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to Answers 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 condi tions, 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 $.10. ANSWER: [($.11 $.10)/$.11] = .091, or 9.1%. 8. Forward Contract. The Wolfpack Corporation is a U.S. exporter that invoices its exports to the United Kingdom in British pounds. If it expects that the pound will appreciate against the dollar in the future, should it hedge its exports with a forward contract? Explain. ANSWER: The forward contract can hedge future receivables or payables in foreign currencies to insulate the firm against exchange rate risk. Yet, in this case, the Wolfpack Corporation should not hedge because it would benefit from appreciation of the pound when it converts the pounds to dollars. 9. Euro. Explain the foreign exchange situation for countries that use the euro when they engage in international trade among themselves. ANSWER: There is no foreign exchange. Euros are used as the medium of exchange. 10. Indirect Exchange Rate. If the direct exchange rate of the euro is worth $1.25, what is the indirect rate of the euro? That is, what is the value of a dollar in euros? ANSWER: 1/1.25 = .8 euros. 11. Cross Exchange Rate. Assume Polands currency (the zloty) is worth $.17 and the Japanese yen is worth $.008. What is the cross rate of the zloty with respect to yen? That is, how many yen equal a zloty? ANSWER: $.17/$.008 = 21.25 1 zloty = 21.25 yen 12. Syndicated Loans. Explain how syndicated loans are used in international markets. Register to View Answerlarge MNC may want to obtain a large loan that no single bank wants to accommodate by itself. Thus, a bank may create a syndicate whereby several other banks also participate in the loan. 13. Loan Rates. Explain the process used by banks in the Eurocredit market to determine the rate to charge on loans. ANSWER: Banks set the loan rate based on the prevailing LIBOR, and allow the loan rate to float (change every 6 months) in accordance with changes in LIBOR. 14. International Markets. What is the function of the international money market? Briefly describe the reasons for the development and growth of the European money market. Explain how the international money, credit, and bond markets differ from one another. ANSWER: The function of the international money market is to efficiently facilitate the flow of international funds from firms or governments with excess funds to those in need of funds. Growth of the European money market was largely due to (1) regulations in the U.S. that limited foreign lending by U.S. banks; and (2) regulated ceilings placed on interest rates of dollar deposits in the U.S. that encouraged deposits to be placed in the Euro currency market where ceilings were nonexistent. The international money market focuses on short-term deposits and loans, while the international credit market is used to tap medium -term loans, and the international bond market is used to obtain long-term funds (by issuing long-term bonds). 15. Evolution of Floating Rates. Briefly describe the historical developments that led to floating exchange rates as of 1973. ANSWER: Country governments had difficulty in maintaining fixed exchange rates. In 1971, the bands were widened. Yet, the difficulty of controlling exchange rates even within these wider bands continued. As of 1973, the bands were eliminated that so rates could respond to market forces without limits (although governments still did intervene periodically). 16. International Diversification. Explain how the Asian crisis would have affected the returns to a U.S. firm investing in the Asian stock markets as a means of international diversification. [See the chapter appendix.] ANSWER: The returns to the U.S. firm would have been reduced substantially as a result of the Asian crisis because of both declines in the Asian stock markets and because of currency depreciation. For example, the Indonesian stock market declined by about 27% from June 1997 to June 1998. Furthermore, the Indonesian rupiah declined again the U.S. dollar by 84%. 17. Eurocredit Loans. a. With regard to Eurocredit loans, who are the borrowers? b. Why would a bank desire to participate in syndicated Eurocredit loans? c. What is LIBOR and how is it used in the Eurocredit market? Register to View AnswerLarge corporations and some government agencies commonly request Eurocredit loans. b. With a Eurocredit loan, no single bank would be totally exposed to the risk that the borrower may fail to repay the loan. The risk is spread among all lending banks within the syndicate. c. LIBOR (London interbank offer rate) is the rate of interest at which banks in Europe lend to each other. It is used as a base from which loan rates on other loans are determined in the Eurocredit market. 