International Financial Management final

International Finance Identify and explain the strategies firms use to participate in international business. Listthem in order of difficulty. Which of these strategies are considered direct foreign investment?
a) Exporting – the exporting strategy involves marketing of products produced in the home country to the foreign market.
b) Acquisition – acquisition strategy involves acquiring an existing firm in a foreign country. The acquisition strategy is considered a foreign direct investment because the company acquires full control of the business assets and decisions.
3. Joint venture – a joint venture strategy involves merging with a foreign investor in the country of interest to execute the business interest.
4. Establishment of a new subsidiary – the strategy involves entering a foreign market through direct initiative. The strategy is considered a foreign direct investment because the firm possesses full control and influence on the operations of the business.
5. Licensing – licensing strategy involves coming up with an agreement with a foreign firm to acquire the right to manufacture a company’s product at a given payment.
2. Assume that Live Co. has expected cash flows of $200,000 from domestic operations, SF 200,000 from Swiss operations, and 150,000 Euros from Italian operations at the end of the year. The Swiss franc’s value and euro’s value are expected to be $0.83 and $1.29 respectively, at the end this year. What are the expected dollar cash flows of Live Co?
Total cash flows = $200,000 + (SF 200,000 * $0.83) + (150,000 Euros * $1.29)
Total cash flows = $200,000 + $166,000 + $193,500 = $559,500
6. Assuming the bid rate of a New Zealand dollar is $.36 while the ask rate is $.365 at Bank X. Assume the bid rate of the New Zealand dollar is $.33 while the ask rate is $.34 at Bank Y. Given this information, what would be your gain if you use $1,000,000 and execute locational arbitrage? That is, how much will you end up with over and above the $1,000,000 you started with?
Buy New Zealand dollar at Bank Y = $1,000,000/ $0.34 = 2,941,176.47 New Zealand dollars
Sell bought New Zealand dollars at Bank X = 2,941,176.47 New Zealand dollars * $0.365 = $1,073,529.412
Dollars above initial amount = $1,073,529.412 – $1,000,000 = $735,529.412
7. Briefly explain the theory of interest rate parity. If interest rate parity holds what type of arbitrage is not feasible? You may wish to utilize a chart to explain when arbitrage opportunities exist and who can take advantage of the arbitrage.
The theory of interest rate parity entails a situation where the difference of interest rates between two given countries is equal to the difference of spot exchange rate and the forward exchange rate. Thus, if the theory of interest rate parity holds, an arbitrage will not be feasible if the spot exchange rate and forward exchange rate markets are in state of equilibrium. In contrast, if the spot exchange rate and forward exchange rate markets are in state of equilibrium, the arbitrage will be feasible.
8. Assume that Mexico’s inflation rate is lower than the U.S. inflation rate. This will cause U.S. consumers to increase their imports from Mexico and Mexican consumers to reduce their imports from the U.S. According to purchasing power parity (PPP), this will result in a depreciation of the Mexico Peso.
reduce. increase. appreciation
reduce. increase. depreciation
increase. reduce. depreciation
increase. increase. appreciation
9. The interest rate in the U.K. is 4%, while the interest rate in the U.S. is 5%. The spot rate for the British pound is $1.50. According to the international Fisher effect (IFE), the British pound should adjust to a new level of:
The British pound is should adjust equally to the interest rate difference in the opposite direction. Thus, the British pound under the international Fisher effect should appreciate by 1% because the interest rate of British pound is lower by one percent to the U.S interest. The appreciation of the British pound will see the spot rate of British pound been ($1.5 * 101% = $515)
10. A firm wants to use an option to hedge 12.5 million in receivables from Chinese firms. The premium is $.06. The exercise price is $.98. If the option is exercised, what is the total amount of dollars received (after accounting for the premium paid)
Total amount of dollars received = $0.06/$0.98 * 12.5 million = $0.765 million
11. The spot rate of British pound is quoted at $1.53. The 90-day forward rate exhibits a 6% premium. What is the 90-day forward rate of the pound?
6% = [(forward rate – $1.53)/ $1.53] * 3
0.06 * 3 days = [(forward rate – $1.53)/ $1.53]
0.18 * $1.53 = (forward rate – $1.53)
$0.2754 + $1.53 = Forward rate
Forward rate = $1.81
12. Crusador International Bank believes the New Zealand dollar will appreciate over the next five days from $.46 to $.49. The following annual interest rates apply:
Lending Rate
Borrowing Rate
New Zealand dollar (NZ$)
Crusador International Bank has the capacity to borrow either NZ$10 million or $6 million. If Crusador International Bank’s forecast is correct, what will its dollar profit be from speculation over the five-day period (assuming it does not use any of its existing consumer deposits to capitalize on its expectations)? Show all your work!
