Chapter 21 - Fundamentals of Corporate Finance 9th Edition - Test Bank

21 Student: ___________________________________________________________________________

1.

Which one of the following securities is used as a means of investing in a foreign stock that otherwise could not be traded in the United States? A. American Depository Receipt B. Yankee bond C. Yankee stock D. LIBOR E. gilt

2.

Assume that $1 is equal to ¥98 and also equal to C$1.21. Based on this, you could say that C$1 is equal to: C$1(¥98/C$1.21) = ¥80.99. The exchange rate of C$1 = ¥80.99 is referred to as the: A. open exchange rate. B. cross-rate. C. backward rate. D. forward rate. E. interest rate.

3.

International bonds issued in multiple countries but denominated solely in the issuer's currency are called: A. Treasury bonds. B. Bulldog bonds. C. Eurobonds. D. Yankee bonds. E. Samurai bonds.

4.

U.S. dollars deposited in a bank in Switzerland are called: A. foreign depository receipts. B. international exchange certificates. C. francs. D. Eurocurrency. E. Eurodollars.

5.

International bonds issued in a single country and denominated in that country's currency are called: A. Treasury bonds. B. Eurobonds. C. gilts. D. Brady bonds. E. foreign bonds.

6.

You would like to purchase a security that is issued by the British government. Which one of the following should you purchase? A. Samurai bond B. kronor C. Euro D. LIBOR E. gilt

7.

On Friday evening, Bank A loans Bank B Eurodollars that must be repaid the following Monday morning. Which one of the following is most likely the interest rate that will be charged on this loan? A. Eurodollar yield to maturity B. London Interbank Offer Rate C. Paris Opening Interest Rate D. United States Treasury bill rate E. international prime rate

8.

Party A has agreed to exchange $1 million U.S. dollars for $1.21 million Canadian dollars. What is this agreement called? A. gilt B. LIBOR C. SWIFT D. Yankee agreements E. swap

9.

A large U.S. company has £500,000 in excess cash from its foreign operations. The company would like to exchange these funds for U.S. dollars. In one of the following markets can this exchange be arranged? A. ADR B. national registry C. national discount window D. foreign exchange market E. Eurobond market

10. The price of one Euro expressed in U.S. dollars is referred to as a(n): A. ADR rate. B. cross inflation rate. C. depository rate. D. exchange rate. E. foreign interest rate. 11. Trader A has agreed to give 100,000 U.S. dollars to Trader B in exchange for British pounds based on today's exchange rate of $1 = £0.62. The traders agree to settle this trade within two business day. What is this exchange called? A. swap B. option trade C. futures trade D. forward trade E. spot trade 12. George and Pat just made an agreement to exchange currencies based on today's exchange rate. Settlement will occur tomorrow. Which one of the following is the exchange rate that applies to this agreement? A. spot exchange rate B. forward exchange rate C. triangle rate D. cross rate E. current rate 13. A trader has just agreed to exchange $2 million U.S. dollars for $1.55 million Euros six months from today. This exchange is an example of a: A. spot trade. B. forward trade. C. currency swap. D. floating swap. E. triangle arbitrage.

14. Mr. Black has agreed to a currency exchange with Mr. White. The parties have agreed to exchange C$12,500 for $10,000 with the exchange occurring 4 months from now. This agreed-upon exchange rate is called the: A. spot rate. B. swap rate. C. forward rate. D. parity rate. E. triangle rate. 15. Assume that an item costs $100 in the U.S. and the exchange rate between the U.S. and Canada is: $1 = C$1.27. Which one of the following concepts supports the idea that the item that sells for $100 in the U.S. is currently selling in Canada for $127? A. unbiased forward rates condition B. uncovered interest rate parity C. international Fisher effect D. purchasing power parity E. interest rate parity 16. The condition stating that the interest rate differential between two countries is equal to the percentage difference between the forward exchange rate and the spot exchange rate is called: A. the unbiased forward rates condition. B. uncovered interest rate parity. C. the international Fisher effect. D. purchasing power parity. E. interest rate parity. 17. Which one of the following states that the current forward rate is an unbiased predictor of the future spot exchange rate? A. unbiased forward rates B. uncovered interest rate parity C. international Fisher effect D. purchasing power parity E. interest rate parity 18. Which one of the following states that the expected percentage change in the exchange rate between two countries is equal to the difference in the countries' interest rates? A. unbiased forward rates condition B. uncovered interest parity C. international Fisher effect D. purchasing power parity E. interest rate parity 19. Which one of the following supports the idea that real interest rates are equal across countries? A. unbiased forward rates condition B. uncovered interest rate parity C. international Fisher effect D. purchasing power parity E. interest rate parity 20. Which one of the following is the risk that a firm faces when it opens a facility in a foreign country, given that the exchange rate between the firm's home country and this foreign country fluctuates over time? A. international risk B. diversifiable risk C. purchasing power risk D. exchange rate risk E. political risk

