Finance Final Exam Review
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These are some practice questions for my final exam. I need some 'direction' to get started. Can you help?
1. How would a domestic company that exports likely be impacted by a weak home currency? How would it be impacted by a strong home currency?
2. A purely domestic company that neither exports nor imports does not need to worry about the exchange rate. Do you agree or disagree? Explain.
3. The one-year interest rate in Singapore is 11 percent. The one-year interest rate in the U.S. is 6 percent. The spot rate of the Singapore dollar (S$) is $.50 and the forward rate of the S$ is $.46. Assume zero transactions costs.
a. Does interest rate parity exist? Explain your answer.
b. Can a U.S. firm benefit from investing funds in Singapore using covered interest arbitrage? Explain.
4. Consider a period in which the U.S. dollar weakens against the euro. How will this affect the reported earnings of a U.S.-based MNC with European subsidiaries? Consider a period in which the U.S. dollar strengthens against most foreign currencies. How will this affect the reported earnings of a U.S.-based MNC with subsidiaries all over the world?
5. Decko Co. is a U.S. firm with a Chinese subsidiary that produces cell phones in China and sells them in Japan. This subsidiary pays its wages and its rent in Chinese yuan, which is presently tied to the dollar. The cell phones sold to Japan are denominated in Japanese yen. Assume that Decko Co. expects that the Chinese yuan will continue to stay fixed against the dollar. The subsidiary's main goal is to generate profits for itself and it reinvests the profits. It does not plan to remit any funds to the U.S. parent.
a. Assume that the Japanese yen strengthens against the U.S. dollar over time. How would this be expected to affect the profits earned by the Chinese subsidiary?
b. If Decko Co. had established its subsidiary in Tokyo, Japan instead of China, would its subsidiary's profits be more exposed or less exposed to exchange rate risk?
c. Why do you think that Decko Co. established the subsidiary in China instead of Japan? Assume no major country risk barriers.
d. If the Chinese subsidiary needs to borrow money to finance its expansion and wants to reduce its exchange rate risk, should it borrow U.S. dollars, Chinese yuan, or Japanese yen?
6. Relate the use of currency options to hedging net payables and receivables. That is, when should currency puts be purchased, and when should currency calls be purchased? Why would Cleveland, Inc., consider hedging net payables or net receivables with currency options rather than forward contracts? What are the disadvantages of hedging with currency options as opposed to forward contracts?
7. If the potential return is high enough, any degree of country risk can be tolerated. Do you agree with this statement? Why or why not? Do you think that a proper country risk analysis can replace a capital budgeting analysis of a project considered for a foreign country? Explain.
8. Explain some of the reasons why a U.S.-based corporation might issue debt denominated in a foreign currency.
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1. How would a domestic company that exports likely be impacted by a weak home currency? How would it be impacted by a strong home currency?
A weak home currency tends to increase a country's exports and decrease its imports, thereby lowering its unemployment. However, it also can cause higher inflation since there is a reduction in foreign competition (because a weak home currency is not worth much in foreign countries). Thus, local producers can more easily increase prices without concern about pricing themselves out of the market.
A strong home currency can keep inflation in the home country low, since it encourages consumers to buy abroad. Local producers must maintain low prices to remain competitive. Also, foreign supplies can be obtained cheaply. This also helps to maintain low inflation. However, a strong home currency can increase unemployment in the home country. This is due to the increase in imports and decrease in exports often associated with a strong home currency (imports become cheaper to that country but the country's exports become more expensive to foreign customers).
2. A purely domestic company that neither exports nor imports does not need to worry about the exchange rate. Do you agree or disagree? Explain.
I disagree because even purely domestic firms are affected by economic exposure because it faces foreign competition in its local markets. If the exchange rate of the foreign competitor's invoice currency depreciates against the dollar, customers
interested the domestic company's products will shift their purchases toward the foreign producer.
Consequently, demand for the domestic company's product will likely decrease, and so will its net cash ...
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- BA, Ain Shams University, Cairo Egypt
- MBA, California State University, Sacramento
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