Question 1

What is the real rate of return if the risk-free rate is 4 percent and the expected rate of inflation is 2.5 percent?

Accepted Answer

Solution:
iR = 0.04 - 0.025 - 0.025iR
iR = 0.0146 or 1.46%

Question 2

If the annual nominal interest rate on 5-year U.S. Government Treasury bonds is 7 percent, and the annual nominal interest rate on 5-year Canadian bonds is 5.5 percent, what is the expected future spot rate in 5 years given that the current spot exchange rate between U.S. dollars and Canadian dollars is $0.587?

Accepted Answer

Solution: S₅/$0.587 = (1.07)⁵)/(1.055)⁵ = 1.4026/1.307 S₅ = $0.6299

Question 3

The theory that the annual percentage differential in the forward market for a currency quoted in terms of another currency is equal to the approximate difference in interest rates in the two countries is known as

Accepted Answer

This theory is known as interest rate parity, which states that the interest rate differential between two countries is equal to the percentage differential between the forward exchange rate and the spot exchange rate. Covered interest arbitrage involves taking advantage of the interest rate parity condition to make riskless profits, while inflation and hedging are not related to this theory.

Question 4

If the annual nominal interest rate on 5-year U.S. Government Treasury bonds is 7 percent and the annual nominal interest rate on 5-year Canadian bonds is 7.75%, what is the expected future spot rate in 5 years given that the current spot exchange rate between U.S. dollars and Canadian dollars is $0.739?

Accepted Answer

Solution: S₅/$0.739 = (1.07)⁵/(1.0775)⁵ = 1.4026/1.4524 S₅= $0.714

Question 5

If U.S. prices are expected to rise by 3 percent over the coming year and prices in Switzerland are expected to rise by 7 percent during the same time, what is the expected spot rate in one year of the Swiss franc given that the current spot exchange rate is $0.168

Accepted Answer

Solution: S₁/$0.168 = 1.03/1.07 S₁=$0.1617

Question 6

If the 182-day interest rate is 1.75 percent in the U.S. and 2.625 percent in Germany, and the current spot exchange rate between dollars and euros is $0.583, what will the 180-day forward rate be if IRP holds?

Accepted Answer

Solution:
F/$0.583 = 1.0175/1.02625
F = $0.578

Question 7

In general, when a foreign subsidiary's assets are ____ than its liabilities, ____ will occur when the exchange rate on the currency of the country in which the foreign subsidiary operates loses value.

Accepted Answer

When a foreign subsidiary's assets are greater than its liabilities, the subsidiary has a net asset position. If the currency of the country in which the subsidiary operates depreciates, the value of its assets will also decrease in terms of the parent currency. This results in a currency exchange loss for the parent company. Therefore, if the foreign subsidiary's assets are greater than its liabilities, currency exchange losses will occur when the exchange rate on the currency of the country in which the foreign subsidiary operates loses value.

Question 8

Today, short-term interest rates in Australia are 8.50% and the corresponding U.S. rate is 6.0%. The current discount on forward Australian dollars is 2.0%. Can a U.S. trader use covered interest arbitrage to take advantage of this situation? If so what is the net effect?

Accepted Answer

Solution:
Sell dollars, buy Australian dollars and invest in Australian securities at 8.5%. Sell Australian dollars forward at 2% discount. Trader earns 8.5% - 2% = 6.5% compared to 6% U.S. rate.

Question 9

Basic hedging techniques include all of the following except

Accepted Answer

The primary market hedge is not a basic hedging technique. Money market and forward market hedges are commonly used, while primary market hedges are more complex and involve issuing securities to offset risk.

Question 10

Crown Honda purchased one of its most popular models for 965,600 yen. The exchange rate for the yen was 142 yen per U.S. dollar at the time of purchase but then rose to 171.8 yen by the time payment was made. What was the dealer's gain or loss on the change in rates?

Accepted Answer

Solution:
Old cost = 965,600/142 = $6,800
New cost = 965,600/171.8 = $5,620
Gain = $6,800 - $5,620 = $1,180

Question 11

If one year U.S. nominal interest rates are 4 percent, one year Canadian nominal interest rates are 7.5 percent, and the current spot exchange rate, S₀, is $0.587, then the expected spot rate in one year will be:

Accepted Answer

Solution: S₁/$0.587=1.04/1.075 S₁=$0.568

Question 12

If U.S. prices are expected to rise by 3.5 percent over the coming year and prices in Great Britain are expected to rise by 5.25 percent during the same time, what is the expected spot rate in one year given that the current spot exchange rate is $1.497?

