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UNIVERSITI TUNKU ABDUL RAHMAN (UTAR)

FACULTY OF ACCOUNTANCY AND MANAGEMENT
ACADEMIC YEAR 2020/2021
JUNE 2020 TRIMESTER

BACHELOR OF INTERNATIONAL BUSINESS (HONS)

YEAR 3 TRIMESTER 3

Tutorial 5 (Topic 4)
The Foreign Exchange Market

Question 1
(a) The foreign exchange has 3 major functions. Explain.
(b) For each of the foreign exchange market participants identify their motive
for buying or selling foreign exchange.
i) Foreign exchange dealers
ii) Foreign exchange brokers
iii) Individuals and firms
iv) Speculators and arbitragers
v) Central banks and Treasuries

Question 2
(a) K Bank’s bid price for New Zealand dollars is $0.5354 and its ask price is
$0.5678. What is the bid/ask percentage spread of New Zealand dollar?
(b) The USD/MYR exchange rate is quoted as 0.3030–0.3268. What is the bid-
offer spread of Ringgit in points and in percentage terms? What is the
monetary value of the point in this case?
Question 3
The current spot exchange rate is $1.35/€ and the three-month forward rate is $1.30/€.
Based on your analysis of the exchange rate, you are pretty confident that the spot
exchange rate will be $1.32/€ in three months. Assume that you would like to buy or sell
€5,000,000.

a. What actions do you need to take to speculate in the forward market? What is the
expected dollar profit from speculation?

b. What would be your speculative profit in dollar terms if the spot exchange rate
actually turns out to be $1.26/€.
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UNIVERSITI TUNKU ABDUL RAHMAN (UTAR)
FACULTY OF ACCOUNTANCY AND MANAGEMENT
Question 4
At 9:30a.m., Maiden Bhd calls Northerly Bank and asks for a quote on RM/$
exchange rate. Northernbank responds by quoting 3.6565-3.6580. Maiden Berhad
decides to buy $3,000,000 at the quoted rate. At 3:30p.m., Northerly Bank quotes
75-85. Will Maiden Berhad make a profit or loss by selling the dollars at 3:30p.m.?
State the profit or loss in RM.

Question 5
The exchange rate between the Australian dollar and the euro, expressed in direct
quotation from an Australian perspective, rises from 1.62020 to 1.63888. Calculate:
(a) The appreciation or depreciation of the euro in points, pips and percentage.
(b) The appreciation or depreciation of the Australian dollar in points, pips and
percentage.
Question 6
On the basis of the following exchange rates, construct a cross exchange rate matrix
that does not include the Australian dollar. All exchange rates must be expressed in
bid-offer terms.
GBP/AUD 0.3820–0.3900
EUR/AUD 0.6020–0.6080
CHF/AUD 0.8800–0.8860
Question 7
Using the following data, calculate the 30- day, 90- day, and 180- day forward
premiums for the British pound.

Spot: £1 = $1.4487
30- day forward: £1 = $1.4498
90- day forward: £1 = $1.4511
180- day forward: £1 = $1.4529
Question 8
Suppose Exim Bank, a bank in Kuala Lumpur, quotes spot and 180-day forward
exchange rates of RM/£ 6.8280-6.8900 and 100-130.
(a) What are the outright 180-day forward rates that Exim Bank is quoting?
(b) What is the forward discount or premium associated to a firm that sells 180-
day Pound Sterling?
(c) Compute the percentage bid-ask spreads for spot and forward Pound
Sterling.
Question 9
Assume the following quotes:
Citibank quote: US$/pound 1.5400
National Westminster quote: euros/pound 1.6000
Deutschebank quote: US$/euro 0.9700
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UNIVERSITI TUNKU ABDUL RAHMAN (UTAR)
FACULTY OF ACCOUNTANCY AND MANAGEMENT
Calculate how a market trader at Citibank with $1 million can make an intermarket
arbitrage profit.
Question 10
Orley Consultant, an international pension fund manager, plans to sell equities
denominated in Swiss Francs (CHF) and purchase an equivalent amount of equities
denominated in South African Rands (ZAR).
Omni will realize net proceeds of 3 million CHF at the end of 30 days and wants to
eliminate the risk that the ZAR will appreciate relative to the CHF during this 30-
day period. The following exhibit shows current exchange rates between the ZAR,
CHF, and the U.S. dollar (USD).

