Question 1

A U.S.-based company, Stewart, Inc., arranged a 2-year, $1,000,000 loan to fund a project in Mexico.The loan is denominated in Mexican pesos, carries a 10.0% nominal rate, and requires equal semiannual payments.The exchange rate at the time of the loan was 5.75 pesos per dollar, but it dropped to 5.10 pesos per dollar before the first payment came due.The loan was not hedged in the foreign exchange market.Thus, Stewart must convert U.S.funds to Mexican pesos to make its payments.If the exchange rate remains at 5.10 pesos per dollar through the end of the loan period, what effective interest rate will Stewart end up paying on the loan?

Accepted Answer

1. Calculate the amount of the loan in pesos: 1,000,000 x 5.75 = 5,750,000 pesos
2. Calculate the semiannual payment in pesos: 5,750,000 / 4 = 1,437,500 pesos
3. Calculate the semiannual payment in dollars at the original exchange rate: 1,437,500 / 5.75 = $250,000
4. Calculate the semiannual payment in dollars at the current exchange rate: 1,437,500 / 5.10 = $282,353. This is the amount that Stewart needs to pay each period in dollars.
5. Calculate the effective interest rate based on the actual payments made: 
PV = $1,000,000
PMT = -$282,353
n = 4
FV = 0
Solve for I/Y = 10.895%
The effective interest rate is therefore 10.895% or 21.79% per annum. The correct answer is E.

Question 2

Tashakori Trucking, a U.S.-based company, is considering expanding its operations into a foreign country.The required investment at Time = 0 is $10 million.The firm forecasts total cash inflows of $4 million per year for 2 years, $6 million for the next 2 years, and then a possible terminal value of $8 million.In addition, due to political risk factors, Tashakori believes that there is a 50% chance that the gross terminal value will be only $2 million and a 50% chance that it will be $8 million.However, the government of the host country will block 20% of all cash flows.Thus, cash flows that can be repatriated are 80% of those projected.Tashakori's cost of capital is 15%, but it adds one percentage point to all foreign projects to account for exchange rate risk.Under these conditions, what is the project's NPV?

Accepted Answer

First, calculate the net cash inflows after the 20% blockage: Years 1-2: $4 million * 80% = $3.2 million per year. Years 3-4: $6 million * 80% = $4.8 million per year. The expected terminal value is calculated as the average of the two possible outcomes, weighted by their probabilities: (0.5 * $2 million + 0.5 * $8 million) * 80% = $4 million. The adjusted cost of capital is 15% + 1% = 16%. Using these figures, the NPV can be calculated as follows: NPV = -$10 million + ($3.2 million / (1+0.16)^1) + ($3.2 million / (1+0.16)^2) + ($4.8 million / (1+0.16)^3) + ($4.8 million / (1+0.16)^4) + ($4 million / (1+0.16)^4) = $2.77 million.

Question 3

Because political risk is seldom negotiable, it cannot be explicitly addressed in multinational corporate financial analysis.

Accepted Answer

Political risk can be explicitly addressed in multinational corporate financial analysis through various measures such as risk management strategies and analysis of the political situation in the country of operation.

Question 4

The cost of capital may be different for a foreign project than for an equivalent domestic project because foreign projects may be more or less risky.

Accepted Answer

The cost of capital calculation incorporates the risk associated with a project, and the risk may be different for a foreign project than a domestic project. This could be due to factors such as political, economic, legal, or cultural differences. Therefore, the cost of capital for a foreign project may be different than for an equivalent domestic project.

Question 5

LIBOR is an acronym for London Interbank Offer Rate, which is an average of interest rates offered by London banks to smaller U.S.corporations.

Accepted Answer

LIBOR is an average of interest rates offered by London banks to other large banks. It is not specifically for smaller U.S. corporations.

Question 6

Suppose Stackpool Inc.had inventory in Britain valued at 240,000 pounds one year ago.The exchange rate for dollars to pounds was 1£ = 2 U.S.dollars.This year the exchange rate is 1£ = 1.82 U.S.dollars.The inventory in Britain is still valued at 240,000 pounds.What is the gain or loss in inventory value in U.S.dollars as a result of the change in exchange rates?

Accepted Answer

The inventory value in U.S. dollars one year ago was 240,000 pounds * 2 U.S. dollars/pound = $480,000. This year, the value is 240,000 pounds * 1.82 U.S. dollars/pound = $436,800. The loss in inventory value is $480,000 - $436,800 = $43,200.

Question 7

Which of the following is NOT a reason why companies move into international operations?

Accepted Answer

Moving into international operations typically involves high costs and risks, so companies are unlikely to do so solely to increase inventory levels. The other options (A, B, C, and E) are all common reasons why companies choose to expand internationally.

Question 8

Due to advanced communications technology and the standardization of general procedures, working capital management for multinational firms is no more complex than it is for large domestic firms.

Accepted Answer

Working capital management for multinational firms involves additional complexities such as foreign exchange risks, different tax laws, and cultural differences, making it more complex than for large domestic firms. While technology has improved the communication and standardization of procedures, it does not eliminate these additional challenges.

Question 9

Credit policy for multinational firms is generally more risky due in part to the additional consideration of exchange rates and also due to uncertainty regarding the credit worthiness of many foreign customers.

Accepted Answer

Multinational firms operate in multiple countries, which introduces currency risk due to fluctuations in exchange rates. In addition, the credit worthiness of foreign customers may be more uncertain compared to domestic customers, making credit policy for multinational firms more risky.

