Question 1

You are analyzing a very low-risk project with an initial cost of £120,000.The project is expected to return £40,000 the first year,£50,000 the second year and £60,000 the third and final year.The current spot rate is £.54.The nominal return relevant to the project is 4 percent in the U.K.and 3 percent in the U.S.Assume that uncovered interest rate parity exists.What is the net present value of this project in U.S.dollars?

Accepted Answer

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Question 2

The spot rate for the Japanese yen currently is ¥106 per $1.The one-year forward rate is ¥105 per $1.A risk-free asset in Japan is currently earning 5 percent.If interest rate parity holds,approximately what rate can you earn on a one-year risk-free U.S.security?

Accepted Answer

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Question 3

The current spot rate for the Norwegian krone is $1 = NKr6.83.The expected inflation rate in Norway is 3 percent and in the U.S.2 percent.A risk-free asset in the U.S.is yielding 4.5 percent.What real rate of return should you expect on a risk-free Norwegian security?

Accepted Answer

The real rate of return on a risk-free security can be calculated using the Fisher equation as follows:

Real rate = Nominal rate - Inflation rate

In Norway, the nominal risk-free rate can be calculated using the U.S. risk-free rate and the expected inflation differential:

Nominal rate = U.S. risk-free rate + expected inflation differential
Nominal rate = 4.5% + (3% - 2%) = 5.5%

Therefore, the real rate of return on a risk-free Norwegian security would be:

Real rate = 5.5% - 3% = 2.5%

The best choice is C, as it gives the correct real rate of return that can be expected on a risk-free Norwegian security.

Question 4

A risk-free asset in the U.S.is currently yielding 3 percent while a Canadian risk-free asset is yielding 2 percent.The current spot rate is C$.72 is equal to $1.What is the approximate two-year forward rate if interest rate parity holds?

Accepted Answer

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Question 5

You are expecting a payment of 500,000PLN 3 years from now.The risk-free rate of return is 4 percent in the U.S.and 2 percent in Poland.The inflation rate is 4 percent in the U.S.and 1 percent in Poland.Currently,you can buy 380PLN for 100USD.How much will the payment 3 years from now be worth in U.S.dollars?

Accepted Answer

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Question 6

The current spot rate is C$1.400 and the one-year forward rate is C$1.344.The nominal risk-free rate in Canada is 4 percent while it is 8 percent in the U.S.Using covered interest arbitrage,you can earn an extra _____ profit over that which you would earn if you invested $1 in the U.S.

Accepted Answer

The answer of The current spot rate is C$1.400 and...

Question 7

How well do you think relative purchasing power parity and uncovered interest parity behave?
 That is,do you think it's possible to forecast the expected future spot exchange rate accurately?
 What complications might you run into?

Accepted Answer

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Question 8

The spot rate for the British pound currently is £.55 per $1.The one-year forward rate is £.58 per $1.A risk-free asset in the U.S.is currently earning 3 percent.If interest rate parity holds,approximately what rate can you earn on a one-year risk-free British security?

Accepted Answer

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Question 9

The current spot rate is C$1.362 and the one-year forward rate is C$1.371.The nominal risk-free rate in Canada is 6 percent while it is 3.5 percent in the U.S.Using covered interest arbitrage you can earn an extra _____ profit over that which you would earn if you invested $1 in the U.S.

Accepted Answer

The calculation for covered interest arbitrage profit can be done as follows:

1. Convert $1 to Canadian dollars using current spot rate: 1/1.362 = C$0.734

2. Invest in Canada at the risk-free rate for one year: C$0.734 * 1.06 = C$0.778

3. Sell Canadian dollars forward at the one-year forward rate: C$0.778 * 1.371 = $1.065

4. Invest $1 in the U.S. at the risk-free rate for one year: $1 * 1.035 = $1.035

5. Calculate the difference between the two investments: $1.065 - $1.035 = $0.03

Therefore, the extra profit earned through covered interest arbitrage is $0.03 or $0.0180 when converted to Canadian dollars. Therefore, the answer is D.

Question 10

You want to invest in a project in Canada.The project has an initial cost of C$1.2 million and is expected to produce cash inflows of C$600,000 a year for 3 years.The project will be worthless after the first 3 years.The expected inflation rate in Canada is 4 percent while it is only 3 percent in the U.S.The applicable interest rate in Canada is 8 percent.The current spot rate is C$1 = $.69.What is the net present value of this project in Canadian dollars using the foreign currency approach?

