Chapter 01
1. What are typical reasons why MNCs expand internationally?
Multinational corporations (MNCs) typically expand internationally for several reasons, including:
1. Market diversification: To diversify their customer base and reduce the risk of relying on
a single market.
2. Resource acquisition: To access resources such as raw materials, labor, and technology that
are scarce or unavailable in their home country.
3. Economies of scale: To spread fixed costs over a larger production base, reducing
production costs and increasing competitiveness.
4. Competitive advantage: To take advantage of lower production costs, favorable
regulations, and access to new markets.
5. Growth and profitability: To expand operations and increase profits through access to new
markets and economies of scale.
These are some of the typical reasons why MNCs expand internationally, as described in the book
"International Financial Management" by Jeff Madura.
2. Explain why unfavorable economic or political conditions affect the MNC’s cash
flows, required rate of return, and valuation.
Unfavorable economic or political conditions can have a significant impact on the cash flows,
required rate of return, and valuation of multinational corporations (MNCs).

Cash flows: If the local economy is in a recession, this can lead to a decrease in consumer
spending and demand for the company's products, affecting the MNC's cash flows.

Required rate of return: The level of risk associated with a country or region can increase
due to unfavorable economic or political conditions, making investors less willing to invest
without a higher return on their investment. This can increase the MNC's required rate of
return.
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
Valuation: The valuation of an MNC can also be negatively impacted by unfavorable
economic or political conditions, as investors may be more cautious about investing in a
company that operates in an uncertain or volatile environment.
These factors can all have a negative impact on the financial performance and valuation of an
MNC operating in an unfavorable economic or political environment, as described in the book
"International Financial Management" by Jeff Madura.
3. Identify the more obvious risks faced by MNCs that expand internationally
Multinational corporations (MNCs) face several risks when expanding internationally, including:
1. Political risk: MNCs may face government intervention or expropriation of assets in
foreign countries.
2. Currency risk: MNCs are exposed to exchange rate fluctuations when conducting business
in foreign currencies.
3. Economic risk: MNCs may face economic instability or recession in the countries they
operate in, affecting their business performance.
4. Cultural risk: MNCs may face challenges adapting to different cultural norms and values
in foreign markets.
5. Legal risk: MNCs may face unfamiliar laws and regulations in foreign countries, leading
to potential legal challenges.
6. Competition risk: MNCs may face increased competition from local firms in foreign
markets.
7. Operational risk: MNCs may face logistical and supply chain challenges in new foreign
markets.
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Case
1. What are the advantages Blades could gain from importing from and/or exporting to
a foreign country such as Thailand?
ANSWER: The advantages Blades, Inc. could gain from importing from Thailand include
potentially lowering Blades’ cost of goods sold. If the inputs (rubber and plastic) are cheaper
when imported from a foreign country such as Thailand, this would increase Blades’ net
income. Since numerous competitors of Blades are already importing components from
Thailand, importing would increase Blades’ competitiveness in the U.S., especially since its
prices are among the highest in the roller blade industry. Furthermore, since Blades is
considering longer range plans in Thailand, importing from and exporting to Thailand may
present it with an opportunity to establish initial relationships with some Thai suppliers. As far
as exporting is concerned, Blades, Inc. could be one of the first firms to sell roller blades in
Thailand. Considering that Blades is contemplating to eventually shift its sales to Thailand,
this could be a major competitive advantage.
2. What are some of the disadvantages Blades could face as a result of foreign trade in
the short run? In the long run?
ANSWER: There are several potential disadvantages Blades, Inc. should consider. First of all,
Blades would be exposed to currency fluctuations in the Thai baht. For example, the dollar
cost of imported inputs may become more expensive over time if the baht appreciates even if
Thai suppliers do not adjust their prices. However, Blades’ sales in Thailand would also
increase in dollar terms if the baht appreciates, even if Blades does not increase its prices.
Blades, Inc. would also be exposed to the economic conditions in Thailand. For example, if
there is a recession, Blades would suffer from decreased sales to Thailand. In the long run,
Blades should be aware of any regulatory and environmental constraints the Thai government
may impose on it (such as pollution controls). Furthermore, the company should be aware of
the political risk involved in operating in Thailand. For example, the likelihood of
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expropriation by the Thai government should be assessed. Another important issue involved
in Blades’ long-run plans is how the foreign subsidiary would be monitored. Geographical
distance may make monitoring very difficult. This is an especially important point since Thai
managers may conform to goals other than the maximization of shareholder wealth.
3. Which theories of international business described in this chapter apply to Blades,
Inc. in the short run? In the long run?
ANSWER: There are at least three theories of international business: the theory of comparative
advantage, the imperfect markets theory, and the product cycle theory. In the short run, Blades
would like to import from Thailand because inputs such as rubber and plastic are cheaper in
Thailand. Also, it would like to export to Thailand to take advantage of the fact that few roller
blades are currently sold in Thailand. Both of these factors suggest that the imperfect markets
theory applies to Blades in the short run. In the long run, the goal is to possibly establish a
subsidiary in Thailand and to be one of the first roller blade manufacturers in Thailand. The
superiority of its production process suggests that the theory of comparative advantage would
apply to Blades in the long run. However, the product cycle theory also applies to Blades, since
its U.S. sales are declining and Blades feels that it must eventually establish a subsidiary in
Thailand in order to preserve its competitive advantage over Thai competitors.
4. What long-range plans other than the establishment of a subsidiary in Thailand are
an option for Blades and may be more suitable for the company?
ANSWER: Since Ben Holt is very unfamiliar with international business, and since Blades has
never operated outside the United States, establishment of a subsidiary in Thailand is probably
not the best way for Blades, Inc. to gain a foothold in Thailand in the long run. Blades should
initially consider a joint venture with Thai firms that manufacture roller blades. The advantage
would be access to Thai distribution channels, familiarity of the Thai firm with customs and
ethics in Thailand, and an established market. Of course, since Blades’ production process is
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unique, a joint venture would provide the Thai subsidiary with knowledge of the production
purposes, which it may duplicate after the joint venture terminates.
Chapter 02
1. Briefly explain how changes in various economic factors affect the U.S. current account
balance.
The U.S. current account balance is influenced by a number of economic factors, including:
1. Exchange rate: Changes in the value of the U.S. dollar can affect the current account
balance by making exports cheaper or more expensive, which in turn affects demand for
goods and services produced in the U.S.