Currency Exchange Rates

ZAR/USD ZAR/USD CHF/USD CHF/USD
Maturi Bid Ask Bid Ask
ty
Spot 6.2681 6.2789 1.5282 1.5343
30-day 6.2538 6.2641 1.5226 1.5285
90-day 6.2104 6.2200 1.5058 1.5115
(a) Describe the currency transaction that Omni should undertake to eliminate
currency risk over the 30-day period.
(b) Calculate the following:
(i) The CHF/ZAR cross-currency rate Orley would use in valuing the
Swiss equity portfolio.
(ii) The current value of Orley’s Swiss equity portfolio in ZAR.
(iii) The annualized forward premium or discount at which the ZAR is
trading versus the CHF.

Tutorial 6 (Topic 5 & 6)

International Parity Conditions & Exchange Rate Determination

Question 1
(a) Define interest rate parity. What is the relationship between interest
rate parity and forward rates?
(b) Define the terms covered interest arbitrage and uncovered interest arbitrage.
What is the difference between these two transactions?
(c) Assume that Mexico’s economy has expanded significantly, causing a high
demand for loanable funds there by local firms. How might these conditions
affect the forward discount of the Mexican peso?
Question 2
Sader is a foreign exchange dealer for a bank in Manchester. He has £2,000,000 (or
its Singapore dollar equivalent) for a short-term money market investment. He
wonders if he should invest in pounds sterling or make a covered interest arbitrage
investment in the Singapore dollar. He faces the following rates.
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UNIVERSITI TUNKU ABDUL RAHMAN (UTAR)
FACULTY OF ACCOUNTANCY AND MANAGEMENT
Spot exchange rate S$ 2.9880/£
3-month forward rate S$ 3.0000/£
3-month UK interest rate 3% p.a.
3-month Singapore interest rate 5% p.a.
Which country’s money market do you recommend Sader to invest? Why?
Calculate the arbitrage profit or loss in £?
Question 3
Mdm Summer is a foreign exchange dealer for a bank in New York City. She has
$1,000,000 (or its Swiss franc equivalent) for a short-term money market investment
and wonder if she should invest in U.S. dollars or make a covered interest arbitrage
investment in the Swiss franc. She faces the following rates.
Spot exchange rate SF 1.6000/$
3-month forward rate SF 1.5800/$
3-month US interest rate 8% p.a.
3-month Swiss interest rate 6% p.a.
(a) Where do you recommend Mdm Summer to invest? Why? Calculate the
arbitrage profit/loss?
(b) Mdm Summer decides to seek the full 8% return available in US dollars by
not covering her forward dollar receipts – an uncovered interest arbitrage.
Assess the decision.
Question 4
Some forecasters believe that foreign exchange markets for the major floating currencies
are “efficient” and forward exchange rates are unbiased predictors of future spot
exchange rates. What is meant by “unbiased predictor” in terms of how the forward rate
performs in estimating future spot exchange rates?
Question 5
(a) When will an opportunity for locational arbitrage profits arise?
(b) Patterson holds NZ$ 500,000. Given the following quotes, what is the amount
of locational arbitrage profits in NZ$ terms that he could earn?
Bid Ask
Kiwi Bank NZ$1.3530/$ NZ$1.3580/$
Auckland Bank NZ$1.3400/$ NZ$1.3450/$
Question 6

Suppose that the treasurer of Gac Enterprise has an extra cash reserve of $10,000,000
to invest for six months. The six-month interest rate is 8 percent per annum in the United
States and 7 percent per annum in France. Currently, the spot exchange rate is $1.40/€
and the six-month forward exchange rate is $1.44/€. The treasurer of G. E does not wish
to bear any exchange risk. Where should he/she invest to maximize the return?
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UNIVERSITI TUNKU ABDUL RAHMAN (UTAR)
FACULTY OF ACCOUNTANCY AND MANAGEMENT
Question 7
Suppose that the current spot exchange rate is €1.06/$ and the three-month forward
exchange rate is €1.02/$. The three-month interest rate is 5.6 percent per annum in
the United States and 5.40 percent per annum in France. Assume that you can
borrow up to $1,000,000 or €1,060,000.
(a) Show how to realize a certain profit via covered interest arbitrage, assuming
that you want to realize profit in terms of U.S. dollars. Also determine the
size of your arbitrage profit.
(b) Assume that you want to realize profit in terms of euros. Show the covered
arbitrage process and determine the arbitrage profit in euros.
Question 8
(a) Assume that Malaysia income level rises at a much lower rate than does the
Singapore income level. Other things being equal, how should this affect the
(i) Malaysia demand for Singapore dollars, (ii) supply of Singapore dollars
for sale, and (iii) equilibrium value of the Singapore dollar? Use a ss and dd
diagram to illustrate.
(b) Assume that the Japanese government relaxes its controls on imports by
Japanese companies. Other things being equal, how should this affect the (a)
U.S. demand for Japanese yen, (b) supply of yen for sale, and (c) equilibrium
value of the yen? Use a ss and dd diagram to illustrate.