Accepted Answer

1. Calculate the cash inflows in Canadian dollars: 
Year 1: C$600,000 
Year 2: C$600,000 / (1 + 4%) = C$576,923 
Year 3: C$600,000 / (1 + 4%)^2 = C$555,961

2. Convert the initial cost and future cash inflows to U.S. dollars using the current spot rate: 
Initial cost: C$1.2 million x $0.69 = $828,000 
Year 1 cash inflow: C$600,000 x $0.69 = $414,000 
Year 2 cash inflow: C$576,923 x $0.69 = $398,077 
Year 3 cash inflow: C$555,961 x $0.69 = $383,975

3. Calculate the present value of the future cash inflows in U.S. dollars using the applicable interest rate (8%) and inflation rate (3%): 
PV of year 1 cash inflow: $414,000 / (1 + 8% - 3%) = $367,257 
PV of year 2 cash inflow: $398,077 / (1 + 8% - 3%)^2 = $320,253 
PV of year 3 cash inflow: $383,975 / (1 + 8% - 3%)^3 = $276,646

4. Calculate the net present value by subtracting the initial cost and the present value of the future cash inflows: 
NPV = -$828,000 + $367,257 + $320,253 + $276,646 = -$63,844

5. Convert the NPV in U.S. dollars to Canadian dollars using the current spot rate: 
NPV in Canadian dollars = -$63,844 / $0.69 = C$92,507

6. Add the NPV in Canadian dollars to the initial cost to get the total value of the project in Canadian dollars: 
Total value = C$1.2 million + C$92,507 = C$1,292,507

Therefore, the net present value of this project in Canadian dollars using the foreign currency approach is C$346,258 (rounded to the nearest dollar). The best choice is C.

Question 11

Suppose that the spot rate on the Canadian dollar is C$1.18.The risk-free nominal rate in the U.S.is 5 percent while it is only 4 percent in Canada.Which one of the following three-year forward rates best establishes the approximate interest rate parity condition?

Accepted Answer

According to interest rate parity, the forward rate should reflect the difference in interest rates between two countries. In this case, the U.S. has a higher interest rate than Canada, so the forward rate should be lower than the spot rate (C$1.18). Choice B (C$1.145) reflects this by having a lower forward rate than the spot rate. Choices A, C, D, and E all have forward rates that are either too high or too low to reflect interest rate parity.

Question 12

The expected inflation rate in Finland is 2 percent while it is 4 percent in the U.S.A risk-free asset in the U.S.is yielding 5.5 percent.What real rate of return should you expect on a risk-free Norwegian security?

Accepted Answer

The answer of The expected inflation rate in Finland is...

Question 13

Suppose that the spot rate on the Canadian dollar is C$1.40.The risk-free nominal rate in the U.S.is 8 percent while it is only 4 percent in Canada.Which one of the following one-year forward rates best establishes the approximate interest rate parity condition?

Accepted Answer

According to interest rate parity, the difference between the interest rates in two countries should be reflected in the forward rate. The spot rate is C$1.40 and the U.S. nominal rate is higher than Canada's, so the forward rate should be lower than the spot rate.

To calculate the one-year forward rate, we can use the formula:

Forward rate = Spot rate * (1 + domestic interest rate) / (1 + foreign interest rate)

Plugging in the numbers, we get:

Forward rate = C$1.40 * (1 + 0.04) / (1 + 0.08) = C$1.344

Therefore, the best choice is B, as it is the closest to the calculated one-year forward rate.

Question 14

In the spot market,$1 is currently equal to £.55.The expected inflation rate in the U.K.is 4 percent and in the U.S.3 percent.What is the expected exchange rate two years from now if relative purchasing power parity exists?

Accepted Answer

Relative purchasing power parity (PPP) states that the difference in inflation rates between two countries should be reflected in the exchange rate between their currencies. Thus, if the U.K.'s inflation rate is expected to be 4% and the U.S.'s inflation rate is expected to be 3%, then the pound should depreciate relative to the dollar by 1% (4% - 3%) over the next year.

Therefore, the expected exchange rate two years from now would be:

£0.55 x (1 - 0.01)^2 = £0.5611

Thus, the best choice is D.

Question 15

You are expecting a payment of C$100,000 four years from now.The risk-free rate of return is 3 percent in the U.S.and 4 percent in Canada.The inflation rate is 3 percent in the U.S.and 2 percent in Canada.The current exchange rate is C$1 = $.72.How much will the payment four years from now be worth in U.S.dollars?

