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Unformatted text preview: Chapter 27 Multinational Financial Management ANSWERS TO BEGINNING-OF-CHAPTER QUESTIONS Most of the questions are illustrated in the BOC spreadsheet model. 27-1 A purely domestic firm does not have to deal with exchange rates, different laws in different countries, transferring funds between subsidiaries in different countries, having to communicate in different languages, and so forth. All of these factors create complications and challenges for multinational firms. In spite of these challenges, there is a strong trend among corporations to go global. The primary motivation is profitmany firms can increase their rates of return on investment, and their stock prices, by going global. Some do it primarily to get raw materials; oil companies are an example. Others go global to expand their markets, which helps them cover huge development costs; this is true for producers of movies like Lord of the Rings . Others go global because production costs are lower overseas; this is true for most electronics firms. Still others buy from foreign suppliers; Wal-Mart and Nike are examples. Finally, banks, accounting firms, and other service companies are going global because their customers are doing so, and they must follow their customers or lose them. 27-2 (See the BOC model for data and examples of exchange rates.) From a U.S. perspective, an exchange rate tells us: a. Direct quotation: Number of dollars required to buy one unit of a foreign currency. b. Indirect quotation: Number of units of the foreign currency that can be bought with one dollar. Thus, the direct quotation for the euro in March 2009 (see the BOC model) was 1.3014, meaning that it took $1.30 to buy a euro, and the indirect quote was 0.7684, meaning that a dollar would buy 0.7684 euros. The direct and indirect quotes are the reciprocals of one another, e.g., 1/1.3014 = 0.7684. c. Cross rates deal with exchange rates between countries other than the U.S., although the exchange rate between each of the countries being considered and the U.S. is typically used to calculate cross rates. The following formula (implemented in the Excel model) shows the number of pairs of exchange rates if N = 5 currencies are being analyzed: Answers and Solutions: 27 - 1 Number of pairs with N = 250 currencies: N i N 1 i- = = 5 i 5 1 i- = = 15 5 = 10. Now note that if there were 250 countries, each with its own currency, there would be 31,125 different exchange rates, which would be a lot to follow and keep track of. However, with things benchmarked off the dollar, there would only be 249 basic exchange rates, and all the cross rates could be found from the dollar exchange rates. Its important to note that if all exchange rates (where currencies can be converted to other currencies) are not priced exactly in accordance with their cross rates, then arbitrageurs can and will trade in currencies and bring about an equilibrium. For example, traders would sell euros and buy pounds, or vice versa, if the pound/euro...
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