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%

ANSWER: C

SOLUTION: (1.09/1.27) – 1 = –14.2%

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) both of these.
D) neither of these.

ANSWER: D

3. All but which one of the following can be achieved with netting?
A) Cross border transactions between subsidiaries are reduced.
B) Transactions costs are reduced.
C) Currency conversion costs are reduced.
D) Transaction exposure is eliminated.

ANSWER: D

4. Which of the following is true?

A) Some countries may prohibit netting.
B) Some countries may prohibit forms of leading and lagging.
C) Both of these are true.
D) Neither of these is true.

ANSWER: C

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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 these.

ANSWER: D

6. 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 about:
A) 5.1%.
B) 6.8%.
C) 6.3%.
D) 5.9%.

ANSWER: D

SOLUTION: (1.11/1.18) – 1 = –5.9%

7. 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%.

ANSWER: B

SOLUTION: (1 + 6%)[1 + (–9%)] – 1 = –4.45%

8. 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.

ANSWER: C
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9. 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.
D) invest in the foreign deposits since they will, on average, generate similar effective yields as a
U.S. deposit.

ANSWER: C

10. 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.

ANSWER: D

11. 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.

ANSWER: C

12. 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.

ANSWER: A

13. 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) both of these.
D) neither of these.

ANSWER: D
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14. 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.

ANSWER: A

15. 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.

ANSWER: B

16. 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.

ANSWER: D

17. 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 these

ANSWER: D
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18. 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 $_______ is 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

ANSWER: A

SOLUTION: ZMK2,500,000 × $.0006 = $1,500

(ZMK2,500,000 × 1.09) × $.00056 = $1,526

19. 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 these.

ANSWER: B

SOLUTION: Depreciation of rand: (.203/.205) – 1 = –.98%

Effective yield: (1 + 10%) + [1 + (–.98%)] – 1 = 8.92%.

20. 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.

ANSWER: B

SOLUTION: If interest rate parity holds, the Australian citizen will be able to earn
approximately his or her domestic interest rate.
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21. Assume that you forecast the value of the euro as follows for the next year:

Percentage Change Probability of Occurrence

–2% 30%
3% 40%
5% 30%

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 these.

ANSWER: D

SOLUTION:

Computation of
Effective Financing Rate Probability Expected Value
(1.12)(.98) – 1 = 9.76% 30% 2.93%
(1.12)(1.03) – 1 = 15.36% 40% 6.14%
(1.12)(1.05) – 1 = 17.60% 30% 5.28%
14.35%
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The following information refers to questions 22 and 23.

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 Percentage Change Probability

Trinidad dollar –1.0% 35%
Trinidad dollar 2.0% 65%

Japanese yen –2.0% 45%

Japanese yen 1.0% 55%

22. 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 these.

ANSWER: B

SOLUTION:

Step 1. Determine effective yield for each currency under each possible scenario.

Percentage
Currency Change Probability Effective Yield
Trinidad dollars –1.0% 35% (1.10)(.99) – 1 = 8.90%
Trinidad dollars 2.0% 65% (1.10)(1.02) – 1 = 12.20%

Japanese yen –2.0% 45% (1.07)(.98) – 1 = 4.86%

Japanese yen 1.0% 55% (1.07)(1.01) – 1 = 8.07%

Step 2. Determine joint probabilities and effective yield of portfolio for each scenario.

Trinidad Japanese Joint Portfolio

Dollar Yen Probability Effective Rate
8.90% 4.86% (.35)(.45) = .1575 (.5)(8.90%) + (.5)(4.86%) = 6.88%
8.90% 8.07% (.35)(.55) = .1925 (.5)(8.90%) + (.5)(8.07%) = 8.49%
12.20% 4.86% (.65)(.45) = .2925 (.5)(12.20%) + (.5)(4.86%) = 8.53%
12.20% 8.07% (.65)(.55) = .3575 (.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%

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23. 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 these.

ANSWER: 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.

The following information refers to questions 24 and 25.

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 3%

Mean effective financing rate of Romanian leu for three months 2%
Standard deviation of Malaysian ringgit’s effective financing rate .15
Standard deviation of Romanian leu’s effective financing rate .07
Correlation coefficient of effective financing rates of these
two currencies .19

24. 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 these.

ANSWER: C

SOLUTION: (.4)(3%) + (.6)(2%) = 2.40%.

25. 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 these.

ANSWER: B

SOLUTION: (.4) 2 (.15) 2  (.6) 2 (.07) 2  2(.4)(.6)(.15)(.07)(.19)  7.95%

638 International Financial Management

26. To _______, MNCs can use preauthorized payments.

A) accelerate cash inflows
B) minimize currency conversion costs
C) manage blocked funds
D) manage intersubsidiary cash transfers

ANSWER: A

27. _______ may complicate cash flow optimization.

A) The use of a zero-balance account
B) Government restrictions
C) Leading and lagging
D) None of these

ANSWER: B

28. 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

ANSWER: C

29. In what is known as dynamic hedging, banks always hedge open positions in any foreign
currencies.
A) true.
B) false.

ANSWER: B

30. 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.

ANSWER: A

31. 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.

ANSWER: A

32. Lockboxes are post office box numbers assigned to employees for picking up their paychecks.
A) true.
B) false.

ANSWER: B
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33. Preauthorized payment is an arrangement that allows a corporation to charge a customer’s

bank account up to some limit.
A) true.
B) false.

ANSWER: A

34. 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.

ANSWER: B

35. Leading refers to the payment of supplies earlier than necessary; lagging refers to the payment
of supplies later than allowed.
A) true.
B) false.

ANSWER: A

36. 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.

ANSWER: A

37. When investing in a portfolio of foreign currencies, the currencies represented within the
portfolio are ideally highly positively correlated.
A) true.
B) false.

ANSWER: B

38. 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.

ANSWER: A

39. Centralized cash management is more complicated when the MNC uses multiple currencies.
A) true.
B) false.

ANSWER: A