Chapter 3
International Financial Markets
Specific Objectives

Describe the background and corporate use of the following international financial markets:
- foreign exchange market
- international money market
- international credit market
- international bond market, and
- international stock markets
Outline
Motives for Using International Financial Markets
• Basic reason: markets are imperfect (e.g., labor, taxes, etc.)
• Motives for investing in foreign markets
– economic conditions
– exchange rate expectations
– international diversification
• Motives for providing credit in foreign markets
– interest rates
– exchange rate expectations
– international diversification
• Motives for borrowing in foreign markets
– interest rates
– exchange rate expectations
Foreign Exchange Market
• Definition: the market where currencies are exchanged
• History
– gold standard (1876 – 1913)
– instability (1914 – 1943)
– Bretton Woods (1944 – 1973)
– floating exchange rates (1973 – present)
• Spot market
– allows for immediate exchange
– average daily trading of $1.5 trillion
– many foreign transactions do not require an exchange of currencies but allow a given
currency to cross country borders
• Spot market structure
– hundreds of banks facilitate foreign exchange transactions
– the top 20 banks handle about 50% of transactions
– similar quotes facilitated by arbitrage opportunities
• Spot market liquidity
– the more willing buyers and sellers there are, the more liquid a market is
– a currency’s liquidity reflects the ease with which an MNC can obtain or sell that currency
27
28
Chapter 3
• Forward rate - the rate at which currencies will be exchanged at a future point in time
–
•
•
•
•
•
•
a contract between a firm and a bank to exchange currencies at a specified rate in a
specified number of days
– used by MNCs to hedge exchange rate exposure
– the forward market for euros is very liquid because many MNCs take forward positions to
hedge their future payments in euros
Customers look for
– competitive quote
– relationship with bank
– speed of execution
– advice about current market conditions
– forecasting advice
Bid/ask spread
– bid/ask spread of banks represent the differential between the bid and ask quotes and
covers the cost involved in accommodating requests to exchange currencies
• example: assume bid of $0.65 per Canadian dollar and ask of $0.70 per Canadian
dollar; you exchange $1,000 for Canadian dollar and immediately convert it back to
U.S. dollars
– comparison of bid/ask spread among currencies
• the spread will look smaller for currencies that have a smaller value
• small retail transactions have a spread between 3 and 7%
• wholesale transactions request by MNCs have a spread between .01 and .03%
– factors that affect the spread
• order costs (positive)
• inventory costs (positive)
• competition (negative)
• volume (negative)
• currency risk (positive)
Quotations
– direct - $/unit of foreign currency
– indirect - units of foreign currency/$
Cross exchange rates - the exchange rate between two foreign currencies
Currency futures - standard volume of a particular currency to be exchanged on a specific
settlement date
Currency options - right but not obligation to buy (call) or sell (put) a currency
International Money Market
• Origins and development
– includes large banks around the world, such as J.P. Morgan
– European money market
• Eurocurrency market developed in the ‘60s and ‘70s
• dollar deposits in banks in other countries are Eurodollars
• growth due to 1968 U.S. regulations limiting foreign lending by U.S. banks
• “Petrodollars” - dollar deposits by OPEC countries
– Asian money market
• Originally known as the Asian dollar market
• emerged to accommodate needs of businesses using dollars for international trade
• centered in Hong Kong and Singapore
International Financial Markets
29
• Standardizing global bank regulations
–
Single European Act (1987) allows capital to move freely within EEC countries and allows
banks to expand freely within other EEC countries
– Basel Accord (1988) - made capital requirements standard for 12 major industrialized
countries
– Basel II Accord – corrects existing inconsistencies
• banks in some countries have required better collateral to back loans
• accounts for operational risk
• plans to require banks to provide more information to existing and prospective
shareholders
International Credit Market
• Eurocredit loans are loans of one year or longer maturity extended to MNCs by banks
– interest rate risk motivates floating rate loans tied to LIBOR
– loans are provided in the Eurocredit market
• Syndicated loans
– each bank participates in lending of large-volume transactions
– lead bank responsible for negotiating terms and organizing group of banks
International Bond Market
• MNCs issue international bonds for three reasons
– may be able to attract stronger demand
– the foreign currency may be widely used
– financing in a foreign currency may reduce financing costs
• A foreign bond is issued by a borrower foreign to the country where the bond is placed
• Parallel bonds are issued in various countries and denominated in various currencies
• Eurobond market
– Eurobonds are bonds that are sold in countries other than the country of the currency
denominating the bond
– U.S. investment in foreign bonds: Interest Equalization Tax in 1963
– foreign Investment in U.S. Bonds: 30% withholding tax before 1984
• Antilles-based subsidiaries
– features
• bearer form, convertibility, few protective covenants
– denominations
• commonly denominated in a number of currencies
• the U.S. dollar denominates 70 to 75% of Eurobonds
– underwriting process accomplished through a multinational syndicate of investment banks
– secondary market facilitated by Euro-clear
International Stock Markets
• Yankee Stock - foreign stock issued in the U.S.