Question 9
If it was reported that the interest rate per annum is 5.93% in A and 70.0% in B. Why do
you think the interest rate is so high in B? Based on the reported interest rates, how
would you predict the change of the exchange rate between the dollar A and the dollar
B?
Tutorial 7 (Topic 7)
Foreign Currency Derivatives

Question 1
Cartel works in the currency-trading unit of Barclays Bank in Manchester,
England. His latest speculative move is to profit from his expectation that the Hong
Kong dollar will rise significantly against the Taiwanese dollar in the next 90 days.
The current sport rate is TWD3.7788/HKD. Based on his expectation, he would like
to long a call option contract on Hong Kong dollar and short a put option contract
on Hong Kong dollar. Details on the 90-day options are as follows:
Options Contract size Premium Strike Price
Call on HKD TWD0.0500/HKD TWD3.8200/HKD
HKD 500,000
Put on HKD TWD0.0750/HKD TWD3.8200/HKD
HKD 500,000
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UNIVERSITI TUNKU ABDUL RAHMAN (UTAR)
FACULTY OF ACCOUNTANCY AND MANAGEMENT
Calculate the net pay off (in Taiwanese dollar) on the long call, the short put and the
combined position if the spot exchange rates at the end of 90 days turn out to be (i)
TWD3.9300/HKD, (ii) TWD3.8300/HKD and (iii) TWD3.7300/HKD respectively.
[Note: you are required to present your answer in organised tabular form.]

Question 2
A trader has written a call and a put on the Canadian dollar. The following
information is available:
Size of option contract = CAD400,000
Price of call AUD0.01/CAD
Price of put AUD0.01/CAD
Exercise exchange rate of call AUD0.96/CAD
Exercise exchange rate of put AUD0.94/CAD
Calculate the net pay-off on the short call, the short put and the combined position
at the following spot exchange rates (AUD/CAD): (a) 0.99, (b) 0.97, (c) 0.95 and (d)
0.93.
Question 3.
In order for a derivatives market to function most efficiently, two types of economic
agents are needed: hedgers and speculators. Explain.
Question 4
Fernando works in the currency-trading unit of La Caxia Bank in Barcelona, Spain.
Contrary to most forecasters, he believes that the Australian dollar (A$) will
depreciate versus the U.S. dollar over the coming 30 days although the Federal
Reserves is likely to reduce interest rates in the U.S. The current spot exchange rate
is $0.7000/A$. Fernando may choose between the following options on the
Australian dollar (A$):
Option Strike Price Premium
Call on A$ $0.7250/A$ $0.0075/A$
Put on A$ $0.7250/A$ $0.0025/A$
i) Should Fernando purchase call option on the Australian dollar or put option
on the Australian dollar? Explain.
ii) What is Fernando’s net profit per unit of Australian dollar if the spot
exchange rate at the end of the 30 days is $0.6900/A$?
Question 5

What is the major difference in the obligation of one with a long position in a futures (or
forward) contract in comparison to an options contract?
Question 6
Explain the difference between foreign currency options and futures and when
either might bemost appropriately used?
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UNIVERSITI TUNKU ABDUL RAHMAN (UTAR)
FACULTY OF ACCOUNTANCY AND MANAGEMENT
Question 7
Assume today’s settlement price on a CME GBP futures contract is $1.8050/£. You
have a short position in one contract. The size of the contract is £62,500. Your
performance bond account currently has a balance of $2,200. The next three days’
settlement prices are $1.8058, $1.8011, and $1.7995. Calculate the daily changes in the
performance bond account from daily marking-to-market and the balance of the
performance bond account after the third day.
Self Study Question 1
A trader holds a call and a put on the British pound. The following information is
available:
Size of option contract = GBP200,000
Price of call AUD0.01/GBP
Price of put AUD0.008/GBP
Exercise exchange rate of call AUD2.50/GBP
Exercise exchange rate of put AUD2.50/GBP
Calculate the net pay-off on the call, the put and the combined position at the
following spot exchange rates (AUD/GBP): (a) 2.505, (b) 2.540, (c) 2.495 and (d)
2.480.

