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# Finance - Exchange Rates and Interest rates

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9.[6] A Swiss bank converted 1.2 million Swiss francs to euros to make a euro loan to a customer when the exchange rate was 1.75 francs per euro. The borrower agreed to repay the principle plus 4% interest in 1 year. The borrower repaid euros at loan maturity and when the loan was repaid the exchange rate was 1.85 francs per EURO. What was the bank's franc rate of return?

#### Solution Summary

A Swiss bank converted 1.2 million Swiss francs to euros to make a euro loan to a customer when the exchange rate was 1.75 francs per euro. The borrower agreed to repay the principle plus 4% interest in 1 year. The borrower repaid euros at loan maturity and when the loan was repaid the exchange rate was 1.85 francs per EURO. What was the bank's franc rate of return?

\$2.19

## International Finance: Multiple Choice Questions. J curve, real interest rate, options, spot rate, international Fisher effect, translation exposure, diversification, cash flow from operations, firm's cost of capital, international trade, interest rate parity, expected effective financing rate, inter-subsidiary leading or lagging strategies, covered interest arbitrage, CAPM

1. The "J curve" effect describes
? the continuous long-term inverse relationship between a country's current account balance and the country's growth in gross national product
? the short-run tendency for a country's balance of trade to deteriorate even while its currency is depreciating
? the tendency for exporters to initially reduce the price of goods when their own currency appreciates
? the reaction of a country's currency to initially depreciate after the country's inflation rate declines

2. When the "real" interest rate is relatively low in a given country, then currency of that country is typically expected to be:
? Weak, since the country's quoted interst rate would be high relative to inflation rate
? Strong, since the country's quoted interest rate would be low relative to the inflation rate
? Strong, since the country's quoted interest rate would be high relative to the inflation rate
? Weak, since the country's quoted interest rate would be low relative to the inflation rate

3. When you own ______, there is no obligation on your part; however, when you own _____, there is an obligation on your part
? Call options; put options
? Futures contracts; call options
? Forward contracts; futures contracts
? Put options; forward contracts

4. Due to ______, market forces should realign the spot rate of a currency among banks.
? Forward realignment arbitrage
? Triangular arbitrage
? Covered interest arbitrage
? Loactional arbitrage

5. According to the international Fisher effect, if investors in all countries require the same real rate of return, the differential in nominal interest rates between any two countries:
? Follows their exchange rate movement
? Is due to their inflation differentials
? Is zero
? Is contestant over time
? C and D

6. __________ is (are) not a determinant of translation exposure
? The MNC's degree of foreign involvement
? The locations of foreign subsidiaries
? The local (domestic) earnings of the MNC
? The accounting methods used

7. Springfield Co., based in the U.S. has a cost of goods sold attributable to foreign materials orders that exceeds its foreign revenue. All foreign transactions are denominated in the foreign currency of concern. This firm would _______ a stronger dollar and would __________ a weaker dollar.
? Benefit from, be unaffected by
? Benefit from; be adversely affected by
? Be unaffected by; be adversely affected by
? Be unaffected by; benefit from
? Benefit from; benefit from

8. A firm will likely benefit most from diversifying if:
? The correlations between country economies are high
? The correlations between country economies are low
? The variability of country economy levels is high
? B and C

9. If an MNC exports to a country, then establishes a subsidiary to produce and sell the same product in the country, then cash flows from prevailing operations would likely be _______ affected by the project. If an MNC establishes a foreign manufacturing subsidiary that busy components from the parent, the cash flows from prevailing operations would likely be ________affected by the project.
? Favorably; favorably

10. Which of the following factors is not expected to generally have a favorable impact on the firm's cost of capital according to the text?
? High degree of international diversification
? Volatile exchange rate fluctuations
? All of the above

11. Which of the following is a reason why commercial banks can facilitate international trade?
? The exporter may not wish to accept credit risk of the importer
? The government may impose exchange contracts that prevent payment by the importer to the exporter
? The exporter may need financing until payment for the goods is received
? All of the above

12. Assume that interest rate parity exists, and there are zero transactions costs. If the forward rate consistently underestimates the future spot rate, then:
? On average, the foreign effecting financing rate is greater than the domestic interest rate
? On average the foreign effect financing rate is less that the domestic rate
? The foreign effecting financing rate exceeds the U.S. interest rate when its forward rate exhibits a premium
? The foreign effective financing rate is less than the U.S. interest rate when it's forward rate exhibits a discount

13. A firm without any exposure to foreign exchange rates would likely increase this exposure the most by:
? Borrowing domestically
? Borrowing a portfolio of foreign currencies that are not highly correlated
? Borrowing a portfolio of foreign currencies that are highly correlated
? Borrowing two foreign currencies that are negatively correlated

14. A U.S. firm plans to borrow Swiss francs today for a one-year period. The Swiss interest rate is 9%. It uses today's spot rate as a forecast for the franc's spot rate in one year. The U.S. one-year interest rate is 10%. The expected effective financing rate on Swiss franc is:
? Equal to the U.S. interest rate
? Less than the U.S. interest rate, but more than the Swiss interest rate
? Equal to the Swiss interest rate
? Less than the Swiss interest rate
? More than the U.S. interest rate

15. Assume that subsidiaries "X" and "Y" often trade with each other. Assume that Subsidiary "X" has excess cash while Subsidiary "Y" is short on cash. How can Subsidiary "X" help out Subsidiary "Y"?
? "X" should lag its payments sent to "Y" to pay for imports from "Y".
? "X" should request that "Y" lead it's payment to be sent for goods that "Y" sent to "X"
? A and B
? None of the above

16. A common purpose of inter-subsidiary leading or lagging strategies is to:
? Allow subsidiaries with excess funds to provide financing to subsidiaries with deficient funds
? Assume that the inventory levels at subsidiaries are maintained within tolerable ranges
? Chance the prices a high-tax rate subsidiary charges a low-tax rate subsidiary
? Measure the performance of subsidiaries according to how quickly subsidiary remit dividend payments to the parent.

17. Assume the following information:
? Spot rate of Canadian dollar \$.80
? 90-day forward rate of Canadian dollar \$.79
? 90-day Canadian interest rate 4%
? 90-day U.S. interest rate 2.5%

Given this information what would be the yield (percentage return) to a U.S. investor who used covered interest arbitrage? Assume the investor invest \$1,000,000

18. The value of Best Candy stock is sensitive to the price of sugar. In years where the Caribbean sugar crop fails, the price of sugar rises significantly and Best Candy suffers considerable losses. On the other hand, SugarKane, a large Hawaiian sugar company reaps unusual profits and its stock price soars. Assume the following probabilities of outcome and returns associated with each probability of outcome:
Bullish Stock Market Bearish Stock Market Sugar Crisis
Probability .2 .5 .3
Best's Rate of Return 25% 10% -25%
SugarKane Rate of Return 10% -5% 20%

If Best Candy and SugarKane are combined in equal proportions into a portfolio, what will be the expected return and risk (standard deviation) of this portfolio?

19. Using the CAPM, what is the expected rate of return of a stock when its beta is 2.0, the expected return of the market is 12%, and the risk free rate is 5%?

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