production cost is in Singapore dollars, so we must convert this to Canadian dollars. Doing so, we find that if the exchange rates stay the same, the profit or loss will be: Profit = 30,000[$150 – {(S$204.70)/(S$1.2248/$1)}] Profit = –$513,879.81 = Loss So this deal is not profitable at the current exchange rate. If the exchange rate rises, we must adjust the
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