Tutorial 8 (Topic 8 Part 1)

Measuring and Managing Exposure

Question 1
Discuss the determinants of operating exposure.
Question 2
Is there a difference between translation exposure and transaction exposure?

Question 3
What factors affect a firm’s degree of translation exposure? Explain how each
factor influences translation exposure.

Question 4
Why are the cash flows of a purely domestic firm exposed to exchange rate
fluctuations?

Question 5
b) a) How may cash inflows and outflows be affected by foreign currency
exposure?
b) Why may lead-lag payment timing be a difficult strategy to implement?
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UNIVERSITI TUNKU ABDUL RAHMAN (UTAR)
FACULTY OF ACCOUNTANCY AND MANAGEMENT
Question 6
General Motors exports cars to Spain but the strong dollar against the euro hurts sales of
GM cars in Spain. In the Spanish market, GM faces competition from the Italian and
French car makers, such as Fiat and Renault, whose operating currencies are the euro.
What kind of measures would you recommend so that GM can maintain its market share
in Spain.

Question 7
What are the advantages and disadvantages of financial hedging of the firm’s operating
exposure vis-à-vis operational hedges (such as relocating manufacturing site)?

Question 8
Derico Co. is a U.S. firm with a Chinese subsidiary that produces cell phones in
China and sells them in Japan. This subsidiary pays its wages and its rent in
Chinese yuan, which is presently tied to the dollar. The cell phones sold to Japan are
denominated in Japanese yen. Assume that Derico Co. expects that the Chinese
yuan will continue to stay fixed against the dollar. The subsidiary’s main goal is to
generate profits for itself and it reinvests the profits. It does not plan to remit any
funds to the U.S. parent.
a) Assume that the Japanese yen strengthens against the U.S. dollar over time.
How would this be expected to affect the profits earned by the Chinese
subsidiary?
b) If Derico Co. had established its subsidiary in Tokyo, Japan instead of China,
would its subsidiary’s profits be more exposed or less exposed to exchange
rate risk?
c) Why do you think that Derico Co. established the subsidiary in China instead
of Japan? Assume no major country risk barriers.
d) If the Chinese subsidiary needs to borrow money to finance its expansion and
wants to reduce its exchange rate risk, should it borrow U.S. dollars, Chinese
yuan, or Japanese yen?

Question 9
Suppose that your company has an equity position in an Italian firm. Discuss the
condition under which the dollar/euro exchange rate uncertainty does not constitute
exchange exposure for your company.
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UNIVERSITI TUNKU ABDUL RAHMAN (UTAR)
FACULTY OF ACCOUNTANCY AND MANAGEMENT
Tutorial 9 (Topic 8 Part 2)
Measuring and Managing Exposure

Question 1
Pallo Ltd is a British importer of chips. The company has contracted to purchase
5,000 units of chips at a unit price of 30 Swiss Franc from one Swiss company.
Three month’s credit is allowed to Pallo Ltd before payment is due. Pallo Ltd
currently has no cash surplus, but can borrow short term at 2% above bank base
rate or invest short term at base rate in either the United Kingdom or Switzerland.
Exchange rates
Swiss franc/Pound
Spot 2.990-3.020
1 month forward 2.975-3.005
3 months forward 2.945-2.965

Current Bank Base rates

Switzerland 6% per annum
United Kingdom 10% per annum

Pallo Ltd has a 3-month call option on Swiss Franc at an exercise price of 2.930
Swiss Franc per Pound with 1% premium and a 3-month put option on Swiss Franc
at an exercise price of 2.930 Swiss Franc per Pound with a 2.5% premium. Assume
Pallo’s cost of capital is 10%.
Calculate the cost of hedging using:
a) Forward market hedge
b) Money market hedge
c) Option hedge
d) Which is the best alternative?

Question 2
Charlston of the United States sold a super computer to the Max Planck Institute in
Germany on credit and invoiced €15 million payable in six months. Currently, the six-
month forward exchange rate is $1.10/€ and the foreign exchange advisor for Charlston
predicts that the spot rate is likely to be $1.06/€ in six months.
(a) What is the expected gain/loss from the forward hedging?
(b) If you were the financial manager of Charlston, would you recommend hedging this
euro receivable? Why or why not?
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UNIVERSITI TUNKU ABDUL RAHMAN (UTAR)
FACULTY OF ACCOUNTANCY AND MANAGEMENT
(c) Suppose the foreign exchange advisor predicts that the future spot rate will be the
same as the forward exchange rate quoted today. Would you recommend hedging in
this case? Why or why not?