Accepted Answer

Solution: S₁/$1.497 = 1.035/1.0525 S₁ = $1.472

Question 13

Vroom Vroom Motors purchased several Mercedes Benz automobiles from its West German broker. The contract was for 10,000,000 euros, due in 180 days. The present exchange rate is $0.51 per euro and the 180 day forward rate is $0.514. If the rate actually goes to $0.50 in 180 days, what is the dollar gain or loss incurred if no hedge is taken relative to a hedged position?

Accepted Answer

Solution:
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Question 14

What is the nominal interest rate in Canada if the real rate of return is 2.5% and the expected inflation rate was 4.5%

Accepted Answer

Solution:
i = .025 + .045 + (.025)(.045) = .0711 or 7.11%

Question 15

What is the real rate of return if the risk-free rate is 3.25 percent and the expected rate of inflation is 2.75 percent?

Accepted Answer

Solution:
iR = .0325 -.0275-iR(.0275)
iR = .00487 or 0.487%

Question 16

If the annual nominal interest rate on 10-year U.S. Government Treasury bonds is 7.35 percent and the annual nominal interest rate on 10-year Japanese bonds is 5.75 percent, what is the expected future spot rate in 10 years given that the current spot exchange rate between U.S dollars and Japanese yen is $0.00959?

Accepted Answer

Solution: S₁₀/$0.00959 = (1.0735)¹⁰ / (1.0575)¹⁰ S₁₀ = $0.01114

Question 17

If the spot rate (in U.S. dollars) for the Australian dollar is $0.559 and the 180 day forward rate is trading at a premium of 2.86%, then the 180 day forward rate is:

Accepted Answer

Solution:
2.86 =  ((x - $0.559)/$0.559)(12/6)(100%)
x = $0.567

Question 18

Firms transacting business with foreign companies can lower exchange rate risk exposure by

Accepted Answer

Hedging is the best way to lower exchange rate risk exposure for firms transacting with foreign companies. Hedging enables the firm to protect against losses that may arise due to fluctuations in exchange rates. This can be achieved by locking in a specific exchange rate, using options or forward contracts. Limiting transaction exposure helps the firm to reduce its exposure to currency fluctuations, but it involves changing business practices, which may not always be feasible. Purchasing LIBORs is not a strategy for reducing exchange rate risk exposure, but a financial instrument used for fundraising. The PPP is used to estimate the fair value of exchange rates, but it is not an effective strategy for reducing exchange rate risk exposure.

Question 19

The (6 month) interest rate on 180 day U.S. Treasury bills is 7.64%. In the foreign exchange markets, the spot rate between U.S. dollars and British pounds is 1 pound = $1.5525. The 180-day (6 month) forward rate is 1 pound = $1.5188. Determine the expected rate of interest on 6 month British government debt securities, assuming interest rate parity between the dollar and pound exists.

Accepted Answer

Solution:
($1.5188) / ($1.5525) = (1.0764)/1 + iUK
iUK = 10.03%

Question 20

The 6 month interest rate on 180 day U.S. Treasury Bills is 7.5 percent. In the foreign exchange markets, the spot rate between U.S. dollars and Australian dollars is 1 Australian dollar = $0.452 and the 180 day (6 month) forward rate is 1 mark = $0.46. Determine the expected rate of interest on 6 month Australian government debt securities, assuming that the interest rate parity between the U.S. dollar and Australian dollar exists.

Accepted Answer

Solution:
$0.46 / $0.452 = 1.075 /1 + iWG
iWG = 5.63%

Quiz 22: International Financial Management

What is the real rate of return if the risk-free rate is 4 percent and the expected rate of inflation is 2.5 percent?

The theory that the annual percentage differential in the forward market for a currency quoted in terms of another currency is equal to the approximate difference in interest rates in the two countries is known as

If U.S. prices are expected to rise by 3 percent over the coming year and prices in Switzerland are expected to rise by 7 percent during the same time, what is the expected spot rate in one year of the Swiss franc given that the current spot exchange rate is $0.168

If the 182-day interest rate is 1.75 percent in the U.S. and 2.625 percent in Germany, and the current spot exchange rate between dollars and euros is $0.583, what will the 180-day forward rate be if IRP holds?

