Question 1

A negative effective financing rate for a UK firm implies that the firm:
A) will incur a loss on the project financed with the funds.
B) paid more interest on the funds than what it would have paid if it had borrowed dollars.
C) will be unable to repay the loan.
D) none of the above

Accepted Answer

A negative effective financing rate implies that the firm effectively gained from the financing, possibly due to favorable exchange rate movements, rather than incurring a loss or being unable to repay the loan.

Question 2

Kushter ltd would like to finance in euros. European interest rates are currently 4%, and the euro is expected to depreciate by 2% over the next year. What is Kushter's effective financing rate next year?
A) 1.92%
B) 2.00%
C) 6.08%
D) None of the above

Accepted Answer

The effective financing rate is the interest rate adjusted for the expected change in the exchange rate. In this case, the interest rate is 4% and the euro is expected to depreciate by 2%. This means that the effective financing rate is 4% - 2% = 2%.

Question 3

Cameron plc would like to simultaneously borrow Japanese yen (¥) and Sudanese dinar (SDD) for a six-month period. Cameron would like to determine the expected financing rate and the variance of a portfolio consisting of 30 per cent yen and 70 per cent dinar. Cameron has gathered the following information: Mean effective financing rate of Japanese yen for six months 4 per cent Mean effective financing rate of Sudanese dinar for six months 1 per cent Standard deviation of Japanese yen's effective financing rate 0.10 Standard deviation of Sudanese dinar's effective financing rate 0.20 Correlation coefficient of effective financing rates of these two currencies 0.23 What is the expected financing rate of the portfolio contemplated by Cameron plc?
A) 3.10%
B) 1.90%
C) 17.00%
D) 13.00%
E) None of the above

Accepted Answer

The expected financing rate of the portfolio is calculated as a weighted average of the individual financing rates: (0.30 * 4%) + (0.70 * 1%) = 1.90%.

Question 4

If interest rate parity exists, the attempt to finance with a foreign currency while covering the position to avoid exchange rate risk will result in an effective financing rate that is ____ the domestic interest rate.
A) lower than
B) greater than
C) similar to
D) none of the above

Accepted Answer

According to interest rate parity, the effective financing rate in a foreign currency should be similar to the domestic interest rate after adjusting for the exchange rate. This is because any potential gains from borrowing in a lower interest rate currency would be offset by potential losses from the currency exchange. Therefore, the effective financing rate should be similar to the domestic interest rate.

Question 5

Assume that the UK interest rate is 11 per cent while the interest rate on euro is 7 per cent. If euros are borrowed by a UK firm, they would have to ____ against the pound by ____ in order to have the same effective financing rate from borrowing pounds.
A) depreciate; about 3.74%
B) appreciate; about 3.74%
C) appreciate; about 4.53%
D) depreciate; about 4.53%

Accepted Answer

The answer of Assume that the UK interest rate is...

Question 6

Assume the annual British interest rate is above the annual US interest rate. Also assume the dollar's forward rate in pounds equals the dollar's spot rate. Given this information, interest rate parity ____ exist, and the US firm ____ lock in a lower financing cost by borrowing pounds for one year.
A) does; could
B) does; could not
C) does not; could not
D) does not; could

Accepted Answer

The answer of Assume the annual British interest rate is...

Question 7

Assume that interest rate parity holds between the UK and Cyprus. The UK one-year interest rate is 7 per cent and the Cyprus one-year interest rate is 6 per cent. What is the approximate effective financing rate of a one-year loan denominated in Cyprus pounds assuming that the MNC covered its exposure by purchasing pounds one year forward?
A) 6%.
B) 7%.
C) 1%.
D) Cannot answer without more information

Accepted Answer

The answer of Assume that interest rate parity holds between...

Question 8

Assume that the Swiss franc has an annual interest rate of 8 per cent and is expected to depreciate by 6 per cent against the pound. From a UK perspective, the effective financing rate from borrowing francs is:
A) 8%.
B) 14.48%.
C) -2%.
D) 1.52%.