Question 3
Discuss and compare hedging transaction exposure using the forward contract vs.
money market instruments. When do the alternative hedging approaches produce the
same result?

Question 4
a) If hedging is expected to be more costly than not hedging, why would a firm
even consider hedging?
b) How can a firm hedge long-term currency positions? Elaborate on each
method.

Question 5
Boeing just signed a contract to sell a Boeing 747 aircraft to Air France. Air France will
be billed €300 million which is payable in one year. The current spot exchange rate is
$1.05/€ and the one-year forward rate is $1.10/€. The annual interest rate is 6.0% in the
U.S. and 5.0% in France. Boeing is concerned with the volatile exchange rate between
the dollar and the euro and would like to hedge exchange exposure.
(a) It is considering two hedging alternatives: sell the euro proceeds from the sale
forward or borrow euros from Credit Lyonnaise against the euro receivable. Which
alternative would you recommend? Why?
(b) Other things being equal, at what forward exchange rate would Boeing be indifferent
between the two hedging methods?

Question 6
Saturn Corporation a U.S car company acquired a Korean company that produces
plastic nuts and bolts for automobile manufacturers. The purchase prices were
7,030 million Won. Won 1,000 million has already been paid, and the remaining
Won 6,030 million is due in six months. The current spot rate is Won 1200/$, and
the 6-manth forward rate is Won 1260/$. Additional data:

6-month Korean interest rate 16.00% p.a.

6-month U.S. interest rate 4.00% p.a.
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UNIVERSITI TUNKU ABDUL RAHMAN (UTAR)
FACULTY OF ACCOUNTANCY AND MANAGEMENT
6-month call option on Korean won at W1200/$ 3.0% premium
6-month put option Korean won at W1200/$ 2.4% premium

Saturn Corporation can invest at the rate given above, or borrow at 2% per annum
above those rates. Saturn Corporation weighted average cost of capital is 25%.
Calculate the cost of hedging using:-
a) Remain Unhedge
b) Forward market hedge
c) Money market hedge
d) Option hedge
e) Which is the best alternative?
Question 7
YSL, the U.S. apparel design firm, owes Mex$ 7 million in 30 days for a recent
shipment of textiles from Mexico. YSL’s treasurer is considering hedging the
company’s peso exposure on this shipment and looking for some help in figuring
out what her different hedging option might cost and which option is preferable. It
faces the following interest and exchange rates:
Spot rate Mex13.00/$ - Mex13.08/$
Forward rate (30 days) Mex13.10/$ - Mex13.18/$
30-day put option on dollars at Mex$ 12.9/$ 1% premium
30-day call option on dollars at Mex$ 13.1/$ 3% premium
U.S. dollar 30-day interest rate (annualized): 7.5%
Peso 30-day interest rate (annualized): 15%
Calculate the cost of hedging using:-
a) Forward market hedge
b) Money market hedge
c) Option hedge (not required to compound premium)
d) Which is the best alternative?
a) e) Suppose that YSL expects the 30-day spot rate to be Mex$ 13.4/$.
Should it hedge this payable? What other factors should go into YSL's
hedging decision?

Tutorial 10 (Topic 9)
Currency and Interest Rate Swap

Question 1
a) How can a business firm that borrowed on a floating rate basis use a forward
rate agreement to reduce interest rate risk?
b) Why would one company with interest payments due in pounds sterling
wants to swap these payments for interest payments due in U.S. dollars?
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UNIVERSITI TUNKU ABDUL RAHMAN (UTAR)
FACULTY OF ACCOUNTANCY AND MANAGEMENT
Question 2
Refer to Chapter 14 Problem 2 Rankine Corporation on (page 385) in Moffett M,
Stonehill A & Eiteman D (2006), Essentials of Global Finance, Boston, Pearson:
Addison Wesley.Identify interest rate risk, credit risk and repricing risk.
Answer
Question 2 Rankine Corporation

Compare the alternatives and make a recommendation.

