Question 1

A project has an initial cost of £80,000 and is expected to return £10,000 the first year,£40,000 the second year,and £50,000 the third and final year.Assume the current spot rate is £.75.Also assume the nominal risk-free return is 3 percent in the U.K.and 5 percent in the U.S.The return relevant to the project is 7.8 percent in the U.K.and 8.1 percent in the U.S.Assume uncovered interest rate parity exists.What is the net present value of this project in U.S.dollars using the home currency approach?

Accepted Answer

The answer of A project has an initial cost of...

Question 2

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

The answer of How well do you think relative purchasing...

Question 3

Explain the difference between a spot trade and a forward trade as they relate to currencies.

Accepted Answer

The answer of Explain the difference between a spot trade...

Question 4

Global Markets wants to invest in a riskless project in Sweden.The project has an initial cost of SKr2.3 million and is expected to produce cash inflows of SKr850,000 a year for 3 years.The project will be worthless after the first 3 years.Assume the expected inflation rate in Sweden is 2.6 percent while it is 3.2 percent in the U.S.Also assume a risk-free security is paying 5.9 percent in the U.S.and the current spot rate is $1 = SKr8.31.What is the net present value of this project in Swedish krona using the foreign currency approach? Assume the international Fisher effect applies.

Accepted Answer

The answer of Global Markets wants to invest in a...

Question 5

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

Accepted Answer

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

Question 6

What is triangle arbitrage?

Accepted Answer

The answer of What is triangle arbitrage?...

Question 7

A Canadian project has an initial cost of Can$1.8 million and is expected to produce cash inflows of Can$710,000 a year for 3 years after which time it will be worthless.Assume 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.Assume the current spot rate is C$1 = $.78.What is the net present value of this project in Canadian dollars using the foreign currency approach?

Accepted Answer

The net present value (NPV) is calculated by discounting the cash inflows at the Canadian interest rate of 8% and subtracting the initial cost. The NPV in Canadian dollars is Can$29,738.86.

Question 8

Describe the foreign currency and home currency approaches to capital budgeting.Which is better? Which approach would you recommend a U.S.firm use? Justify your answer.

Accepted Answer

The answer of Describe the foreign currency and home currency...

Question 9

A project has an initial cost of £1.2 million and expected cash inflows of £400,000,£500,000,and £600,000 for Years 1 to 3,respectively.Assume the current spot rate is £.73 and the nominal risk-free returns are 4 percent in the U.K.and 3 percent in the U.S.If uncovered interest rate parity exists,what is the net present value of this project in U.S.dollars using the home currency approach? Assume the project's U.S.discount rate is 12 percent.

Accepted Answer

The correct answer is A because the net present value of the project in U.S. dollars using the home currency approach is -$56,359.

Question 10

Assume the expected inflation rate in Switzerland is 2.2 percent while it is 1.6 percent in the U.S.Also assume a risk-free asset in the U.S.is yielding 3.7 percent.What real rate of return should you expect on a risk-free Swiss security?

Accepted Answer

The real rate of return can be approximated using the Fisher equation, which is $1 + nominal rate = (1 + real rate) \times (1 + inflation rate)$. Given the U.S. nominal rate is 3.7% and its inflation rate is 1.6%, we can solve for the U.S. real rate: $1.037 = (1 + real rate) \times 1.016$. Solving for the real rate gives approximately 2.1%. Since the question implies looking for a comparable rate in Switzerland and does not provide a Swiss nominal rate, we assume the real rates should be similar due to arbitrage opportunities in an efficient market, thus the expected real rate of return on a risk-free Swiss security would also be around 2.1%.

Quiz 31: International Corporate Finance