Section A (40 marks) Chapter 1: Introduction 1.

The definition of _______________ (international trade) is the movement of goods across national borders.

2.

Generally, greater the proportion of shares of a company held by closely knit family members, _______________ (lower) the companys internal and external monitoring.

3.

_______________ (Industry Agglomeration) Theory says that firms in an industry tend to locate in the same areas because of positive externalities.

4.

The _______________ (OLI) model explains that firms become MNCs because of ownership, location, and internalisation advantages.

Chapter 2: International Financial Markets 1. In foreign exchange markets, _______________ (bid) is the price that market makers are willing to buy a foreign currency.

2.

A market maker who is long in EUR will _______________ (profit) if the value of EUR increases.

3.

A quote of ABCXYZ 1.25 means that _______________ (1.25) units of XYZ can be exchanged for 1 unit of ABC.

4.

When lending or borrowing is in a currency that is not the domestic currency of the country where the transaction takes place, the transaction is said to take place in the _______________ (eurocurrency) market.

5.

_______________ (Global) bonds are issued simultaneously in multiple regions or countries.

Chapter 4: Currency Systems & Valuation 1. _______________ (Demand) for a currency is inversely related to the value (or price) of that currency.

2.

A country with relatively high interest rates will attract foreign investment which will _______________ (increase) the value of the currency in that country.

3.

Central bank intervention in the foreign exchange market that does not change the monetary base in the economy is called _______________ (sterilised) currency intervention.

4.

A currency system, where one country can issue its currency only against reserves of a specified foreign currency, is called _______________ (currency board) arrangement.

5.

As a result of the Bretton Woods Agreement, the _______________ (USD) became the key international currency and its value was established at 35 per ounce of gold.

Chapter 3: Currency Derivatives 1. A short position on CHF futures would be profitable when the CHF futures price _______________ (falls).

2.

A put option on JPY, priced in USD, allows the holder (buyer) the opportunity but not the obligation to _______________ (sell) the underlying currency, which is JPY, at a fixed price.

3.

If the USDJPY 90-day forward exchange rate is lower than its current spot exchange rate, it means that USD is traded at a 90-day forward _______________ (discount) against JPY.

4.

_______________ (Margin account) and daily settlement are two features in a currency futures contract trading that reduces the counterparty default risk.

5.

Higher the EUR interest rate, _______________ (lower) the call option premium on EUR, other factors remaining unchanged.

Chapter 6: Currency Exposure Measurement 1. One of the implicit assumptions in using _______________ (standard deviation) as a measure of currency risk is that the currency changes are normally distributed, which means that the currency changes occur in a regular pattern.

2.

Based on the Markowitz portfolio approach, _______________ (lower) the correlation between currencies, greater the diversification and lower a companys currency risk.

3.

Economic exposure is an aspect of currency risk that assesses the impact of currency changes on a companys overall _______________ (value).

4.

Netting and consolidation of cash flows occurring at different times is made possible by using the _______________ (present) value of those cash flows.

5.

If the currency in which a companys costs are denominated rises in value, usually the companys competitive position should _______________ (fall).

6.

Revenues and expenses are translated at the _______________ (average) exchange rate for the period, while assets and liabilities are translated at the exchange rate at the end of the period.

Chapter 10: Long-term Financing 1. Typically, an MNC has a more diversified portfolio of cash flows compared to a domestic company and this should _______________ (reduce) the MNCs credit risk.

2.

MNCs cash flows, rather than domestic companies cash flows, are more adversely affected by _______________ (country) risk.

3.

A typical currency swap allows an MNC to pay a(n) _______________ (fixed) rate of interest in one currency and receive a (different) fixed rate of interest in another currency.

4.

In a(n) _______________ (syndicated) loan, the default risk is shared by the participating banks, and therefore, the interest rate on the loan is lower.

5.

A bond issued in a country, and denominated in a currency other than the currency of that country, is called a(n) _______________. (eurobond)

6.

In a(n) _______________ (venture capital) arrangement, a major investor provides equity capital at the start-up stage of a firm, and later usually arranges an initial public offering to sell off the ownership in the firm.

7.

The advantage of _______________ (internal) equity capital is lower cost, but the disadvantage is lower dividends are then paid.

8.

Listing _______________ (existing) shares in a foreign exchange does not provide new financing for the MNC but it expands the potential buyers of later issues of new shares.

