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Kirt C. Butler, Solutions for Multinational Multinational Finance Finance,, 4th edition
PART I Overview and Background Chapter 1 An Introduction to Multinational Finance Answers to Conceptual Questions 1.1
List the MNC’s key stakeholders. How does each have a stake in the MNC?
Stakeholders narrowly defined include shareholders, debtholders, and management. More br defined, stakeholders also would include employees, suppliers, customers, host governments residents of host countries. 1.2
In what ways do cultural differences impact the conduct of international business?
Because they define the rules of the game, national business and popular cultures impact each functional disciplines of business from research and development right through to mark production, and distribution. distribution. 1.3
What is country country risk? Describe several types of country country risk one might might face when when conducting conducting in another country.
Country risks refer to the political and financial risks of conducting business in a particular fo country. Country risks include foreign exchange risk, political risk, and cultural risk. 1.4
What is political risk?
Political risk is the risk that a sovereign host government will unexpectedly change the rules o game under which businesses operate. 1.5
What is foreign exchange risk? Foreign exchange risk is the risk of unexpected changes in foreign currency exchange rates.
1.6
What investment opportunities opportunities might MNCs enjoy that are not available to local firms?
Operating cash flows can be increased by increasing revenues or decreasing operating expenses text mentions revenue enhancing opportunities opportunities such as global branding, advantages of size and s and flexibility in marketing and distribution; operating cost reductions through access to low labor or raw materials, flexibility in sourcing or production, and economies of scale or ve integration; and business strategies such as follow the customer, lead the customer, follow the le and building capacity directly in a foreign market (going local).
Master your semester with Scribd Free Foron 30this Days Sign up to vote title 1.7 How can MNCs can reduce operating expenses relative toRead domestic firms. & The New MNCs YorkcanTimes Useful global useful size, and flex enjoy several advantages over domestic firms including brands, Not Cancel anytime.
in marketing and distribution. Strategies for enhancing revenues include follow the customer, Special offer for students: Only $4.99/month.
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Kirt C. Butler, Solutions for Multinational Multinational Finance Finance,, 4th edition
PART I Overview and Background Chapter 1 An Introduction to Multinational Finance Answers to Conceptual Questions 1.1
List the MNC’s key stakeholders. How does each have a stake in the MNC?
Stakeholders narrowly defined include shareholders, debtholders, and management. More br defined, stakeholders also would include employees, suppliers, customers, host governments residents of host countries. 1.2
In what ways do cultural differences impact the conduct of international business?
Because they define the rules of the game, national business and popular cultures impact each functional disciplines of business from research and development right through to mark production, and distribution. distribution. 1.3
What is country country risk? Describe several types of country country risk one might might face when when conducting conducting in another country.
Country risks refer to the political and financial risks of conducting business in a particular fo country. Country risks include foreign exchange risk, political risk, and cultural risk. 1.4
What is political risk?
Political risk is the risk that a sovereign host government will unexpectedly change the rules o game under which businesses operate. 1.5
What is foreign exchange risk? Foreign exchange risk is the risk of unexpected changes in foreign currency exchange rates.
1.6
What investment opportunities opportunities might MNCs enjoy that are not available to local firms?
Operating cash flows can be increased by increasing revenues or decreasing operating expenses text mentions revenue enhancing opportunities opportunities such as global branding, advantages of size and s and flexibility in marketing and distribution; operating cost reductions through access to low labor or raw materials, flexibility in sourcing or production, and economies of scale or ve integration; and business strategies such as follow the customer, lead the customer, follow the le and building capacity directly in a foreign market (going local).
Master your semester with Scribd Free Foron 30this Days Sign up to vote title 1.7 How can MNCs can reduce operating expenses relative toRead domestic firms. & The New MNCs YorkcanTimes Useful global useful size, and flex enjoy several advantages over domestic firms including brands, Not Cancel anytime.
in marketing and distribution. Strategies for enhancing revenues include follow the customer, Special offer for students: Only $4.99/month.
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Kirt C. Butler, Solutions for Multinational Multinational Finance Finance,, 4th edition
Chapter 2 World Trade and the International Monetary System Answers to Conceptual Questions 2.1
List one or more trade trade pacts in which which your country is involved. involved. Do these these trade trade pacts affe residents of your country in the same way? On balance, are these trade pacts good or bad for res of your country?
Figure 2.1 lists the major international trade pacts. The World Trade Organization (WTO) supranational organization that oversees the General Agreement on Tariffs and Trade (GA Important regional trade pacts include the North American Free Trade Agreement (NAFTA inc the U.S., Canada, and Mexico), the European Union (EU), and the Asia-Pacific Econ Cooperation pact (APEC encompasses most countries around the Pacific Rim including Japan, C and the United States). Trade pacts are designed to promote trade, but industries that have protected by local governments can find that they are uncompetitive when forced to compete markets. 2.2
Do countries countries tend tend to export more more or less of their gross gross national national product today than than in in years past? are the reasons for this trend?
Most countries export more of their gross national product today than in years past. Reasons inc a) the global trend toward free market economies, b) the rapid industrialization of some develo countries, c) the breakup of the former Soviet Union and the entry of China into international tra the rise of regional trade pacts and the General Agreement on Tariffs and Trade, and e) advanc communication and in transportation. transportation. 2.3
How has globalizatio globalization n in in the world’s goods markets affected world trade? How has globalizat the world’s financial markets affected world trade?
Some of the economic consequences of globalization in the world’s goods markets include: increase in cross-border investment in real assets (land, natural resource projects, and manufact facilities), b) an increasing interdependence between national economies leading to global bus cycles that are shared by all nations, and c) changing political risk for multinational corporatio nations redefine their borders as well as their national identities. The demise of capital flow barri international financial markets has had several consequences including: a) an increase in cross-b financing as multinational corporations raise capital in whichever market and in whatever cur offers the most attractive rates, b) an increasing number of cross-border partnerships including international mergers, acquisitions, and joint ventures, Read and c)Free increasingly interdependent na Foron 30this Days Sign up to vote title financial markets.
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What distinguishes distinguis hes developed, less developed, and newly industrializing industrializing economies? Special offer for2.4 students: Only $4.99/month.
Developed economies have a well-developed manufacturing base. Less developed countries (L
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Kirt C. Butler, Solutions for Multinational Multinational Finance Finance,, 4th edition 2.7
Describe the Bretton Bretton Woods agreement. How long did the agreement agreement last? What forced its collap
After World War II, representatives of the Allied nations convened at Bretton Woods, Hampshire to stabilize financial markets and promote world trade. Under Bretton Woods’ exchange standard,” currencies were pegged to the price of gold (or to the U.S. dollar). B Woods also created the International Monetary Fund and the International Bank for Reconstru and Development (the World Bank). The Bretton Woods fixed exchange rate system lasted 1970, when high U.S. inflation relative to gold prices and to other currencies forced the dollar o gold exchange standard. 2.8
What factors contributed contributed to the Mexican Mexican peso crisis of 1995 and to the Asian Asian crises of 1997?
In each instance, the government tried to maintain the value of the local currency at artificially levels. This depleted foreign currency reserves. Local businesses and governments were borrowing in non-local currencies (primarily the dollar), which heavily exposed them to a drop value of the local currency. 2.9
What is moral hazard and how does it relate to IMF rescue packages?
Moral hazard occurs when the existence of a contract changes the behaviors of parties to the con When the IMF assists countries in defending their currencies, it changes the expectations and h the behaviors of lenders, borrowers, and governments. For example, lenders might underestima risks of lending to struggling economies if there is an expectation that the IMF will intervene d difficult times.
Problem Solutions 2.1
This open-ended open-ende d question is intended to engage the student and bring their knowledge up-to Useful websites are listed on the inside-front cover of the text, and include: Bank for International Settlements www.bis.org International Monetary Fund (IMF) www.imf.org World Trade Organization (WTO) www.wto.org International Labor Organization www.ilo.org International Chamber of Commerce www.iccwbo.org Michigan State University Global Edge globaledge.msu.edu globaledge.msu.edu United Nations www.un.org United Nations’ Commission on International Trade Law www.uncitral.org www.uncitral.org Read Free Foron 30this Days Sign up to vote title World Bank www.worldbank.org www.worldbank .org World Bank’s Multilateral Investment GuaranteeAgency Useful www.miga.org Not useful Cancel anytime. World Economic Forum www.weforum.org www.weforum.org
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Kirt C. Butler, Solutions for Multinational Finance, 4th edition
Chapter 3 Foreign Exchange and Currency Risk Management Answers to Conceptual Questions 3.1
Define liquidity. Liquidity: the ease with which you can exchange an asset for another asset of equal value.
3.2
What is the difference between a money market and a capital market?
Money markets are markets for financial assets and liabilities of short maturity, usually consider be less than one year. Capital markets are markets for financial assets and liabilities with matu greater than one year. 3.3
What is the difference between an internal and an external market?
Debt placed in an internal market is denominated in the currency of a host country and placed w that country. Debt placed in an external market is placed outside the borders of the country issuin currency. 3.4
What is the Eurocurrency market and what is its function?
The Eurocurrency market is an external credit market in bank deposits and loans. Like a na credit market, the Eurocurrency market permits the transfer of value over time in a given currenc 3.5
In what way is the Eurocurrency market different from an internal credit market?
There are typically no reserve requirements, interest rate regulations or caps, withholding t deposit insurance requirements, or regulations influencing credit allocation decisions. There are less stringent disclosure requirements. You're Reading a Preview 3.6
What is the London Interbank Offer Rate (LIBOR)?
Unlock full access with a free trial.
LIBOR is the rate at which a Euromarket bank offers to make a loan to another Euromarket bank 3.7
What effect did the Basle AccordDownload have on international With Freebanks? Trial
The Basle Accord imposed minimum capital adequacy requirements on international banks protection against the credit risk of the banks’ loan portfolios. The Basle Accord also encourage use of value-at-risk (VaR) measures to quantify the risk of losses greater than a certain amount o given time period.
Master your semester 3.8 What is the differencewith between Scribd spot and forward marketsRead for foreign exchange? Free Foron 30this Days Sign up to vote title the spot market, trades are for immediate delivery. In the forward trades are for f & The New Indelivery York Times Useful Not useful market, according to an agreed-upon delivery date, exchange rate, and amount. Special offer for students: Only $4.99/month.
3.9
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What is Rule #1 when dealing with foreign exchange? Why is it important?
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Kirt C. Butler, Solutions for Multinational Finance, 4th edition exchange markets also facilitate hedging and speculation. 3.12
Define operational, informational, and allocational efficiency.
Operational efficiency refers to how large an influence transactions costs and other market fric have on a market’s operation. Informational efficiency refers to whether or not prices reflect v Allocational efficiency refers to how efficiently a market channels capital toward its most produ uses. 3.13
What is a forward premium? What is a forward discount?
A currency is trading at a forward premium when the nominal value of that currency in the for market is higher than in the spot market. A currency is trading at a forward discount whe nominal value of that currency in the forward market is lower than in the spot market. 3.14
Describe the empirical behavior of exchange rates.
Over daily intervals, spot rate changes are random with a nearly equal probability of rising or fa As the forecast horizon is lengthened, the correlation between interest and inflation differential nominal spot rate changes rises. Eventually, the international parity conditions exert themselve the forward rate begins to dominate the current spot rate as a predictor of future nominal exch rates. Finally, exchange rate volatility is not constant. Instead, volatility comes in waves.
Problem Solutions 3.1
a.
The bid is less than the offer, so Citicorp is quoting the currency in the denominator. Citico buying dollars at the DKr5.62/$ bid rate and selling dollars at the DKr5.87/$ offer rate. b. In American terms, the bid You're price isReading $0.1704/DKr and the ask price is $0.1779/DKr. Citic a Preview buying and selling the kroner at these quotes. c. In direct terms, the bid quote for the dollarwith is $0.1779/DKr and the ask price is $0.1704 Unlock full access a free trial. Citicorp is buying dollars at $0.1779/DKr (which is equivalent to DKr5.62/$) and se dollars at $0.1704/DKr (or DKr5.87/$). Download With Free Trial d. The bank will receive the bid-ask spread on each dollar. When buying one million d DKr5.62/$ and selling one million dollars at DKr5.87/$, the bank’s profit on the bid-ask sp will be (DKr5.87/$–DKr5.62/$)($1,000,000) = DKr250,000.
3.2
The ask price is higher than the bid, so these are rates at which the bank is willing to buy o dollars (in the denominator). You’re selling dollars, so you’ll get the bank’s dollar bid price. need to pay SKr10,000,000/(SKr7.5050/$) ≈ $1,332,445. Read Free Foron 30this Days Sign up to vote title
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be selling at a forward discount. Annualized forward premia on the U.S. dollar are: Special offer for students: Only $4.99/month. Bid ($)
Ask ($)
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c. Sheet Music
(n)(F1$/¥ –S0$/¥)/S0$/¥ = (4)(–0.031401) = –0.125604, or –12.5604 percent. As an APR, the premium is (F1$/¥/S0$/¥)4 –1 = –0.119811, or –11.9811 percent.
3.5
1984 DM1.80/$ or $0.56/DM 1987 DM2.00/$ or $0.50/DM 1992 DM1.50/$ or $0.67/DM 1997 DM1.80/$ or $0.56/DM a. 1984-87 The dollar appreciated 11.1%; ((DM2.0/$)–(DM1.8/$)/(DM1.8/$) = +0.111 1987-92 The dollar depreciated 25%; ((DM1.5/$)–(DM2.0/$)/(DM2.0/$) = –0.25 1992-97 The dollar appreciated 20%; ((DM1.8/$)–(DM1.5/$)/(DM1.5/$) = +0.20 b. 1984-87 The mark depreciated 10.7%; ($0.50/DM)/($0.56/DM)–1= –0.107 1987-92 The mark appreciated 34.0%; ($0.67/DM)/($0.50/DM)–1= +0.340 1992-97 The mark depreciated 16.4%; ($0.56/DM)/($0.67/DM)–1 = –0.164
3.6
a.
(PZ5,000,000) / (PZ4.0200/$) = $1,243,781. Warsaw’s bid price for PZ is their ask pric dollars. So, PZ4.0200/$ is equivalent to $0.2488/PZ. b. (PZ20,000,000) / (PZ3.9690/$) = $5,039,053 PZ3.9690/$ is equivalent to $0.2520/PZ Payment is made on the second business day after the three-month expiration date.
3.7
You initially receive P0$ = P0¥/S0¥/$ = (¥104,000,000)/(¥104/$) = $1 million. When you buy the yen, you pay P1$ = P1¥/S1¥/$ = (¥104,000,000)/(¥100/$) = $1.04 million. Your loss is $40,0
3.8
When buying one currency, you are simultaneously selling another, so a yen bid price is a eu price. Yen quotes yield S¥/€ = 1/S €/¥ = 1/(€0.007634/¥) = ¥130.99/€ and S ¥/€ = 1/(€0.007643 ¥130.84/€, so euro quotes (in theYou're denominator) area Preview ¥130.84/€ BID and ¥130.99/€ ASK. Reading
3.9
a. (1+s¥/$) = 0.90 = 1/(1+s $/¥) ⇔ s$/¥ = (1/0.90)–1 = +0.111, or an 11.1% appreciation. Unlock full access with a free trial. Rbl/$ b. (1+s ) = 11 = 1/(1+s $/Rbl) ⇔ s$/Rbl = (1/11)–1 = –0.909, or a 90.9% depreciation.