Interest expense = (NZ$10 million * 7%) * 5/365 = NZ$9,589.04
Interest expense in dollar = NZ$9,589.04 * $0.49 = $4,698.63
Realized dollars in day 5 = NZ$10 million * $.49 = $4.9 million
Less interest expense = $4.9 million – $4,698.63 = $4,895,301.37
Initial dollar amount = NZ$10 million * $0.46 = $4.6 million
Dollar profit = $4,895,301.37 – $4,600,000 = $295,301.37
14. The one-year forward rate of the British pound is quoted at $1.60, and the spot rate of the British pound is quoted at $1.63. The forward (discount/premium) is ____ percent. Show all your work!
Forward (discount/premium) = [(forward price – spot rate)/spot rate]* duration
Forward (discount/premium) = [($1.63 – $1.60)/$1.60] * 12
Forward premium rate = 36%
15. Zoro Corporation has a beta of 1.42. The risk-free rate of interest is 5%, and the return on the stock market overall is expected to be 13%. According to the Capital Asset Pricing Model what should the required rate of return on Zoro stock be? Show all your work!
CAPM rate of return = expected market return + beta*(expected market return – risk free rate)
CAPM rate of return = 13% + 1.42*(13% – 5%) = 24.36%
16. Country differences, such as differences in the risk-free interest rate and differences in risk premiums across countries, can cause the cost of capital to vary across countries. Answer. True
18. What are the advantages and disadvantages of international acquisitions over the establishment of a new subsidiary?
The decision to enter a foreign market through acquisition has advantages and disadvantages for a foreign firm compared over the establishment of a new subsidiary. One of the advantages of the acquisition strategy over the establishment of a new subsidiary is ability to enable a foreign firm to locate strategic locations in undertaking its operations. Similarly, acquisition strategy is advantageous because the firm is able to get ready human resource. Thus, the firm the firm is able to start operations at an early stage over the establishment of a new subsidiary. Furthermore, acquisition strategy helps the foreign to access vital information on industry and market from the documentations shared during the acquisition process. However, the strategy has the disadvantage of exposing the investor to strange management. Thus, the investor may face difficult coordinating and relating the management. In addition, the acquisition strategy has the potential of deceiving the expectations of the foreign firm due to misleading financial information during the acquisition period.
19. An MNCs parent would consider investing in a target only if the estimated present value of the cash flows it would ultimately receive from the target over time is greater than, positive the initial outlay necessary to purchase the target. In other words the Net Present Value must be.
is less than, negative
is greater than, positive
is less than, positive
is greater than, negative
20. What should a multinational corporation consider when valuing a foreign target for purpose of acquisition? In other words when performing a capital budget for an international project what additional considerations must be made above and beyond those considered for a domestic project. Include those considerations that must be made to the WACC.
The various considerations that a multinational company should evaluate beyond that of domestic project include the legal and political environment, social cultural values, and environmental regulations. The factors should be considered in the WACC due to the added risk they pose to the success and sustainability of the business in a foreign market.
22. An MNC is considering establishing a two-year project in New Zealand with a $30 million initial investment. The firms cost of capital is 12%. The required rate of return on this project is 18%. The project is expected to generate cash flows of NZ$12 million in Year 1 and NZ$30 million in Year 2, excluding the salvage value. Assume no taxes, and a stable exchange rate of $.60 per NZ$ over the next two years. All cash flows are remitted to the parent. What is the break-even salvage value? Show all your work!
Initial investment cost = $30 million
Year 1 cash flow = NZ$12 million * $0.60 = $7.2 million
Year 2 cash flow = NZ$30 million * $0.60 = $18 million
Cash flow
Present value factor (12%)
Present value
-$30 million
-$30 million
$7.2 million
$6 million
$18 million
$14 million
Net present value
($9) million
Break-even salvage value = -$9 * (1+18%)2 = -$12.53 million
23. Petrus Company has a unique opportunity to invest in a two-year project in Australia. The project is expected to generate 1,000,000 Australian dollars (A$) in the first year and 2,000,000 Australian dollars in the second. Petrus would have to invest $1,500,000 in the project. Petrus has determined that the cost of capital for similar projects is 14%. What is the net present value of this project if the spot rate of the Australian dollar for the two years is forecasted to be $.58 and $.63, respectively? Should the project be implemented?
Initial investment cost = -$1,500,000
First cash flow = A$ 1,000,000 * $.58 = $580,000
Second year cash flow = A$ 2,000,000 * $.63 = $1,260,000
Cash flow
Present value factor (14%)
Present value
Net present value
25. Explain how the parent of MNC can implement compensation plans to reduce agency costs that arise from subsidiary managers.
One of the ways the parent of a MNC can implement compensation in reducing the agency cost is introducing a compensation plan of rewarding subsidiary managers based on their subsidiary financial performance. The approach can be undertaken by promising the subsidiary managers stock bonuses for the financial improvements experienced. Consequently, the subsidiary managers will be cautious on the decisions they undertake due to the effect it might have on the financial performance of the subsidiary.