21. The market value of the Blackwell Corporation just declined by 5 percent. Analysts believe this decrease in value was caused by recent legislation passed by Congress. Which type of risk does this illustrate? A. international risk B. diversifiable risk C. purchasing power risk D. exchange rate risk E. political risk 22. Where does most of the trading in Eurobonds occur? A. Munich B. Frankfurt C. London D. New York E. Paris 23. Which one of the following names matches the country where the bond is issued? A. Empire: United Kingdom B. Western: United States C. Samurai: China D. Bulldog: France E. Rembrandt: Netherlands 24. The LIBOR is primarily used as the basis for the rate charged on: A. short-term debt in the Lisbon market. B. mortgage loans in the Lisbon market. C. Eurodollar loans in the London market. D. U.S. federal funds. E. interbank loans in the U.S. 25. A basic interest rate swap generally involves trading a: A. short-term rate for a long-term rate. B. foreign rate for a domestic rate. C. government rate for a corporate rate. D. fixed rate for a variable rate. E. taxable rate for a tax-exempt rate. 26. Which one of the following statements is correct concerning the foreign exchange market? A. The trading floor of the foreign exchange market is located in London, England. B. The foreign exchange market is the world's second largest financial market. C The four primary currencies that are traded in the foreign exchange market are the U.S. dollar, the . British pound, the French franc, and the euro. D. Importers, exporters, and speculators are key players in the foreign exchange market. E. The U.S. created a communications network called SWIFT to facilitate currency trading. 27. Triangle arbitrage: I. is a profitable situation involving three separate currency exchange transactions. II. helps keep the currency market in equilibrium. III. opportunities can exist in either the spot or the forward market. IV. is based solely on differences in exchange ratios between spot and futures markets. A. I and IV only B. II and III only C. I, II, and III only D. II, III, and IV only E. I, II, III, and IV

28. Spot trades must be settled: A. at the time of the trade. B. on the day following the trade date. C. within two business days. D. within three business days. E. within one week of the trade date. 29. Assume the euro is selling in the spot market for $1.33. Simultaneously, in the 3-month forward market the euro is selling for $1.35. Which one of the following statements correctly describes this situation? A. The spot market is out of equilibrium. B. The forward market is out of equilibrium. C. The dollar is selling at a premium relative to the euro. D. The euro is selling at a premium relative to the dollar. E. The euro is expected to depreciate in value. 30. Which one of the following formulas expresses the absolute purchasing power parity relationship between the U.S. dollar and the British pound? A. S0 = PUK × PUS B. PUS = Ft × PUK C. PUK = S0 × PUS D. Ft = PUS × PUK E. S0 × Ft = PUK × PUS 31. Which of the following conditions are required for absolute purchasing power parity to exist? I. goods must be identical II. goods must have equal economic value III. transaction costs must be zero IV. there can be no barriers to trade A. I and III only B. II and IV only C. I, III, and IV only D. I, II, and III only E. I, II, III, and IV 32. Absolute purchasing power parity is most apt to exist for which one of the following items? A. lumber B. computer C. silver D. automobile E. cell phone 33. Relative purchasing power parity: A. states that identical items should cost the same regardless of the currency used to make the purchase. B. relates differences in inflation rates to differences in exchange rates. C. compares the real rate of return to the nominal rate of return. D. explains the differences in real rates across national boundaries. E. relates future exchange rates to current spot rates. 34. Which one of the following formulas correctly describes the relative purchasing power parity relationship? A. E(St) = S0 × [1 + (hFC - hUS)]t B. E(St) = S0 × [1 - (hFC - hUS)]t C. E(St) = S0 × [1 + (hUS + hFC)]t D. E(St) = S0 × [1 - (hUS - hFC)]t E. E(St) = S0 × [1 + (hUS - hFC)]t