– liquidity of U.S. market
– size of U.S. market
– American Depository Receipts (ADRs) - receipts representing a number of foreign shares
that are deposited in a U.S. bank
• Issuance of stock in foreign markets
– listing on multiple exchanges - greater exposure and liquidity of stock
• e.g., Coke is traded in U.S., Frankfurt, and Switzerland
• U.S., Japan, and U.K. combined allow for around-the-clock trading
– more U.S. firms are willing to list their stock in Europe because of the euro
30
Chapter 3
Appendix 3
Investing in International Financial Markets
• Background on international stock exchanges
– reduction in transaction costs has been facilitated by an increase in efficiency and ECNs
– alliances between stock exchanges have facilitated cross-listing
– reduction in information costs has been facilitated by the Internet
– exchange rate risk can be measured by considering the return on the stock and the
percentage change in the exchange rate
• International stock diversification
– investors can benefit by diversifying internationally
– limitations of international diversification
• correlations between stock indexes have increased
• conversion to the euro
• market movements during the market crash of 1987 and the Asian Crisis illustrate
increased correlations between currencies
– valuation of foreign stocks
• use the dividend discount model and adjust for expected exchange rate movements
• use the price-earnings method and also consider exchange rate effects
– methods used to invest internationally
• direct purchases of foreign stocks
• investment in MNC stocks
• ADRs
• WEBS
• international mutual funds
– exchange rate risk of foreign stocks
• can be reduced by taking short positions
• hedging is difficult because the future amount of foreign currency is unknown, because
investors may extend their initially planned investment horizon, and because forward
rates for currencies that are less widely used may not exist
– why perceptions of stock valuation differ among countries
• required rate of return
• exchange rate risk
• taxes
Key Terms Matching
In the following two exercises, place a letter from the right column with the correct number in the
left column.
Part I:
Key Term
1. American Depository
Receipts (ADRs)____
2. Arbitrage____
3. Ask Quote____
Definition
a. a 1944 agreement between countries calling for fixed
exchange rates between currencies; used from 1944 through
1971
b. a 1988 accord between 12 countries to standardize banks’
capital requirements across countries; the resulting capital
ratios are computed using risk-weighted assets
c. a contract specifying a standard volume of a particular
currency to be exchanged on a specific future date
International Financial Markets
4. Basel Accord____
5. Bid Quote____
6. Bretton Woods
Agreement____
7. Cross Exchange
Rate____
8. Currency Call
Option____
9. Currency Forward
Contract____
10. Currency Put
Option____
11. International Money
Market____
12. Eurobond____
13. Eurocredit Loans____
14. Eurocredit Market____
31
d. an international bond sold in countries other than the country
represented by the currency denominating it
e. certificates representing bundles of stock
f. loans of one year or longer extended by banks to MNCs
g. the act of simultaneously buying and selling the same or
equivalent assets or commodities for the purpose of making a
riskless profit
h. financial institutions in this market serve MNCs by accepting
deposits and offering loans in a variety of currencies
i. the exchange rate between two foreign currencies
j.