Assumptions Values
Principal borrowing need $30,000,000
Maturity needed, in years 2.00
Fixed rate, 2 years 5.000%
Floating rate, six-month LIBOR + spread
Current six-month LIBOR 3.500%
Spread 1.500%
Fixed rate, 1 year, then re-fund 4.500%

First 6-months Second 6-months Third 6-months Fourth 6-months

#1: Fixed rate, 2 years
Interest cost per year $1,500,000 $1,500,000
Certainty over access to capital Certain Certain Certain Certain
Certainty over cost of capital Certain Certain Certain Certain
#2: Floating rate, six-month LIBOR + spread
Interest cost per year $750,000.00 $750,000.00 $750,000.00 $750,000.00
Certainty over access to capital Certain Certain Certain Certain
Certainty over cost of capital Certain Uncertain Uncertain Uncertain
#3: Fixed rate, 1 year, then re-fund
Interest cost per year $1,350,000.00 ??? ???
Certainty over access to capital Certain Certain Uncertain Uncertain
Certainty over cost of capital Certain Certain Uncertain Uncertain
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UNIVERSITI TUNKU ABDUL RAHMAN (UTAR)
FACULTY OF ACCOUNTANCY AND MANAGEMENT
Tutorial 11 (Topic 10)
Multinational Cost of Capital and Capital Structure

Question 1
a) Why might a firm use a “local” capital structure at a particular subsidiary
that differs substantially from its “global” capital structure?
b) Rose Inc., a U.S. company, needed to infuse capital into its foreign
subsidiaries to support their expansion. As of August 2001, it planned to
issue stock in the U.S. However, after the September 11, 2001 terrorist attack
on the U.S., it decided that long-term debt was a cheaper source of capital.
Explain how the terrorist attack could have altered the capital structure
decision.
.
Question 2
In recent years, several U.S. firms have penetrated Mexico’s market. One of the
biggest challenges is the cost of capital to finance businesses in Mexico. Mexican
interest rates tend to be much higher than U.S. interest rates. In some periods, the
Mexican government does not attempt to lower the interest rates because higher
rates may attract foreign investment in Mexican
i) How might U.S.-based MNCs expand in Mexico without incurring the high
Mexican interest expenses when financing the expansion? Are any
disadvantages associated with this strategy?
ii) Are there any additional alternatives for the Mexican subsidiary to finance
its business itself after it has been well established? How might this strategy
affect the subsidiary’s capital?

Question 3
a) Pto Inc, a U.S. firm, has been highly profitable, but prefers not to pay out
higher dividends because its shareholders want the funds to be reinvested. It
plans for large growth in several less developed countries. Pto would like to
finance the growth with local debt in the host countries of concern to reduce
its exposure to country risk. Explain the dilemma faced by Pto, and offer
possible solutions.
b) Drake Co. is a U.S.-based company that is establishing a project in a
politically unstable country. It is considering two possible sources of
financing. Either the parent could provide most of the financing, or the
subsidiary could be supported by local loans from banks in that country.
Which financing alternative is more appropriate to protect the subsidiary?
c) Vortex Co. is a U.S.- based MNC that has most of its operations in
Japan. Noticing that the Japanese companies with which it competes use
more financial leverage, it has decided to adjust its financial leverage to be in
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UNIVERSITI TUNKU ABDUL RAHMAN (UTAR)
FACULTY OF ACCOUNTANCY AND MANAGEMENT
line with theirs. With this heavy emphasis on debt, Vortex should reap more
tax advantages. It believes that the market’s perception of its risk will
remain unchanged, since its financial leverage will still be no higher than that
of its Japanese competitors. Comment on this strategy.

Question 4
Axion. is a U.S. firm that provides technology software for the government of
Singapore. It will be paid S$7,000,000 at the end of each of the next five years. The
entire amount of the payment represents earnings since Axion created the
technology software years ago. Axion is subject to a 30 percent corporate income tax
rate in the United States. Its other cash inflows (such as revenue) are expected to be
offset by its other cash outflows (due to operating expenses) each year, so its profits
on the Singapore contract represent its expected annual net cash flows. Its financing
costs are not considered within its estimate of cash flows. The Singapore dollar (S$)
is presently worth $0.60, and Axion uses that spot exchange rate as a forecast of
future exchange rates.

The risk-free interest rate in the United States is 6 percent while the risk-free
interest rate in Singapore is 14 percent. Axion’s capital structure is 60 percent debt
and 40 percent equity. Axion is charged an interest rate of 12 percent on its debt.
Axion’s cost of equity is based on the CAPM. It expects that the U.S. annual market
return will be 12 percent per year. Its beta is 1.5.