18. Foreign Exchange. You just came back from Canada, where the Canadian dollar was worth $.70. You still have C$200 from your trip and could exchange them for dollars at the airport, but the airport foreign exchange desk will only buy them for $.60. Next week, you will be going to Mexico and will need pesos. The airport foreign exchange desk will sell you pesos for $.10 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$200 for 130 pesos. Should you accept the offer or cash the Canadian dollars in at the airport? Explain. ANSWER: Exchange with the tourist. If you exchange the C$ for pesos at the foreign exchange desk, the cross-rate is $.60/$10 = 6. Thus, the C$200 would be exchanged for 120 pesos (computed as 200 6). If you exchange Canadian dollars for pesos with the tourist, you will receive 130 pesos. 19. Foreign Stock Markets. Explain why firms may issue stock in foreign markets. Why might U.S. firms issue more stock in Europe since the conversion to a single currency in 1999? ANSWER: Firms may issue stock in foreign markets when they are concerned that their home market may be unable to absorb the entire issue. In addition, these firms may have foreign currency inflows in the foreign country that can be used to pay divi dends on foreign-issued stock. They may also desire to enhance their global image. Since the euro can be used in several countries, firms may need a large amount of euros if they are expanding across Europe. 20. Stock Market Integration. Bullet, Inc., a U.S. firm, is planning to issue new stock in the United States during this month. The only decision still to be made is the specific day on which the stock will be issued. Why do you think Bullet monitors results of the Tokyo stock market every morning? ANSWER: The U.S. stock market prices sometimes follow Japanese market prices. Thus, the firm would possibly be able to issue its stock at a lower price in the U.S. if it can use the Japanese market as an indicator of what will happen in the U.S. market. However, this indicator will not always be accurate. Advanced Questions 21. Effects of September 11. Why do you think the terrorist attack on the U.S. was expected to cause a decline in U.S. interest rates? Given the expectations for a potential decline in U.S. interest rates and stock prices, how were capital flows between the U.S. and other countries likely affected? ANSWER: The attack was expected to cause a weaker economy, which would result in lower U.S. interest rates. Given the lower interest rates, and the weak stock prices, the amount of funds invested by foreign investors in U.S. securities would be reduced. 22. International Financial Markets. Recently, Wal-Mart established two retail outlets in the city of Shanzen, China, which has a population of 3.7 million. These outlets are massive and contain products purchased locally as well as imports. As Wal-Mart generates earnings beyond what it needs in Shanzen, it may remit those earnings back to the United States. WalMart is likely to build additional outlets in Shanzen or in other Chinese cities in the future. a. Explain how the Wal-Mart outlets in China would use the spot market in foreign exchange. ANSWER: The Wal-Mart stores in China need other currencies to buy products from other countries, and must convert the Chinese currency (yuan) into the other currencies in the spot market to purchase these products. They also could use the spot market to convert excess earnings denominated in yuan into dollars, which would be remitted to the U.S. parent. b. Explain how Wal-Mart might utilize the international money market when it is establishing other Wal-Mart stores in Asia. ANSWER: Wal-Mart may need to maintain some deposits in the Eurocurrency market that can be used (when needed) to support the growth of Wal-Mart stores in various foreign markets. When some Wal-Mart stores in foreign markets need funds, they borrow from banks in the Eurocurrency market. Thus, the Eurocurrency market serves as a deposit or lending source for Wal-Mart and other MNCs on a short-term basis. c. Explain how Wal-Mart could use the international bond market to finance the establishment of new outlets in foreign markets. ANSWER: Wal-Mart could issue bonds in the Eurobond market to generate funds needed to establish new outlets. The bonds may be denominated in the currency that is needed; then, once the stores are established, some of the cash flows generated by those stores could be used to pay interest on the bonds. ... View Full Document

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