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# Interest rate parity, return on domestic bond

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1) In the spot market, 1 U.S. dollar can be exchanged for 121 Japanese yen. In the 1-year forward market, 1 U.S. dollar can be exchanged for 125 Japanese yen. The 1-year, risk-free rate of interest is 5.2 percent in the United States. If interest rate parity holds, what is the yield today on 1-year, risk-free Japanese securities?
a. 1.83%
b. 4.71%
c. 5.03%
d. 5.37%
e. 8.68%

2)A foreign investor who holds tax exempt Eurobonds paying 9 percent interest is considering investing in an equivalent-risk domestic bond in a country with a 27 percent withholding tax on interest paid to foreigners. If 9 percent after-taxes is the investors required return, what before-tax rate would the domestic bond need to pay to provide that after-tax return?
a. 9.00%
b. 10.20%
c. 11.28%
d. 12.33%
e. 13.57%

https://brainmass.com/economics/bonds/interest-rate-parity-return-on-domestic-bond-127216

#### Solution Preview

F/ S = (1+ Japanese Interest rate) / (1+ US interest ...

#### Solution Summary

Answers two multiple choice questions on Interest rate parity and before-tax rate return on domestic bond.

\$2.19

## Internattional Finance

True/False
______ 1. Multinational financial management requires that financial analysts consider the effects of changing currency values.
____ 2.
Legal and economic differences among countries, although important, do NOT pose significant problems for most multinational corporations when they coordinate and control worldwide operations and subsidiaries.
____ 3.
When the value of the U.S. dollar appreciates against another country's currency, we may purchase more of the foreign currency with a dollar.
____ 4.
The United States and most other major industrialized nations currently operate under a system of floating exchange rates.
____ 5.
Exchange rate quotations consist solely of direct quotations.
____ 6.
Calculating a currency cross rate involves determining the exchange rate for two currencies by using a third currency as a base.
____ 7.
A Eurodollar is a U.S. dollar deposited in a bank outside the United States.
____ 8.
LIBOR is an acronym for London Interbank Offer Rate, which is an average of interest rates offered by London banks to smaller U.S. corporations.
____ 9.
Exchange rate risk is the risk that the cash flows from a foreign project, when converted to the parent company's currency, will be worth less than was originally projected because of exchange rate changes.
____ 10.
Because political risk is seldom negotiable, it cannot be explicitly addressed in multinational corporate financial analysis.
____ 11.
Individuals and corporations can buy or sell forward currencies to hedge their exchange rate exposure. Essentially, the process involves simultaneously selling the currency expected to appreciate in value and buying the currency expected to depreciate.
____ 12.
If an investor can obtain more of a foreign currency for a dollar in the forward market than in the spot market, then the forward currency is said to be selling at a discount to the spot rate.
____ 13.
If a dollar will buy fewer units of a foreign currency in the forward market than in the spot market, then the forward currency is said to be selling at a premium to the spot rate.
____ 14.
A foreign currency will, on average, depreciate against the U.S. dollar at a percentage rate approximately equal to the amount by which its inflation rate exceeds that of the United States.
____ 15.
The cash flows relevant for a foreign investment should, from the parent company's perspective, include the financial cash flows that the subsidiary can legally send back to the parent company plus the cash flows that must remain in the foreign country.
____ 16.
The cost of capital may be different for a foreign project than for an equivalent domestic project because foreign projects may be more or less risky.
____ 17.
When considering the risk of a foreign investment, a higher risk might arise from exchange rate risk and political risk while lower risk might result from international diversification.
Multiple Choice
Which of the following are reasons why companies move into international operations?
a. To take advantage of lower production costs in regions where labor costs are relatively low.
b. To develop new markets for the firm's products.
c. To better serve their primary customers.
d. Because important raw materials are located abroad.
e. All of the above.

____ 19.
Multinational financial management requires that
a. The effects of changing currency values be included in financial analyses.
b. Legal and economic differences need not be considered in financial decisions because these differences are insignificant.
c. Political risk should be excluded from multinational corporate financial analyses.
d. Traditional U.S. and European financial models incorporating the existence of a competitive marketplace not be recast when analyzing projects in other parts of the world.
e. Cultural differences need not be accounted for when considering firm goals and employee management.

____ 20.
If the inflation rate in the United States is greater than the inflation rate in Britain, other things held constant, the British pound will
a. Appreciate against the U.S. dollar.
b. Depreciate against the U.S. dollar.
c. Remain unchanged against the U.S. dollar.
d. Appreciate against other major currencies.
e. Appreciate against the dollar and other major currencies.