2. Gross Domestic Product (GDP): When the economy is growing, demand for imports
increases, which can lead to a widening trade deficit and a decrease in the current account
balance.
3. Interest rates: Higher interest rates can lead to an increase in foreign investment in the U.S.,
resulting in a stronger dollar and a lower current account balance.
4. Government policies: Government policies, such as tariffs and trade agreements, can also
impact the current account balance by affecting the competitiveness of U.S. exports and
imports.
5. Consumer spending: Consumer spending is a major driver of demand for imports, so
changes in consumer confidence and spending habits can also affect the U.S. current
account balance.
2. Explain why U.S. tariffs will not necessarily reduce a U.S. balance-of-trade deficit.
U.S. tariffs are taxes on imports that can increase the price of foreign goods and make domestic
goods more competitive. However, reducing a trade deficit is a complex issue that depends on
several factors such as exchange rates, international demand for U.S. goods, domestic saving
and investment patterns, and government spending. Tariffs alone may not be enough to
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significantly reduce a trade deficit because consumers may shift to other foreign suppliers or
substitute goods, or because a reduction in imports could lead to a decrease in exports as
foreign markets retaliate with tariffs of their own. Additionally, a trade deficit can reflect larger
economic imbalances, such as a high level of consumer spending and low levels of saving,
which cannot be resolved by tariffs alone.
3. Explain why a global recession like that in 2008–2009 might encourage some
governments to impose more trade restrictions.
During an economic recession, many countries experience declining demand for their goods
and services, leading to reduced economic activity, increased unemployment, and declining
government revenues. In an effort to protect domestic industries and employment, some
governments may impose trade restrictions, such as tariffs or quotas, on imported goods. These
measures can make foreign goods more expensive and reduce competition for domestic
producers, potentially boosting domestic production and employment. However, trade
restrictions can also lead to retaliation by other countries and contribute to a decline in
international trade, potentially worsening the overall economic situation.
Case
1. How could a higher level of inflation in Thailand affect Blades (assume U.S. inflation
remains constant)?
Answer: A high level of inflation in Thailand relative to the United States could affect Blades
favorably. Generally, if a country’s inflation rate increases relative to the countries with which
it trades, consumers and corporations within the country will most likely purchase more goods
overseas, as local goods become more expensive. Consequently, Blades’ sales to Thailand may
increase.
However, Blades imports rubber and plastic components from Thailand. Due to inflation, the
cost of production of these components in Thailand will go up. This would increase the cost of
Goods Sold. But this negative impact will be low since only 4% of Cost of Goods Sold is
attributable to rubber and plastic imported from Thailand.
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The net effect is that, Blades Inc.’s net profit would increase.
2. How could competition from firms in Thailand and from U.S. firms conducting
business in Thailand affect Blades?
Answer: Blades would be favorably affected relative to Thai roller blade manufacturers and
relative to other U.S. roller blade manufacturers with operations in Thailand. Both groups of
firms will likely be forced to raise their prices if they want to maintain the same profit margin
should inflation in Thailand increase. This is especially true if both groups of firms source their
supplies directly from Thailand, so that the prices of these supplies are subject to the higher
inflation in Thailand. Conversely, Blades’ cost of goods sold incurred in Thailand is relatively
small. Consequently, costs will not be subject to the higher level of inflation in Thailand to a
great extent and Blades will probably not have to raise its prices to the same extent as Thai
roller blade manufacturers or U.S. manufacturers with operations in Thailand.
Not only that, Blades conduct their business(both export and imports) from Thailand in Thai
Baht. The other US competitors who exports in Thailand invoice their exports in U.S. dollars.
This gives Blades a competitive advantage since Thai importers do not have to worry paying
different amounts due to currency fluctuations.
3. How could a decreasing level of national income in Thailand affect Blades?
Answer: At first glance, it would appear that a decreasing level of national income in Thailand
could hurt Blades financially, as Thai consumers will have less money to spend. Furthermore,
this effect may be magnified because Blades manufactures a leisure product, which is probably
one of the first products Thai consumers will stop buying. The arrangement Blades has with
its primary Thai importer mitigates this effect somewhat, since the latter has committed himself
to the purchase of a certain number of “Speedos” annually. Nevertheless, the importer may not
offer to renew this arrangement in excess of the original three years if the Thai economy does
not improve.
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4. How could a continued depreciation of the Thai baht affect Blades? How would it affect
Blades’ relative to U.S. exporters invoicing their roller blades in U.S. dollars?
Answer: A continued depreciation of the Thai baht would hurt Blades, especially because the
firm invoices its roller blades in baht. A continued depreciation of the baht means that the bahtdenominated revenue in Thailand will convert to fewer U.S. dollars. Blades Inc. also has some
expenses in baht, but this amount is less than the revenue denominated in baht.
Although Blades would be hurt by a depreciating baht because its exports are denominated in
baht, the demand for Blades’ products may increase relative to that of its U.S. competitors
exporting to Thailand. This is because most of the U.S. firms exporting roller blades to
Thailand invoice their products in U.S. dollars. If the baht depreciates, Thai importers will
have to convert more baht to dollars in order to pay for the dollar-denominated exports.
5. If Blades increases its business in Thailand and experiences serious financial problems,
are there any international agencies that the company could approach for loans or other
financial assistance?
Answer: If Blade Inc. increases its business in Thailand and experience serious financial
problems then Blades can call for loan from International Financial Corporation (IFC). IFC
not only provides loans to corporations but also purchases stocks. International Financial
Corporation acts as a catalyst. It provides loans to promote economic development of private
sector.
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Chapter 3
1. Stetson Bank quotes a bid rate of $.784 for the Australian dollar and an ask rate of $.80.
What is the bid/ask percentage spread?
The bid/ask percentage spread can be calculated as:
(ask rate - bid rate) / ask rate * 100
For the Australian dollar, the calculation would be:
($.80 - $.784) / $.80 * 100 =2%
So the bid/ask percentage spread is 2%
2. Fullerton Bank quotes an ask rate of $.190 for the Peruvian currency (new sol) and a bid
rate of $.188. Determine the bid/ask percentage spread?
The bid/ask spread can be calculated as the difference between the ask rate and the bid rate, divided
by the ask rate, multiplied by 100 to express it as a percentage.
In this case, the spread would be:
Spread = (Ask rate - Bid rate) / Ask rate * 100
= ($.190 - $.188) / $.190 * 100
= 1.0526%
So the bid/ask percentage spread is approximately 1.0526%.
3. Briefly explain how MNCs can make use of each international financial market described
in this chapter.
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Multinational corporations (MNCs) can make use of various international financial markets in
different ways to meet their financial needs and goals.

