International Finance Essay Questions:
Answering these questions fully, using both the notes and book as a resource, will go a
long way to develop the knowledge expected of you in this course, and prepare you for
the exams. Feel free to go beyond the reading material to internet sources. Answering
these questions will also provide you the richness of knowledge necessary to interview
well.
Lecture 1
1. Describe the characteristics of a Multinational Corporation, any
advantages/drawbacks, and give examples. What reasons does the author of your
text give for becoming a multinational corporation?
2. Give some examples of Market Imperfections, and discuss how they interfere
with the optimality of free trade. Also discuss how multi-national corporations
can get around these imperfections, or use them to their advantage in competing
against domestically oriented firms.
3. What is a VAT? Why is it driving jobs and manufacturing out of the United
States to countries overseas? What does the US have to do to correct the problem,
and why are we not doing that? Also, what international agreement is giving the
VAT this effect, what is the purpose of that agreement?
4. Discuss the Exchange Rate, Market, and Legal/Political risks that foreign
investors confront.
5. Explain the theory of Comparative Advantage, and its implication for production
and trade. Are there some countries that have no comparative advantage? What
happens if two countries have exactly the same skill, technology, and labor costs?
How could comparative advantage explain the overseas shift of manufacturing
and the outsourcing of labor? Does it provide the sole explanation, or are there
other causes? (If so, discuss.)
6. Discuss key events leading to globalization of our markets, and why they are
significant. (Particularly rely on the book and external sources beyond the notes
for this.)
7. Discuss the formation of the European Union, and the introduction of the Euro.
Discuss the key legal and financial steps did they take to achieve the EU and enter
into a common currency, and the challenges they faced (include a timeline).
8. What are the advantages to being in the EU and adopting the Euro (two separate
issues)? What are the chief drawbacks (EU and Euro, economic and political)?
Why hasn’t England, Norway, Sweden, or Switzerland adopted the Euro? Which
are EU members, and why did the others not join the EU?
9. What would be the advantages and disadvantages to the US entering into a similar
union with Mexico and Canada? (This is known as the North American Trade
Union, this you may have to Google. A book, titled “The Late Great USA” by
Corsi, discusses some of the issues in detail.) Who are the principle beneficiaries
of NATU (e.g. countries/categories—workers, so on), who can it hurt? Why?
10. What is the traditional gold standard, how does it differ from our current
monetary system, and how does it work to resolve trade imbalances? Give an
example. What are the advantages to being on a gold standard and what are the
drawbacks? What is the implication for exchange rates (or the exchange rate
system), when two nations are on a gold standard?
11. What was the difference between the traditional gold standard and the Bretton
Woods (BW) system? Why did BW fail and when? When was BW put in place,
and why was it created? What were the attempt(s) to revive the BW, what finally
happened to exchange rates when it did fail? Why did they want BW to succeed,
and what problems resulted after its failure?
12. List and explain the eight (or so) exchange rate arrangements. How do central
banks enforce them (explain the mechanics of buying and selling)? In what two
basic types can we classify each of these arrangements? What are the benefits
and draw backs between these two types (explain the tradeoffs)?
13. What is the Balance of Payments (BOP), and what does it mean to have a surplus
or deficit? Can you BOP deficit/surplus under fixed exchange rates? Floating
rates? Explain how. What two primary accounts is the BOP composed of? What
account does the book specify that I’ve left out, and why am I ignoring it?
Explain what the two primary accounts are, and what having a surplus or deficit
in these accounts implies. In which account will a deficit most likely lead to a
depreciation of our currency if it is sustained over a long period of time? Why?
14. Explain using graphs and words the long-run effects of an increase in government
spending (e.g. what it does to inflation, the rate of economic growth, and the
amount of GDP/productivity that government consumes. Explain how this is
similar to the public increasing its consumption (without increasing productivity)
using graphs. Be sure to discuss what happens to Net Exports (NX).
15. Using those same graphs, explain why we grew so rapidly in the 90’s, and the
problems we now confront. Also explain why our currency has devalued since
2001.
16. Explain what would happen (using graphs) if we were to suddenly find large new
oil supplies in Alaska. Likewise, explain what would happen if terrorist attack
destroy several of our oil terminals. Discuss what would happen to the US dollar
visa vi other currencies following the attack.
17. Discuss the 2008 financial crisis, and chief contributing factors. What is the
“Credit Crunch” the book discusses, explain exactly how it might lead to a
recession, and why it does not fully explain the crisis. If we had not entered into a
war, or had we cut other spending to offset its cost, would we be in a better
position to handle the real estate crisis? Explain why. Explain how consumer
spending has contributed to the crisis.
18. Discuss the Peso Crisis and Asian Crisis. What did they have in common, and
how did they differ? Why did the Peso collapse? What two unique elements of
the Peso Crisis are not normal to most currency crises? Discuss the common
components of most crises (four), and what would be expected to occur under
floating exchange rates given similar circumstances.
Lecture 2
FX Spot Market:
19. What is the Forex or FX market, how is that market organized (e.g. exchange
etc.), who are the major participants, when and where does it operate, how is it
managed, and in what major cities is it located and what regions do these hubs
control? What is the trading volume of this market, and how is trading
conducted?