3.10
The 90-day dollar forward price is 33 bpsWith below theTrial spot price: F1SFr/$ –S0SFr/$ = (SFr0.74 Download Free SFr0.7465/$) = –SFr0.0033/$. The percentage dollar forward premium is (F 1SFr/$ –S0SFr/$)/S (SFr0.7432/$–SFr0.7465/$)/(SFr0.7465/$) = –0.442% per 90 days, or (–0.442%)*4 = –1.768 an annualized basis.
3.11
Banks make a profit on the bid-ask spread. A bank quoting $0.5841/SFr BID and $0.585 ASK is buying francs (in the denominator) at $0.5841/SFr and selling francs at $0.5852/SFr A Read Free Fordollars 30this Days A bank quoting $0.5852/SFr BID and $0.5841/SFr ASK buying (in the numerato Signisup to vote on title $0.5852/SFr BID and selling dollars at $0.5841/SFr ASK. Hence, these areuseful equivalent. Useful Not
Master your semester with Scribd & The New York Times Special offer for3.12 students: Only $4.99/month. DKr is at a forward discount
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($0.18519/DKr–$0.18536/DKr)/$0.18536/DKr = –0.092%
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Kirt C. Butler, Solutions for Multinational Multinational Finance Finance,, 4th edition
Chapter 4 The International Parity Conditions Answers to Conceptual Questions 4.1
What is the law of one price?
The law of one price states identical assets must have the same price wherever they are bought or The law of one price is enforced by arbitrage activity between identical assets. In a perfect m without transaction costs, the law of one price must hold for there to be no arbitrage opportunities 4.2
What is an arbitrage profit?
Arbitrage profit is a profit obtained through the simultaneous purchase and sale of the sam equivalent securities such that there is no net investment or risk. Arbitrage will drive the pric identical assets into equilibrium and enforce the law of one price. 4.3
What is the difference between locational, triangular, and covered interest arbitrage?
Locational arbitrage is conducted between two physical locations, such as between currency pri two different banks (such that ASf/d BSd/f ≠ 1 for banks A and B and currencies d and f). Trian arbitrage is conducted across three different cross exchange rates (such that S d/e Se/f Sf/d currencies d, e, and f). Covered interest arbitrage takes advantage of a disequilibrium in the in rate parity condition [(F td/ f ) / (S0d/ f )] ≠ (1+id) / (1+i f )]t between currency and Eurocurrency marke 4.4
Is interest rate parity a reliable relation in the interbank markets?
Interest rate parity is a reliable relation in the interbank markets. Each of the prices in the IRP re (Ftd/f /S0d/ f ) = [(1+id)/(1+i f )]t is a traded contract in the interbank markets, and so covered in arbitrage is able to enforce the no-arbitrage condition within the bounds of transaction costs (w are small in the interbank market). 4.5
What is relative purchasing power parity? Relative purchasing power parity is a form of the law of one price in which the expected change spot exchange rate is influenced by the difference in expected inflation according to E[S td/f [(1+E[pd])/(1+E[pf ])]t.
4.6
Are forward exchange rates good predictors of future spot rates?
Forward rates are poor predictors of future spot rates over short-term forecast horizons, be exchange rate volatility masks the signal from the international parity condition. Over longer for Read Free For 30 Days Sign up to vote on this title horizons, the signal-to-noise ratio improves and the forecast performance of forward rates (as w inflation differentials from RPPP) improves. Useful Not useful
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Special offer for4.7 students: Only $4.99/month. What does the international Fisher relation say about interest rate and inflation differentials?
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Kirt C. Butler, Solutions for Multinational Multinational Finance Finance,, 4th edition 4.11
Will an appreciation of the domestic currency help help or hurt a domestic exporter?
A nominal appreciation in the domestic currency is likely to have little effect on domestic impo and exporters. A real appreciation of the domestic currency can hurt domestic exporters by raisin price of domestic goods relative to foreign goods. Domestic importers will see their purchasing p increase relative to foreign competitors, and so are likely to be helped by a real appreciation o domestic currency. 4.12
Describe the behavior of real exchange rates.
Although real exchange rates revert to their long run average, in the short run there can be substa deviations from purchasing power parity and the long run r un average. 4.13
What methods can be used to forecast forecast future future spot spot rates rates of exchange?
Market-based forecasts are obtained from forward exchange rates or from interest rate parity forward prices are unavailable. Model-based forecasts can be generated from technical an (analyzing patterns in exchange rates) or from fundamental analysis (from a larger set of econ relationships). 4.14
How can the international international parity conditions conditions allow you you to forecast next year’s spot rate?
In theory, any of the international parity conditions could be used: E[S td/f ]/S0d/f = Ftd/f [(1+id)/(1+if )]t = [(1+E[pd])/(1+E[pf ])]t. In practice, forward rates are usually used to predict spot At the least, forwards have the advantage of reflecting the opportunity costs of capital throug interest rate parity relation, F td/f /S0d/f = [(1+id)/(1+if )]t.
Problem Solutions 4.1 a. S¥SFr = S¥/$S$/SFr = (¥200/$)($0.50/SFr) = ¥100/SFr b. ¥SFr S = S¥/$/SSFr/$ =(¥100/$)/(SFr1.60/$) =(¥100/$)/(SFr1.60/$) = ¥62.5/SFr
4.2 SSFr/$ S$/¥ S¥/SFr = 1.0326 > 1. Spot rates are “too high” relative to the parity condition, so you s sell the currencies in the denominators for the currencies in the numerators at the relatively prices. This means that you should a) sell dollars for francs, b) sell yen for dollars, and c) sell f for yen. Alternatively, a) buy francs with dollars, b) buy dollars with yen, and c) buy yen francs. Triangular arbitrage would yield a profit of 3.26 percent of the starting amount. For trian arbitrage to be profitable, transactions costs on a “round turn” cannot be more than this amount.
Master your semester with Scribdthe interbank forex 4.3 Each of these prices prices is a traded traded contract in the forex and so arbitrage (either Read Free For 30 Days Signmarket, up to vote on this title with or triangular) will ensure that the relations F (Y)/F (X) = 1 and F F F = 1 hold & The New bounds York Times Useful Not useful of transaction costs. t
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4.4 The forward price is is at a 9 bp discount over six months, months, or 18 bps on an annualized annualized basis. Th
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Kirt C. Butler, Solutions for Multinational Multinational Finance Finance,, 4th edition
price for pesos and sell pesos (and buy yen) to the Mexican bank at the ¥29.24/MXN bid for pesos. Buying pesos in Tokyo yields (¥1,000,000)/(¥28.77/MXN) = MXN34,758. Se pesos in Mexico City yields (MXN34,758)(¥29.24/MXN) = ¥1,016,336. Your arbitrage pro 16,336 yen, or about MXN559 at the Mexican bank’s ¥29.24/MXN bid price for pesos.
4.6 In this circumstance, the international international parity parity conditions do not have anything anything to say about the inflation rate. Nominal interest rates will adjust to expected inflation according to the Fisher rela (1+i) = (1+p)(1+ė).
4.7 a. From interest rate parity, (¥210/$)/(¥190/$) (¥210/$)/(¥190/$) = (1+i¥)/(1.15) ⇒ i¥ = 27.11%. b. Because the forward forward rate of ¥210/$ is greater than the spot rate of ¥190/$, the the dollar is at a fo premium. If forward rates are unbiased predictors of future spot rates, the dollar is lik appreciate against the yen by (¥210/$)/(¥190/$)–1 (¥210/$)/(¥190/$)–1 = 10.526%. 4.8 a.
In this problem, we know the spot and forward rates rates and U.S. inflation. inflation. The real and $/£ $/£ interest rates are not needed: F1 /S0 = ($1.20/£)/($1.25/£) = 0.96 = E(1+p $)/E(1+ (1.05)/E(1+p£) => E(p£) = (1.05/0.96)–1 = 9.375% b. From the Fisher equation: i£ = (1+p£)(1+ė£)–1 = (1.09375)(1.02)–1 = 11.56%.
4.9 a. E[P1D] = P0D(1+pD) = D100(1.10) = D110 E[P1F] = P0F(1+pF) = F1(1.21) = F1.21 E[S1D/F] = E[P1D] / E[P1F] = D110 / F1.21 = D90.91/F. D D D 2 2 b. E[P 2 ] = P0 (1+p ) = D100(1.10) = D121 E[P2F] = P0F(1+pF)2 = F1(1.21)2 = F1.4641 E[S2D/F] = E[P2D]/E[P2F] = D121/F1.4641 = S0D/F[(1+pD)/(1+pF)]2 = (D100/F)(1.10/1.21) (D100/F)(1.10/1.21)2 = D82.64/F. 4.10 a.
A 7% annualized annualized rate with quarterly compounding compounding is equivalent equivalent to 7%/4 = 1.75% per qu From interest rate parity, the 3-month MR interest rate is FMR/$/S (MR3.9888/$)/(MR4.0200/$) = (1+i MR )/(1+i$) = (1+iMR )/(1+0.0175) => i MR = 0.00960 0.9603% per three months. Annualized, this is equivalent to (0.9603%)*4 = 3.8412% per with quarterly compounding. Alternatively, the annual percentage rate is (1.009603) 0.03897, or 3.897% per year. b. $10,000,000 invested invested at the the three-month U.S. rate rate yields $10,175,000. $10,175,000. Changed into into MR forward rate, this is worth ($10,175,000)(MR3.9888/$) = MR40,586,040. You can finance $10,000,000 by borrowing MR40,200,000. Your obligation on this contract wil from (MR40,200,000)(1.009603) ≈ MR40,586,040 which is exactly by the proceeds Read Free Foron 30 Days Sign up to offset vote this title forward contract.
Master your semester with Scribd & The New York Times Bt/$ Bt/$ a. FOnly /S$4.99/month. = (1 + iBt)t/(1 Special offer for4.11 students: t 0 Bt
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+ i ) = (Bt 25.64/$)/(Bt 24.96/$) = (1 + i )/(1.06125) ⇒ 1.02724 = (1 + i )/1.06125 ⇒ iBt = 9.02%
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+$1,000,000
Borrow at the 6.125% dollar interest rate
−$1,061,250 Cover baht forward
+$1,070,827 −Bt27,456,000
This leaves a net gain at time 1 of $1,070,827 – $1,061,250 = $9,577, which is w $9,577/1.06125 = $9,024 in present value.
4.12 F1MXN/$/S0MXN/$=(MXN11/$)/(MXN10/$)=1.1<1.1132=(1.18)/(1.06)=(1+iMXN)/(1+i$). The rat interest rates is too high and must fall, so borrow at the relatively low dollar rate and invest a relatively high peso rate. Similarly, the forward premium is too low and must rise, so buy do (and sell pesos) at the relatively low forward rate for the dollar and sell dollars (and buy pesos) relatively high dollar spot rate. - Borrow $1 million so that $1,060,000 is due in six months. - Sell $1 million and buy MXN10,000,000 at the relatively high spot price. - Invest MXN10,000,000 at 18% to yield MXN11,800,000 in six months. - Cover by selling MXN11,800,000 at the MXN11/$ forward rate to yield $1,072,727. This leaves a profit of $1,072,727–$1,060,000 $1,072,727–$1,060,000 = $12,727 at time t=1 in six months.
4.13 The Singapore dollar is at a forward premium; F 1$/S$/S0$/S$ = ($0.51/S$)/($0.50/S$) = 1.02, or 2 year. This is less than is warranted by the difference in interest rates (1+i $)/(1+iS$) = (1.06)/(1. 1.019231, so F 1$/S$/S0$/S$ > (1+i$)/(1+iS$). The forward/spot ratio is too high and must fall, so se (and buy dollars) at the relatively high S$ forward rate and buy S$ (and sell dollars) at the relat low S$ spot rate. Conversely, the ratio of interest rates is too low and must rise, so borrow a relatively low dollar interest rate and invest at the relatively high S$ rate. (Even though S$ in rates are lower than dollar interest rates in nominal terms, S$ interest rates are high and d interest rates are low relative to the forward/spot ratio.) Suppose you borrow ($1,000,000)/(1+ $1,060,000 at i $ = 6.0%. +$1,000,000
Master your semester with Scribd -$1,060,000 & The NewConvert Yorkto S$2,000,000 Times = ($1,000,000)/($0.50/S$) at S Special offer for students: Only $4.99/month.
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Kirt C. Butler, Solutions for Multinational Finance, 4th edition +$1,060,800
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-S$2,080,000
The result is a dollar profit of $1,060,800–$1,060,000 = $800. These transactions are w undertaking only if the costs of executing the four transactions is less than $800.
E[P1F] = P0F(1+pF) = 1.21 E[P1D] = P0D(1+pD) = 110 E[S1D/F] = (S0D/F)(1+pD)/(1+pF) = (D100/F)(1.10/1.21) ≈ D90.91/F. b. Because nominal exchange rates should adjust to reflect changes in relative purchasing powe expected real exchange rate is 100% of the beginning rate: E[X1D/F] = (E[S1D/F]/S0D/F)((1+pF = ((D90.91/F)/(D100/F))(1.21/1.10) = 1.00, or 100%. c. E[P2F]) = P0F(1+pF)2 = F1.4641 E[P2D]) = P0D(1+pD)2 = D121 E[P2F]) = P0F(1+pF)2 = F1.4641 E[P2D]) = P0D(1+pD)2 = D121 E[S2D/F] = S0D/F((1+pD)/(1+pF))2 = (D100/F)(1.10/1.21)2 ≈ D82.64/F The real exchange rate is not expected to change: E[X 2D/F] = (E[S2D/F]/E[S0D/F]) [(1+pF)/(1+ = ((D82.64/F)(D100/F)) / (1.21/1.10) 2 = 1.00, or 100%.
4.14 a.
