Bahir Dar University

College of Business and Economics

Department of Accounting and Finance
MSc in Accounting and Finance
International Business Finance Assignment (15%)

Question No. 1
1.1 There are several methods by which firms can conduct international business. Mention and describe at
least four methods.
1.2 Describe also direct foreign investment (DFI) by relating to those methods.
Ans Q.1
1.1.1 International Trade
International trade is a relatively conservative approach that can be used by firms to
penetrate markets (by exporting) or to obtain supplies at a low cost (by importing).This
approach entails minimal risk because the firm does not place any of its capital at risk. If
the firm experiences a decline in its exporting or importing, it can normally reduce
or discontinue this part of its business at a low cost.
1.1.2 Licensing
Licensing obligates a firm to provide its technology (copyrights, patents, trademarks,
or trade names) in exchange for fees or some other specified benefits.
1.1.3 Franchising
Franchising obligates a firm to provide a specialized sales or service strategy, support
assistance, and possibly an initial investment in the franchise in exchange for periodic
fees.
1.1.4 Joint Ventures
A joint venture is a venture that is jointly owned and operated by two or more firms.
Many firms penetrate foreign markets by engaging in a joint venture with firms that
reside in those markets. Most joint ventures allow two firms to apply their respective
comparative advantages in a given project.
1.2 Describe also direct foreign investment (DFI) by relating to those methods.
ANS.
Any method of increasing international business that requires a direct investment in foreign operations
normally is referred to as a direct foreign investment (DFI).
International trade and licensing usually are not considered to be DFI because they do not involve
direct investment in foreign operations.
Franchising and joint ventures tend to require some investment in foreign operations, but to a
limited degree.
Foreign acquisitions and the establishment of new foreign subsidiaries require substantial
investment in foreign operations and represent the largest portion of DFI.

Question No. 2
Several factors affect International Trade Flows. These factors include:
i) Inflation, ii) National income, iii) Tariff, iV) Subsidies for exporters, iV) Depreciation of currency.
Show how each of the above factors impact (increase or decrease or no impact) on imports,
exports and current account

2.1 Impact of Inflation

If a countrys inflation rate increases relative to the countries with which it trades, its
current account will be expected to decrease, other things being equal. Consumer
and corporations in that country will most likely purchase more goods overseas (due

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 to high local inflation), while the countrys exports to other countries will decline but
import Increase.
A relative increase in a countrys inflation rate will decrease its current account.
2.2 Impact of National income
If a countrys income level (national income) increases by a higher percentage than
those of other countries, its current account is expected to decrease, other things being
equal. As the real income level (adjusted for inflation) rises, so does consumption
of goods. A percentage of that increase in consumption will most likely reflect an
increased demand for foreign goods.
A relative increase in a countrys income level will decrease its current account
2.3 Impact of Tariffs (Restrictions on Imports):
If a countrys government imposes a tax on imported goods (often referred to as a tariff), the
prices of foreign goods to consumers are effectively increased. Some industries, however, are
more highly protected by tariffs than others to a variety of goods imported by the United States
and other countries.
An increase in the tariffs on imported goods will increase the countrys current account.
2.4 Impact of Subsidies for exporters;
Some governments offer subsidies to their domestic firms, so that those firms can produce products
at a lower cost than their global competitors. Thus, the demand for the exports produced by those
firms is higher as a result of subsidies.
2.4 Impact of Depreciation of currency.
A weak currency or lower exchange rate (depreciation) can be better for an economy and for
firms that export goods to other countries.
The disadvantage of a lower exchange rate is that it causes imports to be more expensive
Its prices become more attractive to foreign customers, and many foreign companies
lower their prices to remain competitive with the countrys firms.
Question No. 3
There are several factors that affect Direct Foreign Investment (DFI). Mention at least three factors
and describe how each factor influence DFI.
Ans.
3.1 Changes in Restrictions.
New opportunities may arise from the removal of government barriers.
3.2 Privatization.
Several national governments have recently engaged in privatization, or the selling of some of their
operations to corporations and other investors.
It allows for greater international business as foreign firms can acquire operations sold by national
governments.
3.3 Potential Economic Growth;
Countries that have greater potential for economic growth are more likely to attract DFI because
firms recognize that they may be able to capitalize on that growth by establishing more business
there.
3.4 Tax Rates.
Countries that impose relatively low tax rates on corporate earnings are more likely to attract DFI.
When assessing the feasibility of DFI, firms estimate the after-tax cash flows that they expect to earn.
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3.5 Exchange Rates.
Firms typically prefer to pursue DFI in countries where the local currency is expected to strengthen
against their own. Under these conditions, they can invest funds to establish their operations in a
country while that countrys currency is relatively cheap (weak). Then, earnings from the new
operations can periodically be converted back to the firms currency at a more favorable exchange
rate.
Question No. 4
Exchange rate systems are classified into five categories according to the degree by which
government controls them. Mention and describe at least four exchange rate systems?
Which exchange rate system does Ethiopia follow currently?
ANS. For 1st question