____ 21.
In Japan, 90-day securities have a 4% annualized return and 180-day securities have a 5% annualized return. In the United States, 90-day securities have a 4% annualized return and 180-day securities have an annualized return of 4.5%. All securities are of equal risk, and Japanese securities are denominated in terms of the Japanese yen. Assuming that interest rate parity holds in all markets, which of the following statements is most CORRECT?
a. The yen-dollar spot exchange rate equals the yen-dollar exchange rate in the 90-day forward market.
b. The yen-dollar spot exchange rate equals the yen-dollar exchange rate in the 180-day forward market.
c. The yen-dollar exchange rate in the 90-day forward market equals the yen-dollar exchange rate in the 180-day forward market.
d. The yen-dollar exchange rate in the 180-day forward market equals the yen-dollar exchange rate in the 90-day spot market.
e. The relationship between spot and forward interest rates cannot be inferred.

____ 22.
Which of the following statements is NOT CORRECT?
a. Any bond sold outside the country of the borrower is called an international bond.
b. Foreign bonds and Eurobonds are two important types of international bonds.
c. Foreign bonds are bonds sold by a foreign borrower but denominated in the currency of the country in which the issue is sold.
d. The term Eurobond applies only to foreign bonds denominated in U.S. currency.
e. A Eurodollar is a U.S. dollar deposited in a bank outside the U.S.

____ 23.
Currently, a U.S. trader notes that in the 6-month forward market, the Japanese yen is selling at a premium (that is, you receive more dollars per yen in the forward market than you do in the spot market), while the British pound is selling at a discount. Which of the following statements is CORRECT?
a. If interest rate parity holds, 6-month interest rates should be the same in the U.S., Britain, and Japan.
b. If interest rate parity holds among the three countries, the United States should have the highest 6-month interest rates and Japan should have the lowest rates.
c. If interest rate parity holds among the three countries, Britain should have the highest 6-month interest rates and Japan should have the lowest rates.
d. If interest rate parity holds among the three countries, Japan should have the highest 6-month interest rates and Britain should have the lowest rates.
e. If interest rate parity holds among the three countries, the United States should have the highest 6-month interest rates and Britain should have the lowest rates.

____ 24.
Today in the spot market \$1 = 1.82 Swiss francs and \$1 = 130 Japanese yen. In the 90-day forward market, \$1 = 1.84 Swiss francs and \$1 = 127 Japanese yen. Assume that interest rate parity holds worldwide. Which of the following statements is most CORRECT?
a. Interest rates on 90-day risk-free U.S. securities are higher than the interest rates on 90-day risk-free Swiss securities.
b. Interest rates on 90-day risk-free U.S. securities are higher than the interest rates on 90-day risk-free Japanese securities.
c. Interest rates on 90-day risk-free U.S. securities equal the interest rates on 90-day risk-free Japanese securities.
d. Since interest rate parity holds interest rates should be the same in all three countries.
e. Interest rates on 90-day risk-free U.S. securities equal the interest rates on 90-day risk-free Swiss securities.

____ 25.
If one Swiss franc can purchase \$0.85 U.S. dollars, how many Swiss francs can one U.S. dollar buy?
a. 1.2588
b. 1.1765
c. 1.3647
d. 1.2471
e. 1.0824

____ 26.
If one U.S. dollar buys 1.46 Canadian dollars, how many U.S. dollars can you purchase for one Canadian dollar?
a. 0.7123
b. 0.5548
c. 0.6849
d. 0.5685
e. 0.6781

____ 27.
If one British pound can purchase \$1.90 U.S. dollars, how many British pounds can one U.S. dollar buy?
a. 0.4947
b. 0.6105
c. 0.4053
d. 0.5263
e. 0.4579

____ 28.
If one U.S. dollar buys 0.72 euro, how many dollars can you purchase for one euro?
a. 1.0417
b. 1.5694
c. 1.3889
d. 1.2917
e. 1.0556

____ 29.
If one U.S. dollar sells for 0.51 British pound, how many dollars should one British pound sell for?
a. 1.9020
b. 2.2941
c. 1.5294
d. 2.0588
e. 1.9608

____ 30.
Suppose 144 yen could be purchased in the foreign exchange market for one U.S. dollar today. If the yen depreciates by 23.0% tomorrow, how many yen could one U.S. dollar buy tomorrow?
a. 136.3824
b. 177.1200
c. 132.8400
d. 145.2384
e. 157.6368

____ 31.
Suppose a foreign investor who holds tax-exempt Eurobonds paying 9% is considering investing in an equivalent-risk domestic bond in a country with a 28% withholding tax on interest paid to foreigners. If 9% after-tax is the investor's required return, what before-tax rate would the domestic bond need to pay to provide the required after-tax return?
a. 12.88%
b. 12.75%
c. 10.63%
d. 15.38%
e. 12.50%

____ 32.
Suppose DeGraw Corporation, a U.S. exporter, sold a solar heating station to a Japanese customer at a price of 139.0 million yen, when the exchange rate was 140 yen per dollar. In order to close the sale, DeGraw agreed to make the bill payable in yen, thus agreeing to take some exchange rate risk for the transaction. The terms were net 6 months. If the yen fell against the dollar such that one dollar would buy 154.4 yen when the invoice was paid, what dollar amount would DeGraw actually receive after it exchanged yen for U.S. dollars?
a. \$900,259.07
b. \$711,204.66
c. \$1,008,290.16
d. \$954,274.61
e. \$702,202.07