20. Where are currency derivatives traded, and what financial entities predominate in
their creation? If you wanted to find a job as a currency derivatives hedger
working with major firms, where should you look?
21. What is meant by the Bid, the Ask, and the Bid-Ask Spread? What is a long
position on a currency, and what is a short position on a currency? Does buying
the Euro forward against the Dollar constitute a long position on the Dollar or a
short position? How about the Euro? How about if I am holding Euros currently,
am I long or short the Euro? If I owe Euros, am I long or short the Euro? How
about if I expect to receive Euros in the future?
22. What is meant by the cross-exchange rate? What is the rule for any three
exchange rates? What does it mean and how does it work?
23. Explain how banks/foreign exchange dealers make money off the bid-ask spread,
and why you can have two rate quotes on any currency.
Forwards:
24. What is a forward contract, the forward rate, and what two things does the
forward rate do? Where and with whom can you get into a forward contract?
What do we mean when we say that the bank “builds in a premium”? What do I
mean by the true, or theoretical, forward rate? What is the difference between
how a bank builds in a premium when you are buying a currency forward vs.
selling a currency forward? Give an example, use the Peso. Assume the “true”
forward rate should be 10P/$. Repeat, assuming a true rate of $.10/P.
25. Using words, graphs, and calculations, explain the exchange rate risk from owing
10,000,000P due 6 months from now, and how you would hedge that obligation.
Graphically, show the profit-loss diagram from that obligation in terms of a
currency appreciation, depreciation. Assume that the true forward rate is $.10/P.
Explain how you would hedge that obligation using a forward contract; indicate
what currency you would buy or sell.
26. Repeat the previous question assuming that you are expecting to receive 10
million Pesos.
27. Explain the advantages and disadvantages to entering into a forward contract, and
how you make or lose money by taking a naked position on one. Discuss issues
of liquidity and your ability to tailor the contract to your needs in terms of
delivery date and amount covered.
28. Explain what the Forward Premium or Discount means.
PPP/RER/CIPC
29. Explain what PPP is, what it assumes, why these assumptions means it may not
hold in the real world, and when it tends to hold and why. Discuss crucial reasons
it will tend to break down. Give evidence that it tends to work (see book).
30. Explain what the Real Exchange Rate is, and how it is different from PPP. What
is the implication for the Real Exchange Rate if PPP holds? Explain why.
31. What does interest rate parity (CIPC) imply for the “true” forward rate? Explain
why this is the case (give an intuitive explanation or example as to why it holds).
32. Explain what the fisher equation is, and why it implies the Forward rate can be
written in terms of a ratio of the inflation rates (use algebra). What is the
fundamental assumption you must make for this to be true?
33. Now explain fully what the forward rate tells you.
34. Discuss how exchange rates tend to move (study text as well as notes).
Lecture 3
Futures:
35. What is a futures contract—exactly? How is it structurally similar to a forward
contract (be specific)? How is it structurally different (again be specific)?
Conceptually, how are futures likened to forwards, and why? What weaknesses
in the forward contract does it address?
36. How can you fix the value in dollar terms of a million pesos being paid to you six
months from now using futures? How is this similar to hedging with a forward
contract? How (using futures) are the mechanics of hedging different? Assume
each peso futures contract covers 500,000 pesos.
37. Repeat the previous problem assuming that you owe 10,000,000 peso six months
from now.
38. What is meant by mark-to-market daily? Imagine you buy a futures contract at a
price of $1.29 per Euro, hold it for 4 days, and close the contract. Show using
your own numbers that whether the price increases or decreases, you net the same
gains or losses as if you instead bought the Euro forward at that price.
39. Why do we base the gains or losses on our naked position on the true forward
rate, when hedging with futures? Why do we have the forward rate in our tables?
40. Why does the futures price always converge to the spot price upon the maturity of
the futures contract? What is basis risk? Do you have basis risk if you hold a
futures contract to maturity? Explain.
41. How do firms get themselves in trouble in hedging with futures contracts, and
what is the greatest danger from hedging with futures? Explain the other risk
from hedging with futures in comparison with using forward contracts.
Euro-Currency Markets:
42. What do we mean by Euro-currency Market, and what financial instruments does
that term collectively describe? Does only Euro denominated instruments
available in this market, or are instruments in other currencies? Discuss why
these markets exist, the scope and size of the market, where they are located, and
who participates in them? What is Libor? How do I access this market, look it up
in the book.
43. What agreements govern international banking, and what are the principle tenants
of those agreements? Who are the signatory countries and what is meant by the
term “off-shore markets”? Where are these markets located, and why do they
exist? Who regulates the offshore markets?
International Bond Markets:
44. Discuss the reasons the international bond markets exist. (Go beyond the
summary in my notes and study your text.)
45. Describe the different types of international bonds, explain how they are different,
and give examples. What general type predominates in Euro-bond markets?