o Exchange rate systems can be classified according to the degree to which the rates are controlled by
the government.
o Exchange rate systems normally fall into one of the following categories:
4.1 Fixed Exchange Rate Systems,
4.2 Freely Floating Exchange rate Systems,
4.3 Managed Float Exchange rate Systems & Pegged Exchange Rate Systems.
4.1 Fixed Exchange rate systems
In a fixed exchange rate system, exchange rates are either held constant or allowed to fluctuate only
within very narrow bands
Work becomes easier for the MNCs.
Governments may revalue their currencies. In fact, the dollar was devalued more than once after the
U.S. experienced balance of trade deficits.
Each country may become more vulnerable to the economic conditions in other countries.
4.1 freely floating Exchange rate systems
In a freely floating exchange rate system, exchange rates are determined solely by market forces.
Each country may become more insulated against the economic problems in other countries.
Central bank interventions that may affect the economy unfavorably are no longer needed.
Governments are not restricted by exchange rate boundaries when setting new policies.
Less capital flow restrictions are needed, thus enhancing the efficiency of the financial market.
4.2 Managed Float Exchange Rate System
In a managed (or dirty) float exchange rate system, exchange rates are allowed to move freely on a
daily basis and no official boundaries exist. However, governments may intervene to prevent the
rates from moving too much in a certain direction.
A government may manipulate its exchange rates such that its own country benefits at the expense
of others.
4.3 Pegged Exchange Rate System;
In a pegged exchange rate system, the home currencys value is pegged to a foreign currency or to
some unit of account, and moves in line with that currency or unit against other currencies.

ANS
For 2nd question (Which exchange rate system does Ethiopia follow
currently?)
Floating Exchange Rate System is the most common exchange rate system today in

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 Ethiopia.
Managed floating exchange rate regime is being practiced in Ethiopia since 1992.
This exchange rate regime will continue to be adopted in the years to come.
For example, the dollar, euro, yen, and British pound all float. However, since central banks
frequently intervene to avoid excessive appreciation/depreciation, this system is often called
managed float or a dirty float.
Question no. 5
The strength of currency is a measure of the level of economic development of a country. Do you
agree? Explain by providing both theoretical and practical arguments.

Answer
No B/c; Generally speaking, when Country A's currency is worth more than that of Country B, it does not
necessarily mean that Country A's economy is stronger than B's.

Example -1.
Japan's economy is regarded as one of the world's strongest, and yet a single Japanese yen exchanges
for considerably less than US$1. On the other hand, Cyprus' economy is considerably smaller than
the U.S. economy, but Cyprus' currency, which is the pound, exchanges for about twice as much as
the U.S. dollar.
The fact of the matter is that looking at a currency's worth relative to that of another currency at a
static point in time is meaningless; the best way to judge a currency's worth is to watch it in relation
to other currencies over time. Supply and demand, inflation and other economic factors will cause
changes to a currency's relative worth, and it is this change in value that can be used to evaluate
worth.
Example-2
let's say that at the beginning of the year, the U.S. dollar was worth 1.75 XYZ dollars (a fictitious
currency), and six months later, the U.S. dollar is worth 2.00 XYZ dollars. In this case, the U.S.
dollar increased in value over the XYZ dollar by around 14%. This change could be due to XYZ
having higher inflation, or to just an overall lower demand for the XYZ dollar.
Example-3
A currency's purchasing power can also be used as an indicator of the relative worth of currencies.
For example, if US$1 can be exchanged for XYZ$1, it would appear that the XYZ dollar is worth as
much as the U.S. dollar. However, if the purchasing power of XYZ$1 is equal to only US$0.50, then
you can conclude that the U.S. dollar is worth more than the XYZ dollar, because a single U.S.
dollar can be used to buy more goods than a single XYZ dollar can.