Foreign Exchange Market: MNCs can use the foreign exchange market to hedge against
currency fluctuations and to convert their earnings from one currency to another.

International Bond Market: MNCs can use the international bond market to raise capital
by issuing bonds in different currencies and to access a wider pool of investors.

International Money Market: MNCs can use the international money market to borrow or
lend short-term funds in different currencies.

International Equity Market: MNCs can use the international equity market to raise capital
by issuing stocks in different countries and to gain exposure to foreign stock markets.

International Derivatives Market: MNCs can use the international derivatives market to
hedge against price and currency risks and to speculate on price movements.
Overall, MNCs can utilize these financial markets to diversify their funding sources, manage their
financial risks, and pursue growth opportunities.
Case
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Chapter 04
1. Briefly describe how various economic factors can affect the equilibrium exchange
rate of the Japanese yen’s value with respect to that of the dollar
The value of the Japanese yen with respect to the dollar is determined by the demand and supply
of both currencies in the foreign exchange market. Various economic factors can affect the
equilibrium exchange rate, including:

Interest rates: Higher interest rates in Japan relative to the US will increase demand for the
yen, making it stronger against the dollar.
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
Inflation: High inflation in Japan relative to the US will reduce the value of the yen, as
consumers and investors lose purchasing power.

Trade balances: If Japan has a trade surplus with the US, it will lead to an increase in
demand for yen and result in appreciation of the currency.

Political stability and economic growth: Political and economic stability can impact
investor confidence, which in turn can affect the demand for a particular currency. If
investors perceive Japan to be a more stable and growing economy, they may increase
demand for the yen, leading to an appreciation of the currency.

Monetary policy: The Bank of Japan's monetary policy decisions, such as changes in
interest rates and the money supply, can also affect the value of the yen relative to the
dollar.
2. A recent shift in the interest rate differential between the United States and Country
A had a large effect on the value of Currency A. However, the same shift in the interest
rate differential between the United States and Country B had no effect on the value
of Currency B. Explain why the effects may vary.
The change in the interest rate differential between two countries can affect the value of their
currencies, but the extent of the impact can vary. This is because the effect of interest rate
differential on exchange rates depends on a variety of other factors, including:

Inflation rate: If the inflation rate in one country is higher than the other, this may offset
the impact of a change in interest rate differential, making the effect on the exchange rate
less pronounced.
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
Political stability: Political instability in one country may discourage foreign investment
and reduce demand for its currency, even if its interest rates are high.

Economic conditions: The overall health of a country's economy and its outlook for the
future can also play a role in determining demand for its currency, regardless of interest
rates.

Central bank policies: Central bank policies can also influence exchange rates, particularly
if they are trying to manipulate their currency's value.
Therefore, the reason why the same shift in the interest rate differential between the US and
Country B had no effect on the value of Currency B could be due to the presence of one or more
of these factors, while they were not present or less pronounced in the case of Currency A.
3. Smart Banking Corp. can borrow $5 million at 6 percent annualized. It can use the
proceeds to invest in Canadian dollars at 9 percent annualized over a 6-day period.
The Canadian dollar is worth $.95 and is expected to be worth $.94 in 6 days. Based
on this information, should Smart Banking Corp. borrow U.S. dollars and invest in
Canadian dollars? What would be the gain or loss in U.S. dollars?
Yes, Smart Banking Corp. should borrow U.S. dollars and invest in Canadian dollars as the
expected return from the investment (9 percent) is higher than the cost of borrowing (6 percent).
The gain or loss in U.S. dollars can be calculated as follows:

Borrow $5 million at 6 percent for 6 days, which results in interest expense of $5 million
* 6 percent * 6/365 = $10,164.38.
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
Invest the $5 million in Canadian dollars at 9 percent for 6 days, which results in a return
of $5 million * 9 percent * 6/365 = $15,247.91.