35. Which one of the following statements is correct given the following exchange rates?

A. On Thursday, one U.S. dollar was equal to 0.1023 South African rand. B. On Friday, one Thai baht was equal to $35.21. C. Both the South African rand and the Thai baht appreciated against the U.S. dollar from Thursday to Friday. D. The South African rand appreciated from Thursday to Friday against the U.S. dollar. E. The U.S. dollar depreciated from Thursday to Friday against the Thai baht. 36. Which of the following variables used in the covered interest arbitrage formula are correctly defined? I. RFC: Foreign country nominal risk-free interest rate II. RUS: U.S. real risk-free interest rate III. F1: 360-day forward rate IV. S0: Current spot rate expressed in units of foreign currency per one U.S. dollar A. I and II only B. III and IV only C. I, III, and IV only D. II, III, and IV only E. I, II, III, and IV 37. Interest rate parity: A. eliminates covered interest arbitrage opportunities. B. exists when spot rates are equal for multiple countries. C. means the nominal risk-free rate of return must be the same across countries. D. exists when the spot rate is equal to the futures rate. E. eliminates exchange rate fluctuations. 38. The interest rate parity approximation formula is: A. Ft = S0 × [1 + (RFC + RUS)]t. B. Ft = S0 × [1 - (RFC - RUS)]t. C. Ft = S0 × [1 + (RFC - RUS)]t. D. Ft = S0 × [1 + (RFC × RUS)]t. E. Ft = S0 × [1 - (RFC + RUS)]t. 39. The unbiased forward rate is a: A. condition where a future spot rate is equal to the current spot rate. B. guarantee of a future spot rate at one point in time. C. condition where the spot rate is expected to remain constant over a period of time. D. relationship between the future spot rate of two currencies at an equivalent point in time. E. predictor of the future spot rate at the equivalent point in time. 40. The forward rate market is dependent upon: A. current forward rates exceeding current spot rates. B. current spot rates exceeding current forward rates over time. C. current spot rates equaling current forward rates, on average, over time. D. forward rates equaling the actual future spot rates on average over time. E. current spot rates equaling the actual future spot rates on average over time. 41. Uncovered interest parity is defined as: A. E(St) = S0 × [1 + (hFC - hUS)]t. B. E(St) = S0 × [1 + (RFC - RUS)]t. C. E(St) = S0 × [1 - (RFC - RUS)]t. D. E(St) = S0 × [1 + (RUS - RFC)]t. E. E(St) = S0 × [1 + (RFC + RUS)]t.

42. The international Fisher effect states that _____ rates are equal across countries. A. spot B. one-year future C. nominal D. inflation E. real 43. The home currency approach: A. discounts all of a project's foreign cash flows using the current spot rate. B. employs uncovered interest parity to project future exchange rates. C. computes the net present value (NPV) of a project in the foreign currency and then converts that NPV into U.S. dollars. D. utilizes the international Fisher effect to compute the NPV of foreign cash flows in the foreign currency. E utilizes the international Fisher effect to compute the relevant exchange rates needed to compute the . NPV of foreign cash flows in U.S. dollars. 44. The home currency approach: A. generally produces more reliable results than those found using the foreign currency approach. B. requires an applicable exchange rate for every time period for which there is a cash flow. C. uses the current risk-free nominal rate to discount all cash flows related to a project. D. stresses the use of the real rate of return to compute the net present value (NPV) of a project. E. converts a foreign denominated NPV into a dollar denominated NPV. 45. The foreign currency approach to capital budgeting analysis: I. is computationally easier to use than the home currency approach. II. produces the same results as the home currency approach. III. requires an exchange rate for each time period for which there is a cash flow. IV. computes the NPV of a project in both the foreign and the domestic currency. A. I and III only B. II and IV only C. I, II, and IV only D. II, III, and IV only E. I, II, III, and IV 46. Which one of the following is a suggested method of reducing a U.S. importer's short-run exposure to exchange rate risk? A. entering a forward exchange agreement timed to match the invoice date B. investing U.S. dollars when an order is placed and using the investment proceeds to pay the invoice C. exchanging funds on the spot market at the time an order is placed with a foreign supplier D. exchanging funds on the spot market at the time an order is received E. exchanging funds on the spot market at the time an invoice is payable 47. Long-run exposure to exchange rate risk relates to: A. daily variations in exchange rates. B. variances between spot and future rates. C. unexpected changes in relative economic conditions. D. differences between future spot rates and related forward rates. E. accounting gains and losses created by fluctuating exchange rates.