4.15 a. s¥/SFr = (S0¥/SFr )/(S –1¥/SFr ) –1 = (¥155/SFr)/(¥160/SFr) – 1 = –3.125%. b. From relative purchasing power parity, the spot rate should have been: E[S0¥/SFr ] = (S –1¥/SFr ) [(1+p¥)/(1+pSFr )] = (¥160/SFr) [(1.02)/(1.03)] = ¥158.45. You're Reading a Preview c. As a difference from the expectation, the real change in the spot rate is: ¥/SFr x¥/SFr = (Actual-Expected)/(Expected) (S0¥/SFr –E[S ])/E[S0¥/SFr ]) 0 trial. Unlock full= access with a free = (¥155/SFr–¥158.45/SFr)/¥158.45/SFr = –2.18%. Alternatively, change in the real exchange rate is equal to: SFr Download x¥/SFr = ((S0¥/SFr )/(S –1¥/SFr )) ((1+p )/(1+p¥))With – 1 Free Trial = ((¥155/SFr)/(¥160/SFr)) ((1.03)/(1.02)) – 1 = –2.18%. d. The franc depreciated by 2.18% in purchasing power. e. In real terms, the yen rose by xSFr/¥ = ((S0SFr/¥) / (S –1SFr/¥)) ((1+p¥) / (1+pSFr )) – 1 = ((S0¥/SFr ) –1 / (S –1¥/SFr ) –1) ((1+p¥) / (1+pSFr )) – 1 = ((¥155/SFr) –1 / (¥160/SFr) –1 ) ((1.02)/(1.03)) – 1 = +2.23% Read Free For 30this Days = ((SFr.0064516/¥)/(SFr.00625000/¥)) ((1.02)/(1.03)) – to 1= +2.23%. Sign up vote on title Because the SFr fell by 2.18% in real terms, the yen rose 1/(1–0.0218) 2.23%. Useful by Not≈useful
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4A.2 Inflation rates are pD = ln(1+pD) = ln(1.10) = 9.531% and pF = ln(1+pF) = ln(1.21) = 19.062 continuously compounded returns. Expected price levels and spot rates are: E[P1D] = P0D e(0.09531) = (D100)(1.10) = D110 E[P2D] = P0D e(2)(0.09531) = (D100)(1.21) = D121 E[P1F] = P0F e(0.19062) = (F1)(1.21) = F1.21 E[P2F] = P0F e(2)(0.19062) = (F1)(1.4641) = F1.4641 E[S1D/F] = E[P1D] / E[P1F] = D110 / F1.21 = D90.91/F E[S2D/F] = E[P2D] / E[P2F] = D121 / F1.4641 = D82.64/F
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Kirt C. Butler, Solutions for Multinational Finance, 4th edition
PART II Derivative Securities for Currency Risk Management Chapter 5 Currency Futures and Futures Markets Answers to Conceptual Questions 5.1
How do currency forward and futures contracts differ with respect to maturity, settlement, an size and timing of cash flows? Currency forward contracts are traded in an interbank market, have negotiated terms (mat amount, and collateral), and are traded with a bid-ask spread. Nearly all forward contracts are until maturity. Currency futures contracts are exchange-traded, standardized instruments tha traded on a fee basis rather than with a bid-ask spread. Less than 5% of futures contracts are until maturity.
5.2
What is the primary role of the exchange clearinghouse? The Chicago Board of Trade Clearing Board’s slogan is “A party to every trade.” This i primary role of a futures exchange. Users of futures always know the reputation and c worthiness of the party on the other side of the trade.
5.3
Draw and explain the payoff profile associated with a currency futures contract. Payoff profiles for an underlying exposure and for the corresponding futures hedge: Underlying exposure
ΔVd/f
Futures hedge
ΔVd/f ΔSd/f
ΔSd/f
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Underlying exposure Futures hedge Download With Free Trial
ΔVd/f
ΔVd/f
ΔSd/f
ΔSd/f
currency Master your semester withcurrency Scribd Long the foreign Short the foreign Read Free Foron 30this Days Sign up to vote title & The New York Times a cross-hedge? a delta-cross-hedge? Useful Not useful 5.4 What is a delta-hedge?
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Special offer for students: Only $4.99/month. When there is a maturity mismatch between an underlying transaction exposure and the expir
date of the nearest futures contract, the hedge that minimizes the variance in the hedged posit
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Kirt C. Butler, Solutions for Multinational Finance, 4th edition
domestic currency, f 2 = the currency in which transaction exposure is denominated, and f currency used to hedge against s td/f2. If there is neither a currency nor a maturity mismatch, futures prices converge to spot prices at expiration and exposure to currency risk can be he exactly (an r-square of one) with a futures contract.
Problem Solutions 5.1 Forward:
+$.0180/S$
0
30
60
90
Futures:
0
$0.0002/S$
$0.0002/S$
1
2
...
$0.0002/S$
$0.0002/S$
89
90
Your cumulative gain over the 90 days of the futures contract is $0.018/S$. This is the value o net cash inflow at expiration of the forward contract. 5.2
The U.S. MNC will need (S$3,000,000)/(S$125,000/contract) = 24 futures contracts to cov forward exposure. The underlying position is long S$, so the MNC should sell 24 S$ fu contracts. A short futures position in S$ gains from a depreciation of the S$. If the spot rate c at $0.5900/S$ on the expiration date, then the gain accumulated over the three months o contract (as the contracts are marked to market each day) will be ($0.6075 $0.5900/S$)(S$3,000,000) = $52,500. You're Reading a Preview
5.3
a.
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¥9,000,000
today
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b. Draw a payoff profile for this project with $/¥ on the axes.
ΔV$/¥
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Special offer for students: c. Only Snow$4.99/month. White pays ¥9 million and receives (¥9,000,000)(F$/¥) in six months.
d. Futures contracts are generally less expensive and more liquid than forward cont
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Kirt C. Butler, Solutions for Multinational Finance, 4th edition Sell Singapore dollars in the U.S. dollar futures
+$81,250 -S$125,000
Net payoff on futures hedge
+Sh500,000 -S$125,000
c.
These ending values exactly hedge the currency exposures of the expected cash flows. changes in spot rates S Sh/$ and SS$/$ would be received over the 90-day life of the fu contract according to the daily settlement procedures. Cotton Bolls could take out a 90-day futures contract to sell S$ for Israeli shekels. Becau ratio of exposed amounts (S$125,000/Sh500,000) = S$0.2500/Sh = F S$/Sh, the unde exposures can be matched exactly. The implied forward rate is S$0.25/Sh. Cotton Bolls w save on commissions, having to buy one futures contract rather than two.
5.5
Hedge ratios and delta-, cross-, and delta-cross-hedges: a. The optimal hedge ratio for this delta-hedge is given by: NFut* = (amt in futures)/(amt exposed) = – β ⇒ (amt in futures) = (– β)(amt exposed) = (–1.025)(–DKr10bn) = DKr10.25bn, so buy (DKr10.25bn)($0.80/DKr)/($50,000/contract) = 164,000 contracts. b. The optimal amount in the futures position of this cross-hedge is: ⇒ (amt in futures) = (–1.04)(–DKr10bn) = DKr10.4bn, or (€0.75/DKr)(DKr10.4bn) = €7.8bn at the €0.75/DKr exchange rate. c. The optimal amount in the futures of this delta-cross-hedge is: You'reposition Reading a Preview ⇒ (amt in futures) = (–1.05)(–DKr10bn) = DKr10.5bn. Unlock full access with a free trial. This is equal to (DKr10.5bn)($0.80/DKr)/($50,000/contract) = 168,000 contracts. 2 d. Hedge quality can be ranked as follows: 1) delta-hedge (r = 0.98), 2) cross-hedge (r 2 and 3) delta-cross-hedge (r 2 =0.86). If theWith merchant banker does not enjoy the same volum Download Free Trial liquidity as the futures exchanges, the cross-hedge through the merchant bank is likely to b most expensive hedge.
5.6
a.
Profit/loss on each of the positions is as follows: St$/S$ = $0.6089/S$ i$ = 6.24% iS$ = 4.04% Futt,T$/S$ = ($0.6089/S$) [(1.0624)/(1.0404)] (51/365) ≅ $0.6107/S$
Master your semester with Scribd Read Free Foron 30this Days Sign up to vote title Profit on futures: +($0.6107/S$–$0.6107/S$) +$0.0000/S$ & The New York Times Useful Not useful Profit on spot: –($0.6089/S$–$0.6089/S$) –$0.0000/S$ Scenario #1
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Net gain
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b. Profit/loss on each of the positions is as follows: Scenario #1
St$/S$ = $0.6089/S$ i$ = 6.24% iS$ = 4.04% Futt,T$/S$ = ($0.6089/S$) [(1.0624)/(1.0404)] (51/365) ≅ $0.6107/S$
Profit on futures: Profit on spot: Scenario #2
$/S$
+$0.0000/S$ –$0.0000/S$
$0.0
$
S$
St = $0.6255/S$ i = 6.24% i = 4.04% $/S$ Futt,T = ($0.6255/S$) [(1.0624)/(1.0404)] (51/365) ≅ $0.6273/S$
Profit on futures: Profit on spot: Scenario #3
+($0.6107/S$–$0.6107/S$) –($0.6089/S$–$0.6089/S$) Net gain
+($0.6273/S$–$0.6107/S$) –($0.6255/S$–$0.6089/S$) Net gain
–$0.0166/S$ –$0.0166/S$
$0.0
St$/S$ = $0.5774/S$ i$ = 6.24% iS$ = 4.04% Futt,T$/S$ = ($0.6089/S$) [(1.0624)/(1.0404)] (51/365) ≅ $0.5791/S$
Profit on futures: Profit on spot:
–($0.5791/S$–$0.6107/S$) +($0.5774/S$–$0.6089/S$) Net gain
+$0.0315/S$ –$0.0315/S$
$0.0
Part b shows that the futures hedge provides a perfect hedge against changes in the spot ra exchange if the basis does not change.
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Kirt C. Butler, Solutions for Multinational Finance, 4th edition
Chapter 6 Currency Options and Options Markets Answers to Conceptual Questions 6.1
What is the difference between a call option and a put option?
A call option is an option to buy the underlying asset at a predetermined exercise price. A option is an option to sell the underlying asset at the exercise price. 6.2
What are the differences between exchange-traded and over-the-counter currency options?
Exchange-traded currency options are standardized as to currencies, maturity, exercise prices settlement procedures. Over-the-counter options traded by commercial and investment banks c tailored to fit the needs of the client. 6.3
In what sense is a currency call option also a currency put option?
Because an option to buy one currency is simultaneously an option to sell another curr currency options are both a call (on one currency) and a put (on the other currency). 6.4
In what sense is a currency forward contract a combination of a put and a call?
A currency forward contract to buy currency f at a forward price of F Td/f at time T can be repl by purchasing a European call option on currency f with the same expiration date and an exe price K d/f = FTd/f and simultaneously selling a put option at the same exercise price and ma date. Conversely, a short forward contract on currency f is a combination of a written call on f purchased put on f with the same expiration date and exercise price. 6.5
What are the six determinants of a currency option value?
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The determinants of currency option values are riskless domestic and foreign interest rates exercise price, the underlying spot (orfull futures) price, thetrial. expiration date, and the volatility o Unlock access with a free underlying exchange rate. 6.6
What determines the intrinsic value of an option? time value of an option? Download WithWhat Free determines Trial
The intrinsic value is the value if exercised today. For a call on the spot rate S d/f , intrinsic va equal to max(Sd/f –K d/f ,0). For a put option, intrinsic value is equal to max(K d/f –Sd/f ,0). Time va the difference between the market value and the intrinsic value of an option and reflect additional value of waiting until expiration before exercise. Time value primarily depends on to expiration and volatility in the underlying exchange rate. Foreign and domestic interest rates Read Free Foron 30this Days Sign up to vote title a lesser role for most currency options.
Master your semester with Scribd & The New Times 6.7 InYork what ways can you estimate currency volatility? Special offer for students: Only $4.99/month.
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Exchange rate volatility is a key determinant of currency option value because it is not dir observable in the marketplace. The other determinants of option value (foreign and dom
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Kirt C. Butler, Solutions for Multinational Finance, 4th edition 6.2
An exercise price of DKr8.45/£ is equivalent to £0.11834/DKr. The corresponding krone put values are: Spot rate at expiration (£/DKr) Krone put value at expiration (£/DKr)
6.3
.12500 .11905 .11876 .11848 .11820 .1179 0.00 0.00 0.00 0.00 0.14
A short krone put is equivalent to a short pound call. Here are their payoff profiles.
−ΔPutT£/DKr
−ΔCall TDKr/£
£.11834/DKr
ΔST£/DKr ≡
DKr8.45/£
DKr8.48/£
ΔSTDKr/£
− DKr.03/£ −£.11834/DKr When the premium is included, these diagrams look like this:
−ΔPutT£/DKr
−ΔCall TDKr/£ You're Reading a Preview Unlock full access with a free trial. +£.1464/DKr
+£.00204/DKr
Download With Free Trial
ΔST£/DKr ≡ −£.11633/DKr
DKr8.45/£ DKr8.5964/£
ΔSTDKr/£
£.11834/DKr
Master your semester with Scribd £.11633/DKr Read Free Foron 30this Days Sign up to vote title & The New York Times Useful Not useful 6.4 Buy a A$ call and sell a A$ put, each with an exercise price of F = $0.75/A$ and the $/A$ Cancel anytime. 1
Special offer for students: Only $4.99/month. expiration date as the forward contract. Payoffs at expiration look like this:
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Kirt C. Butler, Solutions for Multinational Finance, 4th edition
Spot exchange rate volatility and at-of-the-money put option value
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You're Reading a Preview Unlock full access with a free trial. 3-
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Increasing variability in the distribution of end-of-period spot rates results in an increase in option value in each case. (For in-the-money puts, the increase in option value with decreases underlying spot rate is greater than the decrease in value from proportional increases in the rate.) Variability in the distribution of end-of-period spot exchange rates comes from exchange volatility and from time to expiration.
Master your semester with Scribd Read Free Foron 30this Days Sign up to vote title 6.6 The payoff profile of a purchased straddle at expiration is shown below. & The New York Times Useful Not useful VT¥/$ Special offer for students: Only $4.99/month.