In general, when a foreign subsidiary's assets are than its liabilities, will occur when the exchange rate on the currency of the country in which the foreign subsidiary operates loses value.

Today, short-term interest rates in Australia are 8.50% and the corresponding U.S. rate is 6.0%. The current discount on forward Australian dollars is 2.0%. Can a U.S. trader use covered interest arbitrage to take advantage of this situation? If so what is the net effect?

Basic hedging techniques include all of the following except

Crown Honda purchased one of its most popular models for 965,600 yen. The exchange rate for the yen was 142 yen per U.S. dollar at the time of purchase but then rose to 171.8 yen by the time payment was made. What was the dealer's gain or loss on the change in rates?

If one year U.S. nominal interest rates are 4 percent, one year Canadian nominal interest rates are 7.5 percent, and the current spot exchange rate, S₀, is $0.587, then the expected spot rate in one year will be:

If U.S. prices are expected to rise by 3.5 percent over the coming year and prices in Great Britain are expected to rise by 5.25 percent during the same time, what is the expected spot rate in one year given that the current spot exchange rate is $1.497?

What is the nominal interest rate in Canada if the real rate of return is 2.5% and the expected inflation rate was 4.5%

What is the real rate of return if the risk-free rate is 3.25 percent and the expected rate of inflation is 2.75 percent?

If the spot rate (in U.S. dollars) for the Australian dollar is $0.559 and the 180 day forward rate is trading at a premium of 2.86%, then the 180 day forward rate is:

Firms transacting business with foreign companies can lower exchange rate risk exposure by

Quiz 22: International Financial Management

What is the real rate of return if the risk-free rate is 4 percent and the expected rate of inflation is 2.5 percent?

The theory that the annual percentage differential in the forward market for a currency quoted in terms of another currency is equal to the approximate difference in interest rates in the two countries is known as

If U.S. prices are expected to rise by 3 percent over the coming year and prices in Switzerland are expected to rise by 7 percent during the same time, what is the expected spot rate in one year of the Swiss franc given that the current spot exchange rate is $0.168

If the 182-day interest rate is 1.75 percent in the U.S. and 2.625 percent in Germany, and the current spot exchange rate between dollars and euros is $0.583, what will the 180-day forward rate be if IRP holds?

In general, when a foreign subsidiary's assets are ____ than its liabilities, ____ will occur when the exchange rate on the currency of the country in which the foreign subsidiary operates loses value.

Today, short-term interest rates in Australia are 8.50% and the corresponding U.S. rate is 6.0%. The current discount on forward Australian dollars is 2.0%. Can a U.S. trader use covered interest arbitrage to take advantage of this situation? If so what is the net effect?

Basic hedging techniques include all of the following except

Crown Honda purchased one of its most popular models for 965,600 yen. The exchange rate for the yen was 142 yen per U.S. dollar at the time of purchase but then rose to 171.8 yen by the time payment was made. What was the dealer's gain or loss on the change in rates?

If one year U.S. nominal interest rates are 4 percent, one year Canadian nominal interest rates are 7.5 percent, and the current spot exchange rate, S0, is $0.587, then the expected spot rate in one year will be:

If U.S. prices are expected to rise by 3.5 percent over the coming year and prices in Great Britain are expected to rise by 5.25 percent during the same time, what is the expected spot rate in one year given that the current spot exchange rate is $1.497?

What is the nominal interest rate in Canada if the real rate of return is 2.5% and the expected inflation rate was 4.5%

What is the real rate of return if the risk-free rate is 3.25 percent and the expected rate of inflation is 2.75 percent?

If the spot rate (in U.S. dollars) for the Australian dollar is $0.559 and the 180 day forward rate is trading at a premium of 2.86%, then the 180 day forward rate is:

Firms transacting business with foreign companies can lower exchange rate risk exposure by

In general, when a foreign subsidiary's assets are than its liabilities, will occur when the exchange rate on the currency of the country in which the foreign subsidiary operates loses value.

If one year U.S. nominal interest rates are 4 percent, one year Canadian nominal interest rates are 7.5 percent, and the current spot exchange rate, S₀, is $0.587, then the expected spot rate in one year will be: