Question 1

XJ Company from the United States is evaluating a proposal to build a new plant in the United Kingdom. The expected cash flows in pounds are as follows: Year 0, −50; Year 1, 25; Year 2, 35; Year 3, 40. The discount rate in BP is 14 percent and the discount rate in the $US is 12 percent. The spot rate is $US1.99/BP. Calculate the NPV in $US.

Accepted Answer

The answer of XJ Company from the United States is...

Question 2

An Australian firm is evaluating a proposal to build a new plant in the United States. The expected cash flows in $US (in millions)are as follows: Year 0, −100; Year 1, 40; Year 2, 50; Year 3, 65. The discount rate in $A is 10 percent, while the discount rate in $US is 12 percent and the spot rate is $US0.85/$A. Calculate the NPV in $A.

Accepted Answer

The correct answer is A because the NPV in $A is +25.69. The NPV is calculated as follows:NPV = -100 + 40/(1.10)^1 + 50/(1.10)^2 + 65/(1.10)^3= -100 + 36.36 + 41.82 + 50.45= +25.69

Question 3

Your U.S.-based firm is deciding between using currency futures contracts or a forward contract with its commercial bank in order to hedge a scheduled dividend from its subsidiary corporation in Germany. The dividend will be repatriated in July, while the currency futures contracts are only available for June or September delivery. Which of the following choices properly hedges the transaction without basis risk?

Accepted Answer

A forward contract to sell euros forward in July directly matches the timing of the dividend repatriation, eliminating basis risk associated with the mismatch in timing that would occur with futures contracts for June or September.

Question 4

Currency risk exposure can be categorized as

Accepted Answer

Currency risk exposure can be categorized into transaction exposure, which is the risk of losses due to fluctuations in exchange rates on a specific transaction, and economic exposure, which is the risk of losses due to fluctuations in exchange rates affecting the overall market value of a company's assets and liabilities. Therefore, both transaction and economic exposure are correct categories of currency risk exposure.

Question 5

XJ Company from the United States is evaluating a proposal to build a new plant in the United Kingdom. The expected cash flows in pounds are as follows: Year 0, −50; Year 1, 25; Year 2, 35; Year 3, 40. The discount rate in BP is 14 percent and the discount rate in $US is 12 percent. The spot rate is $US1.99/BP. Calculate the NPV of the project in BP.

Accepted Answer

The NPV in BP is calculated by discounting the cash flows at the BP discount rate of 14%. NPV = -50 + 25/(1.14) + 35/(1.14^2) + 40/(1.14^3) = +25.86.

Question 6

Political risk is can be thought of as

Accepted Answer

Political risk refers to unanticipated actions by the host government that can affect a project's cash flows. While exchange rate changes can also impact a project's financial performance, they are not necessarily related to political risk. Similarly, the World Bank does not have the power to unilaterally impact the cash flows of a specific project, so option C is not a valid definition of political risk.

Question 7

If the peso is traded at a forward discount relative to the U.S. dollar, then the U.S. dollar is also trading at a discount relative to the peso.

Accepted Answer

If the peso is trading at a forward discount relative to the U.S. dollar, it means that the peso is expected to weaken in the future compared to the U.S. dollar. Therefore, the U.S. dollar is actually trading at a premium relative to the peso, not at a discount.

Question 8

The country with the most favorable political risk score is

Accepted Answer

Norway has consistently been ranked as the country with the most favorable political risk score by various organizations such as the World Bank and the Economist Intelligence Unit. This is due to its stable political environment, low corruption rates, and strong institutions. The United States, United Kingdom, and France have all seen fluctuations in their political risk scores in recent years due to issues such as political polarization, Brexit, and terrorism threats.

Question 9

If the U.S. dollar interest rate is 4 percent and the peso interest rate is 7 percent, what is the likely one-year forward rate if the spot dollar-peso rate is peso 11/$US?

Accepted Answer

The formula for one-year forward exchange rate is:
Forward rate = Spot rate x ((1 + domestic interest rate) / (1 + foreign interest rate))^time
Here, the domestic currency is peso and the foreign currency is U.S. dollar. We are given:
Spot rate = peso 11/$US
Domestic interest rate = 7%
Foreign interest rate = 4%
Time = 1 year
Forward rate = peso 11/$US x ((1 + 0.07) / (1 + 0.04))^1 = peso 11.32/$US. Therefore, the likely one-year forward rate is 11.32.

Question 10

Interest rate parity gives the relationship between the forward rate and the spot rate of exchange in terms of interest rates.

Accepted Answer

Interest rate parity (IRP) explains the relationship between the spot exchange rate, forward exchange rate, and interest rates. It suggests that the difference between the exchange rate and interest rates in two countries should be equal to the difference between the forward exchange rate and the spot exchange rate. Therefore, the statement is true.

Question 11

An Australian firm is evaluating a proposal to build a new plant in the United States. The expected cash flows in $US (in millions)are as follows: Year 0, −100; Year 1, 40; Year 2, 50; Year 3, 65. The discount rate in $A is 10 percent, while the discount rate in $US is 12 percent and the spot rate is $US0.60/$A. Calculate the NPV of the project in $US.

Accepted Answer

The NPV in $US can be calculated using the given cash flows and the discount rate in $US. The formula for NPV is: NPV = Σ [Ct / (1 + r)^t] - C0, where Ct is the cash flow at time t, r is the discount rate, and C0 is the initial investment. Plugging in the values:NPV = -100 + (40 / (1 + 0.12)^1) + (50 / (1 + 0.12)^2) + (65 / (1 + 0.12)^3) = -100 + 35.71 + 39.93 + 46.20 = 21.84

Question 12

The risk associated with unanticipated actions by the host country government or its courts towards a multinational firm is called

Accepted Answer

The risk associated with unanticipated actions by the host country government or its courts towards a multinational firm is called political risk. Economic risk is related to changes in macroeconomic conditions, while transaction risk is related to fluctuations in currency exchange rates. Translation risk is related to the potential impact of changes in exchange rates on the translation of the financial statements of a subsidiary from a foreign currency to the parent company's reporting currency.

Question 13

The dollar interest rate is 6 percent, and the Swiss franc interest rate is 4 percent. If the required rate of return for a project in Switzerland is 15 percent, calculate the required rate of return in the United States for a similar project.

Accepted Answer

To calculate the required rate of return in the United States, we need to use the formula:

Required rate of return in the United States = Risk-free rate in the United States + Beta × (Market rate of return - Risk-free rate in the United States)

We don't have enough information to calculate the beta or the market rate of return, so we'll assume that the project is of similar risk to the Swiss project and use the 15 percent required rate of return as the market rate of return.

Required rate of return in the United States = 6 percent + Beta × (15 percent - 6 percent)
Required rate of return in the United States = 6 percent + 0.9 × 9 percent
Required rate of return in the United States = 6 percent + 8.1 percent
Required rate of return in the United States = 14.1 percent

Therefore, the closest choice is A) 17.2 percent.

Question 14

The current spot rate is GBP 0.5024/USD. The three-month forward rate is GBP 0.5040/USD. The TE Company expects a payment of GBP 100 million in three months. If the firm hedges this transaction in the forward market, what is the USD amount it will receive in three months?

Accepted Answer

The forward rate is GBP 0.5040/USD, which means that in three months, TE Company will receive 0.5040 USD for each GBP. Therefore, the USD amount it will receive in three months is 100 million GBP * 0.5040 USD/GBP = USD 199.04 million.

Question 15

Suppose that the G Company knows that in one month it must pay £7 million for goods that its U.S. subsidiary will receive in Britain. The current exchange rate is $1.99£. The risk that the corporate treasurer faces is that

Accepted Answer

The risk faced by the corporate treasurer is that the $US/pound exchange rate rises in a month's time (i.e., the pound strengthens). If the exchange rate rises to, say, $2.05£, the G Company will have to pay $14.35 million for the goods instead of $13.93 million (which it would have to pay if the exchange rate stayed at $1.99£). This will increase the cost of the goods for the G Company by $420,000, which is a significant amount. Therefore, the corporate treasurer needs to be prepared for this risk and take appropriate measures to hedge against it.

Question 16

If a government were to seize the assets of a multinational company and not provide adequate compensation to its owners, the government would be following which practice?

Accepted Answer

Expropriation refers to the practice where a government seizes the assets of a multinational company without providing adequate compensation to its owners. This action is considered to be a violation of international law and can lead to strained relations with other countries. WTO resolution refers to the dispute settlement mechanism of the World Trade Organization, repatriation refers to the process of bringing back assets to their country of origin, and terrorism refers to the use of violence and intimidation for political purposes.

Question 17

In the forward exchange market, currency is traded for future delivery.

Accepted Answer

In the forward exchange market, buyers and sellers agree to exchange currency at a future date at a predetermined exchange rate. This is different from the spot exchange market where currency is traded for immediate delivery.

Question 18

The beta of a firm's equity in Switzerland is 1.25. The risk-free rate is 4 percent and market risk premium is 8.4 percent. Calculate the required rate of return for the equity of this firm.

Accepted Answer

Required rate of return = risk-free rate + (beta * market risk premium)
= 4% + (1.25 * 8.4%)
= 4% + 10.5%
= 14.5% 
Therefore, the required rate of return for the equity of this firm is 14.5%.

Question 19

The phrase "stronger currency" implies a forward premium. Given a euro-U.S. dollar exchange rate of $1.45/euro, which of the following values for the forward rate shows the strongest dollar?

Accepted Answer

A stronger dollar implies a lower euro-U.S. dollar exchange rate. Therefore, the forward rate that shows the strongest dollar would be the one with the lowest number of euros per U.S. dollar. Among the given options, the forward rate of 1.25 euros per U.S. dollar (or $0.80/euro) shows the strongest dollar.

Question 20

The current spot rate is $US0.8543/$A. The one-year forward rate is $US0.8475/$A. A U.S. exporter denominates its exports to Australia in $A and expects to receive $A600,000 in one year. What is the value of these exports in one year in $US given that the firm executes a forward hedge?

Accepted Answer

The value of the exports in one year in $US using the forward rate is calculated as $A600,000 * $US0.8475/$A = $US 508,500.

Quiz 27: Managing International Risks