48. The type of exchange rate risk known as translation exposure is best described as: A the risk that a positive net present value (NPV) project could turn into a negative NPV project because . of changes in the exchange rate between two countries. B. the problem encountered by an accountant of an international firm who is trying to record balance sheet account values. C. the fluctuation in prices faced by importers of foreign goods. D. the variance in relative pay rates based on the currency used to pay an employee. E.the variance between the revenue of an exporter who uses forward rates and an equivalent exporter who does not use forward rates. 49. Which of the following statements are correct? I. The usage of forward rates increases the short-run exposure to exchange rate risk. II. Accounting translation gains and losses are recorded in the equity section of the balance sheet. III. The long-run exchange rate risk faced by an international firm can be reduced if a firm borrows money in the foreign country where the firm has operations. IV. Unexpected changes in economic conditions are classified as short-run exposure to exchange rate risk. A. I and III only B. II and III only C. I, II, and III only D. II, III, and IV only E. I, III, and IV only 50. Which one of the following types of operations would be subject to the most political risk if the operation were conducted outside of a firm's home country? A. accounting and payroll functions B. partial assembly of components manufactured in the firm's home country C. military weapons manufacturing D. packing materials manufacturing for use by the home country firm E. production of minor parts, such as nuts and bolts, for use by the home country firm 51. How many Euros can you get for $2,100 if one euro is worth $1.2762? A. €1,638.09 B. €1,645.51 C. €2,676.67 D. €2,680.02 E. €2,684.15 52. You are planning a trip to Australia. Your hotel will cost you A$145 per night for seven nights. You expect to spend another A$2,800 for meals, tours, souvenirs, and so forth. How much will this trip cost you in U.S. dollars given the following exchange rates?

A. $2,559 B. $2,604 C. $2,631 D. $5,452 E. $5,688 53. You want to import $147,000 worth of rugs from India. How many rupees will you need to pay for this purchase if one rupee is worth $0.0202? A. Rs 6,887,424 B. Rs 7,238,911 C. Rs 7,277,228 D. Rs 8,367,594 E. Rs 8,415,096

54. Currently, $1 will buy C$1.2103 while $1.2762 will buy €1. What is the exchange rate between the Canadian dollar and the euro? A. C$1 = €0.6474 B. C$1 = €0.6539 C. C$1 = €1.2762 D. C$1.5446 = €1 E. C$1.5528 = €1 55. Assume that ¥98.48 equal $1. Also assume that SKr7.7274 equal $1. How many Japanese yen can you acquire in exchange for 3,000 Swedish krone? A. ¥235 B. ¥261 C. ¥38,233 D. ¥39,024 E. ¥39,520 56. You just returned from some extensive traveling throughout the Americas. You started your trip with $20,000 in your pocket. You spent 3.4 million pesos while in Chile and 16,500 bolivares in Venezuela. Then on the way home, you spent 47,500 pesos in Mexico. How many dollars did you have left by the time you returned to the U.S. given the following exchange rates? (Note: Multiple symbols are used to designate various currencies. For example, the U.S. dollar is notated as "$" or as "USD".)

A. 1,113 USD B. 3,535 USD C. 4,117 USD D. 4,244 USD E. 7,408 USD 57. You have 100 British pounds. A friend of yours is willing to exchange 180 Canadian dollars for your 100 British pounds. What will be your profit or loss if you accept your friend's offer, given the following exchange rates?

A. £7.63 loss B. £13.29 loss C. £28.51 loss D. £7.63 profit E. £28.51 profit 58. Assume you can buy 52 British pounds with 100 Canadian dollars. How much profit can you earn on a triangle arbitrage given the following rates if you start out with 100 U.S. dollars?

A. $0.78 B. $1.04 C. $1.33 D. $1.56 E. $1.64

59. Today, you can exchange $1 for £0.6211. Last week, £1 was worth $1.6104. How much profit or loss would you now have if you had converted £100 into dollars last week? A. loss of ₤1.57 B. loss of ₤0.39 C. loss of ₤0.07 D. profit of ₤0.02 E. profit of ₤1.59 60. Today, you can get either 121 Canadian dollars or 1,288 Mexican pesos for 100 U.S. dollars. Last year, 100 U.S. dollars was worth 115 Canadian dollars or 1,291 Mexican pesos. Which one of the following statements is correct given this information? A. $100 converted into Canadian dollars last year would now be worth $105.22. B. $100 converted into Mexican pesos last year would now be worth $99.77. C. $100 converted into Mexican pesos last year would now be worth $100.36. D. $100 converted into Canadian dollars last year would now be worth $95.05. E. $100 invested in Canadian dollars last year would now be worth $100. 61. The camera you want to buy costs $289 in the U.S. How much will the identical camera cost in Canada if the exchange rate is C$1 = $0.8262? Assume absolute purchasing power parity exists. A. $238.77 B. $242.19 C. $243.52 D. $348.60 E. $349.79 62. A new coat costs 3,900 Russian rubles. How much will the identical coat cost in Euros if absolute purchasing power parity exists and the following exchange rates apply?