9.

The capital asset pricing model estimates the cost of equity as the risk-free rate of return plus the risk _______________. (premium)

Chapter 12: International Trade 1. In international trade matters, _______________ (counterparty) risk refers to the risk that the other party to a contract will not perform their duties under the contract.

2.

Since a letter of credit represents a future payment to an exporter for goods sold, the _______________ (exporter) can use the letter of credit as collateral for a loan.

3.

A(n) _______________ (bankers acceptance) is a time draft that is accepted by bank.

4.

When an importer receives the title to the goods shipped by the exporter only upon the importers payment for those goods, it is called documents against _______________. (payment).

5.

The terms of a(n) _______________ (irrevocable) letter of credit cannot be changed without the consent of the beneficiary of the letter of credit.

6.

The _______________ (order) bill of lading transfers title to the goods being shipped to the holder of that document, whereas the straight bill of lading does not transfer title.

Section B (60 marks) Chapter 5: Currency Parity Conditions Question 1 (15 marks) Assume that you are given the following quotes of Swiss franc (CHF) and US dollar (USD): CHFUSD spot rate today 0.60 CHFUSD 1-year forward rate today 0.63 CHFUSD expected spot rate 1 year from today 0.64 1-year interest rate in CHF today 7% 1-year interest rate in USD today 9% a) Determine CHFs percentage forward premium or discount from the spot rate. (1 marks) (0.630.60)-1 100% = 5% CHF trades at forward premium.

b) Is the interest rate parity (IRP) condition met? Explain why. (1 marks) [(1+9%)(1+7%)]-1 100% = 1.8692% Not equal to 5%. CHF trades at a 5% forward premium, but USD interest rate is only 2% higher. Thus, IRP condition is not met.

c) If you could borrow either CHF 100,000 or USD 60,000 now, state clearly how you would carry out a profitable covered interest arbitrage (CIA). Compute the absolute profit after 1 year. (8 marks) 1. Borrow USD 60,000.00 now for 1 year. Need to repay USD 65,400.00 [60,000(1+9%)] 1 year from now. 2. Sell USD 60,000.00, and buy CHF 100,000.00 [60,0000.60] at spot now. 3. Deposit CHF 100,000.00 now for 1 year. Receive CHF 107,000.00 [100,000(1+7%)] 1 year from now. 4. Sell CHF 107,000.00 and buy USD 67,410.00 [107,0000.63] 1-year forward now. After 1 year, use forward proceeds of USD 67,410.00 to repay loan of USD 65,400.00; Retain a profit of USD 2,010.00

d) Arising from the CIA, explain how and why the various quotes should change. (4 marks) 1. Increased borrowing of USD will raise USD interest rate. 2. Increased spot buying of CHF will raise the spot rate. 3. Increased deposits of CHF will reduce CHF interest rate. 4. Increased forward selling of CHF will reduce the forward rate.

Chapter 7: Currency Exposure Management Question 2 (15 marks) A Japanese company has to make a payment of CHF 50,000 in 6 months. It is considering methods to hedge this exposure. a) If the current 6-month forward rate is CHFJPY 87, determine the amount in JPY that the company would have to pay in 6 months if it hedges forward the exposure. (2 marks) 5000087 = JPY 4,350,000.00

b) The current spot rate is CHFJPY 88. The current 6-month interest rates in Japan and Switzerland are, respectively, 2% and 5%, per annum. Given this, state clearly how the company can hedge the exposure using money market hedge. Compute the amount in JPY that the company would have to pay in 6 months under this hedge. (8 marks) 1. Borrow JPY 4,292,682.93 for 6 months now. 2. Sell JPY 4,292,682.93 [48780.4988], buy CHF 48,780.49 at spot now. 3. Deposit CHF 48,780.49 [50000(1+{5%2})] for 6 months now. 4. Use CHF deposit proceeds to make the CHF payment after 6 months. 5. Repay JPY 4,335,609.76 [4292682.93(1+{2%2})] loan after 6 months.

c) A 6-month European-style call option on CHF, with a strike price of JPY 87.5 per CHF, has a premium of JPY 1.5 per CHF. If the company hedges the exposure with this option, determine the maximum amount in JPY that the company would have to pay in 6 months. When, i.e., at which exchange rate in 6 months, would the option hedge be the best alternative? (5 marks) 50000(87.5+1.5) = JPY4,450,000.00 (4335609.7650000)-1.5 = 85.212 When the spot exchange rate in 6 months is less than CHFJPY 85.212, option hedge would provide the best alternative, i.e., the lowest payment in JPY.