the market in which Eurocredit loans are extended
k. the price for which a bank offers to buy a currency
l. the price for which a bank offers to sell a currency
m. the right to buy a specific currency at a specific price within a
specified period of time
n. the right to sell a specific currency at a specific price within a
specified time period
Part II:
Key Term
1. Eurocurrency
Market____
2. Eurodollars____
3. Floating Rate Notes
(FRNs)____
4. Foreign Bond____
5. Gold Standard____
6. Interbank Market____
7. Interest Equalization
Act (IET)____
8. London Interbank Offer
Rate (LIBOR)____
9. Petrodollars____
10. Smithsonian
Agreement____
11. Spot Rate____
12. Syndicate____
13. Yankee Stock
Offering____
Definition
a. a 1971 agreement between major nations to devalue the U.S.
dollar relative to the major currencies
b. a group of banks providing the necessary funding for large
loans in the international credit market
c. a stock offering by a non-U.S. corporation or government in
the United States
d. a tax imposed by the U.S. government in 1963 in order to
discourage U.S. investors from investing in foreign securities
e. an exchange rate system under which each currency is
convertible into gold at a specified rate; used from 1876
through 1913
f. an international bond issued by a borrower foreign to the
country where the bond is placed
g. dollar deposits by Organization of Petroleum Exporting
Countries (OPEC) member countries
h. Eurobonds with a variable interest rate provision that adjusts
the coupon rate over time according to prevailing market rates
i. the exchange rate used for immediate exchange of currencies
j. the market for Eurodollars; this term is not used as often as in
the past
k. the interest rate commonly charged for loans between banks
l. the market in which banks trade currencies among each other
m. U.S. dollar deposits placed in banks located in other countries
32
Chapter 3
Answers to Key Terms Matching
Part I:
1.
2.
3.
4.
5.
6.
7.
e
g
l
b
k
a
i
8.
9.
10.
11.
12.
13.
14.
m
g
n
h
d
f
j
8.
9.
10.
11.
12.
13.
k
m
a
i
b
c
Part II:
1.
2.
3.
4.
5.
6.
7.
j
m
h
f
e
l
d
Summary of Formulas
1) Bid/ask spread
(Ask rate – Bid rate)/Ask rate
2) Calculating the price of an ADR (ADRs are convertible into one share of stock)
PADR  Pfs  S
3) Calculating the price of an ADR (ADRs are convertible into more than one share of stock)
PADR  Conv  Pfs  S
4) Factors affecting the bid/ask spread
Spread = f(Order costs, Inventory costs, Competition, Volume, Currency risk)
+
+
+
5) Foreign currency received when converting home currency
Amount in home currency to be Converted/Price charged by bank per unit of foreign currency
6) Indirect quotation
Indirect quotation = 1/Direct quotations
International Financial Markets
33
7) Home currency received when converting foreign currency
Amount in foreign currency to be converted × Price paid by bank per unit of foreign currency
8) Return to a U.S. investor from investing in a foreign stock:
R$  (1  R)(1  e)  1
9) Sensitivity of MNC returns to specific international stock markets
RMNC  a0  a1 RL  b1 RI ,1  b2 RI , 2  ...  bn RI ,n  u
10) Value of 1 unit of Currency A in units of Currency B (cross exchange rate)
Value of Currency A in $
Value of Currency B in $
11) Variance of a stock portfolio
 2p  wx2 x2  wy2 y2  2wx wy x y (CORR xy )
Definitional Problems
1. The existence of ______________ is a primary reason for the internationalization of financial
markets.
2. Among the motives for investing in foreign markets are foreign economic conditions,
______________, and international diversification.
3. The level of foreign _____________ and exchange rate expectations are both motives for
lending and/or borrowing in foreign markets.
4. The market in which currencies are exchanged is generally known as the
_________________.
5. The market in which the immediate exchange of currencies takes place is known as the
____________ market.
6. The market in which the future exchange of currencies takes place is known as the
____________ market.
7. An arrangement between countries known as the ____________ Agreement called for fixed
exchange rates between currencies in 1944.
8. In 1971, the dollar appeared to be overvalued; thus, as laid out in the Smithsonian
Agreement, the major nations decided to __________ the dollar relative to the major
currencies.
9. The purchase and sale of currencies between banks takes place in the ____________ market.
34
Chapter 3
10. The ____________ is intended to cover a bank’s cost in accommodating requests to exchange
currencies.