A. €97.23 B. €112.97 C. €119.05 D. €181.27 E. €183.99 63. Assume that $1 can buy you either ¥98.48 or £0.6211. If a TV in London costs £990, what will that identical TV cost in Tokyo if absolute purchasing power parity exists? A. ¥58,797 B. ¥60,554 C. ¥156,972 D. ¥161,855 E. ¥163,542 64. In the spot market, $1 is currently equal to A$1.4910. Assume the expected inflation rate in Australia is 3.5 percent and in the U.S. 4.0 percent. What is the expected exchange rate one year from now if relative purchasing power parity exists? A. A$1.4810 B. A$1.4835 C. A$1.4875 D. A$1.4985 E. A$1.5005

65. In the spot market, $1 is currently equal to £0.6211. Assume the expected inflation rate in the U.K. is 4.2 percent while it is 3.4 percent in the U.S. What is the expected exchange rate one year from now if relative purchasing power parity exists? A. £0.6161 B. £0.6178 C. £0.6239 D. £0.6261 E. £0.6278 66. In the spot market, $1 is currently equal to £0.6211. Assume the expected inflation rate in the U.K. is 2.6 percent while it is 4.3 percent in the U.S. What is the expected exchange rate four years from now if relative purchasing power parity exists? A. £0.5799 B. £0.5822 C. £0.6105 D. £0.6623 E. £0.6644 67. Assume the current spot rate is C$1.2103 and the one-year forward rate is C$1.1952. The nominal riskfree rate in Canada is 3 percent while it is 4 percent in the U.S. Using covered interest arbitrage you can earn an extra _____ profit over that which you would earn if you invested $1 in the U.S. A. $0.003 B. $0.006 C. $0.008 D. $0.015 E. $0.018 68. Assume the current spot rate is C$1.1875 and the one-year forward rate is C$1.1724. The nominal riskfree rate in Canada is 4 percent while it is 3 percent in the U.S. Using covered interest arbitrage you can earn an extra _____ profit over that which you would earn if you invested $1 in the U.S. A. $0.018 B. $0.023 C. $0.029 D. $0.031 E. $0.035 69. Assume the spot rate for the Japanese yen currently is ¥98.48 per $1 and the one-year forward rate is ¥97.62 per $1. A risk-free asset in Japan is currently earning 2.5 percent. If interest rate parity holds, approximately what rate can you earn on a one-year risk-free U.S. security? A. 1.63 percent B. 2.11 percent C. 3.37 percent D. 3.96 percent E. 4.01 percent 70. Assume the spot rate for the British pound currently is £0.6211 per $1. Also assume the one-year forward rate is £0.6347 per $1. A risk-free asset in the U.S. is currently earning 3.4 percent. If interest rate parity holds, what rate can you earn on a one-year risk-free British security? A. 1.18 percent B. 1.57 percent C. 3.67 percent D. 5.66 percent E. 5.92 percent

71. A risk-free asset in the U.S. is currently yielding 3 percent while a Canadian risk-free asset is yielding 2 percent. Assume the current spot rate is C$1.2103. What is the approximate three-year forward rate if interest rate parity holds? A. C$1.1744 B. C$1.2108 C. C$1.2241 D. C$1.2295 E. C$1.2470 72. Assume the spot rate on the Canadian dollar is C$1.1847. The risk-free nominal rate in the U.S. is 5 percent while it is only 4 percent in Canada. What one-year forward rate will create interest rate parity? A. C$1.1362 B. C$1.1429 C. C$1.1734 D. C$1.1799 E. C$1.1961 73. Assume the spot rate on the Canadian dollar is C$0.9872. The risk-free nominal rate in the U.S. is 5.4 percent while it is only 3.8 percent in Canada. Which one of the following four-year forward rates best establishes the approximate interest rate parity condition? A. C$0.9255 B. C$0.9308 C. C$1.0267 D. C$1.0519 E. C$1.0597 74. You are considering a project in Poland which has an initial cost of 275,000PLN. The project is expected to return a one-time payment of 390,000PLN four years from now. The risk-free rate of return is 4.5 percent in the U.S. and 3 percent in Poland. The inflation rate is 4 percent in the U.S. and 2 percent in Poland. Currently, you can buy 277PLN for 100USD. How much will the payment of 390,000PLN be worth in U.S. dollars four years from now? A. $149,568 B. $180,560 C. $987,251 D. $1,016,926 E. $1,304,357 75. You are expecting a payment of 480,000PLN three years from now. The risk-free rate of return is 3 percent in the U.S. and 4 percent in Poland. The inflation rate is 2.5percent in the U.S. and 3 percent in Poland. Currently, you can buy 277PLN for 100USD. How much will the payment three years from now be worth in U.S. dollars? A. $154,751 B. $168,189 C. $219,511 D. $1,317,269 E. $1,369,888 76. You are expecting a payment of C$100,000 four years from now. The risk-free rate of return is 3.8 percent in the U.S. and 4.1 percent in Canada. The inflation rate is 2 percent in the U.S. and 3 percent in Canada. Suppose the current exchange rate is C$1 = $0.8273. How much will the payment four years from now be worth in U.S. dollars? A. $61,129 B. $62,414 C. $66,667 D. $78,202 E. $81,745