A competitor firm U.S. firm, wants to acquire Axion and offers a price of
$10,000,000. Axion’s owner must decide whether to sell the business at this price
and hires you to make a recommendation. Estimate the NPV to Axion as a result of
selling the business, and make a recommendation about whether Axion’s owner
should sell the business at the price offered.

Question 5
C Ltd, a French multinational enterprise, considers obtaining 20 percent of its
one- year financing in US dollars and 80 percent in British pounds in order to
finance working capital needs of its foreign subsidiaries. Forecast on the changes in
spot rate of US dollar per euro and British pound per euro for the next year are as
follows:
Currency Possible % Change in Spot Rate Probability
British pound Depreciate 10% 80%
British pound Appreciate 5% 20%
US dollar Depreciate 8% 50%
US dollar Appreciate 12% 50%
The interest rate on the US dollar is 5 percent, and the interest rate on the British
pound is 7 percent. Develop the possible effective financing rates of the overall
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UNIVERSITI TUNKU ABDUL RAHMAN (UTAR)
FACULTY OF ACCOUNTANCY AND MANAGEMENT
portfolio and the probability of each possibility based on the use of joint
probabilities.

Question 6
I Co. considers placing 30% of its excess funds in a one- year Singapore dollar
deposit and the remaining 70% of its funds in a one- year Canadian dollar
deposit. The Singapore one- year interest rate is 15%, while the Canadian one- year
interest rate is 13%. The possible percentage changes in the two currencies for the
next year are forecasted as follows:

Possible % Change in Possible Percentage Probability of

Change in Spot Rate Change in Spot
Currency Over the Investment Horizon Rate Occurring
Singapore dollar –2% 20%
Singapore dollar 1% 60%
Singapore dollar 3% 20%
Canadian dollar 1% 50%
Canadian dollar 4% 40%
Canadian dollar 6% 10%

Given this information, determine the possible effective yields of the portfolio and
the probability associated with each possible portfolio yield. Given a one- year U.S.
interest rate of 8%, what is the probability that the portfolio’s effective yield will be
lower than the yield achieved from investing in the U.S.?

Self Study Question 1

Pepperdine, Inc., considers obtaining 40 percent of its one- year financing in
Canadian dollars and 60 percent in Japanese yen. The forecasts of appreciation in
the Canadian dollar and Japanese yen for the next year are as follows:

Probability
Possible Percentage of that Percentage
Change in the Spot Change in the
Currency Rate Over the Loan Life Spot Rate Occurring
Canadian dollar 4% 70%
Canadian dollar 7 30
Japanese yen 6 50
Japanese yen 9 50

The interest rate on the Canadian dollar is 9 percent, and the interest rate on the
Japanese yen is 7 percent. Develop the possible effective financing rates of the
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overall portfolio and the probability of each possibility based on the use of joint
probabilities.

Tutorial 12 (Topic 11)

Multinational Capital Budgeting

Question 1
(a) Why is capital budgeting analysis so important to the firm?
(b) Relate the concept of “lost sales” to the definition of incremental cash flow.

Question 2
(a) Discuss the difference between performing the capital budgeting analysis
from the parent firm’s perspective as opposed to the project perspective.
(b) What is the nature of a concessionary loan and how is it handled in the APV
model?

Question 3
Zeda, Inc., a U.S. MNC, is considering making a fixed direct investment in Denmark.
The Danish government has offered Zeda a concessionary loan of DKK15,000,000 at
a rate of 4 percent per annum. The normal borrowing rate is 6 percent in dollars
and 5.5 percent in Danish krone. The loan schedule calls for the principal to be
repaid in three equal annual installments. What is the present value of the benefit
of the concessionary loan? The current spot rate is DKK5.60/$1.00 and the expected
inflation rate is 3% in the U.S. and 2.5% in Denmark.
Question 4
Consider a project with the following information:
The 5-year project requires equipment that costs $100,000. If undertaken, the
shareholders will contribute $20,000 cash and borrow $80,000 at 6% with an
interest-only loan with a maturity of 5 years and annual interest payments. The
equipment will be depreciated straight-line to zero over the 5-year life of the project.
There will be a pre-tax salvage value of $5,000. There are no other start-up costs at
year 0. During years 1 through 5, the firm will sell 25,000 units of product at $5;
variable costs are $3; there are no fixed costs. The firm is subject to a 34%
corporation tax rate.
The cost of equity for unlevered (ungeared) firm Ku (rasset) is 12%.
Cost of debt (rdebt) and cost of equity (requity) are 6% and 27.84% respectively.
Compute base case NPV, PV of depreciation tax shield, PV of interest tax shield,
and the APV of the project.
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UNIVERSITI TUNKU ABDUL RAHMAN (UTAR)
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Question 5
An Italian firm is considering selling its line of coin-operated cappuccino machines
in the U.K. The business risk will be identical to the firm’s existing line of business
in the euro zone, the cost of capital in the euro zone is i€ = 10%. The expected
inflation rate over the next two years in the U.K. is 3% per year and 2% per year in
the euro zone. The spot exchange rates are $1.80 = £1.00 and $1.15 = €1.00
The pound sterling denominated cash flows are as follows:
Year 0: – £100,000
Year 1: £25,000
Year 2: £100,000
What is the €-denominated NPV of this project?

