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Unformatted text preview: Chapter 26 Multinational Financial Management ANSWERS TO END-OF-CHAPTER QUESTIONS 26-1 a. A multinational corporation is one that operates in two or more countries. b. The exchange rate specifies the number of units of a given currency that can be purchased for one unit of another currency. The fixed exchange rate system was in effect from the end of World War II until August 1971. Under the system, the U. S. dollar was linked to gold at the rate of $35 per ounce, and other currencies were then tied to the dollar. Under the floating exchange rate system, which is currently in effect, the forces of supply and demand are allowed to determine currency prices with little government intervention. c. A country has a deficit trade balance when it imports more goods from abroad than it exports. Devaluation is the lowering, by governmental action, of the price of its currency relative to another currency. For example, in 1967 the British pound was devalued from $2.80 per pound to $2.50 per pound. Revaluation, the opposite of devaluation, occurs when the relative price of a currency is increased. d. Exchange rate risk refers to the fluctuation in exchange rates between currencies over time. A convertible currency is one which can be traded in the currency markets and can be redeemed at current market rates. When an exchange rate is pegged, the rate is fixed against a major currency such as the U. S. dollar. Consequently, the values of the pegged currencies move together over time. e. Interest rate parity holds that investors should expect to earn the same return in all countries after adjusting for risk. Purchasing power parity, sometimes referred to as the law of one price, implies that the level of exchange rates adjusts so that identical goods cost the same in different countries. f. The spot rate is the exchange rate which applies to on the spot trades, or, more precisely, exchanges that occur two days following the day of trade. In other words, the spot rate is for current exchanges. The forward exchange rate is the prevailing exchange rate for exchange (delivery) at some agreed-upon future date, usually 30, 90, or 180 days from the day the transaction is negotiated. Forward exchange rates are analogous to future prices on commodity exchanges. Discounts (or premiums) on forward rates occur when the forward exchange rate differs from the spot rate. When the forward rate is below the spot rate, the forward rate is said to be at a discount. Conversely, when the forward rate is above the spot rate, it is said to be at a premium. Answers and Solutions: 26 - 1 g. Repatriation of earnings is the cash flow, usually in the form of dividends or royalties, from the foreign branch or subsidiary to the parent company. These cash flows must be converted to the currency of the parent, and thus are subject to future exchange rate changes. A foreign government may restrict the amount of cash that may be repatriated. Political risk refers to the possibility of expropriation and to the...
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- Spring '10