CHAPTER 21
INTERNATIONAL CORPORATE FINANCE
Answers to Concepts Review and Critical Thinking Questions
1.
a.
b.
c.
The dollar is selling at a premium because it is more expensive in the forward market than in the spot
market (SFr 1.53 versus SFr 1.50).
The franc is expected to depreciate relative to the dollar because it will take more francs to buy one dollar
in the future than it does today.
Inflation in Switzerland is higher than in the Canada, as are interest rates.
2.
The exchange rate will increase, as it will take progressively more euros to purchase a dollar. This is the
relative PPP relationship.
3.
a.
b.
c.
The Australian dollar is expected to weaken relative to the dollar, because it will take more A$ in the
future to buy one dollar than it does today.
The inflation rate in Australia is higher.
Nominal interest rates in Australia are higher; relative real rates in the two countries are the same.
4.
A Yankee bond is most accurately described by d.
5.
No. For example, if a country’s currency strengthens, imports become cheaper (good), but its exports become
more expensive for others to buy (bad). The reverse is true for currency depreciation.
6.
Additional advantages include being closer to the final consumer and, thereby, saving on transportation,
significantly lower wages, and less exposure to exchange rate risk. Disadvantages include political risk and
costs of supervising distant operations.
7.
One key thing to remember is that dividend payments are made in the home currency. More generally, it may
be that the owners of the multinational are primarily domestic and are ultimately concerned about their wealth
denominated in their home currency because, unlike a multinational, they are not internationally diversified.
8.
a.
b.
c.
9.
a.
b.
c.
d.
False. If prices are rising faster in Great Britain, it will take more pounds to buy the same amount of
goods that one dollar can buy; the pound will depreciate relative to the dollar.
False. The forward market would already reflect the projected deterioration of the euro relative to the
dollar. Only if you feel that there might be additional, unanticipated weakening of the euro that isn’t
reflected in forward rates today will the forward hedge protect you against additional declines.
True. The market would only be correct on average, while you would be correct all the time.
Canadian exporters: their situation in general improves because a sale of the exported goods for a fixed
number of DMs will be worth more dollars.
Canadian importers: their situation in general worsens because the purchase of the imported goods for a
fixed number of DMs will cost more in dollars.
Canadian exporters: they would generally be better off if the British government’s intentions result in a
strengthened pound.
Canadian importers: they would generally be worse off if the pound strengthens.
Canadian exporters: would generally be much worse off, because a reduction in the value of the peso will
make Canadian more expensive to consumers in Argentina.
Canadian importers: would generally be much better off. In dollar terms, goods from Argentina will
become much cheaper to buy.
Canadian exporters: would generally be much worse off, because an extreme case of fiscal expansion
like this one will make Canadian goods prohibitively expensive to buy, or else Brazilian sales, if fixed in
cruzeiros, would become worth an unacceptably low number of dollars.
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Canadian importers: would generally be much better off, because Brazilian goods will become much
cheaper to purchase in dollars.
10. IRP is the most likely to hold because it presents the easiest and least costly means to exploit any arbitrage
opportunities. Relative PPP is least likely to hold since it depends on the absence of market imperfections and
frictions in order to hold strictly.
Solutions to Questions and Problems
Basic
1.
a.
b.
c.
d.
e.
f.
g.
$100(€.7027/$1) = €70.27
$1.4231
€5M($1.4231/€) = $7,115,500
Hong Kong dollar
Mexican peso
SFr 1.5620/€; this is a cross rate.
Most valuable: U.K. pound = $2.0642
Least valuable: Japanese yen = $0.0098
2.
a.
b.
c.
£100, since (£100)($2.0642/£1) = $206.42
£100, since (£100)(€1.4501/£1) = €145.01
Euros per British pounds = €1.4501/£1; British pounds per euro = £0.6893/€1
3.
a.
F6 = ¥100.73 (per $). The yen is selling at a premium because it is more expensive in the forward market
than in the spot market ($0.0099275/¥ versus $0.0098068/¥).
F3 = $1.4280/€. The dollar is selling at a discount because it is less expensive in the forward market than
in the spot market (€0.70028/$ versus €0.70269/$).
The value of the dollar will fall relative to the yen, since it takes more dollars to buy one yen in the future
than it does today. The value of the dollar will fall relative to the euro, because it will take more dollars
to buy one euro in the future than it does today.
b.
c.
4.
a.
b.
c.
d.
e.
The U.S. dollar, since U.S.$1 = 1/0.85 = Can $1.1765
Can $2.19 = 2.19/1.1765 = U.S. $1.86. Among the reasons that absolute PPP doesn’t hold are tariffs and
other barriers to trade, transactions costs, taxes, and different tastes.
The Canadian dollar is selling at a discount, because it is less expensive in the forward market than in the
spot market (U.S. $0.82 six months forward versus U.S. $0.85 spot).
The U.S. dollar is expected to appreciate in value relative to the Canadian dollar, because it takes fewer
U.S. dollars to buy one Canadian dollar in the future than it does today.
Interest rates in the United States are probably higher than they are in Canada. This fuels additional
investment in the U.S. relative to Canada and a strengthening U.S. dollar.
5.
a.
b.
(¥107/$1)($2.29/£1) = ¥245.03/£1
The yen is quoted too high relative to the pound. Take out a loan for $1 and buy £0.436681. Use the
£0.436681 to purchase yen at the cross-rate—£0.436681(¥250/£1) = ¥109.17. Use the yen to buy back
dollars and repay the loan – ¥109.17($1/¥107) = $1.020; arbitrage profit is 2¢ per dollar used.
