Question 1: What type of international risk exposure measures the change in present value of a

firm resulting from changes in future operating cash flows caused by any unexpected change in
exchange rates?
Answer: operating exposure
Question 2 : Annual inflation rates in the US and Turkey were 2% and 20% and 3% and 10% in
2003 and 2004 respectively. The spot rate for the New Turkish Lira (TRY) was is 1.55 per dollar
in January 2003.
Calculate the expected PPP implied USD/TRY exchange rate as of end of 2004.
Answer:
Spot rate : USD/TRY 1.55 Annual inflation (2003): 2% for USD and 20% for TRY
Annual inflation (2004): 3% for USD and 10% for TRY
(1+20 )
Inflation during 2003 : Spot rate (1+2 ) = USD/TRY 1.82
(1+10 )
Inflation during 2004: Spot rate (1+3 ) = USD/TRY 1.9475
Question 3: Assume that Oregon selected to use December call option.What will be the
expected cost of the rail cars?
Answer:
Price of rail car : Euro 2,500,000
At December striker price of $0.90/ Euro: 2,500,000 x 0.90 = $2,250,000
In case of first probability of exchange rate being $0.86 / Euro the call option will not be
exercised. In this case , Euro 2,500,000 = $2,150,000
In the second probability of exchange rate being $0.8750 per dollar, the call option will not be
exercised and Euro 2,500,000 = 2,500,000 x 0.8750 = $2,187,500
In the third probability of exchange rate being $0.9500 / Euro the call option will be exercised
and price of railroad car will be $2,250,000
Option premium = 0.015 x 2,250,000 = $33,750
Expected cost of rail car : 0.333 x (2,150,000 + 33,750 + 2,187,500 + 33,750 + 2,250,000
+33,750) = $727,188.75 +$739,676.25 + $760,488.63 = $2,227,353.63

Question 4 : Suppose annual inflation rates in the US and Mexico are expected to be 3% and
10% respectively, over the next three years. If the current spot rate for the Peso/USD is
P12/USD, then relative purchasing power parity suggests that the exchange rate in three years
will be approximately _________.
Calculate the expected PPP implied USD/TRY exchange rate as of end of 2004.
Answer:
(1+10 ) 3
Inflation for 3 years: Spot rate (1+3 ) = P 14.6166/USD

Question 5: Suppose that on January 1st the annual cost of borrowing in Swiss Francs is 5%.
The spot rate of USD on January 1st is CHF/USD0.95. One Year forward rate was quoted as
CHF/USD 0.98. Account interest rate parity, what is the cost of borrowing in USD?
Answer:
Forward ratespot rate Rd5
0.980.95
=
=> Rd0.05=
x 1.05=> Rd 8.32
spot rate
1+5
0.95

Question 6: Based on the above information, what is the cost to the firm of the loan in Mexican
peso's (percent)?
Answer:
Loan amount: $20 million
Spot exchange rate at the time of taking the loan: Peso 3.40/ USD
Therefore loan amount in Peso = $20 million x 3.40 = 68 million Pesos
Interest amount: 8% of $20 million = $1.6 million
Amount to be paid at the end of the year = 20+1.6 = $21.6 million
Exchange rate at the end of loan period Peso 5.80/ USD
$21.6 million = 21.6 x 5.80 = 125.28 million pesos
Cost of the loan in Pesos = (125.28 68) / 68 = 84.23%
Question 7: What would be the net USD receipts of the ABC if the spot rate
is EUR/USD1.2930?

Answer:
Question 8: If OTI locks in the forward hedge at $1.140/
transaction was recorded on the books was $1.178/

, and the spot rate when the

, this will result in a "foreign exchange

________" accounting transaction of ________.

Answer:
Spot rate when the transaction was recorded in the books: $1.140 per Euro
2,500,000 Euros = $2,850,000
Forward rate hedge locked in = $1.178/ Euro.
Therefore 2,500,000 Euros = $2,945,000
Therefore foreign exchange loss and accounting transaction of $2,945,000 - $2,850,000 =
$95,000
Question 9: Use the following data to calculate the Net Change in Reserves for Dotcomland :
Answer:
Net change in reserves = Private Savings + Government revenues Private investments Private
Expenditure + Capital account statistical discrepancy = 20 bn
Question 10: Assume that Oregon selected to use money market hedge. What will be the
expected cost of the rail cars?
Answer:
Euro 2,500,000 at the spot rate of 0.8924/ Euro = $2,231,000
Forward contract to buy Euro 2,500,000 at the end of six months at the rate of $0.8750/Euro
There Euro 2,500,000 at the forward rate is: $2,187,500
If at the end of six months the spot rate is: $0.8600, then Euro 2,500,000 = $2,150,000
If at the end of six months the spot rate is: $0.8750 then Euro 2,500,000 = 2,187,500
OTI will have to buy Euro 2,500,000 at $2,187,500 because of the forward contract.
If at the end of six months the spot rate is $0.9500 then Euro $2,500,000 = $2,375,000