11. A bank will buy a foreign currency at the _________ quote and will sell a foreign currency at
the ___________ quote.
12. The exchange rate at which currencies will be exchanged at a future point in time is known as
the _________________.
13. The increase in international business has resulted in the development of a(n)
_______________, in which financial institutions accept deposits from MNCs and offer loans
in a variety of currencies.
14. The _________ Accord is intended to correct some inconsistencies still existing as a result of
Basel Accord.
15. A stock offering of non-U.S. stock in the U.S. is known as a(n) ___________ stock offering.
16. Rather than directly issuing stock in the U.S. to obtain equity funds, foreign corporations can
issue _________________, which are certificates representing underlying bundles of stock.
17. The value of a foreign currency expressed in dollars is known as a(n) __________ quotation,
while the value of a foreign currency expressed in units of foreign currency per dollar is
known as a(n) _______________ quotation.
18. A _____________________ expresses the amount of one foreign currency per unit of another
foreign currency.
19. A ________________ contract is similar to a _______________ contract, but the former
specifies a standard volume of a particular currency to be exchanged on a specific settlement
date, while the latter may be tailor-made.
20. A currency ___________ option provides the right, but not the obligation, to buy a specific
currency at a specific price within a specific period of time.
21. A currency put option provides the right, but not the obligation, to __________ a specific
currency at a specific price within a specific period of time.
22. The strike price is also known as the ____________ price.
23. U.S. dollar deposits placed in banks located in Europe and other continents are known as
___________________.
24. _____________ loans are loans of one year or longer extended by banks in the Eurocredit
market.
25. The interest rate commonly charged for loans between banks is called the
_________________.
International Financial Markets
35
26. There is a fine difference between a ____________ bond, which is issued by a borrower
foreign to the country where the bond is placed, and a _____________, which is sold in
countries other than the country represented by the currency denominating it.
27. To protect themselves against interest rate risk, issuers of Eurobonds have come to issue a
special type of Eurobond, known as ________________.
28. _________ help to inform all traders about outstanding Eurobond issues for sale, thus
allowing a more active secondary market.
29. _______________ are portfolios of stocks from various countries.
Answers to Definitional Problems
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
15.
imperfect markets
exchange rate expectations
interest rates
foreign exchange market
spot
forward
Bretton Woods
devalue
interbank
bid/ask spread
bid; ask
forward rate
international money market
Basel II
Yankee
16.
17.
18.
19.
20.
21.
22.
23.
24.
25.
26.
27.
28.
29.
American Depository Receipts (ADRs)
direct; indirect
cross exchange rate
futures; forward
call
sell
exercise
Eurodollars
Eurocredit loans
London Interbank Offer Rate (LIBOR)
foreign; Eurobond
floating rate notes (FRNs)
Euro-clear
International mutual funds
True/False Problems
1. The existence of imperfect markets has prevented the internationalization of financial
markets.
2. Economic conditions, exchange rate expectations, and international diversification are all
motives for investing in foreign markets.
3. It can be argued that a country’s currency may depreciate with high inflationary expectations,
but the relationship between expected inflation and currency movements is not precise.
4. When lending in foreign markets, international diversification increases the probability of
simultaneous bankruptcy across borrowers.
5. International diversification is a good risk-reduction technique for investment, but it may be
less effective if the countries of concern tend to experience somewhat similar business cycles.
6. When extending credit in foreign markets, investors probably anticipate that the local
currency will depreciate against their own; when borrowing in foreign markets, borrowers
probably anticipate that the local currency will appreciate against their own currency.
36
Chapter 3
7. In 1914, when World War I began, the gold standard was implemented; it lasted until 1944,
when exchange rates were fixed under the Bretton Woods Agreement.
8. Under the gold standard, each currency was convertible into gold at a specified rate, and the
exchange rate between two currencies was determined by their relative convertibility rates
per ounce of gold.
9. From 1944 until 1971, the Bretton Woods agreement called for exchange rates to remain
within 1% of their previously established levels. However, the Smithsonian Agreement of
1973 allowed exchange rates to fluctuate within 5% of their previously established levels.