Accepted Answer

The effective financing rate is calculated by adjusting the interest rate for the expected depreciation. The formula is: Effective Rate = (1 + Interest Rate) * (1 + Depreciation Rate) - 1. Here, it is (1 + 0.08) * (1 - 0.06) - 1 = 1.08 * 0.94 - 1 = 1.0152 - 1 = 0.0152 or 1.52%.

Question 9

The effective financing rate:
A) adjusts the nominal interest rate for inflation over the period of concern.
B) adjusts the nominal interest rate for the change in the spot exchange rate over the period of concern.
C) adjusts the nominal rate for a change in foreign interest rates over the period of concern.
D) adjusts the nominal rate for the forward discount (or premium) over the period of concern.

Accepted Answer

The answer of The effective financing rate:
A) adjusts the nominal...

Question 10

Assume that interest rate parity exists, and there are zero transactions costs. If the forward rate consistently underestimates the future spot rate, then:
A) on average, the foreign effective financing rate is greater than the domestic interest rate.
B) on average, the foreign effective financing rate is less than the domestic rate.
C) the foreign effective financing rate exceeds the domestic interest rate when its forward rate exhibits a discount and is less than the domestic interest rate when its forward rate exhibits a premium.
D) the foreign effective financing rate is less than the domestic interest rate when its forward rate exhibits a discount and exceeds the domestic interest rate when its forward rate exhibits a discount.

Accepted Answer

If the forward rate underestimates the future spot rate, it implies that the foreign currency is expected to appreciate. This means that borrowing in foreign currency would result in a higher effective financing rate compared to the domestic interest rate.

Question 11

If interest rate parity exists and transactions costs are zero, foreign financing with a simultaneous forward purchase of the currency borrowed will result in an effective financing rate that is:
A) less than the domestic interest rate.
B) greater than the domestic interest rate.
C) equal to the domestic interest rate.
D) greater than the domestic interest rate if the forward rate exhibits a premium and less than the domestic interest rate if the forward rate exhibits a discount.

Accepted Answer

If interest rate parity holds and there are no transaction costs, the forward exchange rate should be such that the domestic interest rate and the foreign interest rate equalize. So, the effective financing rate will be equal to the domestic interest rate.

Question 12

Assume Jelly ltd, a UK-based MNC, obtains a one-year loan of 1,500,000 Malaysian ringgit (MYR) at a nominal interest rate of 7 per cent. At the time the loan is extended, the spot rate of the ringgit is £0.14. If the spot rate of the ringgit in one year is £0.16, the pound amount initially obtained from the loan is £____, and £____ are needed to repay the loan.
A) 210,000; 256,800
B) 210,000; 375,100
C) 6,000,000; 5,357,143
D) 5,357,143; 6,000,000

Accepted Answer

The pound amount initially obtained from the loan is calculated as 1,500,000 MYR * £0.14 = £210,000. The amount needed to repay the loan is 1,500,000 MYR * (1 + 0.07) * £0.16 = £256,800.

Question 13

A firm without any exposure to foreign exchange rates would likely increase this exposure the most by:
A) borrowing domestically.
B) borrowing a portfolio of foreign currencies that are not highly correlated.
C) borrowing a portfolio of foreign currencies that are highly correlated.
D) borrowing two foreign currencies that are negatively correlated.

Accepted Answer

The answer of A firm without any exposure to foreign...

Question 14

One reason an MNC may consider foreign financing is that the proceeds could be used to offset a foreign net payables position.

Accepted Answer

The answer of One reason an MNC may consider foreign...

Question 15

MNCs may be able to lock in a lower cost from financing in a low interest rate foreign currency if they:
A) have future cash inflows in that foreign currency.
B) have future cash outflows in that foreign currency.
C) have offsetting future cash inflows and outflows in that foreign currency.
D) have no other cash flows in that foreign currency.

Accepted Answer

The answer of MNCs may be able to lock in...

Question 16

Assume the UK financing rate is 10 per cent and that the financing rate in Germany is 9 per cent. An MNC would be indifferent between financing in pounds and financing in euros next year if the euro is expected to ____.
A) appreciate by 0.92%
B) depreciate by 0.92%
C) appreciate by 1.00%
D) depreciate by 1.00%

Accepted Answer

The MNC would be indifferent if the cost of financing in both currencies is the same. The UK rate is 10%, and the German rate is 9%. To equalize the cost, the euro must appreciate by the difference in rates, which is 1% (10% - 9%). The formula for appreciation is (1 + foreign rate) / (1 + domestic rate) - 1, which gives approximately 0.92% appreciation.