At the end of the 6-day period, convert the Canadian dollars back to U.S. dollars at the
expected rate of $.94 per Canadian dollar, resulting in $5 million * .94 = $4,700,000.

The net gain in U.S. dollars is $4,700,000 - $5 million + $10,164.38 = $5,164.38.
Therefore, the net gain in U.S. dollars from this transaction is $5,164.38.
Case
1. How are percentage changes in a currency’s value measured? Illustrate your answer
numerically by assuming a change in the Thai baht’s value from a value of $.022 to $.026.
Percentage change in a currency's value is measured by finding the difference between the old and
new values, divided by the old value, and then multiplying by 100 to express it as a percentage.
For example, if the value of the Thai baht changes from $0.022 to $0.026, the percentage change
can be calculated as follows:
(New value - Old value) / Old value * 100 = (0.026 - 0.022) / 0.022 * 100 = 18.18%
So, the Thai baht has appreciated by 18.18% from $0.022 to $0.026.
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2. What are the basic factors that determine the value of a currency? In equilibrium, what
is the relationship between these factors?
The value of a currency is determined by various factors, including the following:

Inflation: the rate at which prices of goods and services rise over time.

Interest Rates: the cost of borrowing money, which affects the demand for a currency.

Political stability: a stable government and favorable economic policies can increase the
demand for a currency.

Balance of trade: the difference between a country's exports and imports, which can affect
its currency's supply and demand.
In equilibrium, the value of a currency is determined by the interaction of these factors, as well as
others such as economic growth and investor sentiment. The relationship between these factors is
complex and dynamic, and changes over time. When one factor changes, it can impact the others,
leading to shifts in the value of the currency.
3. How might the relatively high levels of inflation and interest rates in Thailand affect the
baht’s value. (Assume a constant level of U.S. inflation and interest rates.)
The higher levels of inflation and interest rates in Thailand can lead to a weaker value of the baht.
In a high inflation environment, prices for goods and services increase, which can reduce the
purchasing power of a currency and lower its value relative to other currencies. High interest rates,
on the other hand, can attract foreign investors to invest in the country's bonds, thereby increasing
demand for the currency. However, if interest rates are high but inflation is also high, the benefit
from higher interest rates may be offset by the decrease in purchasing power, leading to a potential
decline in the currency's value. A constant level of U.S. inflation and interest rates compared to
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Thailand's may make the U.S. Dollar a more attractive investment, leading to a decrease in demand
for the baht and a weaker exchange rate.
4. How do you think the loss of confidence in the Thai baht, evidenced by the withdrawal of
funds from Thailand, will affect the baht’s value? Would Blades be affected by the change
in value, given the primary Thai customer’s commitment
The loss of confidence in the Thai baht will likely result in a decrease in the value of the
currency, as investors and depositors withdraw their funds and sell the baht. This devaluation
will likely have an impact on companies that have exposure to the Thai market, such as Blades.
The change in the value of the baht may affect the purchasing power of the primary Thai
customer, which could impact their commitment to Blades. However, it's important to note
that there could be many other factors that could influence the Thai customer's commitment,
and it's difficult to predict the exact outcome without more information about the specific
situation.
5. Assume that Thailand’s central bank wishes to prevent a withdrawal of funds from its
country in order to prevent further changes in the currency’s value. How could it
accomplish this objective using interest rates?
Thailand's central bank could use interest rates to prevent a withdrawal of funds from its
country by increasing the interest rates. Higher interest rates make holding on to the local
currency more attractive, as it generates more income for depositors. This reduces the incentive
for individuals and businesses to convert their local currency into foreign currency, slowing
down or stopping the outflow of funds from the country. The result is that the demand for the
local currency increases and its value relative to foreign currencies stabilizes or increases.
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Chapter 6
1. Explain why it would be virtually impossible to set an exchange rate between the
Japanese yen and the U.S. dollar and to maintain a fixed exchange rate
It is virtually impossible to set a fixed exchange rate between two currencies and maintain it due
to several economic factors. The most important ones are:

Different inflation rates: Inflation is the general rise in prices over time, and different
countries may have different inflation rates. If a currency has higher inflation than the other,
its purchasing power will decrease, and it will need to be devalued in order to maintain the
fixed exchange rate.

Trade imbalances: If a country is exporting more than it is importing, its currency will
appreciate, making its exports more expensive. On the other hand, if a country is importing
more than it is exporting, its currency will depreciate, making its imports cheaper. These
imbalances can put pressure on the fixed exchange rate and make it difficult to maintain.

Interest rate differentials: Different countries may have different monetary policies and
interest rates, which can impact their currencies. If one country has a higher interest rate
than the other, it will attract more investment, causing its currency to appreciate.

Political and economic stability: Political and economic instability can cause uncertainty
and make it difficult to maintain a fixed exchange rate.
Therefore, it would be virtually impossible to set and maintain a fixed exchange rate between two
currencies due to these constant economic and political factors.
2. Assume the Federal Reserve believes that the dollar should be weakened against the
Mexican peso. Explain how the Fed could use direct and indirect intervention to weaken
the dollar’s value with respect to the peso. Assume that future inflation in the United
States is expected to be low, regardless of the Fed’s actions.
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The Federal Reserve could use the following methods to weaken the dollar against the peso:
Direct intervention:

Selling dollars: The Fed can sell dollars and purchase pesos in the foreign exchange market,
increasing the supply of dollars and decreasing the demand, which would lower the value
of the dollar relative to the peso.