77. Suppose the current spot rate for the Norwegian kroner is $1 = NKr6.6869. The expected inflation rate in Norway is 6 percent and in the U.S. it is 3.5 percent. A risk-free asset in the U.S. is yielding 4 percent. What risk-free rate of return should you expect on a Norwegian security? A. 3.5 percent B. 4.0 percent C. 4.5 percent D. 5.0 percent E. 6.5 percent 78. Suppose the current spot rate for the Norwegian kroner is $1 = NKr6.7119. The expected inflation rate in Norway is 4 percent and in the U.S. 3 percent. A risk-free asset in the U.S. is yielding 4.5 percent. What approximate real rate of return should you expect on a risk-free Norwegian security? A. 1.0 percent B. 1.5 percent C. 2.0 percent D. 2.5 percent E. 3.0 percent 79. The expected inflation rate in Finland is 2.8 percent while it is 3.7 percent in the U.S. A risk-free asset in the U.S. is yielding 4.9 percent. What approximate real rate of return should you expect on a risk-free Finnish security? A. 1.2 percent B. 1.7 percent C. 2.1 percent D. 2.5 percent E. 2.8 percent 80. You want to invest in a project in Canada. The project has an initial cost of C$2.2 million and is expected to produce cash inflows of C$900,000 a year for 3 years. The project will be worthless after the first 3 years. The expected inflation rate in Canada is 4 percent while it is only 3 percent in the U.S. The applicable interest rate for the project in Canada is 13 percent. The current spot rate is C$1 = $0.8158. What is the net present value of this project in Canadian dollars? A. -C$91,889 B. -C$87,924 C. -C$74,963 D. C$165,139 E. C$167,528 81. You want to invest in a riskless project in Sweden. The project has an initial cost of SKr4.1million and is expected to produce cash inflows of SKr1.75 million a year for three years. The project will be worthless after three years. The expected inflation rate in Sweden is 3.2 percent while it is 4.3 percent in the U.S. A risk-free security is paying 5.5 percent in the U.S. The current spot rate is $1 = SKr7.7274. What is the net present value of this project in Swedish kroner? Assume the international Fisher effect applies. A. SKr587,561 B. SKr601,458 C. SKr623,333 D. SKr658,029 E. SKr719,774

82. You are analyzing a project with an initial cost of £48,000. The project is expected to return £11,000 the first year, £36,000 the second year and £38,000 the third and final year. There is no salvage value. The current spot rate is £0.6211. The nominal return relevant to the project is 12 percent in the U.S. The nominal risk-free rate in the U.S. is 4 percent while it is 5 percent in the U.K. Assume that uncovered interest rate parity exists. What is the net present value of this project in U.S. dollars? A. $23,611 B. $25,938 C. $26,930 D. $29,639 E. $30,796 83. You are analyzing a project with an initial cost of £130,000. The project is expected to return £20,000 the first year, £50,000 the second year and £100,000 the third and final year. There is no salvage value. The current spot rate is £0.6211. The nominal risk-free return is 5.5 percent in the U.K. and 6 percent in the U.S. The return relevant to the project is 14 percent in the U.S. Assume that uncovered interest rate parity exists. What is the net present value of this project in U.S. dollars? A. -$8,030 B. -$5,409 C. $2,505 D. $4,730 E. $4,947 84. Using currencies A, B, and C construct an example in which triangle arbitrage exists and then show how to exploit it.

85. What is the relationship between the value of the dollar and the value of the euro in relation to the rate of inflation in the United States?