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Kirt C. Butler, Solutions for Multinational Finance, 4th edition ln [(¥70.38/$) / (¥105/$)] = ln(0.50819) = –0.40 = –40% 6.9
Exchange rate volatility and standard deviations: a. A daily standard deviation of 0.742% measured over 252 trading days implies σ√T = (0.742%)(√252) = 11.78% per year. b. +2 σ: e2(+0.1178) = e+0.2356 = 1.2657 ⇒ (A$1.4/$)(1.2657) = A$1.7719/$ –2σ: e2(–0.1178) = e –0.2356 = 0.7901 ⇒ (A$1.4/$)(0.7901) = A$1.1061/$ c. +2σ: r = ln((A$1.7719/$)/(A$1.4/$)) = ln(1.2657) = +0.2356 ⇒ 0.1178/year –2σ: r = ln((A$1.1061/$)/(A$1.4/$)) = ln(0.7901) = –0.2356 ⇒ 0.1178/year Alternatively, S$/A$ = 1/SA$/$ = 1/(A$1.4/$) = $0.714285/A$. +2σ: e2*(+0.1178) = 1.2657 ⇒ ($0.7143/A$)(1.2657) = $0.9040/A$ ⇒ A$1.1061/$ –2σ: e2*(–0.1178) = 0.7901 ⇒ ($0.7143/A$)(0.7901) = $0.5644/A$ ⇒ A$1.7719/$
Appendix 6-A Currency Option Valuation 6A.1 Option determinants are as follows: i¥ = i$ = 0.05, T = ½ year = 0.5, S¥/$ = $80, K ¥/$ = $100, = 0.10. Assume these are continuously compounded rates calculated from holding period according to i = ln(1+i). Then, d1 = [ln(Sd/f /K d/f ) + (id – if +σ2/2)T] / (σ√T) = [ln((¥80/$)/(¥100/$)) + (0.05–0.05+(0.10)2/2)(0.5)] / (0.10)(0.5)1/2 = –3.1204 d2 = d1 – σ√T = –3.1204 – (0.10)(0.5) 1/2 = –3.1911 Calld/f = e- i
f
T
[Sd/f N(d1)] – e- i
d
T
[K d/f N(d2)]
= e(–0.05*.5)[(¥80/$)(0.0009)]–e(–0.05*.5)[(¥100/$)(0.0007)] = ¥0.0013/$. This deep-out-of-the-money dollar call has almosta no chance of being exercised. You're Reading Preview 6A.2 Option determinants: Same as above, except σ = 0.20. Unlock full access with a free trial. d/f d/f d f 2 d1 = [ln(S /K ) + (i – i + σ /2)T] / (σ√T) = [ln((¥80/$)/(¥100/$)) + (0.05–0.05+(0.20)2/2)(0.5)] / (0.20)(0.5)1/2 = –1.5071 1/2 Download With Free Trial d2 = d1 – σ√T = –1.5071 – (0.20)(0.5) = –1.6486 f
d
Calld/f = e(– i T) [Sd/f N(d1)] – e(– i T) [K d/f N(d2)] = e(–0.05*.5)[(¥80/$)(0.0659)]–e(–0.05*.5)[(¥100/$)(0.0496)] = ¥0.3015/$. If the true volatility is 20% per year and this option is priced as if the volatility is 10% per then the option will be undervalued by (¥0.3015/$–¥0.0013/$) = ¥0.3002/$.
Master your semester with Scribd 6A.3 The implied variance of the $/¥ exchange rate is aboutRead 0.000877 from the currency option p Free Foron 30 Days Sign up to vote this title Taking the square root to find the standard deviation implied in the option price, w & The New model. York Times Useful Not useful 0.0296 or 2.96% per year. As verification, here are the calculations: d/f d/f Special offer for students: $4.99/month. d Only = [ln(S /K ) + (id – if +σ2/2)T] / (σ√T) 1
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[ln(($.008345/¥)/($.0084/¥))+(0.04–0.04+(0.0296) 2/2)(2.5/12)]/(0.0296)(2.5/12)1/2
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Kirt C. Butler, Solutions for Multinational Finance, 4th edition
(a violation of Rule #2 from Chapter 3) of the exchange rates. This is not unusual, as the pou often left in the denominator of a foreign exchange quote. Historically, the pound was comp of shillings and pence rather than decimal units. (Nobody understands cricket, either.) For cl the table below includes forward rates in £/DKr and quotes option prices in direct £/DKr t from a Londoner’s perspective. The current spot rate is S 0£/DKr = 1/(DKr8.4528 £0.11830/DKr and the exercise price is K £/DKr = 1/(DKr8.5/£) = £0.11765/DKr. 1-month 3-month 6-month 1-year Forward rate (DKr/£) 8.4404 8.4157 8.3787 8.3053 Forward rate (£/DKr) 0.11848 0.11883 0.11935 0.12040 Call option value (£/DKr) 0.00180 0.00294 0.00412 0.00583 Put option value (£/DKr) 0.00100 0.00178 0.00247 0.00326 b. Here is a sample calculation for the three-month (= one period) call and put values. d1 = [ln(Sd/f /K d/f ) + (id – if +σ2/2)T] / (σ√T) = [ln((£0.11830/DKr)/(£0.11765/DKr))+(0.0174–0.0130+(0.05) 2/2)(1)]/(0.05)(1)1/2 = +0.2244 d2 = d1 – σ√T = +0.2244 – (0.05)(1)1/2 = +0.1744 Calld/f = e- i c.
dT
[Ftd/f N(d1) – K d/f N(d2)]
= e(–0.0174*1)[(£0.11883)(0.5888)–(£0.11765)(0.5692)] = £0.00294/DKr. Here are the call option payoff profiles for the four options prior to expiration. The one option is plotted as the highest line in the graph.. The one-month option is the lowest (curved in the graph. The darkened forty-five degree line is the intrinsic value of the option. 0.018
0.016
0.014
You're Reading a Preview Unlock full access with a free trial.
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0.012
0.010
Master your semester with Scribd & The New York Times 0.008
0.006
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Kirt C. Butler, Solutions for Multinational Finance, 4th edition 0.120
Sheet Music 0.100
0.080
0.060
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0.020
0.000 0.0000
0.0200
0.0400
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6A.5 Let’s restate these exercise prices as pound per krone rates before proceeding. Exercise prices Exercise prices (DKr/£) 8.2000 8.4000 8.6000 You're Reading a Preview Exercise prices (£/DKr) 0.12195 0.11905 0.11628
8.8000 0.11364
Call option value Unlock full access with 0.00114 0.00222 a free trial. Put option value 0.00421 0.00244
0.00568 0.00058
0.00377 0.00127
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Kirt C. Butler, Solutions for Multinational Finance, 4th edition
Chapter 7 Currency Swaps and Swaps Markets Answers to Conceptual Questions 7.1
What is a parallel loan arrangement. What are its advantages and disadvantages?
In a parallel loan, one company borrows in its home currency and then trades this debt fo foreign currency debt of a foreign counterparty. This a) legally circumvents any restriction cross-border capital flows, b) allows each company to borrow in its home country where it enj relative borrowing advantage, and c) can be used to reduce the currency risk exposure of fo subsidiaries, and d) it may facilitate access to new capital markets. Disadvantages includ default risk, b) the balance sheet impact of offsetting assets and liabilities, and c) search co finding a counterparty. 7.2
How can a currency swap remedy the problems of parallel loans?
Currency swaps bundle a parallel loan into a single contract that a) greatly reduces default ris eliminates the need to capitalize the offsetting asset and liability on the balance sheet, an reduces search costs through high volume and active market makers (dealers). 7.3
How are swaps related to forward contracts? A swap is a portfolio of simultaneous forward contracts each with a different maturity date.
7.4
What is a currency coupon swap?
A currency coupon swap is a fixed-for-floating rate non-amortizing currency swap. Cur coupon swaps are primarily traded through international commercial banks. 7.5
What is a fully covered currency You're couponReading swap? a Preview
A fully covered currency coupon swapfullfully covers interest rate obligations o Unlock access with a the free customers trial. underlying exposure by adding a premium to both the fixed and the floating rate side of the s Interest payments on the fixed-rate side are set equal in present value to the interest paymen the floating rate side of the swap Download With Free Trial 7.6
What is a coupon swap?
A coupon swap is a fixed-for-floating rate non-amortizing interest rate swap. These swaps are traded primarily through international commercial banks.
Master your semester 7.7 What is the differencewith between Scribd a bond equivalent yield and a money market yield? Read Free For 30this Days Sign up to vote on title U.S. Treasuries are quoted as a bond equivalent yield (BEY) assuming a 365-day year & The Newsemiannual York Times Useful Not useful interest payments. Floating rate Eurocurrencies such as those pegged to LIBOR Special offer for students: Only $4.99/month.
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quoted as a money market yield (MMY) based on a 360-day year and semiannual coupons relation between the two is MMY = BEY(360/365).
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Kirt C. Butler, Solutions for Multinational Finance, 4th edition b. A parallel loan results in the following cash flows: Sunflower borrow Lira: +100% borrow $: +100% lend $:
-100%
Rosa borrow $: +100% borrow Lira: +100% lend Lira:
c.
7.2
-100%
-8% -5% +9% -9% -7% +8%
-8% -5% +9% -9% -7% +8%
-108% Lira -105% $ +109% $ -109% $ -107% Lira +108% Lira
Sunflower borrows at 8% in lira but earns (9%–5%) = 4% over cost on the dollar loan to for a net borrowing cost of (8%–4%) = 4% in lira. This is a 4% savings over borrowing dir in the lira market at 8%. Rosa borrows at 9% in dollars but earns (8%–7%) = 1% over cost on the lira loan to Sunfl for a net borrowing cost of (9%–1%) = 8% in dollars. This is a 1% savings over the co borrowing directly in the dollar market at 9%.
Little Prince could form a coupon swap (an interest rate swap) of its existing fixed rate deb floating rate debt. Consider the coupon swap pricing table from the text:
2 years 3 years 4 years 5 years
Maturity 2 yr 3 yr 4 yr 5 yr
Bank Pays Bank Receives Fixed Rate Fixed Rate TN sa + 19bps 2 yr TN sa + 40bps You're Reading a Preview TN sa + 24bps 3 yr TN sa + 47bps Unlock full access with a free trial. TN sa + 28bps 4 yr TN sa + 53bps TN sa + 33bps 5 yr TN sa + 60bps
Current TN Rate 7.05% 7.42% 7.85% 7.92%
This schedule assumes non-amortizing semiannual rates (sa). Downloaddebt Withand Free Trial All quotes are against 6-month LIBOR flat. TN = Treasury Note rate.
LP would pay LIBOR flat on the floating rate side and receive the 2-year T-note rate of 7 (7.05%+19 bp) on the fixed rate side. Because LP is now paying 8.25% on its fixed rate de interest shortfall would be (8.25%–7.24%) = 1.01%. This is equal to 1.01%(360/365) = 0.9 per year in money market yield. LP’s net cost of floating rate funds is then LIBOR + 99.6 b Read Free Foron 30this Days Sign up to vote title money market yield. In this example, the swap just barely beats the market rate on new flo rate debt of LIBOR + 100 bps. Useful Not useful
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Special offer for7.3 students: a. Only Ford$4.99/month. pays fixed-rate zloty interest at a bond equivalent yield of 7.98%+0.78% = 8.76%
receives floating rate zloty interest at the 6-month LIBOR rate. After converting the 4
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Kirt C. Butler, Solutions for Multinational Finance, 4th edition
0.01468052, or about 1.468 percent per six months. Note in passing that the PV an factors that correspond to these interest rates are PVIFA(i ¥=1.46805,T=6) = 5.7033908 PVIFA(i£=2.06%,T=6) = 5.59010642. b. Step (1): JI’s 105 bps spread to LIBOR translates into a BEY of (1.05%/2)(365/3 53.2292 bps per six months. Step (2): Solving equation (7.2) for the equivalent semiannual pound spread yields r PVIFA(i¥=1.46805,T=6)/PVIFA(i£=2.06%,T=6) = (53.2292 bps)(5.70339081/5.590106 54.3079 bps in bond equivalent yield. Step (3): JI also must pay the fixed rate side of the swap to the swap bank at a rate of 4.1 5 bps, or a semiannual rate of 2.085%. JI’s all-in cost of fixed rate pound sterling d (2.085% + 0.543079%) = 2.628079 percent (BEY), or 5.256157 percent per year compou semiannually. c. Step (1): BD is paying 7.45% over the 4.07 pound swap rate that it receives from the bank, for a semiannual premium of (7.45%–4.07%)/2 = 169 bps. Step (2): The corresponding yen premium to LIBOR is r ¥ = r £ PVIFA(i£,6)/PVIFA(i¥,6) = bps)(5.59010642/5.70339081) = 165.6432 bps (BEY). Step (3): This is equivalent to (165.6432 bps)(360/365) = 163.3741 bps in money m yield. BD’s all-in cost of floating rate yen financing over the LIBOR yen rate is 2(163 bps) = 3.267483% in money market yield, or about 3.27 percent. d. The swap bank earns a (4.17%–4.07%) = 10 bp spread in bond equivalent yield o notional principal regardless of whether the bank quotes fully covered rates or uses the pricing schedule given in the problem. When the bank quotes fully covered rates, it a premium to both the fixed and floating rate sides that leaves its net position unchanged.
The dollar interest rate that corresponds the zloty swap mid-rate is ((1+i Z)/(1+i You're Readingto a Preview FtZ/$/S0Z/$ ⇒ i$ = (1+iZ)/(FtZ/$/S0Z/$)–1 = (1.079)/(1.038)–1 = 0.03949904, or about 3.95 pe access with a freeare trial.PVIFA(i Z=7.9%,5) = 4.0032554 The corresponding presentUnlock valuefull annuity factors PVIFA(i$=3.949904%,5) = 4.45809446. Usually, we know the notional principal andFree needTrial to calculate payments based on the Download With pricing schedule. In this problem, GE knows the payments and needs to calculate the not principal. GE wants zloty cash outflows of Z5 million per year to hedge one-half of thei million expected after-tax operating cash flow. GE will be paying the fixed zloty cash and so will pay the swap bank’s ask rate of 8.10%. This requires notional principal of PV PMTZ PVIFA(iZ=8.1%,5) = (Z5 million)(3.98220886) = Z19,911,044 to generate a 5 annuity of Z5 million. This is equivalent to $7,111,087 at Free the Z2.80/$ spot rate. Read Foron 30this Days Sign up to vote title Step (1): GE’s cost of floating rate dollar debt is at LIBOR + 32 bps, or (32 bps)(365/3 Useful Not useful 32.4444 basis points in (dollar) bond equivalent yield. Cancel anytime. Z Special offer for students: Only $4.99/month. Step (2): The zloty spread to LIBOR is r = (32.4444 bps)(4.45809446/4.00325549) = 36 bps (BEY). 7.5
a.
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Kirt C. Butler, Solutions for Multinational Finance, 4th edition in BEY. This is a yen spread over LIBOR of (0.00532292)(¥2.4 billion) = ¥12,775,000. –¥ LIBOR (MMY) –¥12,775,000
–¥ LIBOR (MMY) –¥12,775,000
The swap offsets these yen spreads to LIBOR with fixed rate pound CFs with the same pr value through equation (7.2), or semiannual payments of (0.00543079)(£10,000,00 £53,079. JI also has to pay the 2.085% swap rate, for a cash flow of (0.02085)(£10,000,0 £208,500. +¥ LIBOR (MMY) +¥12,775,000
–¥ LIBOR (MMY) +¥12,775,000
–£54,308 –£208,500
–£54,308 –£208,500
This leaves a net pound payment of (£208,500+£54,308) = £262,808 every six months.
–£262,808
–£262,808
This is an all-in cost of (£262,808)(£10,000,000) = 0.0262808 per six months, or 5.25 percent per year compounded semiannually. b. Similarly, the all-in cost of BD’s swap can be verified from the cash flows of BD’s BD’s underlying fixed rate pound are (7.45%/2)(£10,000,000) = –£372,500. You'reCFs Reading a Preview Unlock full access with a free trial.
–£372,500
–£372,500
The swap offsets these pound cash flowsWith withFree floating Download Trialrate yen interest payments over LIB The corresponding yen spread over LIBOR is (165.6432 bps)(¥2.4 billion) = ¥39,754,371
– £372,500
+£372,500
–¥ Scribd LIBOR (MMY) –¥ LIBOR (MMY) Master your semester with Read Free Foron 30 Days Sign up to vote this title –¥39,754,371 –¥39,754,371 & The New York Times Useful Not useful This leaves a spread over LIBOR of ¥39,754,371 every six months. Special offer for students: Only $4.99/month.