10. An investor engaging in a transaction whereby he or she contracts to purchase British pounds
one year from now is an example of a spot market transaction.
11. The immediate exchange of currencies takes place in the spot market.
12. Besides considering the competitiveness of a bank’s quote, an investor frequently engaging in
currency conversions and international trade will also consider the bank’s advice regarding
foreign market conditions and exchange rate forecasts.
13. At any given point in time, a bank’s bid quote will be greater than its ask quote.
14. A forward contract is an agreement between a firm and a bank to exchange currencies at a
specified rate (the forward rate) in a specified number of days.
15. An MNC with receivables in Japanese Yen purchases yen forward to hedge its exposure to
exchange rate fluctuations. This is an example of how MNCs can use forward contracts to
hedge their exposure.
16. Many MNCs use forward contracts.
17. If the forward rate were the same as the spot rate, and interest rates between two countries
differed, it would be possible for astute investors to engage in arbitrage to earn virtually
riskless profits.
18. An advantage of a forward contract for an MNC is that it can be tailored to accommodate the
needs of the MNC.
19. The value of the IMF’s special drawing right (SDR) is based on the value of MNCs’ stock.
20. A cross exchange rate between two foreign currencies can easily be obtained with the two
currencies’ exchange rates relative to the dollar.
21. An MNC frequently uses either forward or futures contracts to hedge its exposure to foreign
receivables. To do so, the MNC can either sell the foreign currency forward or sell futures
contracts.
22. A currency put option provides the right, but not the obligation, to buy a specific currency at
a specific price within a specific period of time.
International Financial Markets
37
23. The price at which a currency may be bought or sold according to an option is known as the
strike (or exercise) price.
24. U.S. dollar deposits in Europe are known as Eurodollars; U.S. dollar deposits in Latin
America are known as Latinodollars.
25. The Asian money market is centered in Hong Kong and Singapore and consists of banks that
accept deposits and make loans in various foreign currencies.
26. All loans in the international credit market are so large that they require the use of bank
syndicates.
27. The Single European Act, which allowed banks established in an EEC country to expand into
any other EEC country, and the Basel Accord, which called for risk-weighted bank capital
ratios, prevented a trend toward increased globalization in the banking industry.
28. The LIBOR varies among currencies because the market supply of and demand for funds
vary among currencies.
29. To avoid interest rate risk resulting from a mismatch of assets and liabilities, a bank may float
its Eurocredit loan rate in accordance with the London Interbank Offer Rate (LIBOR).
30. Some institutional investors prefer to invest in international bond markets rather than their
respective local markets when they can earn a higher return on bonds denominated in foreign
currencies.
31. A foreign bond is a bond sold in countries other than the country represented by the currency
denominating it; a Eurobond is issued by a borrower foreign to the country where the bond is
placed.
32. If an MNC issues a variety of foreign bonds in various countries, these foreign bonds are
specifically called parallel bonds.
33. Eurobond ratings are available for most issues, but there has been a tendency of the
purchasers to ignore ratings in favor of a well-known name.
34. An American Depository Receipt (ADR) is a drawing right, and it is available only for U.S.
stocks.
35. Foreign firms that issue stock in the U.S. through a Yankee stock offering are generally
required to satisfy more stringent disclosure rules on their financial condition than domestic
firms.
36. Most of the largest firms based in Europe have listed their stock on the Euronext market,
which was created by the Amsterdam, Brussels, and Paris stock exchanges in 2000.
37. The international money market is frequently accessed by MNCs for short-term investment
and financing decisions, while longer term financing decisions are made in the international
credit market or the international bond market and in international stock markets.
38
Chapter 3
38. With an ECN, investors can place orders on their computers that are then executed by the
computer system and confirmed through the Internet to the investor.
39. Alliances between stock exchanges have resulted in monopolies and have resulted in market
segmentation.
40. Since stock market correlations become more pronounced during favorable market
conditions, international diversification will be more effective during a downturn.
41. When using the price-earnings method to value foreign stocks, investors should still consider
exchange rate effects.
42. ADRs in the U.S. are primarily traded on the over-the-counter (OTC) market.
43. One limitations of hedging exchange rate risk is that investors may decide to retain the
foreign stock beyond the initially planned investment horizon.
44. Typically, a given stock will appear undervalued to investors from all countries at the same
time.
45. Other things being equal, investors based in low-tax countries should value stocks lower.
Answers to True/False Problems
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
15.
16.
17.
18.
19.
20.
21.
22.
23.
F
T
T
F
T
F
F
T
F
F
T
T
F
T
F
T
T
T
F
T
T
F
T
24.
25.
26.
27.
28.
29.
30.
31.
32.
33.
34.
35.
36.
37.
38.
39.
40.
41.
42.
43.
44.
45.
F
T
F
F
T
T
T
F
T
T
F
T
T
T
T
F
F
T
T
T
F
F
International Financial Markets
39
Multiple Choice Problems
1. Which of the following is not mentioned in the text as a motive for investing in foreign
markets?
a. Economic conditions
b. Interest rate levels
c. International diversification
d. Exchange rate expectations
e. All of the above are mentioned in the text as motives.
2. Which of the following is not true regarding the decision to provide credit in foreign markets?
a. Creditors may consider supplying capital to countries whose currencies are expected to
depreciate against their own.
b. Creditors may consider supplying capital to countries whose interest rates are expected to rise
above their own (everything else constant).
c. Creditors can benefit from international diversification, which may reduce the probability of
simultaneous bankruptcy across borrowers.
d. If the foreign countries targeted for the provision of credit tend to experience somewhat
similar business cycles, diversification across countries will be less effective.
e. To the extent that inflation can cause depreciation of the local currency against others, high
interest rates in the foreign country may be somewhat offset by a weakening of the local
currency over the time period of concern.
3. Investors expecting the level of foreign interest rates to be __________ relative to their own
would probably provide credit in foreign markets; borrowers expecting the level of foreign
interest rates to be ___________ relative to their own would probably borrow in foreign
markets.
a. High; high
b. Low; low
c. Low; high
d. High; low
e. None of the above
4. Investors expecting the foreign currency to __________ relative to their own would probably
provide credit in foreign markets; borrowers expecting the foreign currency to ___________
relative to their own would probably borrow in foreign markets.
a. Appreciate; appreciate
b. Depreciate; depreciate
c. Appreciate; depreciate
d. Depreciate; appreciate
5. Which of the following is not true regarding the Bretton Woods Agreement?
a. It called for fixed exchange rates between currencies.
b. Governments intervened to prevent exchange rates from moving more than 1% above or
below their initially established levels.
c. The agreement lasted from 1944 until 1971.
d. Each country used gold to back its currency.
e. All of the above are true regarding the Bretton Woods Agreement.
40
6.
a.
b.
c.
d.
e.
Chapter 3
The Smithsonian Agreement
Devalued the U.S. dollar relative to the major currencies.
Widened the boundaries within which exchange rates were allowed to fluctuate.
Was a first step in letting market forces determine the appropriate price of a currency.
a and b only
a, b, and c
7. The market in which the immediate exchange of currencies takes place is known as the
_________ market.
a. Spot
b. Forward
c. Futures
d. Eurocurrency
e. Eurocredit
8. The market in which financial intermediaries transfer short-term funds from surplus units to
deficit units is known as the _________ market.
a. Spot
b. Forward
c. Futures
d. International money
e. International credit
9. The average daily foreign exchange trading by banks around the world is closest to
$____________.
a. 600 billion
b. 700 billion
c. 1 trillion
d. 1.3 trillion
e. 1.5 trillion
10. Which of the following is not a bank attribute important to customers in need for foreign
exchange?
a. Number of foreign branches
b. Competitiveness of quote
c. Speed of execution
d. Advice about current market conditions
e. Forecasting advice
11.
a.
b.
c.
d.
e.
Which of the following is not a possible bid/ask quotation for the Barbados dollar?
$.50/$.51
$.49/$.50
$.52/$.51
$.51/$.52
All of the above are possible bid/ask quotations
International Financial Markets
41
The following information refers to questions 12 through 14.
Assume a bank’s bid rate for the Danish kroner (DKK) is $0.1875, while its ask rate is $0.1895.
Assume you convert $1,000 to Danish kroner to take on your trip to Denmark. Immediately after
conversion, a family emergency arises, and you are unable to go on your trip. Thus, you convert
the Danish kroner back to dollars.
12.
a.
b.
c.
d.
e.
How many dollars will you have left after the two conversions?
$1,000
$998.37
$989.45
$500
$998
13.
a.
b.
c.
d.
e.
How many Danish kroner will you receive when converting the dollars initially?
189.50
187.50
5,333.33
5,277.04
5,000
14.
a.
b.
c.
d.
e.
What is the bank’s bid/ask percentage spread?
1.06%
1%
2%
1.07%
0%
15. Your company expects to receive 5,000,000 Japanese yen 60 days from now. You decide to
hedge your position by selling Japanese yen forward. The current spot rate of the yen is
$.0089, while the forward rate is $.0095. You expect the spot rate in 60 days to be $.0090.
How many dollars will you receive for the 5,000,000 yen 60 days from now if you sell yen
forward?
a. $44,500
b. $45,000
c. $526 million
d. $47,500
e. $556 million
16. Which of the following is probably not an example of the use of forward contracts by an
MNC?
a. Hedging pound payables by selling pounds forward
b. Hedging peso receivables by selling pesos forward
c. Hedging yen payables by purchasing yen forward
d. Hedging peso payables by purchasing pesos forward
e. All of the above are examples of using forward contracts
42
Chapter 3
17. A quotation representing the value of a foreign currency in dollars is referred to as a(n)
___________ quotation; a quotation representing the number of units of a foreign currency
per dollar is referred to as a(n) ______________ quotation.
a. Direct; indirect
b. Indirect; direct
c. Direct; direct
d. Indirect; indirect
e. Cannot be answered without more information
18. You observe a quotation of the Japanese yen (¥) of $0.007. You are, however, interested in
the number of yen per dollar. Thus, you calculate the __________ quotation of ___________
¥/$.
a. Direct; 142.86
b. Indirect; 142.86
c. Indirect; 150
d. Direct; 150
e. Indirect; 0
19. A Japanese Yen is worth $0.0080, and a Fijian dollar (F$) is worth $0.5900. What is the
value of the yen in Fijian dollars (i.e., how many Fijian dollars do you need to buy a yen)?
a. 73.75
b. 125
c. 1.69
d. 0.014
e. None of the above
20. Which of the following is probably not an option for an MNC wishing to reduce its exposure
to British pound payables?
a. Purchase pounds forward
b. Buy a pound futures contract
c. Buy a pound put option
d. Buy a pound call option
e. Remain unhedged if the British pound is expected to depreciate
21.
a.
b.
c.
d.
e.
Which of the following was not a reason for the emergence of the Eurocurrency market?
The growth of MNCs in the ‘60s and ‘70s.
U.S. regulations encouraging foreign lending by U.S. banks.
Interest rate ceilings on dollar deposits in the U.S.
Absence of reserve requirements for Eurodollar deposits
All of the above are reasons for the emergency of the Eurocurrency market.
22. All of the following are provisions of the Single European Act regarding bank regulation,
except
a. Capital can flow freely throughout Europe.
b. Banks can offer a wide variety of lending, leasing, and securities activities in the EEC.
c. The regulations regarding competition, mergers, and taxes will be similar throughout the
EEC.
d. A bank established in any one of the EEC countries will have the right to expand into any or
all of the other EEC countries.
e. Capital requirements of EEC banks will be based on the bank’s risk-weighted assets.
International Financial Markets
43
23.
a.
b.
c.
d.
The Basel II Accord would not
Account for differences among countries with respect to loan collateral.
Account for operational risk, which is the risk of losses resulting from financing activities.
Encourage banks to improve their techniques for controlling operational risk.
Require banks to provide more information to existing and prospective shareholders about
their exposure to different types of risk.
e. The Basel II Accord would do all of the above.
24. MNCs may choose to issue bonds in the international bond market because
a. They may be able to attract stronger demand by issuing their bonds in a particular foreign
country rather than in their home country.
b. They may prefer to finance a specific foreign project in a particular currency and therefore
may attempt to obtain funds where that currency is widely used.
c. Financing in a foreign currency with a lower interest rate may enable an MNC to reduce its
financing costs.
d. All of the above
25. A bond sold in countries other than the country represented by the currency denominating it
is known as a
a. Eurobond.
b. Foreign bond.
c. Parallel bond.
d. Eurocredit loan.
e. Floating rate note.
26.
a.
b.
c.
d.
e.
A bond issued by a borrower foreign to the country where the bond is placed is called a
Eurobond.
Foreign bond.
Parallel bond.
Eurocredit loan.
Floating rate note.
27. Futures contracts are sold on exchanges and are consequently _____________ than forward
contracts, which can be _____________ to satisfy an MNCs needs.
a. More standardized; standardized
b. More standardized; custom-tailored
c. More custom-tailored; standardized
d. More custom-tailored; custom-tailored
e. Less standardized; custom-tailored
28. Which of the following is not a reason why an MNC may decide to issue stock in a foreign
country?
a. The market in which the stock is to be issued is highly liquid.
b. The market in which the stock is to be issued is very large, contributing to the market’s
liquidity.
c. Regulations in the market in which the stock is to be issued are more stringent than
regulations in the home market.
d. The MNC wishes to establish a global image.
e. All of the above are reasons why an MNC may decide to issue stock in a foreign country.
44
Chapter 3
The following information refers to questions 29 and 30.
A share of the ADR of the German firm Bergerschnus represents one share of this firm’s stock
that is traded on the Frankfurt Stock Exchange. The share price of Bergerschnus was 30 euros
when the Frankfurt exchange closed. When the U.S. market opens, the euro is worth $1.15.
29.
a.
b.
c.
d.
e.
The price of the ADR should be
$30.00.
$34.50.
$26.09.
$31.15.
None of the above
30.
a.
b.
c.
d.
e.
If the Bergerschnus ADR is convertible into three shares of stock, the ADR price would be
$34.50.
$78.27.
$103.50.
$93.45.
None of the above
31. An MNC’s short-term financing decisions are probably satisfied in the __________ market,
while its medium financing decisions are probably satisfied in the _________________
market.
a. International money; international credit
b. International money; international bond
c. International credit; international money
d. International bond; international credit
e. International money; international stock
32. An MNC’s long-term financing decisions are satisfied in the _________________ market
and the ___________.
a. International money; international credit
b. International money; international bond
c. International credit; international money
d. International bond; international credit
e. International bond; international stock
33.
a.
b.
c.
d.
e.
Which of the following is not true regarding electronic communications networks (ECNs)?
They have a visible trading floor.
Trades are executed by a computer network.
They have been created in many countries to match orders between buyers and sellers.
They allow investors to place orders on their computers.
All of the above are true
International Financial Markets
45
34. A year ago, Peter Allan invested in the stock of Jober, a German company. Over the last year,
the stock declined in value by 20%. However, the euro appreciated over the year by 10
percent. If Peter sold the stock today, his return would be _________.
a. –10%
b. 32%
c. –12%
d. 30%
e. None of the above
35.
a.
b.
c.
d.
e.
Which of the following is not a method that can be used to invest internationally?
Investment in MNC stocks
American depository receipts (ADRs)
World Equity benchmark Shares (WEBS)
International mutual funds
All of the above are methods that can be used to invest internationally.
Answers to Multiple Choice Problems
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
b
a
d
c
d
e
a
d
e
a
c
c
18. b
1
 ¥142.86 / $
$0.007 / ¥
19. d
$0.008 / ¥
 F $0.014 / ¥
$0.59 / F $
$1,000
 $0.1875 / DKK  $989.45
$0.1895 / DKK
13. d
$1,000
 DKK5,277.04
$0.1895 / DKK
14. a
20.
21.
22.
23.
24.
25.
26.
27.
28.
29.
c
b
e
b
d
a
b
b
c
b
30. c
$0.1895  $0.1875  106%
.
$0.1895
15. d
¥5,000,000  $0.0095 / ¥  $47,500
16. a
17. a
31.
32.
33.
34.
a
e
a
c
35. e
30  $1.15  $34.50
3  20  $1.15  $103.50
(1  .20)(1  .10)  1  12%