Answers to End of Chapter 3 Questions
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
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.
List some of the important characteristics of bank foreign exchange services
that MNCs should consider.
The important characteristics are (1) competitiveness of the quote, (2) the firm’s
relationship with the bank, (3) speed of execution, (4) advice about current market conditions,
and (5) forecasting advice.
Utah Bank’s bid price for Canadian dollars is $.7938 and its ask price is
$.81. What is the bid/ask percentage spread?
($.81 – $.7938)/$.81 = .02 or 2%
Compute the bid/ask percentage spread for Mexican peso retail transactions
in which the ask rate is $.11 and the bid rate is $.10.
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