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Kirt C. Butler, Solutions for Multinational Finance, 4th edition
The swap offsets the dollar spread to LIBOR with fixed rate zloty CFs of the same pr value through equation (7.2), or an annual spread of (0.00361307)(Z19,911,044) = Z71 GE also has to pay the 8.1% swap rate, for a fixed-rate zloty payment of (0.081)(Z19,911 = Z1,612,795. +$ LIBOR (MMY) +$23,072
–$ LIBOR (MMY) +$23,072
–Z71,940 –Z1,612,795
– Z71,940 – Z1,612,795
The total fixed-rate zloty payment is Z1,684,735 each year.
– Z1,684,735
– Z1,684,735
This is indeed an all-in cost (Z1,684,735)/(Z19,911,044) = 0.08461307 per year (or about percent) on GE’s fixed-rate zloty debt. b. SP’s underlying fixed rate zloty payments are (10.24%)(Z19,811,044) = Z2,038,891 per y
–Z2,038,891
– Z2,038,891
The swap offsets these fixed-rate zloty CFs with floating rate dollar payments over LIB The corresponding $ spread over LIBOR is (0.02280855)($7,111,087) = $162,194 as a
You're Reading a Preview +Z2,038,891
+Z2,038,891
Unlock full access with a free trial.
–$ LIBOR (MMY) Download With Free Trial –$162,194
–$ LIBOR (MMY) –$162,194
When combined with the underlying zloty obligation, this leaves net cash flows of
–$ LIBOR (MMY) –$ LIBOR (MMY) Master your semester with Scribd –$162,194 –$162,194 Read Free Foron 30this Days Sign up to vote title This is a money market spread of (228.0855 bps)(360/365) 224.8611 bps, or about 2 & The New York Times Not useful Useful = over$4.99/month. the one-year LIBOR Eurodollar rate. Special offer for students: Only
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Kirt C. Butler, Solutions for Multinational Finance, 4th edition
PART III The International Financial Environment Chapter 8 The Rationale for Hedging Currency Risk Answers to Conceptual Questions 8.1
Describe the conditions that can lead to tax schedule convexity.
Tax schedule convexity can arise from any of the following: a) progressive taxation in which l taxable income receives a higher tax rate, b) tax-loss carryforwards or carrybacks, c) Altern Minimum Tax (AMT) rules, d) investment tax credits. 8.2
Define financial distress. Give examples of direct and indirect costs of financial distress.
Financial distress refers to the additional financial troubles facing firms when the value of e approaches zero. Direct costs are incurred during bankruptcy proceedings. Indirect costs include revenues or higher operating/financial costs. 8.3
What is an agency conflict? How can agency costs be reduced?
Agency conflicts arise as managers act in their own interests rather than those of shareho Agency costs are the costs of aligning managers’ and shareholders’ objectives. Although currenc may be diversifiable to shareholders, managers are undiversified and care about currency Allowing managers to hedge exposure to currency risk may reduce agency conflicts.
Problem Solutions 8.1
a.
Expected taxable income is (½)($250,000) + (½)(–$250,000) = $0.
You're Reading a Preview E[PV(taxes)|unhedged] = (½)($125,000)–(½)($125,000)/(1.25) = $12,500. The present val current taxes is $125,000. Unlock The present value of the tax shield received in one year is full access with a free trial. ($125,000)/(1.25) = $100,000.
E[PV(taxes)|hedged] = Tax rate times expected taxable income = (½)($0) = $0, an expecte Download With Free Trial savings of $12,500. b. Expected taxable income is (½)($250,000) + (½)(–$250,000) = $0. E[PV(taxes)|unhedged] = (½)($125,000)–(½)($125,000)/(1.00) = $0.
Master your semester with Scribd The present value of the tax shield from tax loss carryforwards increases attitle lower discount Read Free Foron 30this Days Sign up to vote If the discount rate is zero, time doesn’t matter and future tax shields have the same magnitu & The New York Times Useful Not useful current tax payments. E[PV(taxes)|hedged] = (tax rate) times (expected taxable income) = (½)($0) = $0.
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c.
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Expected taxable income is (½)($250,000) + (½)(–$250,000) = $0.
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Kirt C. Butler, Solutions for Multinational Finance, 4th edition 8.2
a. Taxes
Sheet Music
20% tax rate
40% tax rate
R250,000 R200,000
R0
R1,000,000
R500,000
R2,000,000
Taxable income
R1,500,000
You're Reading a Preview b. Expected taxes with no hedging: (½) [(R500,000)(0.20)] + (½)[(R1,000,000)(0.20) + (R500,000)(0.40)] Unlock full access with a free trial. = (½) (R100,000) + (½) (R400,000) = R250,000. c. Expected taxes with hedging: (R1,000,000)(0.20) = R200,000 < R250,000. Download Freetax Trial d. Hedging allows Widget to minimize its With expected liability. This increase in expected cash flows to equity results in an increase in equity value. 8.3
a.
At $6,000 in taxable income, debt receives $4,000 and equity receives nothing. At $16,000 in taxable income, debt receives $10,000 and equity receives $6,000. b. Firm value as a combination of debt plus equity:
Master your semester with Scribd VBonds & The New York Times + VStock Special offer for students: Only $4.99/month.
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= VBonds + Stock
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Kirt C. Butler, Solutions for Multinational Finance, 4th edition
Hedged Sheet Music
E[VBonds] + E[VStock ] E[VFirm]
= = =
$10,000 $1,000 $11,000
Firm value rises from $10,000 when unhedged to $11,000 when hedged. Hedging results $3,000 increase in the value of debt and a $2,000 decrease in the value of equity, for a net ga $1,000. The $1,000 net gain is captured by avoiding the ½ probability of a $2,000 deadw bankruptcy cost. Whether equity chooses to hedge in this circumstance depends on whether the gain in firm is more or less than the shift in value from equity to debt from the reduction in risk.
In this example, debt gains at equity’s expense. The $3,000 shift in value from equity to d less than the $1,000 net gain to the firm, so equity bears the $2,000 net loss. In the absence renegotiation of the debt contract, equity would choose to leave its currency risk exp unhedged. 8.4
a.
VBonds
+ VStock
= VBonds + Stock
+ You're Reading a Preview = Unlock full access with a free trial.
$10,000
$10,000 Download With Free Trial
$10,000 $4,000
$14,000
Firm value Unhedged E[V ] = (½)($4,000–$2,000) + (½)($10,000) = Master your b.semester with Scribd + E[V ] = (½)($0) + up (½)($4,000) = Read Free Foron 30this Days Sign to vote title E[V ] = (½)($4,000–$2,000) + (½)($14,000) = & The New York Times Useful Not useful Bonds Stock Firm
$6,000
$2,000 $8,000
In this example, hedging can keep the firm solvent and Cancel avoidanytime. all of the costs of bankru Hedged value is then $11,000 with certainty as in Problems 9.2 and 9.3. Payoffs are as follow
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Kirt C. Butler, Solutions for Multinational Finance, 4th edition 8.5
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a.
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If firm value is £9,000, equity will not exercise its option to buy the firm at a price of £10,0 this case, equity receives nothing and debt receives £9,000. If the firm is worth £19,000, e pays bondholders £10,000 and retains the residual £9,000. Firm value is E[V FIRM] = E[V E[VSTOCK ] = [(½)(£9,000) + (½)(£10,000)] + [(½)(£0)+(½)(£9,000)] = £9,500 + £4,5 £14,000.
Hedged, firm value is VFIRM = VBONDS + VSTOCK = £10,000 + £4,000 = £14,000. The reduct the variability of firm value results in a reduction in call option value and a £500 shift in v from equity to debt.
b. Unhedged, firm value is decomposed as: E[VFIRM] = E[VBONDS] + E[VSTOCK ] = [(½)(£9 £1,000) + (½)(£10,000)] + [(½)(£0) + (½)(£9,000)] = £9,000 + £4,500 = £13,500. With hed VFIRM = VBONDS + VSTOCK = £10,000 + £4,000 = £14,000. As in the previous example, ther reduction in the variability of firm value and an accompanying £500 transfer of wealth equity to debt. Hedging also avoids the deadweight £1,000 bankruptcy cost and yields a h expected payoff in the amount of (½)(£1,000) = £500. In this example, debt captures the exp gain of £500. Equity may capture some of the gain if hedging results in lower interest paym on the next round of debt. c.
Unhedged, firm value is E[VFIRM] = E[VBONDS] + E[VSTOCK ] = [(½)(£6,000–£1,00 (½)(£10,000)] + [(½)(£0) + (½)(£8,000)] = £7,500 + £4,000 = £11,500. If the firm hedges VFIRM = VBONDS + VSTOCK = £10,000 + £4,000 = £14,000. This is the same as in b after incl indirect costs of financial distress with an expected value of [(½)(£9,000–£6,000) + (½)(£19 £18,000)] = £1,500+£500 = £2,000.
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Kirt C. Butler, Solutions for Multinational Finance, 4th edition
Chapter 9 Multinational Treasury Management Answers to Conceptual Questions 9.1
What is multinational treasury management?
Multinational treasury management involves five functions: 1) set overall financial goal manage the risks of international transactions, 3) arrange financing for international trad consolidate and manage the financial flows of the firm, and 5) identify, measure, and manag firm’s risk exposures. 9.2
What function does a firm’s strategic business plan perform?
The strategic business plan performs the following functions: 1) identify the firm’s competencies and potential growth opportunities, 2) evaluate the business environment w which the firm operates, 3) formulate a comprehensive strategic plan for turning the firm’s competencies into sustainable competitive advantages, 4) develop robust processes implementing the strategic business plan. 9.3
Why is international trade more difficult than domestic trade?
International trade is difficult largely because of information costs. Exporters must ensure ti payment from far-away customers. Importers must ensure timely delivery of quality goo services. Also, dispute resolution is difficult across multiple jurisdictions. 9.4
Why use a freight forwarder?
A freight shipper coordinates the logistics of transportation and documentation, which ca formidable on international shipments. You're Reading a Preview 9.5
Describe four methods of payment on international sales.
Unlock full access with a free trial.
The methods are open account, cash in advance, drafts, and letters of credit. In an open acc the seller bills the buyer upon delivery of the goods. In cash in advance, the buyer pays pr Download With Free Trial receiving shipment. A draft is used to pay upon delivery and is like a check or money ord bank letter of credit guarantees payment upon presentation of the specified trade documents. 9.6
What is a banker’s acceptance, and how is it used in international trade?
A banker’s acceptance is a time draft drawn on a commercial bank in which the bank promis pay the holder of the draft a stated amount on a specified future date. Banker’s acceptanc Free Foron 30this Days Sign up to vote title negotiable and so may be sold by the exporter to financeRead working capital.
Master your semester with Scribd & The New York Times Useful 9.7 What is discounting, and how is it used in international trade? Special offer for students: Only $4.99/month.
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Discounting is the purchase of a promised payment at a discount from face value.
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Kirt C. Butler, Solutions for Multinational Finance, 4th edition 9.11
How can treasury assist in managing relations among the operating units of the MNC?
Treasury can serve as a “corporate bank” satisfying the financing requirements of the oper units. This central role allows Treasury to net transactions within the corporation and the minimize the number and size of external market transactions. Treasury can also direct oper units on transfer pricing issues and identify hurdle rates on new investments. 9.12
What are the five steps in a currency risk management program?
1) Identify those currencies to which the firm is exposed and the distribution of future exch rates for each of these currencies. 2) Estimate the firm’s sensitivity to changes in these cur values. 3) Determine the desirability of hedging, given the firm’s estimated risk exposures and management policy. 4) Evaluate the cost/benefit performance of each hedging alternative, the forecasted exchange rate distributions. Select and implement the hedging instrume strategy. 5) Monitor the firm’s evolving exposures and revisit these steps as necessary. 9.13
What is the difference between passive and active currency risk management?
Active management selectively hedges FX exposures depending on the manager’s market v Passive management does not take a view, but applys the same hedging rule to each exposure 9.14
What is the difference between technical and fundamental analysis?
Technical analysis uses exchange rate history to predict short-term exchange rate movem Fundamental analysis uses macroeconomic data to forecast long-term exchange rate moveme 9.15
Are small, medium, or large firms most likely to use derivatives to hedge currency risk? firms benchmark their hedges?
You're a Preview Derivatives users tend to be large firms,Reading and typically use the forward rate for benchmarking.
Problem Solutions 9.1
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a.
A 6% interest rate compounded quarterly is the same as a 1.5% quarterly rate. The net Download With Free Trial payable at maturity is $9,990,000 after subtracting Paribas’ acceptance fee. Fruit of the Loom receive ($9,990,000)/(1.015) = $9,842,365 if it sells the acceptance to its bank. b. The all-in cost of the acceptance is ($10,000,000)/($9,842,365)–1 = 1.60% per quarter effective annual rate of (1.0160) 4 –1= 0.0656, or 6.56% per year.
9.2 a. The 2%/month factoring fee of ($10 million)(0.02/month)(3 months) = $600,000 is due Master your semester with Scribd with a time the receivables are factored. Fruit of the Loom Read is giving accounts receivable Free For 30this Days Sign up toup vote on title amount of $10 million due in three months in exchange for a net amount of $9,400,000. & The New b.York Times Useful Not useful The all-in cost to Fruit of the Loom is ($10,000,000)/($9,400,000)–1 = 0.06383 per quarter Cancel anytime.
Special offer for students: Only $4.99/month. effective annual rate of (1.06383) 4 –1 = 0.2808, or 28.08% per year. While this all-in cost s
high, note that Fruit of the Loom has no collection expenses or credit risk on this nonrecours
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a.
The sale is invoiced in Czech koruna, so the expected future cash flow is:
+CZK40,000,000
b. The contractual payment is a positive cash flow in koruna, so Hippity Hops is posi exposed to the value of the koruna.
ΔV €/CZK Hippity Hops’ koruna exposure
ΔS €/CZK
The expected cash flow in euros is E[CF1 €] = E[CF1CZK ] E[S1 €/CZK (CZK40,000,000)(€0.025/CZK) = €1,000,000. The actual euro cash flow is CF CF1CZK S1 €/CZK = (CZK40,000,000)(€0.04/CZK) = €1,600,000. This leaves an unexpected of €600,000, or 60% of the expected value. As the value of the koruna rises by 60% You're Reading a Preview €0.025/CZK to €0.040/CZK, so too does the euro value of the koruna cash flow. d. Sell 40 million koruna forward buy Unlock fulland access with€1,000,000 a free trial. at the forward price of F CZK/€ €0.025/CZK, or F 1 = CZK40/€. c.
+€1,000,000
Download With Free Trial -CZK40,000,000
The koruna is being sold forward, so Hops’ exposure to the value of the koruna in this for contract is negative. The negative exposure on the forward contract offsets the po exposure on the underlying position. The net result is no exposure to the koruna.