Lending dollars: The Fed can lend dollars to Mexican financial institutions, increasing the
supply of dollars in the Mexican economy, leading to a decrease in the value of the dollar
relative to the peso.
Indirect intervention:

Lowering interest rates: The Fed can lower interest rates in the US, making US investments
less attractive, which would reduce the demand for dollars and weaken its value relative to
the peso.

Increasing money supply: The Fed can increase the money supply in the US by purchasing
Treasury securities, which would increase the supply of dollars and decrease its value
relative to the peso.
Note that regardless of the Fed's actions, a low expected future inflation in the US would likely
keep the value of the dollar relatively stable, and additional measures beyond monetary policy may
be needed to achieve a substantial devaluation of the dollar against the peso.
3. Briefly explain why the Federal Reserve may attempt to weaken the dollar
The Federal Reserve may attempt to weaken the dollar in order to stimulate economic growth by
making exports cheaper and increasing demand for foreign goods, therefore promoting job creation
and reducing the trade deficit. Additionally, a weaker currency can help lower the cost of imports,
reducing inflationary pressure, and allowing the central bank to achieve its mandate of maximum
employment and stable prices. However, weakening the dollar can also result in higher interest
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rates and may lead to a decrease in the value of dollar-denominated assets held by foreign
investors, potentially affecting global confidence in the currency.
4. Assume the country of Sluban ties its currency (the slu) to the dollar and the exchange rate will
remain fixed. Sluban has frequent trade with countries in the eurozone and the United States.
All traded products can easily be produced by all the countries, and the demand for these
products in any country is very sensitive to the price because consumers can shift to wherever
the products are relatively cheap. Assume that the euro depreciates substantially against the
dollar during the next year.
a. What is the likely effect (if any) of the euro’s exchange rate movement on the volume
of Sluban’s exports to the eurozone? Explain.
The substantial depreciation of the euro against the dollar will likely increase the price
competitiveness of Sluban's exports to the eurozone. As the value of the euro decreases relative
to the dollar, Sluban's exports priced in slu will become relatively cheaper in comparison to
products produced in the eurozone, making Sluban's exports more attractive to consumers.
This could lead to an increase in the volume of Sluban's exports to the eurozone.
b. What is the likely effect (if any) of the euro’s exchange rate movement on the volume
of Sluban’s exports to the United States? Explain.
The exchange rate between the euro and the US dollar can have an effect on the volume of
Sluban's exports to the United States. If the value of the euro decreases relative to the US dollar,
it makes Sluban's products cheaper for US consumers, potentially leading to an increase in
demand and volume of exports. On the other hand, if the value of the euro increases relative to
the US dollar, Sluban's products become more expensive for US consumers, which may result
in a decrease in demand and volume of exports. It is important to note that other factors such
as changes in trade policies, economic conditions, and competitiveness of other suppliers in
the market can also affect the volume of Sluban's exports to the US.
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Case
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Chapter 7
1. Assume that the following spot exchange rates exist today: £1 = $1.50, C$ = $.75, £1 =
C$2 Assume no transaction costs. Based on these exchange rates, can triangular arbitrage
be used to earn a profit? Explain.
Yes, triangular arbitrage can be used to earn a profit based on the given exchange rates.
With the given exchange rates, you can convert £1 to C$2 and then convert C$2 to $1.50. If
$1.50 is greater than £1, then a profit can be earned through triangular arbitrage.
In this case, $1.50 = £1 x (1/1.50) = C$2 x (.75) > £1, so a profit can be earned through
triangular arbitrage.
2. Assume the following information: Spot rate of £ = $1.60, 180-day forward rate of £=
$1.56, 180-day British interest rate = $4%, 180-day U:S interest rate = $3%, Based on
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this information, is covered interest arbitrage by U.S. investors feasible (assuming that
U.S. investors use their own funds)? Explain
Yes, covered interest arbitrage is feasible for U.S. investors based on the given information.
Covered interest arbitrage occurs when an investor borrows in a currency with a lower interest
rate, converts the funds into a currency with a higher interest rate, invests the funds in a riskfree security in the high-interest rate currency, and then repays the loan with the proceeds.
Given the information, U.S. investors can borrow in dollars at an interest rate of 3% and
convert the dollars into pounds at the spot rate of $1.60 to obtain £1. The investor can then
invest the £1 in a risk-free security for 180 days at a British interest rate of 4%. At the end of
180 days, the investor would have £1.04. The investor can then convert the £1.04 back into
dollars at the 180-day forward rate of $1.56 to receive $1.6224. Finally, the investor can repay
the dollar loan with the proceeds, earning a positive return of 0.0224, or 2.24%.
Thus, covered interest arbitrage is feasible for U.S. investors using their own funds.
3. Using the information in the previous question, does interest rate parity exist? Explain.
Interest rate parity (IRP) exists when the difference between the foreign and domestic interest rates
is equal to the difference between the forward and spot exchange rates.
To determine if IRP exists, we can use the formula:
(1 + rf) * F = (1 + rh) * S
where: rf = foreign interest rate rh = domestic interest rate F = forward exchange rate S = spot
exchange rate
Plugging in the given values, we have:
(1 + 0.04) * 1.56 = (1 + 0.03) * 1.60
Solving for the left side, we find that:
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1.064 * 1.56 = 1.09 * 1.60
Since the two sides are not equal, IRP does not exist in this scenario.
Another solution for 3:
4. Explain in general terms how various forms of arbitrage can remove any discrepancies
in the pricing of currencies
Arbitrage is the act of taking advantage of differences in prices between two or more markets
to make a profit. In the context of currency markets, arbitrage refers to exploiting differences
in the pricing of currencies to make a profit without taking on any risk.
There are several forms of currency arbitrage that can help to remove discrepancies in the
pricing of currencies:
Triangular Arbitrage: This involves taking advantage of discrepancies in the exchange rates
between three currencies. For example, if the exchange rate between currency A and B is
different from the exchange rate between currency B and C, an arbitrageur can buy currency
A, convert it to B, and then convert B to C to make a profit.