Question No. 6

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Why are firms motivated to expand their business internationally? We have three theories explaining this.
Please mention and describe these theories.
Ans.
Three commonly held theories to explain why firms become motivated to expand their business
internationally are:-

1. The theory of comparative advantage,

2. The imperfect markets theory, and
3. The product cycle theory.
1. The theory of comparative advantage
Multinational business has generally increased over time. Part of this growth is due to firms
increased realization that specialization by countries can increase relative production
efficiency and trade for other products.
2. Imperfect Markets Theory
Factors of production (labor and other resources) are immobile. Firms can capitalize on
imperfect markets by exploiting foreign opportunities.
3. Product Cycle Theory
One of the more popular explanations as to why firms evolve into MNCs is the product cycle
theory. According to this theory, firms become established in the home market as a result of
some perceived advantage over existing competitors, such as a need by the market for at
least one more supplier of the product. Because information about markets and competition is
more readily available at home, a firm is likely to establish itself first in its home country.

Question No. 7
Mr. Jackson resides in the United States of America and currently he is contemplating in which country
bank to deposit his wealth of $200,000. For this purpose, he is considering two alternative countries-Great
Britain and U.S.A. The current spot rate is as follows: 1=U.S.D 1.45. British banks pay 4% per annum and
U.S. banks pay 2% per annum. Assume interest rates will be constant every year throughout the next five
years. Assume the five year forward rate is: 1=U.S.D 1.43. Assume further that there is no tax on interest
for both countries. Mr. Solomon has a five year investment horizon and engages forward contract if he has
to invest in Britain.
Required:
A. During the five year investment horizon, how much U.S. dollar will Mr. Solomon obtain if
he deposits in Great Britain? United States?
B. Which country do you recommend for Mr. Solomon to deposit his money?
C. Is covered interest arbitrage possible in the above scenario? Calculate the gain from covered
interest arbitrage, if any
Question No. 8
Assume that the United States inflation rate is expected to be 2% over the next year, while Ethiopian
inflation rate is expected to be 7% over the next year. Assume the spot rate is as follows: 1 U.S.D=
21 Birr

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Required:
A. Assuming PPP, determine the percentage change in the value of Birr?
B. What is the forecasted value of Birr at the end of one year?
Question No. 9
CFO of Trident (U.S. firm) has just concluded a sale to Regency, a British firm, for 1,000,000. The sale is
made in March for settlement due in June (3 months).
Assumptions:

Spot rate is $1.7640/

3-month forward rate is $1.7229/
UK 3 month investing rate is 8.0% p.a.
US 3 month investing rate is 6.0% p.a.
June put option in OTC market for 1,000,000; strike price $1.75/; priced at $0.0265/
June call option in OTC market for 1,000,000; strike price $1.77/; priced at $0.0265/
Trident can invest at the rates given above or borrow at 2% p.a. above those rates. Tridents
cost of capital is 12%.
Assume any new proceeds are invested in T-bills (not used to replace borrowings nor
invested in the firms tangible assets)
Any new funds can be raised at the borrowing rate. Option premium is also financed using
borrowings.
Tridents foreign exchange advisory service forecasts future spot rate in 3 months to be
$1.7400/
Required:
A. Calculate the amount of cash Trident will secure in each of the following hedging
strategies:
i. Forward market hedge
ii. Option market hedge
iii. Money market hedge
B. Compare the above three hedging alternatives and make a recommendation as to which
alternative Trident has to adopt.