Question 17

Euronotes are underwritten by:
A) European central banks.
B) commercial banks.
C) the International Monetary Fund.
D) the Federal Reserve System.

Accepted Answer

Euronotes are typically underwritten by commercial banks, who act as intermediaries between investors and the issuer.

Question 18

Assume a UK-based MNC is borrowing Romanian leu (ROL) at an interest rate of 8 per cent for one year. Also assume that the spot rate of the leu is £0.00007 and the one-year forward rate of the leu is £0.00005. The expected spot rate of the leu one-year from now is £0.00006. What is the effective financing rate (to the nearest percent) for the MNC assuming it borrows leu on a covered basis?
A) 10%.
B) -23%.
C) -1%.
D) 1%.
E) None of the above

Accepted Answer

The answer of Assume a UK-based MNC is borrowing Romanian...

Question 19

If interest rate parity exists, financing with a foreign currency may still be feasible, but it would have to be conducted on an uncovered basis (i.e., without use of a forward hedge).

Accepted Answer

If interest rate parity exists, the forward exchange rate should adjust to reflect the difference in interest rates between two currencies. Therefore, financing with a foreign currency on an uncovered basis should not result in any advantage or disadvantage as compared to financing with the domestic currency.

Question 20

If interest rate parity exists, and the forward rate is an accurate estimator of the future spot rate, the foreign financing rate will be ____ the home financing rate.
A) lower than
B) greater than
C) similar to
D) none of the above

Accepted Answer

Interest rate parity implies that the interest rate differential between two countries is equal to the percentage difference between the forward rate and the spot rate. If the forward rate is an accurate estimator of the future spot rate, then the interest rate differential will be zero, and the foreign financing rate will be similar to the home financing rate. This means there is no advantage or disadvantage to financing in one currency or another.

Quiz 18: Short-Term Financing

A negative effective financing rate for a UK firm implies that the firm:

Kushter ltd would like to finance in euros. European interest rates are currently 4%, and the euro is expected to depreciate by 2% over the next year. What is Kushter's effective financing rate next year?

If interest rate parity exists, the attempt to finance with a foreign currency while covering the position to avoid exchange rate risk will result in an effective financing rate that is ____ the domestic interest rate.

Assume that the UK interest rate is 11 per cent while the interest rate on euro is 7 per cent. If euros are borrowed by a UK firm, they would have to against the pound by in order to have the same effective financing rate from borrowing pounds.

Assume the annual British interest rate is above the annual US interest rate. Also assume the dollar's forward rate in pounds equals the dollar's spot rate. Given this information, interest rate parity exist, and the US firm lock in a lower financing cost by borrowing pounds for one year.

Assume that the Swiss franc has an annual interest rate of 8 per cent and is expected to depreciate by 6 per cent against the pound. From a UK perspective, the effective financing rate from borrowing francs is:

The effective financing rate:

Assume that interest rate parity exists, and there are zero transactions costs. If the forward rate consistently underestimates the future spot rate, then:

If interest rate parity exists and transactions costs are zero, foreign financing with a simultaneous forward purchase of the currency borrowed will result in an effective financing rate that is:

A firm without any exposure to foreign exchange rates would likely increase this exposure the most by:

One reason an MNC may consider foreign financing is that the proceeds could be used to offset a foreign net payables position.

MNCs may be able to lock in a lower cost from financing in a low interest rate foreign currency if they:

Assume the UK financing rate is 10 per cent and that the financing rate in Germany is 9 per cent. An MNC would be indifferent between financing in pounds and financing in euros next year if the euro is expected to ____.

Euronotes are underwritten by:

If interest rate parity exists, financing with a foreign currency may still be feasible, but it would have to be conducted on an uncovered basis (i.e., without use of a forward hedge).

If interest rate parity exists, and the forward rate is an accurate estimator of the future spot rate, the foreign financing rate will be ____ the home financing rate.