6.
European Union: RFC = [(€0.6985/€0.7027)](1.04) – 1 = 3.38%
Japan:
RFC = [(¥100.73 /¥101.97)](1.04) – 1 = 2.74%
Britain:
RFC = [(£0.4904/£0.4844)](1.04) – 1 = 5.29%
7.
Canada:
Great Britain:
$30M(1.0045)3 = $30,406,825.23
($30M)(£0.56/$1)(1.0060)3/(£0.59/$1) = $28,990,200.05; Invest in Canada since you end up
with more dollars. Notice that the British pound is expected to depreciate against the
Canadian dollar since it takes more pounds in three months to buy one dollar than it does
currently.
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8.
We are relying on Relative PPP: €0.73 = (€0.70)(1 + {hFC – hCAN})3 ; (0.73/0.70)1/3 – 1 = 0.01408
Inflation in Europe is expected to exceed that in Canada by about 1.41% over this period.
9.
Assuming only spot rates are used throughout we have:
No change in exchange rate: profit = 30,000[$1,500 – {(¥113,000)/( ¥101.97/$1)}] = $11,754,927.92
If the yen weakens: profit = 30,000[$1,500 – {(¥113,000)/1.1(¥101.97/$1)}] = $14,777,207.20
If the yen gets stronger: profit = 30,000[$1,500 – {(¥113,000)/0.9(¥101.97/$1)}] = $8,061,031.02
Breakeven: $1,500 = ¥113,000/ST; ST = ¥75.3333/$1; or ¥1 = $0.0133.
The initial spot exchange rate is ¥1 = $0.0098. The Japanese yen would have to be worth 35.36% more.
In this case if the Japanese yen is expected to fluctuate wildly with respect to the dollar, it would make a lot of
sense to eliminate foreign exchange risk by buying ¥3,390,000,000 = 30,000  ¥113,000 forward 90 days at
the quoted forward rate.
10. a.
b.
If IRP holds, then F6 = (Kr5.50)[1 + (.04 – .05)]1/2 = Kr5.4724
Since given F6 = Kr5.57, an arbitrage opportunity exists; the forward premium is too high.
Borrow Kr1 today at 4% interest. Agree to a 6-month forward contract at Kr5.57. Convert the loan
proceeds into dollars: $1/Kr5.50 = $0.1818 today. Invest these dollars at 5%, ending up with $0.1863.
Convert the dollars back into krone as $0.1863(Kr5.57/$1) = Kr1.0377. Repay the Kr1 loan, ending with
a profit of 1.0377 – 1.0198 = Kr0.0179. For every Kr1,000,000 transacted you would gain Kr17,933.
F6 = (Kr5.50)[1 + (.04 – .05)]1/2 = Kr5.4724
11. a.
b.
c.
hNETH = .05 + .035 – .041 = 0.044 = 4.4%
hCAN = .07 + .035 – .041 = 0.064 = 6.4%
hFRA = .10 + .035 – .041 = 0.094 = 9.4%
12. a.
The yen is expected to get stronger, since it will take fewer yen to buy one dollar in the future than it
does today.
hCAN – hJAP  (¥85 – ¥89)/¥89 = – .0449; (1 – .0449)4 – 1 = –.1680
The (very) approximate inflation differential between Canada and Japan is 16.8% annually.
b.
E[S1] = 215{1 + (.108 – .036)}1 = HUF 230.48
E[S1] = 215{1 + (.108 – .036)}2 = HUF 247.07
E[S5] = 215{1 + (.108 – .036)}5 = HUF 304.38
13. Relationship is UIP:
Intermediate
14. a.
b.
Implicitly, it is assumed that interest rates won’t change over the life of the project, but the exchange rate
is projected to decline because the Euroswiss rate is lower than the Eurodollar rate.
E[St] = (SFr 01.15)[1 + (.072 – .085)]t = 1.15(.987)t
t
0
1
2
3
4
5
c.
15.
SFr
–27.0M
+7.5M
+7.5M
+7.5M
+7.5M
+7.5M
E[St]
1.1500
1.1351
1.1203
1.1057
1.0914
1.0772
Euro$
–$23,478,260.87
6,607,638.43
6,694,669.13
6,782,846.13
6,872,184.53
6,962,699.62
NPV @ 13% = $306,881.18
RSF = 1.13(0.987) – 1 = 11.531%
NPV = -27M + 7.5M  PVIFA11.531%, 5 = SFr 352,913.35
Convert by dividing by 1.15 to get = $306,881.18 as before.
If absolute purchasing power parity holds, then the price of a Big Mac in the U.K. should be the same as the
price in the U.S. when the exchange rate is considered. Upon conversion to $U.S. a Big Mac priced at £3.50 in
the U.K. is worth:
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£3.50  1.8554 $/£ = U.S. $6.49
Since this is considerably higher than the $3.50 price of a Big Mac in the U.S., the British pound is overvalued
relative to the U.S. dollar. For the price of Big Macs in the two countries to be equal, the exchange rate would
have to be £1 = $1. Accordingly, the British pound is overvalued by 85.54%.
The big assumption here is that absolute PPP holds. Transactions costs and trade barriers generally invalidate
this assumption.
16.
a. According to the approximate version of interest rate parity (IRP):
F1 = S0  [1 + (REUR – RUS] = 0.98 €/$  [1 + (0.07 – 0.04)] = 1.0094 €/$
b. Magic Potion can hedge against its foreign exchange risk by locking in an exchange rate in the forward
market. The company could achieve this by buying enough Euros forward at the stated forward rate to
cover its required payment three months in the future.
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