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Kirt C. Butler, Solutions for Multinational Finance, 4th edition
Chapter 10 Managing Transaction Exposure to Currency Risk Answers to Conceptual Questions 10.1
What is transaction exposure to currency risk?
Transaction exposure is change in the value of monetary (contractual) cash flows due t unexpected change in exchange rates. 10.2
What is a risk profile?
A risk profile graphically displays change in the value of an underlying currency exposu change in the value of the underlying currency, such as ΔVd/f as a function of ΔSd/f . Risk pr can be displayed in levels or in changes in levels. 10.3
In what ways can diversified multinational operations provide a natural hedge of transa exposure to currency risk?
Geographically diversified multinational corporations have relatively low transaction exposu currency risk when they have cash inflows and outflows in a wide variety of curren Geographically diversified operations provide opportunities to reduce the multinat corporation’s currency risk exposures through multinational netting and leading and laggin intracompany transactions. 10.4
What is multinational netting? Why is it used by multinational corporations?
In multinational netting, a corporation’s exposure to currency risk is found by consolidating then netting the exposures of individual assets and liabilities. Multinational netting reduce transactions costs of hedging individual currency a risk exposures in external financial markets. You're Reading Preview 10.5
What is leading and lagging? Why is it used by multinational corporations? Unlock full access with a free trial.
Leading and lagging is a way to reduce the firm’s transaction exposure by altering the timi cash flows within the corporation. Like multinational netting, leading and lagging works Downloadunits Withwithin Free the Trial when the currency needs of the individual corporation offset one another. 10.6
Define each of the following: a) currency forwards, b) currency futures, c) currency op currency swaps, and e) money market hedges.
Currency forwards are contracts for future delivery according to an agreed-upon delivery exchange rate, and amount. Exchange-traded currency futures contracts are similar to forw For 30this Days Sign vote on titlemarked-to-m except that changes in value are settled daily as the twoRead sidesupFree oftothe contract are A currency option contract gives the option holder the right to buy or Not selluseful an underlying cur Useful Cancel anytime. at a specified price and on a specified date. A currency swap is a contractual agreeme Special offer for students: Only $4.99/month. exchange a principal amount of two different currencies and, after a prearranged length of tim
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Problem Solutions 10.1. Receiving affiliate United States Canadian Mexican Puerto Rican Total payments
U.S. 0 $500 $400 $400
Total Receipts $1400 $1100 $1300 $1700
P.R. $600 $200 $200 0
$1300 $1900 $1300 $1000
10.2 Receiving affiliate U.S. United States 0 Canadian $600 Mexican $100 Puerto Rican $200 Total payments
Paying affiliate Can. Mex. $300 $500 0 $400 $700 0 $900 $400
Paying affiliate Can. Mex. P.R. $800 $300 $400 0 $300 $700 $900 0 $800 $600 $600 0
0
Total receipts $1500 $1600 $1800 $1400
$900 $2300 $1200 $1900
0
Net Net Receipts Payme $100 $0 $800 $0 $700 $800
$800
Net Receipts $600 $0 $600 $0
Net Paymen
$1200
$1200
$700
$500
Here is one possible set of settling transactions.
Mexican affiliate
U.S. affiliate
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V
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Kirt C. Butler, Solutions for Multinational Finance, 4th edition b. Hedges: i) A short euro forward hedge can exactly offset the underlying exposure. $/€
ΔV
ΔS
$/€
Short euro forward contract
ii) Short euro futures have the same exposure as the forward, although the gain or loss o futures is settled daily whereas the loss or gain on the underlying position accrues at mat iii) A money market hedge
Borrow an amount such that €1 million is € due in one period at an interest rate of i +( €1m)/(1+i )
Money market hedge
You're-(Reading a Preview €1 million) Unlock full access with a free trial.
Convert to dollars at today’s spot rate S 0 $
+($x)/(1+i )
$/ €
+($x)
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⇒
-( €1 million)
-(€1m)/(1+i )
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Kirt C. Butler, Solutions for Multinational Finance, 4th edition
iv) A long euro put option hedge eliminates the downside risk of the underlying exposure an results in a net position that replicates the payoff of a long euro call.
V$/€
Underlying exposure
v$/€ Net position
s
/€
S$/€ Lon euro ut
Lon euro call
Not necessarily. From interest rate parity, FtA$/$/S0A$/$ = [(1+iA$)/(1+i$)]t, the forward pre says only that interest rates are higher in Australia than in the United States. b. Rupert is short the U.S. dollar, so he might want to leave some of his exposure uncovered expects the dollar to close below the forward price. How much he leaves uncovered depen his risk tolerance and on his corporate hedging policy. c. By hedging at a forward price of A$1.6035/$, Rupert avoids having to buy U.S. dollars higher expected spot price. d. Rupert should ask himself: “Do I feel lucky?”a Over-hedging in this way is a form of cu You're Reading Preview speculation. Rupert is surely better off sticking to the beer business. e. This differs from the situation in d.full because Rupert Unlock access with a freehas trial.a legitimate business reason for more than $5 million forward. Hedging an anticipated transaction makes good business when the anticipated transaction is highly likely to occur. If Rupert is not sure that he’ll ac Download With Free Trial incur this additional dollar exposure, he should probably wait before hedging.
10.4 a.
10.5 a.
Rupert should buy the U.S. dollar forward against the Australian dollar. Futures contrac the AS/$ exchange rate are traded on a number of exchanges, including the Chicago Merc Exchange. Futures are marked-to-market daily, so Rupert will have to put up an initial m and then settle any changes in the value of the contract on a daily basis. dolla b. Rupert can replicate a long U.S. dollar forward position by: borrowing Australian Read Free For 30this Days Sign up to1)vote on title converting to U.S. dollars, and 3) investing in U.S. dollars. The bid-ask spread on both spo Not useful Useful Cancel anytime. 3-month forward exchange is 10 basis points (0.10%), so the additional transaction costs Special offer for students: Only $4.99/month. money market hedge will primarily depend on the spreads of borrowing Australian dollar lending U.S. dollars.
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Kirt C. Butler, Solutions for Multinational Finance, 4th edition Borrow (£100,000)/(1+i £) = £89,638 at the i £ = 11.56% pound sterling interest rate.
+£89,638 -£100,000 Convert to (£89,638)($1.25/£) = $112,047 at S 0$/£ = $1.25/£.
+$112,047 -£89,638 Invest in dollars at the U.S. dollar rate of i $ = 9.82%.
+$123,050 -$112,047
The net result is a forward contract to buy dollars with pounds.
+£100,000 -$123,050 You're Reading a Preview
Note that this is on more favorable terms than the forward contract. Forward prices are no Unlock full access with a free trial. equilibrium with the interest rate differential. In this situation, it is cheaper to hedge throu the money markets than through the forward market. $/£ DownloadF1With Free Trial c. These markets are not in equilibrium. /S0$/£ = ($1.20/£)/($1.25/£) = 0.96 < =0.98440 = (1.0982)/(1.1156) = (1+i $)/(1+i£), so you should buy pounds at the relatively low forward price, sell pounds at the relatively high spot price, invest in dollars at the relatively high do interest rate, and borrow pounds at the relatively low pound interest rate.
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Kirt C. Butler, Solutions for Multinational Finance, 4th edition
Chapter 11 Managing Operating Exposure to Currency Risk Answers to Conceptual Questions 11.1
What is operating exposure to currency risk, and why is it important?
A firm has operating exposure to currency risk when the value of its nonmonetary (real) flows changes with unexpected changes in currency values. 11.2
In a discounted cash flow framework, in what ways can operating risk affect the value o multinational corporation?
Operating exposure (indeed, currency exposure generally) affects value either through the flows or the discount rate in the valuation equation V d = Σt E[CFtd]/(1+id)t. 11.3
What is an integrated market? a segmented market? Why is this distinction import multinational financial management?
Purchasing power parity holds in an integrated market for goods, services, or financial assets. means that equivalent assets trade for the same price. A market is segmented if purchasing p parity does not hold. Companies operating in segmented markets have prices that are lo determined. Companies operating in integrated markets face prices that are globally determin 11.4
State how each of the following companies are affected by a real depreciation of the dom currency: a) an importer, b) an exporter, c) a diversified multinational corporation competi globally competitive goods and financial markets.
a) The classic exporter faces costs that are locally determined in segmented markets and reve that are globally determined in You're integrated markets, resulting in a positive exposure to the fo Reading a Preview currency. b) The classic importer buys goods in integrated global markets and sell the Unlockin fullaaccess with aexposure free trial. to foreign currency values. A segmented local markets, resulting negative depreciation of the foreign currency hurts the exporter and helps the importer. c) Multinat corporations operating in integrated global input and output markets have foreign cur Download With Free Trial exposures in both revenues and costs. The net exposure of the multinational corporation dep on the balance between its import and export activities. 11.5
What is meant by the statement “Exposure is a regression coefficient?”
Exposure is measured by the slope coefficient in the regression r td = αd + βf std/f + regression coefficient βf captures the sensitivity of an asset (such as a share of common stoc Read Free For 30 Days Sign up to vote on this title changes in exchange rates.
Master your semester with Scribd & The New York Times Useful Not useful 11.6 Suppose the correlation of a share of stock with a foreign currency value is +0.10. Calculate Special offer for students: Only What $4.99/month. square. does it tell you?
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Kirt C. Butler, Solutions for Multinational Finance, 4th edition
11.9 List several operating strategies for hedging operating risk. What are the advantages disadvantages of these hedges compared to financial market hedges?
Operating strategies for hedging currency risk exposures include: (a) product sourcing decis (b) plant location decisions, and (c) market selection and promotion strategies. Although oper hedges are likely to be more effective than financial market hedges for managing oper exposures, they are also more costly and more difficult to reverse. 11.10 What is the price elasticity of demand, and why is it important?
The price elasticity of demand is defined as minus the percentage change in quantity demande a given percentage change in price, –( ΔQ/Q)/(ΔP/P). The price elasticity of demand determ whether and how much revenues will increase or decrease with a given change in price. 11.11 What five steps are involved in estimating the impact of exchange rate changes on the value firm’s real assets or on the value of equity?
The five steps are: a) Identify the distribution of future exchange rates, b) estimate the sensi of revenues and operating expenses to changes in exchange rates, c) determine the desirabil hedging, given the firm’s risk management policy, d) identify the hedging alternatives evaluate the cost/benefit performance of each alternative, given the forecasted exchange distributions, and e) monitor the position and revisit steps 1 through 4 as necessary.
Problem Solutions 11.1
Operating exposure to currency risk is more difficult to measure than transaction exposure be the values of exposed real assets do not vary one-for-one with exchange rate changes as expos You're Preview monetary assets and liabilities do. WeakReading relationsa(i.e. low r-squares) between asset and curre values make financial market hedges of operating exposures less than perfect. Operating hedg Unlock full access with a free trial. might be more effective, but they are also more difficult to implement.
11.2
a.
Sterling & Co. has exposed monetary assets of $30,000 and exposed monetary liabilities Download With Free Trial $45,000+$90,000 = $135,000. Net monetary assets of –$105,000 are exposed to the dolla b. A 10 percent dollar appreciation will change the pound value of Sterling & Co. by (0.10)(£0.66667/$)(–$105,000) = –£7,000. Exposed monetary assets and liabilities change value one-for-one with changes in exchange rates, so the r-square of this relation is +1, or percent. c. The sensitivity of plant and equipment to the value of the dollar is β$ = ρr,s(σr /σs)= Free For 30 Days Sign up to vote this title (0.10)(0.20/0.10) = +0.2. A 10 percent appreciationRead of the dollar ison likely to increase the value of Sterling’s plant and equipment by 0.2(10%) 2 percent $1,600, usefulfrom £80,000 =Useful orNot Cancel anytime. £81,600. The relation between real asset value and the exchange rate is not very strong. T Special offer for students: Only $4.99/month.2 square is (0.10) = 0.01, so one percent of the variation in real asset value is explained by
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Kirt C. Butler, Solutions for Multinational Finance, 4th edition 11.3
a.
Monetary assets = Cash ($) + Accts receivable ($) + Accts receivable (€) = $40,000 + $30,000 + $60,000 = $130,000. Monetary liabilities = Wages ($) + Accts payable ($) + Bank note (€) + Bank note (€) = $40,000 + $70,000 + $10,000 + $50,000 = $170,000. Net monetary assets = Monetary assets less monetary liabilities = $130,000 – $170,000 = –$40,000. b. Monetary assets exposed to currency risk = Accts receivable (euros) = $60,000. Monetary liabilities exposed to currency risk = Bank note due (€) + Bank note (€) = $10,000 + $50,000 = $60,000. Net monetary assets exposed to currency risk = Exposed monetary assets less exposed monetary liabilities = $60,000 – $60,000 = $0, so there is no net transaction exposure to the euro. c. The negative euro exposure of the euro bank note offsets the positive exposure of t receivables, and hence reduces the firm’s net exposure to the euro. d. Even though the firm has no net transaction exposure, this exporter’s real assets (i.e. plan equipment) are likely to have a positive operating exposure to the euro.
11.4
Low currency risk exposures for U.S. firms means that U.S. investors are more likely to be diversify away currency risk than investors in other countries. This also suggests that currency management is more important outside the United States than within the United States.
11.5
Figure 11.5 is reconstructed for a ¥50 million forward hedge as follows.
Uncertain yen revenues a Preview Underlying revenues in yen You're Reading +¥50 million +¥100 million +¥150 million Cash flows of the forward hedge Unlock full access with a free trial. long dollars +$500,000 +$500,000 +$500,000 short yen –¥50 million –¥50 million –¥50 million Net position Download With Free Trial in dollars +$500,000 +$500,000 +$500,000 in yen +¥0 +¥50 million +¥100 million Exchange rate uncertainty at revenues of ¥50 million Underlying revenues in yen +¥50 million +¥50 million +¥50 million Cash flows of the forward hedge long dollars +$500,000 +$500,000 +$500,000 Read Free For 30this Days Sign up to vote on title short yen –¥50 million –¥50 million –¥50 million Not useful Useful Net position Cancel anytime. in dollars +$500,000 +$500,000 +$500,000 Special offer for students: Only $4.99/month. in yen ¥0 ¥0 ¥0
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Kirt C. Butler, Solutions for Multinational Finance, 4th edition
The partial hedge of –¥50 million is a perfect hedge when yen revenues are ¥50 million. Whe revenues are ¥150 million, the –¥50 million hedge isn’t nearly large enough and the range dollar outcomes is twice as large as in the text example. 11.6
Figure 11.6 is reconstructed for this problem as follows. Twenty percent depreciation of the pound to $1.20/£ Maintain £4 price Base case $1.50/£
Sales volume remains constant
Maintain $6 price Elastic demand Sell 50% less
Inelastic deman Sell 10% less
£
$
£
$
£
$
£
£4.00 £2.00 20,000
$6.00 $3.00 20,000
£4.00 £2.50 20,000
$4.80 $3.00 20,000
£5.00 £2.50 10,000
$6.00 $3.00 10,000
£5.00 £2.50 18,000
Revenues £80,000 $120,000 - COGS –40,000 –60,000 Taxable income 40,000 60,000 - Tax (at 50%) –20,000 –30,000
£80,000 –50,000 30,000 –15,000
$96,000 –60,000 36,000 –18,000
£50,000 –25,000 25,000 –12,500
$60,000 –30,000 30,000 –15,000
Price Cost Sales volume
Net cash flow
Value of Tao
20,000
30,000
£200,000 $300,000
Percentage change
a.