Chapter 8: Capital Budgeting Question 3 (15 marks) Petrus Company has an opportunity to invest in a 5-year project in Australia. Petrus would have to invest US dollar (USD) 3,000,000 in the project. The project is expected to generate annual cash flows in Australian dollar (AUD). The annual AUD cash flows and the corresponding expected AUDUSD exchange rates are as below. Year 1 2 3 4 5 AUD cash flow 500,000 1,000,000 1,500,000 2,000,000 2,500,000 AUDUSD 0.55 0.60 0.53 0.59 0.54 a) Given the information above, compute the yearly cash flows in USD arising from the project. (5 marks) Year 1: 500,0000.55 = USD 275,000.00 Year 2: 1,000,0000.60 = USD 600,000.00 Year 3: 1,500,0000.53 = USD 795,000.00 Year 4: 2,000,0000.59 = USD 1,180,000.00 Year 5: 2,500,0000.54 = USD 1,350,000.00

b) If Petrus cost of capital for similar projects is 12%, what is then the net present value of this project? Would you invest in the project? (5 marks) 2 3 4 275,000(1+12%) + 600,000(1+12%) + 795,000(1+12%) + 1,180,000(1+12%) + 1,350,000(1+12%)5 - 3,000,000 = - USD 194,345.07 As the NPV is negative, the project should be rejected.

c) Given the above cash flows, determine the breakeven constant AUDUSD exchange rate (to 4 decimal points) over the 5 years, which would make Petrus indifferent between accepting and rejecting the project. (5 marks) 2 3 3,000,000 { [500,000(1+12%)] + [1,000,000(1+12%) ] + [1,500,000(1+12%) ] + [2,000,000(1+12%)4] + [2,500,000(1+12%)5] }= AUDUSD 0.5999

Chapter 11: Optimising & Financing Working Capital Question 4 (15 marks) A Malaysian company needs to obtain some debt financing for a year. The local interest rate is 6% per annum. The company is also considering foreign sources of debt. a) The interest rate in Singapore is 4% per annum. The current spot SGDMYR exchange rate is 2.40. The table below provides the possible spot SGDMYR exchange rates a year from now and their corresponding probabilities. Determine the companys expected cost of financing in Singapore, and the probability that the cost would be more than the local cost of financing. Probability 30% 40% 30% SGDMYR 2.37 2.41 2.45 (6 marks) {[(30%2.37)+(40%2.41)+(30%2.45)]2.40}(1+4%) - 1 = 4.4333% When the spot rate is 2.45 a year from now, the cost of financing would be 6.1667%, i.e., higher than the local cost of 6%. The probability of this happening is 30%.

b) The interest rate in Indonesia, however, is 8% per annum. The current spot MYRIDR exchange rate is 2900. The table below provides the possible spot MYRIDR exchange rates a year from now and their corresponding probabilities. As above, determine the companys expected cost of financing in Indonesia, and the probability that the cost would be more than the local cost of financing. Probability 30% 40% 30% MYRIDR 2940 2980 3020 (6 marks) {2900[(30%2940)+(40%2980)+(30%3020)]}(1+8%) - 1 = 5.1007% When the spot rate is 2940 a year from now, the cost of financing would be 6.5306%, i.e., higher than the local cost of 6%. The probability of this happening is 30%.

c) The table below provides the scenarios of combinations of the spot SGDMYR and MYRIDR exchange rates a year from now and their corresponding probabilities. If the company finances 50% in Singapore and 50% in Indonesia, determine the companys expected cost of financing, and the probability that the cost would be more than the local cost of financing. Scenario 1 2 3 4 5 Probability 5% 25% 40% 25% 5% SGDMYR 2.37 2.37 2.41 2.45 2.45 MYRIDR 3020 2940 2980 3020 2940 (3 marks) (50%4.4333%)+(50%5.1007%) = 4.7170% The cost of financing would be higher than the local cost when the SGDMYR and MYRIDR exchange rates are respectively 2.45 and 2940. The probability of these rates occurring (in scenario 5) is only 5%.