Therefore expected price of the rail car: 0.333 x (2,150,000 + 2,187,500 + 2,375,000) = 715,950
+ 728,437.5 + 790,875 = 2,235,262.5
Question 11: If Plains States locks in the forward hedge at $1.1480/
when the transaction was recorded on the books was $1.174/

, and the spot rate

, this will result in a "foreign

exchange loss" accounting transaction of ________.

Answer:
Spot rate when the transaction was recorded was: $1.174/Euro
Therefore 1,250,000 Euros = $1,467,500
Forward rate locked in: $1.1480 / Euro
Therefore 1,250,000 Euros = 1,250,000 * 1.1480 = $1,435,000
Foreign exchange loss = 1,467,500 1,435,000 = $32,500
Question 12: A US based speculator wanted to take advantage of high domestic interest rates in
ABC-Land. One month ABC-Land treasuries offered 40% pa interest while speculator's US
dollar cost was only 20%pa. Speculator bought $10,000,000 equivalent of one-month maturity
ABC-Land treasuries when the exchange rate was at ABCL687. Speculator expected a slight
depreciation to ABCL690 since ABC-Land was under a crawling peg exchange rate regime.
However, a political crisis led ABC-Land to abandon the crawling peg and currency was floated.
At the maturity of treasury (in one month) ABCLand Lira was trading at ABCL1,200/USD.
Calculate the loss of the speculator?
Answer:
Amount in USD raised for one month: $10,000,000
Interest paid by the speculator on this amount: (10,000,000 x 0.20)/12 = $166,666.67
At the time of investment in ABC-land treasuries $10,000,000 = $10,000,000 x 687 =
6,870,000,000
Interest gained on the ABC land treasuries: (6,870,000,000 x 0.40)/12 = 229,000,000
Total amount = 6,870,000,000 + 2,290,00,000 = 7,099,000,000 Lira
Exchange rate at the end of one month: 1200/ USD or 1/1200 USD / Lira
Therefore 7,099,000,000 x 1/1200 = $ 5,915,833.33
Loss of the speculator: $10,000,000 + $ 166,666.67 5,915,833.33 = $4,250,833.34

Question 13: Assume that Oregon selected to use forward hedge.What will be the expected cost
of the rail cars?
Answer:
Price of rail car: Euro 2,500,000
At December striker price of $0.90/ Euro: 2,500,000 x 0.90 = $2,250,000
In case of first probability of exchange rate being $0.86 / Euro the call option will not be
exercised. In this case, Euro 2,500,000 x 0.86= $2,150,000
In the second probability of exchange rate being $0.8750 per dollar, the call option will not be
exercised and Euro 2,500,000 = 2,500,000 x 0.8750 = $2,187,500
In the third probability of exchange rate being $0.9500 / Euro the call option will be exercised
and price of railroad car will be $2,250,000
Option premium = 0.015 x 2250000 = $33,750
Expected cost of rail car: 0.333 x (2,150,000 + 33750) + 0.333 x (2,187,500 + 33750) +0.333 x
(2,250,000 +33,750) = $727,188.75 +$739,676.25 + $760,488.63 = $2,227,353.63
Question 14: Plains States would be ________ by an amount equal to ________ with a forward
hedge than if they had not hedged and their predicted exchange rate for 6 months had been
correct.
Answer:
Six month forward rate is : $1.19/ Euro
If hedged then 1,250,000 Euro = 1,250,000 x 1.19 = $1,487,500
If Plains hadnt hedged and its forecast of $1.1480 would have come true then 1,250,000 Euro =
1,250,000* 1.1480 = $1,435,000
Amount by which Plains would have been worse off if it chooses the second option by:
1,487,500 1,435,000 = $52,500
Question 15: A ________ is a bond underwritten by a syndicate from a single country, sold
within that country, denominated in that country's currency, but the issuer is from outside that
country.
Answer: Foreign bond

