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Answers to End of Chapter 3 Questions 1. Motives for Investing in Foreign Money Markets. Explain why an MNC may invest funds in a financial market outside its own country. ANSWER: The MNC may be able to earn a higher interest rate on funds invested in a financial market outside of its own country. In addition, the exchange rate of the currency involved may be expected to appreciate. 2. Motives for Providing Credit in Foreign Markets. Explain why some financial institutions prefer to provide credit in financial markets outside their own country. ANSWER: Financial institutions may believe that they can earn a higher return by providing credit in foreign financial markets if interest rate levels are higher and if the economic conditions are strong so that the risk of default on credit provided is low. The institutions may also want to diversity their credit so that they are not too exposed to the economic conditions in any single country. 3. Exchange Rate Effects on Investing. Explain how the appreciation of the Australian dollar against the U.S. dollar would affect the return to a U.S. firm that invested in an Australian money market security. ANSWER: If the Australian dollar appreciates over the investment period, this implies that the U.S. firm purchased the Australian dollars to make its investment at a lower exchange rate than the rate at which it will convert A$ to U.S. dollars when the investment period is over. Thus, it benefits from the appreciation. Its return will be higher as a result of this appreciation. 4. Exchange Rate Effects on Borrowing. Explain how the appreciation of the Japanese yen against the U.S. dollar would affect the return to a U.S. firm that borrowed Japanese yen and used the proceeds for a U.S. project. ANSWER: If the Japanese yen appreciates over the borrowing period, this implies that the U.S. firm converted yen to U.S. dollars at a lower exchange rate than the rate at which it paid for yen at the time it would repay the loan. Thus, it is adversely affected by the appreciation. Its cost of borrowing will be higher as a result of this appreciation. 5. Bank Services. List some of the important characteristics of bank foreign exchange services that MNCs should consider. ANSWER: The important characteristics are (1) competitiveness of the quote, (2) the firms relationship with the bank, (3) speed of execution, (4) advice about current market conditions, and (5) forecasting advice. 6. Bid/ask Spread. Utah Banks bid price for Canadian dollars is $.7938 and its ask price is $.81. What is the bid/ask percentage spread? ANSWER: ($.81 $.7938)/$.81 = .02 or 2% 7. Bid/ask Spread. Compute the bid/ask percentage spread for Mexican peso retail transactions in which the ask rate is $.11 and the bid rate is $.10. ... View Full Document

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