86. How well do you think relative purchasing power parity (PPP) and uncovered interest parity (UIP) behave? That is, do you think it's possible to forecast the expected future spot exchange rate accurately? What complications might you run into?

87. What conditions are necessary for absolute purchasing power parity (PPP) to exist? Is it realistic to believe PPP can exist within a country let alone across national borders?

88. Describe the foreign currency and home currency approaches to capital budgeting for a foreign project. Which is better? Which approach would you recommend a U.S. firm use? Justify your answer.

89. Based on the information below, what is the cross-rate for Australian dollars in terms of Swiss francs?

A. 0.5607 B. 0.7219 C. 0.8744 D. 1.1437 E. 1.2834 90. Suppose the spot exchange rate for the Canadian dollar is C$1.28 and the six-month forward rate is C$1.33. The U.S. dollar is selling at a _____ relative to the Canadian dollar and the U.S. dollar is expected to _____ relative to the Canadian dollar. A. discount; appreciate B. discount; depreciate C. premium; appreciate D. premium; depreciate E. premium; remain constant 91. Based on the following information, the value of the U.S. dollar will _____ with respect to the yen and will _____ with respect to the Canadian dollar.

A. appreciate; appreciate B. appreciate; depreciate C. depreciate; appreciate D. depreciate; depreciate E. depreciate; remain constant

92. Suppose the Japanese yen exchange rate is ¥114 = $1, and the United Kingdom pound exchange rate is £1 = $1.83. Also suppose the cross-rate is ¥191 = £1. What is the arbitrage profit per one U.S. dollar? A. $0.0743 B. $0.0846 C. $0.0857 D. $0.0923 E. $0.0948 93. Suppose the exchange rates are as follows:

Assume interest rate parity holds and the current six-month risk-free rate in the United States is 3.1 percent. What must the six-month risk-free rate be in Great Britain? A. 2.73 percent B. 2.87 percent C. 2.94 percent D. 3.10 percent E. 3.52 percent 94. Suppose your company imports computer motherboards from Singapore. The exchange rate is currently 1.5803S$/US$. You have just placed an order for 30,000 motherboards at a cost to you of 170.90 Singapore dollars each. You will pay for the shipment when it arrives in 120 days. You can sell the motherboards for $148 each. What will your profit be if the exchange rate goes up by 8 percent over the next 120 days? A. $913,564 B. $1,008,121 C. $1,216,407 D. $1,435,999 E. $1,502,400 95. Suppose the spot and six-month forward rates on the Norwegian krone are Kr6.36 and Kr6.56, respectively. The annual risk-free rate in the United States is 5 percent, and the annual risk-free rate in Norway is 7 percent. What would the six-month forward rate have to be on the Norwegian krone to prevent arbitrage? A. Kr6.4233 B. Kr6.4872 C. Kr6.5103 D. Kr6.5174 E. Kr6.6067 96. You observe that the inflation rate in the United States is 3.5 percent per year and that T-bills currently yield 3.8 percent annually. What do you estimate the inflation rate to be in Australia, if short-term Australian government securities yield 4.5 percent per year? A. 4.17 percent B. 4.20 percent C. 4.24 percent D. 4.27 percent E. 4.30 percent 97. Suppose the spot and three-month forward rates for the yen are ¥128.79 and ¥133.85, respectively. What is the approximate annual percent difference between the inflation rate in the U.S. and in Japan? A. 3.93 percent B. 4.21 percent C. 4.90 percent D. 16.67 percent E. 17.28 percent

98. Assume the spot exchange rate for the Hungarian forint is HUF 215. Also assume the inflation rate in the United States is 4 percent per year while it is 9.5 percent in Hungary. What is the expected exchange rate 5 years from now? A. 269 B. 276 C. 281 D. 294 E. 299 99. Lakonishok Equipment has an investment opportunity in Europe. The project costs €12 million and is expected to produce cash flows of €2.7 million in year 1, €3 million in year 2, and €2.8 million in year 3. The current spot exchange rate is $1.3/€. The current risk-free rate in the United States is 5 percent, compared to that in Europe of 3.5 percent. The appropriate discount rate for the project is estimated to be 18 percent, the U.S. cost of capital for the company. In addition, the subsidiary can be sold at the end of three years for an estimated €6.5 million. What is the NPV of the project? A. -$2,448,215 B. -$2,016,686 C. -$1,878,787 D. $879,402 E. $2,316,519