Question No. 10
Assume that a bank has quoted the British pound () at $1.55, the Newzland dollar (NZ$) at $ 0.55
and the cross exchange rate at 1=NZ$ 3.15.
Required:
A. Determine the correct cross exchange rate.
B. If you have $ 10,000, how many U.S. dollars will you end up with in one round trip
triangular arbitrage?
C. How much is the gain from triangular arbitrage?
Question No. 11

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Assume that the Mexican peso exhibits a six month interest rate of 6 percent, while the U.S. dollar
exhibits a six month interest rate of 5 percent. Assume further that the pesos spot rate is $0.10.
Required:
A. Determine forward premium or discount.
B. Determine the forward rate.
C. If the actual forward rate in the open market is $0.08, will covered interest arbitrage
be possible? If yes by which investors (local or foreign)? Assume no market
imperfections.

Question No. 12
XYZ Company plans to determine how changes in British and U.S. interest rates will affect the value of
British pound. The control variables are relative inflation rates and relative income growth.

Required:

a) Describe a regression model that could be used to achieve the stated objective. Also explain the
expected sign of the regression coefficient
b) If XYZ Company thought that the existence of a quota in particular historical periods may have
affected exchange rates, how might this be accounted for in the regression model?

Question No. 13
Blue Demon Bank expects that the Chinese currency (the yuan) will depreciate against the dollar from its
spot rate of $0.15 to $0.14 in 30 days. The following interbank lending and borrowing rates exist:

Lending Rate Borrowing Rate

U.S. dollar 8.0% 8.3%
Chinese yuan 8.5% 8.7%

Assume that Blue Demon Bank has a borrowing capacity of either $10 million or 70 million yuan in
the interbank market, depending on which currency it wants to borrow.
a) How could Blue Demon Bank attempt to capitalize on its expectations without using
deposited funds? Estimate the profits that could be generated from this strategy.
b) Assume all the preceding information, with this exception: Blue Demon Bank expects the
yuan to appreciate from its present spot rate of $0.15 to $0.17 in 30 days. How could it
attempt to capitalize on its expectations without using deposited funds? ? Estimate the
profits that could be generated from this strategy.

Question No. 14
Gandor Co. is a U.S. firm that is considering a joint venture with a Chinese firm to produce and sell
videocassettes. Gandor will invest $12million in this project, which will help to finance the Chinese
firms production. For each of the first three years, 50 percent of the total profits will be distributed
to the Chinese firm, while the remaining 50 percent will be converted to dollars to be sent to the
United States. The Chinese government is expected to impose a 20 percent income tax on the profits
earned by Gandor. The Chinese government has guaranteed that the after tax profits (denominated in
yuan, the Chinese currency) can be converted to U.S. dollars at an exchange rate of $0.20 per yuan
and sent to Gandor Co. each year. At the current time, there is no withholding tax imposed on profits
to be sent to the United States as a result of joint ventures in China. Assume that even after

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considering the taxes paid in China, there is an additional 10 percent tax imposed by the U.S.
government on profits received by Gandor Co. After the first three years, all profits earned are
allocated to the Chinese firm. The expected total profits resulting from the joint venture per year are
as follows:
End Total Profits From Joint Venture (in
of yuan)
Year
1 60 million
2 80 million
3 100 million

Gandors average cost of debt is 13.8 percent before taxes. Its average cost of equity is 18 percent.
Assume that the corporate income tax rate imposed on Gandor is normally 30 percent. Gandor uses a
capital structure composed of 60 percent debt and 40 percent equity. Gandor automatically adds 4
percentage points to its cost of capital when deriving its required rate of return on international joint
ventures. While this project has particular forms of country risk that are unique, Gandor plans to
account for these forms of risk within its estimation of cash flows.