Question 16: What would be your net loss or gain with these sharp movements in interest rates,
how much money would your bank loss or gain because of the forward contract you quoted
based on the given rate?
Answer:
Average US interest rate = 3.125%
Average Euro interest rate = 4.25%
Average spot rate: 1.2325 USD/ Euro
Forward rate (1.03125/ 1.0425) x 1.2325 = 1.219 USD/ Euro
Forward contract of 100 million Euros at this rate will amount to: 100 million x 1.219 = $121.9
million
Actual spot rate at the end of 3 months: 1.207 USD/ Euro
100million x 1.207 = $120.7 million
US interest rate after they go up by 2%: 5.125%
Interest earned in nine months on $120.7 million = (120.7 x 0.05125)* 9/12 = $4.64 million
Interest paid on 100 million Euros in nine months: (100 x 0.0425)*9/12 = Euro 3.19 million or
$3.85 million
Total amount earned = $121.9 + 4.64 3.85 = $122.69 million
Actual gain: 122,690,000 121,900,000 = $790,000
Question 17: P&G is a US based MNC and has operations in Germany. P&G expects
120,000,000 DEM cash flows in 6 months, however due to significant volatility; cash flows are
expected to fluctuate as much as 20%. In other words P&G can get DEM120m, DEM96m or
DM144m depending on the economic conditions. Based on their expectations, P&G treasurers
choose to sell DEM96m forward at DEM1.90and buy DEM48m put option at DEM1.90 both
with six month maturities. The cost of the put option is $0.02. Assume that the spot exchange
rate turns out to be DEM2.10/USD at the expiration and cash flows materialize as DEM
144,000,000. What will the net USD cash-flows of P&G and what will be the cost of acquiring
one US dollar?
Answer:
USD inflows from the exercise of the forward contract: 96 million x 0.5263 = $50.5248 million
Put option premium paid: $0.02* 48 million = $0.96 million

Spot exchanges rate: 2.10 DEM/ USD or 0.4761 USD/ DEM

Put exercise price: DEM 1.90/ USD or 0.52631 USD / DEM
Therefore the put option will be exercised: 44 million * .52631 = $23.157 million
Net USD cash-inflows: $50.5248 + $23.157 - $0.96 = $72.7218 million
Therefore $1 = 120,000,000 / 72,721,800 = 1.65 DEM/ USD

Question 18: Firm "J" is a U.S.-based MNC with net cash inflows of German marks and net
cash inflows of Sunland francs. These two currencies are highly negatively correlated in their
movements against the dollar. Firm "K" is a U.S.-based MNC that has the same exposure as Firm
"J" in these currencies, except that its Sunland francs represent cash outflows. Which firm has a
higher exposure to exchange rate risk?
Answer: Firm "K"
Question 19: Suppose you work for XYZLand-Citicorp in XYZLand. A local bank wanted to
buy USD50,000,000 three month forward. Since you think XYZLand is a very risky
environment you need to built 10% margin (annual) in your forward price to account for risk.
Current spot and interest rates in USD and XYZLand Lira are as follows. What would be your
forward quote?
Answer:
Average interest rate on foreign currency (USD) = (7.5 + 8.5) / 2 = 8%
Average interest rate on domestic currency (XYZ Lira) = (35+45)/2 = 40%
Exchange rate parity implied by International Fischer Effect : (1+ foreign interest rate)/
(1+domestic interest rate) = (Forward rate/ Spot rate)
Average Spot rate = (685+700)/2 = 692.5 XYZ/USD or .0014 USD/ XYZ
(1+.08)/ (1+.4) = Forward rate / .0014
Therefore forward rate = (1.08 * .0014)/ 1.40 = .00108 USD/ XYZ or 925.92 XYZ/USD
Add 10% margin: .10* 925.92 = 92.593
Therefore forward rate quote = 925.92+ 92.593 = 1018.513 XYZ/USD

Question 20: A US company expects SFR120m cash inflow 12 months from now. However the
exact amount may vary +/-20%. Company develops an analysis to decide on the best hedging
strategy. They forecast that spot exchange rate can be either SFR1.2030, 1.375 or 1.5470. They
consider selling SFR 96m forward @1.375 and buying SFR48m put option @ strike price
SFR1.375/$. They pay $0.0345 per SFR. Assume that actual cash flows turned out to be
SFR120m. Calculate the net USD receipts if spot rate is SFR 1.5470/USD
Answer:
96 million SFR sold at 1.375/ dollar (or .7272 USD/ SFR) as part of the forward contract.
Amount gained: 96 *.7272 = $69.81 million.
Now the premium amount paid for buying the put option = .0345 *48000000 = $1656000
The put option will be exercised on remaining $24 million of $120 million that will be received:
24*.7272 = $17.4258 million
Net USD receipts: $69810000 - $1656000 + 17425800 = $85579800