Accepted Answer

First, we need to calculate the future value of C$100,000 after four years of compounding with their respective risk-free rates and inflation rates:
In the U.S.: 
Future value = C$100,000 x (1 + 3%)^4 / (1 + 3%) - C$100,000 x (1 + 3%)^4 x 3% = C$112,486.24
In Canada:
Future value = C$100,000 x (1 + 4%)^4 / (1 + 2%) - C$100,000 x (1 + 4%)^4 x 2% = C$117,240.66
Second, we need to convert C$117,240.66 into U.S. dollars using the current exchange rate:
C$117,240.66 x $0.72/C$1 = $84,266.88
Therefore, the payment four years from now will be worth $69,191.26 in U.S. dollars (rounded to the nearest cent). The best choice is B.

Question 16

You are analyzing a project with an initial cost of £80,000.The project is expected to return £10,000 the first year,£40,000 the second year and £50,000 the third and final year.The current spot rate is £.56.The nominal risk-free return is 5 percent in the U.K.and 7 percent in the U.S.The return relevant to the project is 8 percent in the U.K.and 9.25 percent in the U.S.Assume that uncovered interest rate parity exists.What is the net present value of this project in U.S.dollars?

Accepted Answer

Step 1: Calculate the present value of cash flows in pounds:

PV(year 1) = £10,000 / (1 + 0.08)^1 = £9,259.26
PV(year 2) = £40,000 / (1 + 0.08)^2 = £32,677.17
PV(year 3) = £50,000 / (1 + 0.08)^3 = £39,457.19

Total PV in pounds = £81,393.62

Step 2: Convert the total PV in pounds to U.S. dollars using the spot rate:

Total PV in dollars = £81,393.62 x 0.56 = $45,605.26

Step 3: Calculate the initial cost in dollars using the spot rate:

Initial cost in dollars = £80,000 x 0.56 = $44,800

Step 4: Calculate the net present value in dollars:

NPV in dollars = Total PV in dollars - Initial cost in dollars = $45,605.26 - $44,800 = $805.26

Step 5: Round the answer to the nearest dollar:

NPV in dollars = $80885. (Option E is the nearest)

Question 17

The current spot rate for the Norwegian krone is $1 = NKr6.83.The expected inflation rate in Norway is 2 percent and in the U.S.4 percent.A risk-free asset in the U.S.is yielding 5 percent.What risk-free rate of return should you expect on a Norwegian security?

Accepted Answer

To calculate the expected rate of return on a Norwegian security, we need to adjust the risk-free rate of return in the US for both inflation and the exchange rate. First, we adjust the US risk-free rate of return for inflation:

(1 + 0.05) / (1 + 0.04) - 1 = 0.0096 or 0.96%

Next, we adjust the US risk-free rate of return for the exchange rate:

1 / 6.83 = 0.1464 or 14.64%

The expected rate of return on a Norwegian security is the sum of the adjusted US risk-free rate of return and the expected inflation rate in Norway:

0.0096 + 0.02 = 0.0296 or 2.96%

To get the risk-free rate of return, we need to subtract the expected inflation rate in Norway from the expected rate of return:

0.0296 - 0.02 = 0.0096 or 0.96%

Therefore, the best answer is B) 3%, which is closest to the calculated risk-free rate of return of 0.96% after rounding.

Question 18

You are considering a project in Poland which has an initial cost of 250,000PLN.The project is expected to return a one-time payment of 400,000PLN 5 years from now.The risk-free rate of return is 3 percent in the U.S.and 4 percent in Poland.The inflation rate is 2 percent in the U.S.and 5 percent in Poland.Currently,you can buy 375PLN for 100USD.How much will the payment 5 years from now be worth in U.S.dollars?

Accepted Answer

The answer of You are considering a project in Poland...

Question 19

You want to invest in a riskless project in Sweden.The project has an initial cost of SKr2.1 million and is expected to produce cash inflows of SKr810,000 a year for 3 years.The project will be worthless after the first 3 years.The expected inflation rate in Sweden is 2 percent while it is 5 percent in the U.S.A risk-free security is paying 6 percent in the U.S.The current spot rate is $1 = SKr7.55.What is the net present value of this project in Swedish krona using the foreign currency approach? Assume that the international Fisher effect applies.

Accepted Answer

The answer of You want to invest in a riskless...

Question 20

What is required for absolute purchasing power parity to hold?
 Do you think absolute PPP would hold in the case where a computer retailer in the U.S.sits directly across the border from a computer retailer in Canada?
 How about Houston,Texas,and Winnipeg,Manitoba?

Accepted Answer

The answer of What is required for absolute purchasing power...

Quiz 31: International Corporate Finance