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Spot-Forward Arbitrage: This involves exploiting the difference between the spot rate and the
forward rate of a currency. For example, if the forward rate of a currency is higher than the
spot rate, an arbitrageur can buy the currency at the spot rate, sell it at the forward rate, and
make a profit.
Interest Rate Arbitrage: This involves taking advantage of differences in interest rates between
two currencies. For example, if the interest rate for currency A is higher than the interest rate
for currency B, an arbitrageur can borrow currency B, invest it in currency A, and make a profit
from the difference in interest rates.
These forms of arbitrage help to remove discrepancies in the pricing of currencies by creating
a self-correcting mechanism in the currency markets. As arbitrageurs take advantage of these
discrepancies, the prices of currencies will adjust to eliminate the opportunity for further
profits, leading to a more efficient and stable market.
5. Assume that the British pound’s 1-year forward rate exhibits a discount. Assume that
interest rate parity continually exists. Explain how the discount on the British pound’s 1year forward discount would change if British 1-year interest rates rose by 3 percentage
points while U.S. 1-year interest rates rose by 2 percentage points.
Interest rate parity (IRP) states that the difference between the foreign and domestic interest
rates should be equal to the difference between the forward rate and the spot rate of a currency.
If IRP holds, a change in interest rates will affect the forward rate in such a way that the
difference between the foreign and domestic interest rates remains constant.
In this scenario, if British 1-year interest rates rise by 3 percentage points while U.S. 1-year
interest rates rise by 2 percentage points, the difference between the foreign and domestic
interest rates will increase from the original value to 5%.
Since IRP holds, the difference between the forward rate and the spot rate should also increase
by 5%. If the British pound's 1-year forward rate originally exhibited a discount, this increase
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in the difference between the forward rate and spot rate would lead to a decrease in the size of
the discount. In other words, the forward rate would become closer to the spot rate, reducing
the size of the discount.
Case
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Chapter 8
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Case
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Chapter 14
1. Two managers of Marshall, Inc., assessed a proposed project in Jamaica. Each manager
used exactly the same estimates of the earnings to be generated by the project, as these
estimates were provided by other employees. The managers agree on the proportion of
funds to be remitted each year, the life of the project, and the discount rate to be applied.
Both managers also assessed the project from the U.S. parent’s perspective. Nevertheless,
one manager determined that this project had a large net present value, while the other
manager determined that the project had a negative net present value. Explain the
possible reasons for such a difference
There could be several reasons for the difference in net present value (NPV) calculations by
the two managers:
Different exchange rates: If the managers used different exchange rates to convert the earnings
from Jamaican dollars to U.S. dollars, this could result in a different NPV calculation.
Different inflation rates: If the managers used different inflation rates for Jamaica, this could
also affect the NPV calculation as inflation can impact the real value of future cash flows.
Different tax rates: If the managers used different tax rates for Jamaica, this could also affect
the NPV calculation as taxes can reduce the net cash flows generated by the project.
Different cost of capital: If the managers used different discount rates to calculate the NPV,
this could result in a different NPV calculation.
Different estimation methods: If the managers used different methods to estimate the earnings
of the project, such as different methods for estimating expected cash flows or depreciation,
this could result in a different NPV calculation.
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Overall, it is important to ensure that all relevant factors are considered and used consistently
in NPV calculations to obtain accurate results.
2. Pinpoint the parts of a multinational capital budgeting analysis for a proposed sales
distribution center in Ireland that are sensitive when the forecast of a stable economy in
Ireland is revised to predict a recession.
When the forecast of a stable economy in Ireland is revised to predict a recession, the following
parts of a multinational capital budgeting analysis for a proposed sales distribution center in
Ireland would be sensitive:
Sales Forecast: A recession in Ireland could result in a decrease in demand for the company's
products and services, leading to a revision of the sales forecast and a decrease in expected
cash flows.
Exchange rate fluctuations: A recession in Ireland could result in a decrease in the value of the
local currency relative to the U.S. dollar, leading to increased costs for importing raw materials
or exporting products and affecting the profitability of the project.
Local taxes and regulations: A recession in Ireland could lead to changes in local taxes and
regulations that could impact the expected cash flows of the project.
Local labor market: A recession in Ireland could lead to an increase in the unemployment rate,
making it harder to find and retain qualified employees, which could increase labor costs and
reduce the expected cash flows of the project.
Local economic conditions: A recession in Ireland could lead to an increase in the cost of
capital and a decrease in the willingness of local investors to invest in new projects, making it
harder to secure financing for the project.
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It is important to consider these changes and their potential impact on the expected cash flows
and overall profitability of the project when revisiting the multinational capital budgeting
analysis in light of the revised forecast for a recession in Ireland.
3. New Orleans Exporting Co. produces small computer components, which are then sold
to Mexico. It plans to expand by establishing a plant in Mexico that will produce the
components and sell them locally. This plant will reduce the amount of goods that are
transported from New Orleans. The firm has determined that the cash flows to be earned
in Mexico would yield a positive net present value after accounting for tax and exchange
rate effects, converting cash flows to dollars, and discounting them at the proper discount
rate. What other major factor must be considered to estimate the project’s NPV?
When estimating the net present value (NPV) of a proposed project to establish a plant in
Mexico, it is important to consider several factors, including:
Political and Economic stability: The stability of the political and economic environment in