Question 21: Last week ABCLandLira-US dollar exchange rate moved from
ABCL687,000/USD to ABCL1,072,000/USD. Calculate the depreciation of ABCLand lira visa
vie US dollar.
Answer:
687,0001,072,000
=35.91
1,072,000
Question 22: Plains States could hedge the Euro receivables in the money market. Using the
information provided how much would the money market hedge return in six months assuming
Plains States reinvests the proceeds at the U.S. investment rate?
Answer:
At the spot rate of $1.1740 / Euro, 1,250,000 Euros (1,250,000 x 1.1740) = $1,467,500
Interest on this dollar amount borrowed: $1,467,500 x 3% = $44,025
Interest earned on $1,467,500 in US money market fund = $1,467,500 x 2.25%= $33018.75
$1,467,500 + $33,018.5 = $1,500,518.75
Question 23: A Canadian subsidiary of a U.S. parent firm is instructed to bill an export to the
parent in U.S. dollars. The Canadian subsidiary records the accounts receivable in Canadian

dollars and notes a profit on the sale of goods. Later, when the U.S. parent pays the subsidiary
the contracted U.S. dollar amount, the Canadian dollar has appreciated 10% against the U.S.
dollar. In this example, the Canadian subsidiary will record a
Answer: 10% foreign exchange loss on the U.S. dollar accounts receivable.
Question 24: TropiKana Inc. has just borrowed

1,000,000 to make improvements to an

Italian fruit plantation and processing plant. If the interest rate is 5.00% per year and the Euro
depreciates against the dollar from $1.15/
at the time the loan was made to $1.12/
at
the end of the first year, how much interest and principle will TropiKana pay at the end of the
first year if they repay the entire loan plus interest (rounded)?
Answer:
Loan amount: 1,000,000 Euro
Amount in dollars = 1,000,000 x 1.15 = $1,150,000
Interest to be paid during the year: 1,000,000 x 5% = Euro 50,000
Total amount to be paid at the end of the year: Euro 1,050,000
Exchange rate at the end of the year: $1.12/ Euro
1,050,000 x 1.12 = $1,176,000
Question 25: If the Fed desires to weaken the dollar without affecting the dollar money supply, it
should:
Answer: sell dollars for foreign currencies, and sell some of its existing Treasury security
holdings for dollars.
Question 26: Sony of Japan produces DVD players and exports them to the United States. Last
year the exchange rate was 135/$ and Sony charged $145 per DVD player. Currently the spot
exchange rate is 105/$ and Sony is charging $175 per DVD player. What is the degree of pass
through by Sony of Japan on their DVD players?

Answer:
price 175145 135105
=
/
=72.41
rate
145
105
Question 27: An MNE may cross list its shares on a foreign stock exchange so that it can

Answer: accomplish all of the above.

Question 28: Assume that Fisher Effect holds. Based on the following market information
for Argentina and US, calculate the One-Year "t-bill" rate for US (Do not use the approximation).
Answer:
(1+inflation rateArgentina) (1+treasury yield Argentina )
=
(1+inflation rateUS)
(1+treasury yield US)
1.02
( 1.111.08
)1=4.83

treasury yield US=

Question 29: Annual inflation rates in the US and Turkey were 2% and 20% and 3% and 10% in
2003 and 2004 respectively. The spot rate for the New Turkish Lira (TRY) was is 1.55 per US
Dollar in January 2003.
The actual spot rate observed on January 1st 2005 was USD/TRY1.35. Based on the PPP
expectations which one of the following is a correct statement?
Answer: Exchange rate parity as per international Fischer effect
(1+ inflation rate of foreigncurrency ) Forward rate
=
(1+inflation rate of domestic currency )
Spot rate

Forward rate=

(1+ inflation rate of foreign currency)

Spot rate
(1+inflation rate of domestic currency )

Forward rate=

1.20
1.55=1.8235
1.02

At the beginning of 2004 spot rate is likely to be 1.8235 per dollar

Therefore forward rate for the end of 2004 is:

1.10
1.8235=1.9474
1.03

As per PPP theory spot rate at the beginning of 2005 should be: 1.9474 per dollar.
However actual spot rate observed: 1.35/ dollar
Actual spot rate less than the rate predicted by PPP theory

Question 30: If OTI chooses to hedge its transaction exposure in the forward
market, the company will ________ 2,500,000 forward at a rate of ________.
Answer: Six months forward rate is $1.148/ Euro therefore it will buy
2500000 Euros at this rate