Question 1

Suppose the spot rate on the Canadian dollar is Can$1.023.The risk-free nominal rate in the United States is 2.6 percent while it is 3.25 percent in Canada.Which one of the following 1-year forward rates best establishes the approximate interest rate parity condition?

Accepted Answer

E(S₁)= Can$1.023[1 + (0.0325 - 0.026)] = Can$1.0296

Question 2

You are expecting a payment of Can$150,000 four years from now.The risk-free rate of return is 3.9 percent in the United States and 4.6 percent in Canada.The inflation rate is 3 percent in the United States and 4.2 percent in Canada.Assume the current exchange rate is Can$1 = $.87.How much will the payment four years from now be worth in U.S.dollars?

Accepted Answer

E(S₄)= (Can$1 / $.87)[1 + (0.046 − 0.039)]⁴ = Can$1.1819/$1 Can$150,000($1 / Can$1.1819)= $126,909

Question 3

You want to invest in a riskless project in Sweden that has an initial cost of SKr428,000 and is expected to produce cash inflows of SKr231,000 a year for 2 years.The project will be worthless after 2 years.The expected inflation rate in Sweden is 1.7 percent while it is 2.6 percent in the United States.A risk-free security is paying 3.8 percent in the United States.Assume the current spot rate is $1 = SKr7.51.What is the net present value of this project in U.S dollars using the foreign currency approach?

Accepted Answer

0.038 − 0.026 = R_FC − 0.017 R_FC = 0.029 NPV = (−SKr428,000 + SKr231,000 / 1.029 + SKr231,000 / 1.0292)($1 / SKr7.51)= $1,951.11

Question 4

You want to invest in a project in Canada.The project has an initial cost of Can$318,000 and is expected to produce cash inflows of C$126,000 a year for 3 years.The project will be worthless after 3 years.The expected inflation rate in Canada is 3.2 percent.The applicable interest rate in Canada is 12.7 percent.Assume the current spot rate is Can$1 = $1.12.What is the net present value of this project in U.S.dollars using the foreign currency approach?

Accepted Answer

NPV = (−Can$318,000 + Can$126,000 / 1.127¹ + Can$126,000 / 1.127² + Can$126,000 / 1.127³)($1.12 / Can$1)= −$21,249

Question 5

The expected inflation rate in Finland is 3.67 percent while it is 2.45 percent in the United States.A risk-free asset in the United States is yielding 3.21 percent.What real rate of return should you expect on a risk-free Finnish security?

Accepted Answer

0.0321 − 0.0245 = R_FC - 0.0367 R_FC = 0.0443,or 4.43%

Question 6

Assume today you can exchange $1 for €.8026,while 1 month ago €1 was worth $1.2272.Assume you converted €300 into dollars last month and then converted your dollars back to euros this week.What is your net profit or loss in euros?

Accepted Answer

[€300($1.2272 / €1)(€.8026 / $1)] − €300 = −€4.51

Question 7

Assume the current spot rate is Can$.9892 and the 1-year forward rate is Can$.9901.The nominal risk-free rate in Canada is 3.8 percent while it is 3.9 percent in the U.S.If you use covered interest arbitrage,how much extra profit can you earn over that which you would earn if you invested $100 in the U.S.for one year?

Accepted Answer

Profit = [$100(Can$.9892 / $1)(1.038)($1 / Can$.9901)] − ($100 × 1.039)= −$.19

Question 8

Assume the spot exchange rate is £.7024.The expected inflation rate in the United Kingdom is 1.8 percent and in the United States it is 2.4 percent.What is the expected exchange rate 3 years from now if relative purchasing power parity exists?

Accepted Answer

E(S₃)= £.7024[1 + (0.018 - 0.024)]³ = £.6898

Question 9

Assume the current spot rate for the Norwegian krone is $1 = NKr7.0305.The expected inflation rate in Norway is 2.6 percent,and in the United States its 1.3 percent.A risk-free asset in the U.S.is yielding 2.2 percent.What risk-free rate of return should you expect on a Norwegian security?