Mexico should be considered as this can affect the expected cash flows of the project. For
example, a change in government policies or regulations, inflation, or currency devaluation
could impact the project's profitability.
Infrastructure: The availability and quality of infrastructure in Mexico, such as transportation,
communication, and energy, should be evaluated to ensure that they are adequate to support
the operation of the plant.
Local labor market: The availability and cost of labor in Mexico should be considered as this
could impact the operating costs of the plant.
Competition: The level of competition in the local market should be evaluated to ensure that
the plant will be able to compete effectively and generate sufficient sales to cover its costs.
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Currency risk: Currency risk, or the risk that changes in exchange rates will negatively impact
the project's expected cash flows, should be considered and accounted for in the NPV
calculation.
In addition to these factors, any other relevant risks or uncertainties that could impact the
expected cash flows of the project should also be considered in order to accurately estimate the
project's NPV.
4. Explain how the present value of the salvage value of an Indonesian subsidiary will be
affected (from the U.S. parent’s perspective) by (a) an increase in the risk of the foreign
subsidiary and (b) an expectation that Indonesia’s currency (rupiah) will depreciate
against the dollar over time.
The present value of the salvage value of an Indonesian subsidiary, from the perspective of the
U.S. parent, can be affected by both an increase in the risk of the foreign subsidiary and an
expectation of a depreciation of the rupiah against the dollar.
(a) An increase in the risk of the foreign subsidiary: An increase in the risk of a foreign
subsidiary can reduce the perceived value of its future cash flows, including the salvage value.
This can lead to a decrease in the present value of the salvage value as the discount rate used
to calculate the present value will likely be higher to reflect the increased risk.
(b) An expectation of rupiah depreciation against the dollar: An expectation of a depreciation
of the Indonesian rupiah against the U.S. dollar can also impact the present value of the salvage
value. A decrease in the value of the rupiah will reduce the value of the salvage value when
translated back into dollars, thus reducing the present value of the salvage value in dollar terms.
Therefore, both an increase in the risk of the foreign subsidiary and an expectation of a
depreciation of the rupiah can lead to a decrease in the present value of the salvage value from
the perspective of the U.S. parent.
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5. Wilmette Co. and Niles Co. (both from the United States) are assessing the acquisition of
the same firm in Thailand and have obtained the future cash flow estimates (in
Thailand’s currency, baht) from the firm. Wilmette would use its retained earnings from
U.S. operations to acquire the subsidiary. Niles Co. would finance the acquisition mostly
with a term loan (in baht) from Thai banks. Neither firm has any other business in
Thailand. Which firm’s dollar cash flows would be affected more by future changes in
the value of the baht (assuming that the Thai firm is acquired)?
Niles Co. would be affected more by future changes in the value of the baht, as the company would
finance the acquisition mostly with a term loan in baht from Thai banks. Changes in the value of
the baht would directly impact Niles Co.'s cash flows, as it would have to repay the loan in baht
and the amount in dollars would change based on the exchange rate. On the other hand, Wilmette
Co. would use its retained earnings from U.S. operations to acquire the subsidiary, so the
company's dollar cash flows would not be directly impacted by changes in the value of the baht.
6. Review the capital budgeting example of Spartan, Inc., discussed in this chapter. Identify
the specific variables assessed in the process of estimating a foreign project’s net present
value (from a U.S. perspective) that would cause the most uncertainty about the NPV.
In the capital budgeting example of Spartan, Inc., the following variables would cause the most
uncertainty in estimating the foreign project's net present value (NPV) from a U.S. perspective:
Exchange rate: The exchange rate used to convert foreign currency cash flows into U.S. dollars
can significantly affect the NPV. Fluctuations in the exchange rate can cause unexpected changes
in the project's cash flows and ultimately its NPV.
Inflation rate: The inflation rate in the foreign country can affect the purchasing power of the local
currency and ultimately the future cash flows of the project.
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Political stability: Political stability in the foreign country can have a significant impact on the
project's ability to generate cash flows and meet its obligations.
Economic stability: The economic stability of the foreign country can affect the project's future
cash flows and NPV. For example, a downturn in the local economy can reduce demand for the
project's output, resulting in lower cash flows.
Project risks: The specific risks associated with the foreign project, such as production disruptions,
supply chain disruptions, or changes in regulations, can also affect the NPV and cause uncertainty.
These variables should be carefully considered and estimated when evaluating a foreign project's
NPV from a U.S. perspective, as they can have a significant impact on the final results.
Case
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Chapter 16
1. Key West Co. exports highly advanced phone system components to its subsidiary shops
on islands in the Caribbean. The components are purchased by consumers to improve
their phone systems. These components are not produced in other countries. Explain how
political risk factors could adversely affect the profitability of Key West Co
Political risk factors can have a significant impact on the profitability of Key West Co due to their
influence on the company's ability to conduct business in the Caribbean islands. Some of these
factors include:
Changes in government regulations: If the government imposes new restrictions or regulations on
the import of phone system components, Key West Co could face difficulties in exporting their
products to its subsidiary shops in the Caribbean.
Political instability: If there is a political uprising or civil unrest in the Caribbean islands, it could
disrupt Key West Co's operations and lead to a loss of revenue.
Currency fluctuations: If the currency of the Caribbean islands experiences significant
fluctuations, it could increase the cost of exporting the components and affect Key West Co's
profitability.
Trade barriers: If the government of the Caribbean islands imposes trade barriers, such as tariffs
or quotas, Key West Co could face difficulties in exporting their products, which would negatively
impact their profitability.
Nationalization of industries: If the government nationalizes the telecommunications industry in
