Tutorial

International Finance Prof. Dr. Christian Kraus

Tutorial 1

Questions 1. Explain agency problems of multinational companies (MNCs). 2. Why might agency costs be larger for an MNC than for domestic companies? 3. If perfect markets existed, would wages, prices, and interest rates among countries be more similar or less similar than under conditions of imperfect markets? Why? 4. How does access to international opportunities affect the size of corporations? 5. Describe a scenario in which the size of a corporation is not affected by access to international opportunities. 6. Turnip plc (a UK fictitious company), based in Birmingham, considers several international opportunities in Europe that could affect the value of its firm. The valuation of its firm is dependent on four factors: (1) expected cash flows in pounds, (2) expected cash flows in euros that are ultimately converted into pounds, (3) the rate at which it can convert euros to pounds, and (4) Turnips weighted average cost of capital. For each opportunity, identify the factors that would be affected. Turnip plans a licensing deal in which it will sell technology to a firm in Germany for 3,000,000; the payment is invoiced in pounds, and this project has the same risk level as its existing businesses. Turnip plans to acquire a large firm in Portugal that is riskier than its existing businesses. Turnip plans to discontinue its relationship with a U.S. supplier so that it can import a small amount of supplies (denominated in euros) at a lower cost from a Belgian supplier. Turnip plans to export a small amount of materials to Ireland that are denominated in euros.

Discussion: Should an MNC reduce its ethical standards to compete internationally?

Tutorial International Finance Prof. Dr. Christian Kraus

Tutorial 2

Questions 1. Explain why an MNC may invest funds in a financial market outside its own country. 2. Explain why some financial institutions prefer to provide credit in financial markets outside their own country. 3. Explain how the appreciation of the Australian dollar against the euro would affect the return to a French firm that invested in an Australian money market security. 4. Explain how the appreciation of the Japanese yen against the UK pound would affect the return to a UK firm that borrowed Japanese yen and used the proceeds for a UK project. 5. Compute the bid/ask percentage spread for Mexican peso in which the ask rate is 20.6 New peso to the dollar and the bid rate is 21.5 New peso to the dollar. 6. You just came back from Canada, where the Canadian dollar was worth0.43. You still have C$200 from your trip and could exchange them for pounds at the airport, but the airport foreign exchange desk will only buy them for 0.40. Next week, you will be going to Mexico and will need pesos. The airport foreign exchange desk will sell you pesos for 0.055 per peso. You met a tourist at the airport who is from Mexico and is on his way to Canada. He is willing to buy your C$200 for 1500 New Pesos. Should you accept theoffer or cash the Canadian dollars in at the airport? Explain. 7. Why do interest rates vary among countries? Why are interest rates normallysimilar for those European countries that use the euro as their currency? Offer a reason why the government interest rate of one country could be slightly higher than that of the government interest rate of another country, even though the euro is the currency used in both countries.

Discussion: Should firms that go public engage in international offerings?

Tutorial International Finance Prof. Dr. Christian Kraus Questions

Tutorial 3

1. Assume that the UK inflation rate becomes high relative to euro inflation. Other things being equal, how should this affect the (a) UK demand for euros, (b) supply of euros for foreign currency, and (c) equilibrium value of the euro? 2. Assume euro interest rates fall relative to British interest rates. Other things being equal, how should this affect the (a) euro demand for British pounds, (b) supply of pounds for sale, and (c) equilibrium value of the pound? 3. Assume that the income level in the euro area rises at a much higher rate than does the UK income level. Other things being equal, how should this affect the (a) euro area demand for British pounds, (b) supply of British pounds for sale, and (c) equilibrium value of the British pound in terms of the euro? 4. Explain why a public forecast about the future value ofthe euro and about future interest rates by a respected economist could affect the value of the euro today. Why do some forecasts by well-respected economists have no impact on todays value of the euro? 5. Blue Demon Bank expects that the Mexican peso will depreciate against the dollarfrom its spot rate of $.15 to $.14 in 10 days. The following interbank lending and borrowing rates exist: Lending Rate U.S. dollar Mexican peso Borrowing Rate 8.3% 8.7%

Assume that Blue Demon Bank has a borrowing capacity of either $10 million or 70 million peos in the interbank market, depending on which currency it wants to borrow. 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. Assume all the preceding information with this exception: Blue Demon Bank expects the peso to appreciate from its present spot rate of $.15 to $.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.