Accepted Answer

0.022 − 0.013 = R_FC − 0.026 R_FC = 0.035,or 3.5%

Question 10

You are expecting a payment of €630,000 three years from now.The risk-free rate of return is 3.4 percent in the United States and 2.9 percent in Euroland.The inflation rate is 2.5 percent in the United States and 2.1 percent in Euroland.Assume you can currently buy €82 for $100.How much will the payment 3 years from now be worth in U.S.dollars?

Accepted Answer

E(S₃)= (€82 / $100)[1 + (0.029 − 0.034)]³ = €.8078/$1 €630,000($1 / €.8078)= $779,933

Question 11

Assume the spot exchange rate is A$.8629.The expected inflation rate is 2.8 percent in Australia and 3.4 percent in the United States.What is the expected exchange rate one year from now if relative purchasing power parity exists?

Accepted Answer

E(S₁)≈ A$.8629[1 + (0.028 − 0.034)] ≈ A$.8577

Question 12

Assume the inflation rate in the United States is 2.8 percent.The spot rate for a foreign currency is 1.6349 while the 3-year forward rate is 1.7084.What is the approximate rate of inflation in the foreign country?

Accepted Answer

1.7084 = 1.6349[1 + (h_FC − 0.028)]³ h_FC = 0.0428 or 4.28%

Question 13

Assume a risk-free asset in the United States is currently yielding 2.14 percent while a Canadian risk-free asset is yielding 2.57 percent.The current spot rate is Can$.9894.What is the approximate 3-year forward rate if interest rate parity holds?

Accepted Answer

E(S₃)= Can$.9894[1 + (0.0257 − 0.0214)]³= Can$1.0022

Question 14

Assume the spot rate for the British pound is currently £.1.5604 while the 1-year forward rate is £1.5587.A risk-free asset in the United States is currently earning 2.6 percent.If interest rate parity holds,approximately what rate can you earn on a 1-year risk-free British security?

Accepted Answer

£1.5587 / £1.5604= (1 + R_Fc)/ (1 + 0.026) R_FC = 0.0249,or 2.49%

Question 15

Assume the spot rate for the Japanese yen currently is ¥111.04 per $1.The 1-year forward rate is ¥111.62 per $1.Also assume a risk-free asset in Japan is currently earning 3.4 percent.If interest rate parity holds,approximately what rate can you earn on a 1-year risk-free U.S.security?

Accepted Answer

¥111.62 / ¥111.04 ≈ (1 + .034)/ (1 + R_US) R_US = 0.0286,or 2.86%

Question 16

You are considering a project in India which has an initial cost of 250,000RS.The project is expected to return a one-time payment of 425,000RS 5 years from now.The risk-free rate of return is 2.7 percent in the United States and 4.3 percent in India.The inflation rate is 2.2 percent in the United States and 5.3 percent in India.Currently,you can buy 6,300RS for $100.How much will the payment 5 years from now be worth in U.S.dollars?

Accepted Answer

RS/$ = (6,300RS / $100)[1 + (0.043 − 0.027)]⁵ = 68.2039RS/$ 425,000RS($1 / 68.2039RS)= $6,231

Question 17

Assume the expected inflation rate in the United States its 2.8 percent while a risk-free asset in the United States is yielding 3.5 percent.A similar asset in Norway earns a rate of 4.8 percent.What is the inflation rate in Norway if the international Fisher effect applies?

Accepted Answer

0.035 - 0.028 = 0.048 - h_FC h_FC = 0.041,or 4.1%

Question 18

Assume the current spot rate is Can$1.0267 and the 1-year forward rate is C$1.0259.The nominal risk-free rate in Canada is 2.5 percent while it is 2.1 percent in the United States.If you use covered interest arbitrage,how much extra profit can you earn over that which you would earn if you invested $1,000 in the United States for 1 year?

Accepted Answer

Profit = [$1,000(Can$1.0267 / $1)(1.025)($1 / Can$1.0259)] − ($1,000 × 1.021)= $4.80

Question 19

Assume today you can exchange $1 for £.7998,while last week £1 was worth $1.2506.Also assume you converted £500 into dollars last week and then converted your dollars back to pounds this week.What is your net profit or loss in pounds?

Accepted Answer

[£500($1.2506/£1)(£.7998/ $1)] − £500 = £.1149

Quiz 20: International Corporate Finance