Question 1

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

.05 - .04 = R_FC - .02;R_FC = .03 = 3%

Question 2

The expected inflation rate in Switzerland is 2 percent while it is 3 percent in the U.S.A risk-free asset in the U.S.is yielding 3.5 percent.What real rate of return should you expect on a risk-free Swiss security?

Accepted Answer

.035 - .03 = R_FC - .02;R_FC = .025 = 2.5%

Question 3

What is triangle arbitrage? Using the U.S.dollar,the Canadian dollar,and the euro,construct an example in which triangle arbitrage exists,and then show how to exploit it.

Accepted Answer

The answer of What is triangle arbitrage? Using the U.S.dollar,the...

Question 4

Are exchange rate changes between the U.S.dollar and the Japanese yen necessarily good or bad for Japanese automakers? Explain your reasoning.

Accepted Answer

The answer of Are exchange rate changes between the U.S.dollar...

Question 5

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 Finnish security?

Accepted Answer

.055 - .04 = R_FC - .02;R_FC = .035 = 3.5%

Question 6

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

E(S₁)= .56 F1F1F1S1F1F1F10 [1 + (.05 - .07)]¹ = .548800E(S₂)= .56 F1F1F1S1F1F1F10 [1 + (.05 - .07)]² = .537824E(S₃)= .56 F1F1F1S1F1F1F10 [1 + (.05 - .07)]³ = .527068CF₀ = -£80,000 F1F1F1S1F1F1F10 ($1 F1F1F1S1F1F1F10 £.560000)= -$142,857.14CO₁ = £10,000 F1F1F1S1F1F1F10 ($1 F1F1F1S1F1F1F10 £.548800)= $18,221.57CO₂ = £40,000 F1F1F1S1F1F1F10 ($1 F1F1F1S1F1F1F10 £.537824)= $74,373.77CO₃ = £50,000 F1F1F1S1F1F1F10 ($1 F1F1F1S1F1F1F10 £.527068)= $94,864.42NPV = -$142,857.14 + ($18,221.57 F1F1F1S1F1F1F10 1.0925¹)+ ($74,373.77 F1F1F1S1F1F1F10 1.0925²)+ ($94,864.42 F1F1F1S1F1F1F10 1.0925³)= $8,885.40 = $8,885

Question 7

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

.045 - .02 = R_FC - .03;R_FC = .055 = 5.5%

Question 8

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

.06 - .05 = R_FC - .02;R_FC = .03;NPV = -SKr2.1m + (SKr810,000 F1F1F1S1F1F1F10 1.03¹)+ (SKr810,000 F1F1F1S1F1F1F10 1.03²)+ (SKr810,000 F1F1F1S1F1F1F10 1.03³)= SKr191,175

Question 9

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

NPV = -C$1.2m + (C$600,000 F1F1F1S1F1F1F10 1.08¹)+ (C$600,000 F1F1F1S1F1F1F10 1.08²)+ (C$600,000 F1F1F1S1F1F1F10 1.08³)= C$346,258

Question 10

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 11

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...

Question 12

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 13

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

E(S₁)= .54 F1F1F1S1F1F1F10 [1 + (.04 - .03)]¹ = .545400E(S₂)= .54 F1F1F1S1F1F1F10 [1 + (.04 - .03)]² = .550854E(S₃)= .54 F1F1F1S1F1F1F10 [1 + (.04 - .03)]³ = .556363CF₀ = -£120,000 F1F1F1S1F1F1F10 ($1 F1F1F1S1F1F1F10 £.540000)= -$222,222.22CO₁ = £40,000 F1F1F1S1F1F1F10 ($1 F1F1F1S1F1F1F10 £.545400)= $73,340.67CO₂ = £50,000 F1F1F1S1F1F1F10 ($1 F1F1F1S1F1F1F10 £.550854)= $90,768.15CO₃ = £60,000 F1F1F1S1F1F1F10 ($1 F1F1F1S1F1F1F10 £.556363)= $107,843.26NPV = -$222,222.22 + ($73,340.67 F1F1F1S1F1F1F10 1.03¹)+ ($90,768.15 F1F1F1S1F1F1F10 1.03²)+ ($107,843.26 F1F1F1S1F1F1F10 1.03³)= $33,232

Quiz 31: International Corporate Finance