46. Explain the difference between fixed rate (coupon), floating, zero’s and dual
currency bonds, and explain how each bond provides a return to investors. Is a
dual currency bond a zero or a coupon bond? What rate are floaters typically
indexed to in the Euro-bond markets? Why do floaters remain much closer to par
value than their fixed rate counterpart?
47. Explain what the yield to maturity (YTM) is, what the current yield is, and why
the current yield approaches the YTM the longer the maturity of the bond. In
general, explain what must be done to convert yield of a bond from one currency
to another, and how you should go about comparing two bonds issued in different
currencies. Discuss what you can do if you don’t know the inflation rates for
those currencies.
International Equity Markets
48. In what areas are the world’s most heavily capitalized and most highly traded
stock markets located? List in descending order.
49. What is meant by the Primary Market? What meant by the Secondary Market?
Who participates in these markets and how are they organized? How are issues
transacted in these markets? What different purposes do these markets serve?
50. List the types of exchanges and how they work. (Again, refer to your text.) What
is meant by cross-listing?
51. Explain what an ADR is, and the difference, benefits, and drawbacks from
holding corresponding shares of foreign stock. What is the advantage of owning
globally registered shares?
52. Explain what the portfolio frontier is, and the potential advantages to including
foreign stocks in your investment portfolio. Explain in terms of the frontier.
Lecture 4
Options:
53. Explain why the options/futures markets are nearly unlimited in size, and who
creates the contracts. Why is an exchange necessary for these markets? Discuss
how these markets work (see the book).
54. What exactly is the definition of a Call option? Why is the diagram sloped up and
to the right? Is owning a call like a long or short position? Using diagrams for a
long/short positions on forward/futures contract on a foreign currency, show why.
55. Repeat the above for a Put option.
56. What is meant by Intrinsic Value and Time Value? Conceptually, how is the
option premia determined? Under what circumstances can the price of an
American option exceed the price of a European option? Explain using a graph.
Does this apply to currency options?
57. What is the payoff diagram, the profit-loss diagram, and how is the payoff
diagram used to construct the profit-loss diagram?
58. Which option do you use to hedge an obligation (call or put)? Why? Do you
want the option to expire in the money? Explain. Does the option premia
increase or decrease your effective exchange rate? What is the potential
drawback of using an option with a strike above the forward rate? Below it?
Explain. (Play with some numbers to think through the issues.)
59. Repeat the previous question for hedging a revenue.
60. What factors determines an option’s price and when are you most likely to hedge
with options versus using forwards/futures? Discuss the crucial issues.
Swaps:
61. Explain the difference between an interest rate swap, exchange rate swap, and
parallel loan.
62. In general what is the structure of a swap? Why do firms enter into them?
63. What is comparative advantage, and when it exists, how is it that firms can use a
swap to save money? Explain the mechanics of how it is done.
64. How does a bank make money when arranging a swap? (Note: while this is
illustrated in the notes for an interest rate swap, it also applies to exchange rate
swaps.)
65. What is our “simplest rule” for valuing a currency swap, and why is a currency
swap like entering into a series of forward contracts? Explain the mechanics of
determining the correct swap rate.
66. What is the Notional Amount, and how is it used in defining swap payments?
Suppose that you have a swap based on a notional amount of 5,000,000E, and a
swap rate of $1.40/E. The day the swap occurs, the Euro interest rate 1% and the
US rate is 1.2%. Explain what the rates would be.
67. What is meant by a principle and interest swap?
Lecture 5
Hedging Comparison:
68. Explain why we hedge in both theoretical and practical terms.
69. Discuss the tradeoffs, strengths and weakness, in using each hedging contract
(Forward vs. Futures vs. Option vs. Swap). Discuss when you would select one
contract over another.
70. Discuss the payment mechanisms, and the process of conducting an import-export
deal. (Review the text, my notes only give a brief summary)
71. Explain what wire netting is, and why any retard should be able to do it.
72. Discuss what counter-trade is, and what off-sets are.
73. Discuss what transfer pricing is, and how we can use it to circumvent taxes or
repatriation restrictions.
Lecture 6
(Yeah! My last f…ing lecture! You don’t know how much time it took to write these
damn questions.)
74. Explain the difference between transaction, translation, and economic risk (asset
exposure and operating exposure). Which is easiest to hedge and why?
75. What’s the chief problem in hedging operating risk? What role do financial
derivatives play? How should you use them? How could you get yourself in
trouble hedging operating risk? Give an example.
76. What is the chief problem in hedging Translation risk? What should be your
approach in general (think in terms of steps)? Is there any role for financial
derivatives in hedging this risk? How can you get yourself in trouble? Give an
example.
77. Explain what contingent exposure is and how we might hedge it? What is the
problem when using forwards, futures, or swap contracts to hedge this risk? Do
we need necessarily need to hedge the accounting dollar value of the CF’s when
hedging this risk, or hedge the cash-flows out to their expected maturity? If not,
explain how you would minimize the size and cost of the hedging position.
78. Explain what cross-hedging is, and when you might do it. Is there remaining risk
after implementing a cross-hedge? If so, can you eliminate this risk? Explain
how.
79. What is money market hedging? Explain.
80. What is netting of cash-flows, and how can it be used for hedging?