21 Key 1. A 2. B 3. C 4. D 5. E 6. E 7. B 8. E 9. D 10. D 11. E 12. A 13. B 14. C 15. D 16. E 17. A 18. B 19. C 20. D 21. E 22. C 23. E 24. C 25. D 26. D 27. C 28. C 29. D 30. C 31. E 32. C 33. B 34. A 35. D 36. C

37. A 38. C 39. E 40. D 41. B 42. E 43. B 44. B 45. C 46. A 47. C 48. B 49. B 50. C 51. B 52. A 53. C 54. D 55. C 56. B 57. A 58. C 59. D 60. D 61. E 62. B 63. C 64. B 65. D 66. A 67. A 68. B 69. C 70. D 71. A 72. C 73. A 74. A

75. B 76. E 77. E 78. B 79. A 80. C 81. E 82. B 83. A Feedback: Refer to section 21.2 84. Students should construct an example similar to Example 21.2 in the text.

Feedback: Refer to section 21.3 85. The question asks the student to define and discuss the absolute and relative purchasing power parity (PPP) theories as well as some of the market frictions that keep PPP relationships from holding precisely.

Feedback: Refer to section 21.3 86. Each of the variables in these equations must be estimated so it is unlikely, even unrealistic, to expect them to hold with any high degree of accuracy especially over long periods of time. In addition, most countries manage the value of their currencies to some extent which adds a significant amount of noise to the exchange rate process.

Feedback: Refer to section 21.3 87. The requirements for absolute PPP to hold are zero trading costs, lack of trade barriers, and identical goods. Students should discuss the forces that either create or prevent these requirements both within a country and across national borders.

Feedback: Refer to section 21.5 88. In the home currency approach, you must forecast both the foreign cash flows and the future expected exchange rates, convert the foreign currency cash flows into dollars, and discount those dollar cash flows at the cost of capital for dollar-denominated investments. In the foreign currency approach, you forecast the foreign cash flows, determine the discount rate appropriate for cash flows denominated in the foreign currency and discount those cash flows to the present. You then convert the foreign currency NPV to dollars using the current exchange rate. If done properly, both approaches give identical results. However, the foreign currency approach is computationally somewhat more straightforward.

89. C 90. C 91. D 92. D 93. A 94. D 95. A 96. B 97. D 98. C 99. B

21 Summary Category AACSB: Analytic AACSB: N/A AACSB: Reflective thinking Blooms: Analysis Blooms: Application Blooms: Comprehension Blooms: Knowledge Difficulty: Basic Difficulty: Intermediate EOC #: 21-10 EOC #: 21-11 EOC #: 21-12 EOC #: 21-13 EOC #: 21-14 EOC #: 21-2 EOC #: 21-3 EOC #: 21-4 EOC #: 21-5 EOC #: 21-6 EOC #: 21-9 Learning Objective: 21-1 Learning Objective: 21-2 Learning Objective: 21-3 Learning Objective: 21-4 Ross - Chapter 21 Section: 21.1 Section: 21.2 Section: 21.3 Section: 21.4 Section: 21.5 Section: 21.6 Section: 21.7 Topic: Absolute purchasing power parity Topic: American depository receipt Topic: Approximate interest rate parity Topic: Arbitrage Topic: Capital budgeting Topic: Covered interest arbitrage Topic: Cross-rate Topic: Currency appreciation Topic: Currency conversion Topic: Currency premium Topic: Eurobonds Topic: Eurocurrency Topic: Exchange rate Topic: Exchange rate risk Topic: Expected spot rate Topic: Foreign bonds Topic: Foreign currency approach Topic: Foreign exchange market Topic: Forward exchange rates Topic: Forward trade Topic: Gilts

# of Questions 44 50 5 12 36 13 38 91 8 1 1 1 1 1 1 1 1 1 1 1 38 45 13 3 99 13 24 18 27 9 6 2 7 1 3 1 1 3 5 3 3 1 2 1 1 6 1 2 3 2 3 1 1

Topic: Home currency approach

4

Topic: Inflation and exchange rates Topic: Interest rate parity Topic: Interest rate swap Topic: International capital budgeting Topic: International Fisher effect Topic: London interbank offer rate Topic: Political risk Topic: Purchasing power parity Topic: Relative PPP and UIP Topic: Relative purchasing power parity Topic: Spot exchange rate Topic: Spot trades Topic: Spot versus forward rates Topic: Swaps Topic: Triangle arbitrage Topic: Unbiased forward rates Topic: Uncovered interest parity

1 7 1 1 6 2 2 1 1 5 1 2 1 1 4 3 5