Question 10

If a dollar will buy fewer units of a foreign currency in the forward market than in the spot market, then the forward currency is said to be selling at a premium to the spot rate.

Accepted Answer

If the forward currency is selling at a higher price than the spot currency, it is considered to be at a premium. This means that the foreign currency is more expensive in the forward market than in the spot market.

Question 11

Suppose Yates Inc., a U.S.exporter, sold a consignment of antique American muscle-cars to a Japanese customer at a price of 143.5 million yen, when the exchange rate was 140 yen per dollar.In order to close the sale, Yates agreed to make the bill payable in yen, thus agreeing to take some exchange rate risk for the transaction.The terms were net 6 months.If the yen fell against the dollar such that one dollar would buy 154.4 yen when the invoice was paid, what dollar amount would Yates actually receive after it exchanged yen for U.S.dollars?

Accepted Answer

The answer of Suppose Yates Inc., a U.S.exporter, sold a...

Question 12

If an investor can obtain more of a foreign currency for a dollar in the forward market than in the spot market, then the forward currency is said to be selling at a discount to the spot rate.

Accepted Answer

When a forward currency is cheaper (in terms of domestic currency) than the spot rate, it is said to be selling at a discount. This means that an investor can buy more of the foreign currency in the forward market for a dollar than in the spot market.

Question 13

Which of the following statements is NOT CORRECT?

Accepted Answer

The term Eurobond applies to foreign bonds denominated in any currency other than the currency of the country in which it is issued. It does not apply only to U.S. currency.

Question 14

Suppose a foreign investor who holds tax-exempt Eurobonds paying 9% is considering investing in an equivalent-risk domestic bond in a country with a 28% withholding tax on interest paid to foreigners.If 9% after-tax is the investor's required return, what before-tax rate would the domestic bond need to pay to provide the required after-tax return?

Accepted Answer

To maintain a 9% after-tax return in the face of a 28% withholding tax, the before-tax interest rate needs to be calculated using the formula: required return = before-tax return * (1 - tax rate). Rearranging to solve for the before-tax return gives: before-tax return = required return / (1 - tax rate) = 9% / (1 - 0.28) = 9% / 0.72 = 12.5%.

Question 15

The cash flows relevant for a foreign investment should, from the parent company's perspective, include the financial cash flows that the subsidiary can legally send back to the parent company plus the cash flows that must remain in the foreign country.

Accepted Answer

The answer of The cash flows relevant for a foreign...

Question 16

When considering the risk of a foreign investment, a higher risk might arise from exchange rate risk and political risk while lower risk might result from international diversification.

Accepted Answer

Exchange rate risk and political risk are factors that can increase the risk of a foreign investment, while international diversification can lower the risk.

Question 17

Exchange rates influence a multinational firm's inventory policy because changing currency values can affect the value of inventory.

Accepted Answer

Exchange rates can impact the value of inventory and can influence a firm's inventory policy. For example, if a multinational firm holds inventory in a foreign currency, a change in exchange rates can affect the value of the inventory. The firm may need to adjust its inventory policy to account for currency fluctuations and minimize potential losses.

Question 18

The interest rate paid on Eurodollar deposits depends on the particular bank's lending rate and on rates available on U.S.money market instruments.

Accepted Answer

The interest rate paid on Eurodollar deposits is influenced by the particular bank's lending rate and by the rates of U.S. money market instruments, such as Treasury bills and commercial paper.

Question 19

Suppose a U.S.firm buys $200,000 worth of stereo speaker wire from a Mexican manufacturer for delivery in 60 days with payment to be made in 90 days (30 days after the goods are received).The rising U.S.deficit has caused the dollar to depreciate against the peso recently.The current exchange rate is 5.50 pesos per U.S.dollar.The 90-day forward rate is 5.45 pesos/dollar.The firm goes into the forward market today and buys enough Mexican pesos at the 90-day forward rate to completely cover its trade obligation.Assume the spot rate in 90 days is 5.30 Mexican pesos per U.S.dollar.How much in U.S.dollars did the firm save by eliminating its foreign exchange currency risk with its forward market hedge?

Accepted Answer

The firm saved $4,517.26 by eliminating its foreign exchange currency risk with its forward market hedge.The firm bought $200,000 worth of stereo speaker wire from a Mexican manufacturer for delivery in 60 days with payment to be made in 90 days (30 days after the goods are received). The current exchange rate is 5.50 pesos per U.S. dollar. The 90-day forward rate is 5.45 pesos/dollar. The firm goes into the forward market today and buys enough Mexican pesos at the 90-day forward rate to completely cover its trade obligation.The firm's total cost in U.S. dollars if it does not hedge is:$200,000 * 5.50 pesos/dollar = $1,100,000 pesosThe firm's total cost in U.S. dollars if it hedges is:$200,000 * 5.45 pesos/dollar = $1,090,000 pesosThe firm saved $10,000 by hedging.

Question 20

The threat of expropriation creates an incentive for the multinational firm to minimize inventory holdings in certain countries and to bring in goods only as needed.

Accepted Answer

The threat of expropriation can make a multinational firm cautious about investing in inventory in certain countries as there is a risk of losing those investments in the event of nationalization. As a result, the firm may bring in goods only as needed, minimizing inventory holdings.

Quiz 17: Multinational Financial Management