Discussion:
The currencies of some Latin American countries depreciate against other currencies on a consistent basis. How can persistently weak currencies be stabilized?

Tutorial International Finance Prof. Dr. Christian Kraus Questions

Tutorial 4

1. Assume the following information: Value of Canadian dollar in British pounds 0.60 Value of New Zealand dollar in British pounds $0.20 Value of Canadian dollar in New Zealand dollars NZ$3.02 Given this information, is triangular arbitrage possible? If so, explain the steps that would reflect triangular arbitrage, and compute the profit from this strategy if you had 1,000,000 to invest. What market forces would occur to eliminate any further possibilities of triangular arbitrage?

2. Assume the following information: Spot rate of Canadian dollar 90-day forward rate of Canadian dollar 90-day Canadian interest rate 90-day UK interest rate = 0.4400 = 0.4345 = 4% = 2.5%

Given this information, what would be the yield (percentage return) to a UK investor who used covered interest arbitrage? (Assume the investor invests 1,000,000.) 3. What market forces would occur to eliminate any further possibilities of covered interest arbitrage? 4. Assume the following information: Spot rate of Mexican peso = 14.00 euros 180-day forward rate of Mexican peso = 13.72 euros 180-day Mexican interest rate = 6% 180-day euro interest rate = 5% Given this information, is covered interest arbitrage worthwhile for Mexican investors who have pesos to invest? Explain your answer. 5. Assume that the existing UK one-year interest rate is 10 % and the EU one-year interest rate is 11 %. Also assume that interest rate parity exists. Should the forward rate of the euro exhibit a discount or a premium? If UK investors attempt covered interest arbitrage, what will be their return? If Euro zone investors attempt covered interest arbitrage, what will be their return? 6. Why would UK investors consider covered interest arbitrage in France when the interest rate on euros in France is lower than the U.S. interest rate? 7. Assume that the annual U.S. interest rate is currently 8 percent and Germanys annual interest rate is currently 9 percent. The euros one-year forward rate currently exhibits a discount of 2 percent. Does intersest parity exist? How could a German subsidiary of a U.S. firm. benefit from the situiation?

Tutorial International Finance Prof. Dr. Christian Kraus Questions

Tutorial 5

1. Inflation differentials between the U.S. and other industrialized countries have typically been a few percentage points in any given year. Yet, in many years annual exchange rates between the corresponding currencies have changed by 10 percent or more. What does this information suggest about PPP? 2. Explain why PPP does not hold. 3. Explain the international Fisher effect (IFE). What is the rationale for the existence of the IFE? What are the implications of the IFE for firms with excess cash that consistently invest in foreign Treasury bills? Explain why the IFE may not hold. 4. Compare and contrast interest rate parity (discussed in the previous chapter), purchasing power parity (PPP), and the international Fisher effect (IFE). 5. Assume that the nominal interest rate in Mexico is 48 percent and the interest rate in the United States is 8 percent for one-year securities that are free from default risk. What does the IFE suggest about the differential in expected inflation in these two countries? Using this information and the PPP theory, describe the expected nominal return to U.S. investors who invest in Mexico. 6. Assume that the spot exchange rate of the British pound is $1.73. How will this spot rate adjust according to PPP if the United Kingdom experiences an inflation rate of 7 percent while the United States experiences an inflation rate of 2 percent? 7. Beth Miller does not believe that the international Fisher effect (IFE) holds. Current oneyear interest rates in Europe are 5 percent, while one-year interest rates in the U.S. are 3 percent. Beth converts $100,000 to euros and invests them in Germany. One year later, she converts the euros back to dollars. The current spot rate of the euro is $1.10. According to the IFE, what should the spot rate of the euro in one year be? If the spot rate of the euro in one year is $1.00, what is Beths percentage return from her strategy? If the spot rate of the euro in one year is $1.08, what is Beths percentage return from her strategy? What must the spot rate of the euro be in one year for Beths strategy to be successful?

Discussion:

Does PPP eliminate concerns about long-Term exchange rate risk?