Tutorial 13 (Topic 12)

Foreign Direct Investment

Question 1
a) What do you understand by FDI?
b) As a firm evolves from purely domestic into a true multinational enterprise,
it must consider (a) its competitive advantages, (b) where it wants to locate
production, (c) the type of control it wants to have over any foreign
operations, and (d) how much monetary capital to invest abroad. Explain
how each of these four considerations is important to the success of foreign
operations.

Question 2
Summarize the five main motives that drive the decision to initiate FDI. Strategic
motives drive the decision to invest abroad and become a MNE. These motives can
be summarized under the following five categories.
Question 3
What are the advantages and disadvantages of limiting a firm’s activities to
exporting compared to producing abroad?

Question 4
What are the advantages and disadvantages of serving a foreign market through a
Greenfield foreign direct investment compared to an acquisition of a local firm in
the target market?.

Question 5
a) What are the financial incentives to attract FDI?
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UNIVERSITI TUNKU ABDUL RAHMAN (UTAR)
FACULTY OF ACCOUNTANCY AND MANAGEMENT
b) What are the marketing-related incentives to attract FDI?
c) What are the production-related incentives to attract FDI?

Question 6
a) If the United States imposed long-term restrictions on imports, would the
amount of FDI by non-U.S. MNCs in the United States increase, decrease, or
be unchanged? Explain.
b) What potential benefits do you think were most important in the decision of
the Walt Disney Co. to build a theme park in France?
Tutorial 14 (Topic 13 & 14)
Multinational Cash Management and Financing International Trade

Question 1
a) Every quarter, Bronx Co. ships computer chips to a firm in central Asia. It
had not used any trade financing because the importing firm always pays its
bill in a timely manner upon receipt of the computer chips. After the
September 11, 2001 terrorist attack on the U.S., it reconsidered whether it
should use some form of trade financing that would ensure that it would be
paid for its exports upon delivery. Offer a suggestion to Bronx Co. on how it
could achieve its goal.
b) What is the role of a factor in international trade transactions?

Question 2
a) For what reason might an exporter uses standard international trade
documentation (letter of credit, draft, order bill of lading) on an intra-firm
export to its parent or sister subsidiary?
b) Explain the difference between a letter of credit (L/C) and a draft. How are
they linked?

Question 3
a) Identify each party to a letter of credit (L/C) and indicate its responsibility.
b) Why would an exporter insist on a confirmed letter of credit?

Question 4
The Sport Export Company produces footballs and exports them to a distributor in
United Kingdom. It typically sends footballs in bulk and then receives payment after
the distributor receives the shipment. The business relationship with the distributor
is based on trust. Although the relationship has worked thus far, Jim Logan (owner
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UNIVERSITI TUNKU ABDUL RAHMAN (UTAR)
FACULTY OF ACCOUNTANCY AND MANAGEMENT
of the Sports Exports Company) is concerned about the possibility that the
distributor will not make its payment.
a) How could Jim use a letter of credit to ensure that he will be paid for the
products he exports?
b) Jim has discussed the possibility of expanding his export business through a
second sporting goods distributor in the United Kingdom, this second
distributor would cover a different territory than the first distributor. This
second distributor is only willing to engage in a consignment arrangement
when selling footballs to retail stores. Explain the risk to Jim beyond the
typical types of risk he incurs when dealing with the first distributor. Should
Jim pursue this type of business?

Question 5
MCQ questions on cash management.