15,000
18,000
£150,000 $180,000 –25%
–40%
12,500
–37.5%
You're Reading a Preview
£90,000 $108,00 –45,000 –54,00 45,000 54,00 –22,500 –27,00
15,000
£125,000 $150,000 –50%
$6.0 $3.0 18,00
22,500
2
£225,000 $270,00 12.5%
–10
If Dow maintains its £4 price, value will fall by 25 percent in pounds and by 40 percent in Unlockfor fullproposed access withchanges a free trial. dollars. This sets the benchmark in the pound price. b. If Dow maintains its $6 price (resulting in a £5 price in the U.K.), value will fall by 37.5 percent in pounds and by 50 percent in dollars. With price elastic demand, Dow should Download With Free Trial maintain its £4 price to minimize the impact on its dollar value. c. If Dow maintains its $6 price, value will rise by 12.5 percent in pounds and fall by 10 per in dollars. With price inelastic demand, Dow should maintain its $6 price to minimize the impact on its dollar value.
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Kirt C. Butler, Solutions for Multinational Finance, 4th edition
Chapter 12 Managing Translation Exposure and Accounting for Financial Transaction Answers to Conceptual Questions 12.1
What are the advantages and disadvantages of valuing assets and liabilities at historical market value?
From a financial point of view, assets and liabilities are ideally reported at market values bec market values reflect true values formed by a consensus of market participants. However, m values are not observable for nontraded assets such as privately held equity. In these c historical costs provide reliable, verifiable values that can be consistently applied across bus situations. 12.2
List the rules of the current/noncurrent translation method.
Current accounts are translated at current exchange rates. Noncurrent accounts are translat historical exchange rates. Most income statement items are translated at the average exchang over the reporting period. Depreciation is translated at historical rates. 12.3
List the rules of the monetary/nonmonetary translation method.
Monetary accounts are translated at the current exchange rate. Nonmonetary account translated at historical rates. Most income statement items are translated at the average exch rate over the reporting period. Depreciation and COGS are translated at historical exchange ra 12.4
List the rules of the current rate translation method.
All assets and liabilities except equity are translated at the current exchange rate. Equ translated at historical exchange rates. Incomea statement You're Reading Preview items are translated at the cu exchange rate. Gains or losses caused by translation adjustments are put in a cumul Unlock full access with aof free translation adjustment account in the equity section thetrial. balance sheet. 12.5
Which translation method is the most realistic from the perspective of finance theory?
Download With Free Trial
The current/noncurrent method is the least realistic, because it values long-term debt at histo exchange rates. The choice between the temporal method (as in FAS #8) and the curren method (as in FAS #52) depends on whether real assets are more realistically translat historical or current exchange rates. The temporal method translates real assets at historical assuming real assets are unaffected by currency risk. The current rate method (FAS #52) ass real assets are exposed one-for-one to exchange rate risk. For most firms, the truth is somew Read Free For 30 Days Sign up to vote on this title between these two positions.
Master your semester with Scribd & The New York Times Useful Not useful 12.6 Did the switch from FAS #8 to FAS #52 in the United States improve the quality Special offer for students: Only $4.99/month. informativeness) of corporate earnings? How can we tell?
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Kirt C. Butler, Solutions for Multinational Finance, 4th edition on the part of investors or information providers. 12.9
How can corporate hedging of translation exposure reduce the agency conflict between man and other stakeholders? In what other ways can agency conflicts be reduced?
If managers are evaluated based on accounting performance rather than on the value they a the firm, then allowing them to hedge can remove this source of risk from their deliberation help align managerial incentives with shareholder objectives. 12.10 Identify several cross-border differences in corporate hedging of translation exposure? What account for these differences.
Studies have documented higher derivatives usage as well as a greater willingness to h translation exposure to currency risk outside the U.S. than within the United States. It could b non-U.S. managers are either more exposed to currency risk or more risk averse given exposures.
12.11 Recommend some general policies for deciding whether to hedge a translation exposu currency risk.
(a) In general, only economic exposures should be hedged. (b) Financing foreign operations foreign capital can reduce both translation and economic exposures. (c) To the extent poss insulate managers’ performance evaluations from currency risk. (d) If hedging transl exposure is necessary to align managers with shareholders, then individual units should be cha market prices for these hedges. (e) The treasury should hedge internally whenever possible.
12.12 How did accounting standard setters react to the prominent derivatives-related failures o 1990s? You're Reading a Preview The short-term response was to require increased disclosure of derivative transactions. Unlock full access withaccounting a free trial. for derivatives, often with sp nations are also moving toward market value accounting rules for hedge transactions.
Download With Free Trial 12.13 Describe the four key elements of the United States’ FAS #133 “Accounting for Deriv Instruments and Hedging Activities.”
(a) Derivatives should be reported in the financial statements. (b) Market value is the most rel measure of value. (c) Only assets and liabilities should be reported on the balance sheet. In and expenses should be reported on the income statement. (d) Special accounting rules shou limited to qualifying hedge transactions.
Master your semester with Scribd Read Free Foron 30this Days Sign up to vote title 12.14 What International Accounting Standards Board? Over which organizations does it & The New Yorkis the Times useful Useful Not jurisdiction?
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The IASB is an international committee charged with harmonizing accounting standards.
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Kirt C. Butler, Solutions for Multinational Finance, 4th edition The linkage between the exposed position and the hedge must then be carefully and documented.
Problem Solutions 12.1
Balance sheets
Assets Cash A/R Inventory P&E Total assets Liabilities A/P ST debt LT debt Net worth Total liabs
€ value 50,000 € 30,000 € 20,000 € 900,000 € 1,000,000 €
€
125,000 € 75,000 € 750,000 € 50,000 € 1,000,000
Value at $1.00/€ $50,000 $30,000 $20,000 $900,000 $1,000,000
$125,000 $75,000 $750,000 $50,000 $1,000,000
Translated value at $0.80/€ Current/ noncurrent Temporal Curren $40,000 $40,000 $40,00 $24,000 $24,000 $24,00 $16,000 $16,000 $16,00 $900,000 $900,000 $720,00 $980,000 $980,000 $800,00
$100,000 $60,000 $750,000 $70,000 $980,000
$100,000 $60,000 $600,000 $220,000 $980,000
$100,00 $60,00 $600,00 $40,00 $800,00
a) Net exposed assets: Current/noncurrent rate method: ($50,000+$30,000+$20,000) –($125,000+$75,000) = $100,000–$200,000 = –$100,000. You're Reading a Preview Temporal method (FAS #8): ($50,000+$30,000+$20,000) – ($125,000+$75,000+$750,000) Unlock full access with a free trial. = $100,000–$950,000 = –$850,000. Current rate method (FAS #52): Download With –Free Trial ($50,000+$30,000+$20,000+$900,000) ($125,000+$75,000+$750,000) = $1,000,000–$950,000 = +$50,000. b) Translation gain or loss (note that the dollar is in the numerator) Current/noncurrent rate method: (–0.2)(–$100,000) = +$20,000. Temporal method (FAS #8): (–0.2)(–$850,000) = +$170,000. Current rate method (FAS #52): (–0.2)(+$50,000) = –$10,000. Read Free Foron 30this Days Sign up to vote title 12.2 Balance sheets Translated value at C$1.50/$: Useful Not useful Value at Current/Cancel anytime. Special offer for students: Only $4.99/month. C$ value C$1.60/$ noncurrent Temporal Curren Assets C$ Cash 320,000 $200,000 $213,333 $213,333 $213,333
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Kirt C. Butler, Solutions for Multinational Finance, 4th edition
Temporal method (FAS #8): ($200,000+$100,000+$400,000) – ($200,000+$100,000) = $700,000–$300,000 = $400,000. Current rate method (FAS #52): ($200,000+$100,000+$400,000+$300,000) – ($200,000+$100,000) = $1,000,000–$300,000 = $700,000. b) The Canadian dollar has appreciated by (S1$/C$/S0$/C$)–1 = (C$1.60/$)/(C$1.50/$)–1 = 6.67 percent. Translation gains from the appreciation of the C$ are then: Current/noncurrent rate method: (+0.066667)($400,000) = +$26,667. Temporal method (FAS #8): (+0.066667)($400,000) = +$26,667. Current rate method (FAS #52): (+0.066667)($700,000) = +$46,667. 12.3
a.
Capitalizing the forward asset (long MXN 300,000 at $0.10/MXN) and the forward liabil (short $30,000) on the balance sheet would result in the following. Assets Current assets Accounts receivable $60,000 (€60,000 at $1.00/€) Forward asset $30,000 (long 300,000 MXN at $0.10/MXN) Fixed assets Furnishings (beds & blankets) $30,000 Property and buildings $910,000 Total assets $1,030,000 b.
Liabilities and Owners’ Equity Current liabilities Accounts payable (MXN300,000 at MXN0.10/$) Forward liability (short $30,000) Long-term liabilities & owners’ equity Long-term debt $17 Owners’ equity $80 Total liabilities & owners’ equity $1,03
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Current ratio Debt-to-assets Before $60,000/$30,000 = 2.000 = 0.200 Unlock full access with a free$200,000/$1,000,000 trial. After $90,000/$60,000 = 1.500 $230,000/$1,030,000 = 0.233 Although the leverage and liquidity ratios have apparently deteriorated, Silver Saddle is in Download With Free Trial less risky after the hedge than before. Capitalizing both sides of the hedge on the balance misrepresents the impact of the hedge on the financial leverage and liquidity of the firm.
c.
Silver Saddle can qualify this hedge under FASB #133 by documenting the underlying exposure and showing how the hedge is linked to this exposure. After qualifying the hedg the balance sheet will appear as in the original problem. This hedge is important enough f Silver Saddle to provide a footnote to the balance sheet indicating the forward contract an Read Free Foron 30this Days Sign up to vote title how it relates to the underlying exposure.
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a. Only If a $4.99/month. forward hedge of this euro receivable were capitalized on the balance sheet, the balan Special offer for12.4 students: sheet would look like this.
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Kirt C. Butler, Solutions for Multinational Finance, 4th edition c.
As in Problem 12.3 b, both debt and current ratios have deteriorated. However, Silver Sad is actually less risky after the hedge than before. Silver Saddle can qualify this hedge und FASB #133. However, because this is only an anticipated transaction, the forward positio an element of speculation in it. The speculative element depends on the probability of not receiving the anticipated euro payment.
Upon further review: Note in passing that the exposure of the peso payable partially offse exposure of the euro receivable. If the euro-per-peso spot rate S €/MXN does not change, the depreciation of the dollar (and hence an appreciation of the foreign currency in the denominator of the spot rate) will increase the dollar value of the euro receivable and – at same time – increase the dollar value of the peso payable. Conversely, if the dollar apprec then the peso and euro depreciations will reduce the dollar value of the euro receivable at same time that it reduces the dollar value of the peso payable. With no change in the S €/M exchange rate, the dollar value of Silver Saddle’s net exposure to currency risk is ($60,00 $30,000) = $30,000. Of course, the peso payable will not be a perfect hedge of one-half o euro receivable because there is a chance that the euro-per-peso spot rate S €/MXN will chan (For those of you that studied the chapter on currency futures, note that Silver Saddle’s offsetting euro and peso exposures are similar to a currency futures cross-hedge where the exposure of the Mexican peso payable partially offsets the exposure of the euro receivable 12.5
a.
Capitalizing the long Canadian dollar (short U.S. dollar) position results in:
Assets Liabilities and Owners’ Equity Current assets Current liabilities Accounts receivable $60,000 Accounts payable (€60,000 at $1.00/€) (MXN300,000 at MXN0.10/$) You're Reading a Preview Forward asset $22,000 Forward liability Unlock full access with a free trial. (long C$20,000 at $1.10/C$) (short $22,000) Fixed assets Long-term liabilities & owners’ equity Furnishings (beds & blankets) $30,000 Long-term debt $17 Download With Free Trial Property and buildings $910,000 Owners’ equity $80 Total assets $1,022,000 Total liabilities & owners’ equity $1,02
b. Before After
Current ratio Debt-to-assets $60,000/$30,000 = 2.000 $200,000/$1,000,000 = 0.200 $82,000/$52,000 = 1.577 $222,000/$1,022,000 = 0.217
Master your semester with Scribd Read Free For 30this Days SignIndeed, up to vote on title is more risk c. The debt-to-assets and current ratios have deteriorated. Silver Saddle after this speculative transaction than before because now has new exposure to the & The New York Times Useful useful she aNot Cancel anytime. Canadian dollar. There is no underlying exposure that is hedged by this speculative transaction, so the transaction cannot be qualified as a hedge under FASB #133.
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Kirt C. Butler, Solutions for Multinational Finance, 4th edition
PART IV Valuation and the Structure of Multinational Operations Chapter 13 Foreign Market Entry and Country Risk Management Answers to Conceptual Questions 13.1
Describe five modes of entry into international markets. Which of these modes requires t resource commitment on the part of the MNC? Which has the greatest risks? Which offers the gr growth potential?
Entry modes into foreign markets include export-based entry, import-based entry, contract-b entry, investment-based entry, and entry through a strategic alliance. Investment entry require most resource commitment and exporting the least. The other side of the coin is that expected re are often higher with investment-based entry than with exporting (so long as the project is pos NPV and the MNC can pull it off). The advantages and disadvantages of contract-based entry de on the particular contract. A strategic alliance refers to any collaborative agreement that is design achieve some strategic goal. Strategic alliances often combine elements of other market entry 13.2
What are the relative advantages and disadvantages of foreign direct investment, interna acquisitions/mergers, and international joint ventures?
The resource commitments of FDI and foreign acquisition are generally higher than joint venture a. FDI allows the MNC relatively permanent access to foreign product and factor markets. Th of a new investment in an unfamiliar business culture can be high. b. Acquisitions of stock or of assets may be difficult or impossible in countries with inves restrictions or ownership structures (such as the German banking system or the Japanese ke industrial structure) that impede foreign acquisitions. Acquisition premiums can als You're Reading a Preview prohibitive. c. Joint ventures can allow the Unlock MNC full to gain to foreign markets and to new produ accessquick with aaccess free trial. technologies. It can also come with risks, such as the risk of losing control of the M intellectual property rights to the joint venture partner. 13.3
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Define country risk? Define political risk? Define financial risk? Give an example of different type of country risk.