There are two forms of country risk that concern Gandor. First, there is the risk that the Chinese
government will increase the corporate income tax rate from 20 percent to 40 percent (20 percent
probability). If this occurs, additional tax credits will be allowed, resulting in no U.S. taxes on the
profits from this joint venture. Second, there is the risk that the Chinese government will impose a
withholding tax of 10 percent on the profits that were to be sent to the United States (20 percent
probability). In this case, additional tax credits will not be allowed, and Gandor will still be subject
to a 10 percent U.S. tax on profits received from China. Assume that the two types of country risk
are mutually exclusive. That is, the Chinese government will only adjust one of its tax guidelines
(the income tax or withholding tax),if any.
Required:
A Determine Gandors cost of capital. Also, determine Gandors required rate of return for the
joint venture in China.
B Determine Gandors net present values for the joint venture for the three scenarios:
Scenario 1. Based on original assumptions.
Scenario 2. Based on an increase in the corporate income tax by the Chinese government.
Scenario 3. Based on the imposition of a withholding tax by the Chinese government.
C Determine the estimated NPV for Gandors joint venture
D Would you recommend that Gandor participate in the joint venture? Explain
E What do you think would be the key underlying factor that would have the most influence on
the profits earned in China as a result of the joint venture?

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 F Is there any reason for Gandor to revise the composition of its capital (debt and equity)
obtained from the United states when financing joint ventures like this?

Question No. 15
Mr. Daniel resides in the United States of America and currently he is contemplating in which
country bank to deposit his wealth of $100,000. For this purpose, he is considering three alternative
countries-Ethiopia, Great Britain, and U.S.A. The current spot rate is as follows: U.S.D. 1=Br.20
and 1=U.S.D.1.5. Banks in Ethiopia are expected to pay an interest rate of 5% per annum, British
banks pay 3% per annum and U.S. banks pay 2% per annum. The inflation rate per annum for
Ethiopia, Britain and United States is expected to be 10%, 7% and 6% respectively. Assume interest
rates and inflation rates will be constant every year throughout the next five years. Use purchasing
power parity (PPP) to forecast exchange rates five years from now. Assume further that there is no
tax on interest for all the three countries. Mr. Daniel has a five year investment horizon.
Required:
1 During the five year investment horizon, how much U.S. dollar will Mr. Daniel obtain if he
deposits in Ethiopia? Great Britain? United States?
2 Which country do you recommend for Mr. Daniel to deposit his money?
Question No. 16

Assume the following information:

Spot rate of Canadian dollar =$0.80
90-day forward rate of Canadian dollar =$0.79
90-day Canadian interest rate = 4%
90-day U.S. interest rate =2.5%

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

Question No. 17
In forecasting foreign exchange rates, experts may use fundamental forecasting techniques. What is a
fundamental forecasting technique? Discuss by using an illustration.

Question No. 1 8
Mr. Solomon resides in the United States of America and currently he is contemplating in which
country bank to deposit his wealth of $200,000. For this purpose, he is considering two alternative
countries-Great Britain and U.S.A. The current spot rate is as follows: 1=U.S.D 1.5. British banks
pay 2% per annum and U.S. banks pay 1% per annum. Assume interest rates will be constant every
year throughout the next five years. Assume the five year forward rate is: 1=U.S.D 1.45. Assume
further that there is no tax on interest for both countries. Mr. Solomon has a five year investment
horizon and engages forward contract if he has to invest in Britain.
Required:

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 1. During the five year investment horizon, how much U.S. dollar will Mr. Solomon obtain if he
deposits in Great Britain? United States?
2. Which country do you recommend for Mr. Solomon to deposit his money?
3. Is covered interest arbitrage possible in the above scenario? Calculate the gain from covered
interest arbitrage, if any
Question No. 19
Assume that the United States inflation rate is expected to be 1% over the next year, while Ethiopian
inflation rate is expected to be 6% over the next year. Assume the spot rate is as follows: 1 U.S.D=
20 Birr
Required:
1. Assuming PPP, determine the percentage change in the value of Birr?
2. What is the forecasted value of Birr at the end of one year?
Question No. 20
Assume that a bank has quoted the British pound () at $1.50, the Newzland dollar (NZ$) at $ 0.50
and the cross exchange rate at 1=NZ$ 2.95.
Required:
1. Determine the correct cross exchange rate.
2. If you have $ 10,000, how many U.S. dollars will you end up with in one round trip
triangular arbitrage?
3. How much is the gain from triangular arbitrage?

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