the Caribbean islands, Key West Co could lose its market and profitability.
In conclusion, political risk factors can have a significant impact on Key West Co's profitability
and operations, and the company should monitor these factors closely to minimize their impact on
the business.
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2. Using the information in question 1, explain how financial risk factors could adversely
affect the profitability of Key West Co.
Financial risk factors can also have a significant impact on the profitability of Key West Co. Some
of these factors include:
Exchange rate risk: If the currency of the Caribbean islands fluctuates against the currency used
by Key West Co, it could increase the cost of exports and affect the company's profitability.
Interest rate risk: If interest rates in the Caribbean islands increase, Key West Co's subsidiary shops
could face difficulties in obtaining financing to purchase the phone system components, leading
to a decrease in demand and negatively impacting the company's profitability.
Credit risk: If Key West Co's customers in the Caribbean islands are unable to pay their debts, it
could result in a loss of revenue and negatively impact the company's profitability.
Liquidity risk: If Key West Co is unable to meet its short-term obligations, such as paying its
employees or suppliers, it could lead to financial difficulties and negatively impact the company's
profitability.
Market risk: If the demand for phone system components decreases, Key West Co could
experience a drop in sales and negatively impact the company's profitability.
In conclusion, financial risk factors can also have a significant impact on Key West Co's
profitability, and the company should carefully manage these risks to maintain its financial
stability and profitability.
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3. Given the information in question 1, do you expect that Key West Co. is more concerned
about the adverse effects of political risk or of financial risk?
Political risks can have a significant impact on Key West Co's ability to conduct business in the
Caribbean islands. Some of the ways in which political risks can affect the company include:
Changes in government regulations: If the government of a Caribbean island changes its
regulations on imports or exports, it could make it more difficult or expensive for Key West Co to
export its phone system components, leading to a decrease in sales and profitability.
Political instability: If there is political instability in a Caribbean island, it could lead to disruptions
in the local market and affect Key West Co's ability to conduct business, potentially leading to a
loss of revenue and profitability.
Trade barriers: If the government of a Caribbean island imposes trade barriers, such as tariffs or
quotas, it could make Key West Co's products more expensive and less competitive, leading to a
decrease in demand and profitability.
Nationalization of industries: If the government of a Caribbean island nationalizes industries,
including the telecommunications industry, it could negatively impact Key West Co's ability to
sell its phone system components, leading to a loss of revenue and profitability.
In conclusion, political risks can have a significant impact on Key West Co's ability to conduct
business and generate revenue in the Caribbean islands. As such, it is likely that the company is
more concerned about the adverse effects of political risk than financial risk. However, without
further information, this is a subjective conclusion.
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4. Explain what types of firms would be most concerned about an increase in country risk
as a result of the terrorist attack on the United States on September 11, 2001.
The terrorist attack on the United States on September 11, 2001 led to an increase in country risk
for firms operating in or doing business with the United States. Firms that were most concerned
about this increase in country risk include:
International firms: Firms that have operations, investments, or customers in the United States
would be most concerned about the increase in country risk. The attack led to economic uncertainty
and instability in the US, which could negatively impact these firms' ability to conduct business
and generate revenue.
Tourism and hospitality firms: The attack led to a decrease in tourism and travel to the United
States, which would be particularly concerning for firms in the tourism and hospitality industries.
Airline and transportation firms: The attack had a significant impact on the airline and
transportation industries, as air travel was disrupted and many people were hesitant to fly. This
would be particularly concerning for firms in these industries with operations or customers in the
United States.
Defense and security firms: The attack led to an increase in demand for defense and security
services, which would be particularly concerning for firms in these industries.
Financial firms: The attack led to increased uncertainty and instability in financial markets, which
would be particularly concerning for financial firms.
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In conclusion, firms that have operations, investments, or customers in the United States or that
are in industries that were directly impacted by the attack would be most concerned about the
increase in country risk as a result of the September 11 terrorist attack.
5. Rockford Co. plans to expand its successful business by establishing a subsidiary in
Canada. However, it is concerned that after 2 years the Canadian government will either
impose a special tax on any income sent back to the U.S. parent or order the subsidiary
to be sold at that time. The executives have estimated that each of these scenarios has a
15 percent chance of occurring. They have decided to add four percentage points to the
project’s required rate of return to incorporate the country risk that they are concerned
about in the capital budgeting analysis. Is there a better way to more precisely
incorporate the country risk of concern here?
Yes, there is a better way to more precisely incorporate the country risk of concern in the capital
budgeting analysis. One approach is to use a simulation model to estimate the expected cash flows
and the uncertainty surrounding them, taking into account the two scenarios (tax imposition or
subsidiary sale) and their probabilities. This can give a more accurate representation of the impact
of country risk on the project's expected return and help make a more informed decision. Another
approach could be to use a scenario analysis, where different assumptions are made about the
future events and the impact on cash flows is estimated. Both these methods provide a more
nuanced and informed view of the potential risks and uncertainties associated with the project,
which is essential in international financial management. Additionally, considering the use of
financial instruments such as currency hedging, options, or forwards can also help manage
currency risk in international financial management.
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Case
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