____ 33.
Suppose the exchange rate between U.S. dollars and Swiss francs is SF 1.41 = \$1.00, and the exchange rate between the U.S. dollar and the euro is \$1.00 = 0.50 euros. What is the cross rate of Swiss francs to euros?
a. 2.9046
b. 3.0738
c. 2.8200
d. 2.3970
e. 3.1584

____ 34.
Suppose that currently, 1 British pound equals 1.98 U.S. dollars and 1 U.S. dollar equals 1.40 Swiss francs. How many Swiss francs are needed to purchase 1 pound?
a. 2.3008
b. 3.1046
c. 2.5225
d. 2.8274
e. 2.7720

____ 35.
A currency trader observes the following quotes in the spot market:
1 U.S. dollar = 1.21 Japanese yen
1 British pound = 2.25 Swiss francs
1 British pound = 1.65 U.S. dollars
Given this information, how many yen can be purchased for 1 Swiss franc?
a. 1.0471
b. 1.0382
c. 0.8873
d. 0.9494
e. 0.6832

____ 36.
A currency trader observes the following quotes in the spot market:
1 U.S. dollar = 10.875 Mexican pesos
1 British pound = 3.955 Danish krone
1 British pound = 1.65 U.S. dollars
Given this information, how many Mexican pesos can be purchased for 1 Danish krone?
a. 5.3083
b. 3.6750
c. 5.6259
d. 3.4935
e. 4.5370

____ 37.
If the spot rate of the Israeli shekel is 5.51 shekels per dollar and the 180-day forward rate is 5.97 shekels per dollar, then the forward rate for the Israeli shekel is selling at a ______________ to the spot rate.
c. 7.51% discount
d. 8.35% discount
e. 9.18% discount

____ 38.
Suppose one British pound can purchase 1.82 U.S. dollars today in the foreign exchange market, and currency forecasters predict that the U.S. dollar will depreciate by 12.0% against the pound over the next 30 days. How many dollars will a pound buy in 30 days?
a. \$1.4860
b. \$1.6511
c. \$1.8346
d. \$2.0384
e. \$2.2422

____ 39.
Stover Corporation, a U.S. based importer, makes a purchase of crystal glassware from a firm in Switzerland for 39,960 Swiss francs, or \$24,000, at the spot rate of 1.665 francs per dollar. The terms of the purchase are net 90 days, and the U.S. firm wants to cover this trade payable with a forward market hedge to eliminate its exchange rate risk. Suppose the firm completes a forward hedge at the 90-day forward rate of 1.682 francs. If the spot rate in 90 days is actually 1.665 francs, how much will the U.S. firm have saved or lost in U.S. dollars by hedging its exchange rate exposure?
a. \$242.57
b. \$259.55
c. \$208.61
d. \$213.46
e. \$269.25

____ 40.
Suppose a U.S. firm buys \$200,000 worth of television tubes from a Mexican manufacturer for delivery in 60 days with payment to be made in 90 days (30 days after the goods are received). The rising U.S. deficit has caused the dollar to depreciate against the peso recently. The current exchange rate is 5.975 pesos per U.S. dollar. The 90-day forward rate is 5.45 pesos/dollar. The firm goes into the forward market today and buys enough Mexican pesos at the 90-day forward rate to completely cover its trade obligation. Assume the spot rate in 90 days is 5.30 Mexican pesos per U.S. dollar. How much in U.S. dollars did the firm save by eliminating its foreign exchange currency risk with its forward market hedge?
a. \$5,088.63
b. \$7,012.38
c. \$5,336.85
d. \$6,205.64
e. \$6,391.81

____ 41.
Suppose 90-day investments in Britain have a 6% annualized return and a 1.5% quarterly (90-day) return. In the U.S., 90-day investments of similar risk have a 4% annualized return and a 1% quarterly (90-day) return. In the 90-day forward market, 1 British pound equals \$1.50. If interest rate parity holds, what is the spot exchange rate (\$/£)?
a. \$1.5074
b. \$1.4019
c. \$1.4924
d. \$1.5376
e. \$1.7185

____ 42.
Suppose hockey skates sell in Canada for 165 Canadian dollars, and 1 Canadian dollar equals 0.71 U.S. dollars. If purchasing power parity (PPP) holds, what is the price of hockey skates in the United States?
a. \$94.89
b. \$99.58
c. \$113.64
d. \$131.21
e. \$117.15

____ 43.
Suppose 6 months ago a Swiss investor bought a 6-month U.S. Treasury bill at a price of \$9,708.74, with a maturity value of \$10,000. The exchange rate at that time was 1.255 Swiss francs per dollar. Today, at maturity, the exchange rate is 1.324 Swiss francs per dollar. What is the annualized rate of return to the Swiss investor?
a. 20.96%
b. 13.17%
c. 18.89%
d. 17.33%
e. 20.27%

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