Country risk refers to the political and financial risks of conducting business in a particular fo country. Political risk is the risk that a host government will unexpectedly change the rules o game under which businesses operate, such as through an election outcome. Financial risk refe unexpected events in a country’s financial, economic, or business lifeon that impact Read Free For 30this Days Sign up to vote title financial p such as an oil price shock in an oil-producing country. Useful Not useful
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Special offer for13.4 students: Onlyfactors $4.99/month. What might contribute to political and to financial risk in a country according to the
country risk rating system?
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Kirt C. Butler, Solutions for Multinational Finance, 4th edition 13.6
How is expropriation included in a discounted cash flow analysis of a proposed f investment? Does expropriation impact expected future cash flows? From a discounted cash perspective, is it likely to impact the discount rate on foreign investment?
Expropriation occurs when a government seizes foreign assets. This risk clearly affects exp cash flows. It can affect the discount rate when investors cannot diversify their invest portfolios against this risk; that is, when it is a systematic risk. 13.7
What is protectionism and how can it impact the multinational corporation?
Protectionism refers to protection of local industries through tariffs, quotas, and regulatio ways that discriminate against foreign businesses. 13.8
What are blocked funds? How might they arise?
Blocked funds are cash flows generated by a foreign project that cannot be immediately repat to the parent firm. They most commonly arise from capital flow restrictions imposed by the government. 13.9
What are intellectual property rights? How are they at risk when the multinational corporati foreign operations?
Intellectual property rights include patents, copyrights, and proprietary technologies and proce Host governments sometimes protect local businesses at the expense of foreign firms. multinational corporation must work to minimize the exposure of its intellectual property righ theft or expropriation by foreign firms or governments. 13.10 What is an investment agreement? What conditions might it include?
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An investment agreement specifies the rights and responsibilities of a host government a corporation in the structure and operation ofwith an ainvestment project in the host country. Unlock full access free trial. agreement should specify the investment and financial environments including taxes, concess obligations, and restrictions on the multinational corporation’s operations. It also should spec Download With Free Trial jurisdiction for the arbitration of disputes. 13.11 What constitutes an insurable risk? List several insurable political risks.
Insurable risks have four elements: (a) The loss is identifiable in time, place, cause, and amoun A large number of individuals or businesses are exposed to the risk, ideally in an independ and identically distributed manner. (c) The expected loss over the life of the contract is estim so that reasonable premiums can be set by the insurer. Read (d) The ison outside the influence o Free For 30this Days Sign up toloss vote title insured. Useful Not useful
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Special offer for13.12 students: Onlyoperational $4.99/month. What strategies does the multinational corporation have to protect itself ag
political risk?
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Kirt C. Butler, Solutions for Multinational Finance, 4th edition
Problem Solutions 13.1
There is not always a clear distinction between political and financial risks. Indeed, financi often result from political decisions. In Russia’s case, the financial risks of investment in Ru have been acerbated by the inability of the Russian government to establish and enforce law regulations for the orderly conduct of business. Organized crime and corruption have contrib to poor political, economic, financial country risk ratings in Russia. Governments ma convenient scapegoats, and this hedge fund manager clearly holds the Russian govern responsible for his losses.
13.2
Although the most obvious form of expropriation occurs when a host government confis company’s assets, in fact each type of political risk can be thought of as a form of expropri Host governments can appropriate foreign assets for themselves or for local companies thr actions that differentially impair nonlocal firms, including protectionism, blocked funds, or th misappropriation of intellectual property rights.
13.3
a. Total risk is conventionally measured by standard deviation of return. The foreign asset standard deviation of σi’ = 0.3 has greater total risk than the domestic asset with a stan deviation of σi = 0.2. b. The foreign asset also has greater systematic risk: βi’ = ρiW’ (σi’/σW) = (0.3)(0.3/0.1) = 0.9 > ρiW (σi /σW) = (0.4)(0.2/0.1) = 0.8.
13.4
Although the answer to this question will be specific to the chosen country, country risks tha up usually include factors from the ICRG political risk categories. These factors include politica (leadership, government corruption, internal or external political tensions), economic risk (infl current account balance, or foreign trade collection experience), and financial risk (currency con You're Reading a Preview expropriations, contract renegotiations, payment delays, loan restructurings or cancellations course, other political risk information use these Unlockproviders full access with a free same trial. types of factors.
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Chapter 14 Cross-Border Capital Budgeting Answers to Conceptual Questions 14.1
Describe the two recipes for discounting foreign currency cash flows. Under what conditions are recipes equivalent?
Recipe #1: Discount foreign currency cash flows at a foreign currency discount rate. Recipe #2: Discount domestic currency cash flows at a domestic currency discount rate. These two recipes are equivalent if the international parity conditions hold and there are no m frictions such as repatriation restrictions. These recipes can give different values if PPP does not or if there are repatriation restrictions. 14.2
Discuss each cell in Figure 14.5. What should (or shouldn’t) a firm do when faced with a fo project that fits the description in each cell?
Top left: Both NPVs are negative, so reject the foreign project. Top right: V0d|id>0 but V0d|if <0; Reject the project. There must be better alternatives than the pro project for speculating on foreign exchange. Bottom left: V0d|id<0 but V0d|if >0; Anticipated changes in exchange rates are likely to hurt the Financing the project in local currency, hedge forward (with forwards or futures), or swap into currency debt. Bottom right: There are two possibilities. If V 0d|id > V0d|if > 0, then changes in exchange rat expected to help the parent. The home office may choose to leave the foreign currency cash unhedged, although this captures the higher expected value but also exposes the firm to currency If 0 < V0d|id < V0d|if , then the parent can capture a higher expected value and lower currency ri hedging its expected future foreign currency cash flows and locking in the relatively high l You're Reading a Preview currency value of the project. 14.3
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Why is it important to separately identify the value of any side effects that accompany fo investment projects?
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Separately identifying the value of a project from the value of any side effects (such as blocked f subsidized financing, or tax holidays) allows the firm to negotiate with host governments and parties on a more informed basis.
Master your semester with Scribd Free For 30this Days Cross-border capital budgeting when the international parityRead conditions hold. Sign up to vote on title & The New York Times Useful Not useful 14.1 a. Note that relative purchasing power parity holds for this class of risky investments. Problem Solutions
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ILS Special offer for students: Only (1+i$4.99/month. )/(1+iCNY) = (1.15)/( 1.11745) ≈ (1+pILS)/(1+pCNY) = (1.06)/(1.03) ≈ 1.0291.
Discounting yuan cash flows at the yuan discount rate yields
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Kirt C. Butler, Solutions for Multinational Finance, 4th edition E[CF2ILS] = (CNY500m)(ILS 0.5853/CNY) = ILS 292.63m E[CF3ILS] = (CNY300m)(ILS 0.6023/CNY) = ILS 180.69m The project should be accepted because V0$|i$ 14.2
a.
= –$331.56m+$113.74m/(1.15)+$292.63m/(1.15)2+$180.69m/(1.15)3 = $107.42 million > $0
Expected future cash flows in euros are as follows: Investment cash flows Land tax on capital gain Plant tax on capital gain NWC tax on capital gain Operating cash flows Rev (Price=100, Q=5,000) Variable cost (20%) FC (20,000 at t=0) Depreciation Earnings before tax Tax (at 40%) Net income Net cash flow (Euros)
0 –100000
1
–50000 –50000 0
2 121000 grows at 10% inflation rate –8400 25000 market value at t=2 –10000 60500 grows at 10% inflation –4200
1 550000 –110000 –22000 –25000 393000 –157200
2 605000 grows at 10% inflation rate –121000 –24200 grows at 10% inflation rate –25000 434800 –173920 235800 260880 260800 285880 CF = NI + Depreciation
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Sum of investment/disinvestment and operating cash flows Unlock full access with a free trial. Total net CFs –200000 260800 469780 € € V0 at i = 20% +€343,569.4
b. If the international parity conditions hold,With then Free 20% interest Download Trial rates in both the foreign and dom currencies imply that forward (and expected future spot) exchange rates will equal the cu spot rate of $10/€. So, Sum of investment/disinvestment and operating cash flows Expected dollar CFs –2000000 2608000 4697800 $ € $ V0 |i at i = 20% $3,435,694
Master your semester with Scribd 14.3 a. i = (1+p )(1+ė ) – 1 = (1.50)(1.10)–1 = 65% & The New York Times i = (1+p )(1+ė ) – 1 = (1.00)(1.10)–1 = 10% W
L
W
L
W
L
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Useful
W/L Special offer for students: b.Only E[S ] = (S0W/L) [(1+pW) / (1+pL)]t = (W100/L) [(1.50) / (1.00)] = W150/L 1$4.99/month.
E[S2W/L] = (S0W/L) [(1+pW) / (1+pL)]t = (W100/L) [(1.50) / (1.00)]2 = W225/L
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Kirt C. Butler, Solutions for Multinational Finance, 4th edition Net income Net operating CFW
167,500 267,500
276,250 376,250 CF = NI + Depreciation
Sum of investment/disinvestment and operating cash flows Net CFtW –400,000 267,500 701,250 W W V0 at i = 65% W19,697 V0L|iW = V0W / S0W/L = L197 d. E[CFtL] = E[CFtW] / E[StW/L]
⇒
E[CF0L] = (–W400,000) / (W100/L) = –L4,000 E[CF1L] = (W267,500) / (W150/L) = L1,783 E[CF2L] = (W701,250) / (W225/L) = L3,117 ⇒ V0L|iL = –L4,000 + (L1,783) / (1.10) + (L3,117) / (1.1)2 = L197 This is the same as in part c because the international parity conditions hold.
14.4
a. t=1
Bt3.4m
Bt3.4m
Bt3.4m
Bt6,913,840
−Bt4m
t=2
t=3
t=4
t=5
⏐ ⎯⎯⎯⎯⎯⏐ ⎯⎯⎯⎯⎯⏐ ⎯⎯⎯⎯⎯⏐ ⎯⎯⎯⎯⎯⏐ iBt = 20%
Initial outlay = Bt4m at time t = 1 After-tax cash flows over t=2,…,5 =(Bt100m–Bt90m–Bt5m)(1–0.40)+(Bt1m*(0.4))=Bt3,400,000 Terminal CF= (Bt4m*(1.10)4) – {[(Bt4m*(1.10)4) – 0]*(0.4)} = Bt3,513,840 V0Bt = Bt5,413,548 You're Reading a Preview Bt b. (1+i ) = (1+ėBt)(1+pBt) ⇒ ėBt = (1.20/1.10)–1=0.0909091 ⇒ ėBt = 9.09091% = ė¥ = (1.0909091)(1.05) – 1trial. = 0.1454545, or 14.54545% ⇒ i¥ = (1+ė¥)(1+p¥) – 1Unlock full access with a free ¥ Bt ¥ Bt Alternatively, i = (1+i )(1+p )/(1+p )–1 = 1.20(1.05/1.10)–1 ⇒ i¥ = 14.54545% c. E(S1Bt/¥) = (Bt0.25/¥)(1.20/1.1454545) = Bt.2619048/¥ Download 2With Free Trial E(S2Bt/¥) = (Bt0.25/¥)(1.20/1.1454545) = Bt.2743764/¥ Bt/¥ 3 E(S3 ) = (Bt0.25/¥)(1.20/1.1454545) = Bt.2874420/¥ E(S4Bt/¥) = (Bt0.25/¥)(1.20/1.1454545)4 = Bt.3011297/¥ E(S5Bt/¥) = (Bt0.25/¥)(1.20/1.1454545)5 = Bt.3154692/¥ d. Recipe #1: V0¥|iBt = (V0Bt)/(S0Bt/¥) = (Bt5,413,548)/(Bt0.25/¥) = ¥21,654,192 Recipe #2:
Master your semester with Scribd t=1 ¥12,391,736 ¥11,828,475 & The New York Times ⏐ ⎯⎯⎯⎯⎯⏐ Special offer for students: Only $4.99/month. t=2 −¥15,272,727
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¥11,290,817 Useful ¥21,916,055 Not useful
Cancel anytime. ⎯⎯⎯⎯⎯⏐ ⎯⎯⎯⎯⎯⏐ ⎯⎯⎯⎯⎯⏐
t=3
t=4
t=5
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Kirt C. Butler, Solutions for Multinational Finance, 4th edition
While the project has a positive NPV regardless of the perspective, the project has more from the parent’s perspective than from the project perspective. This is because the exp future value of the shekel (yuan) is less (more) than under the equilibrium conditions parent company may choose to leave its cash flows from the project unhedged in the hop benefiting from the expected future spot exchange rates. This does expose the pare currency risk. b. Discount in yuan: V0CNY = [Σt E[CFtCNY] / (1+iCNY)t ] = [– CNY600m + CNY200m/(1.1175) + CNY500m/(1.1175)2+CNY300m/(1.1175)3] = CNY194.39 ⇒ V0ILS|iILS = (S0ILS/CNY) (V0CNY) = (ILS 0.5526/CNY)(CNY194.39m) = ILS 107.42 million Discount in ILS: V0ILS|iILS = Σt {E[StILS/CNY]E[CFtCNY] / (1+iILS)t } = [(– CNY600m)(ILS 0.5526/CNY) + (CNY200m)(ILS 0.5575/CNY)/(1.15) + (CNY500m)(ILS 0.5625/CNY)/(1.15)2 + (CNY300m)(ILS 0.5676/CNY)/(1.15)3 ] = ILS 90.04m < ILS 107.42 million
Although the project has a positive NPV from each perspective, the project has more value i local currency than it does in shekels. The parent should hedge the yuan cash flows either di in the forward market, by borrowing a part of the project in yuan, or by swapping shekel de yuan debt to hedge its expected future yuan cash flows from the project.
Cross-border capital budgeting in the presence of investment or financial side effects. 14.6
The funds are invested with the China Construction Bank, so the appropriate opportunity co capital is the (risky) bank rate of 6.09 percent. It is easiest to focus on the funds that are blocked exclude other cash flows (in particular, the initial investment) from the analysis. Following the t You're Reading a Preview step procedure from the text: a) The present value of blocked funds assuming they are not blocked is CNY200m(1.060 Unlock full access with a free trial. CNY 500m(1.0609) –2 + CNY300m(1.0609) –3 = CNY884.01 million. b) Cash flows will not be received until one year later, so the present value of blocked fun –3 Trial With Free really only CNY200m(1.0609) –2Download + CNY500m(1.0609) + CNY300m(1.0609) –4 = CNY833.26 millio c) The opportunity cost of the blocked funds is the difference between project value with without the blocked funds: V SIDE EFFECT = VPROJECT WITH SIDE EFFECT – VPROJECT WITHOUT SIDE EF CNY 833.26m – CNY884.01m = – CNY50.75 million.
Alternatively, incremental cash flows can be valued directly. Yuan flows in years 1-4 in the ori case are (200,500,300,0). In the alternative with blocked funds, yuan cash flows inyears 1Read Free For 30 Days Signblockage up to vote this title (0,200,500,300). The change in cash flow created by the ofon funds is then (0–200, Notincremental useful 500,500–300,300–0) = (–200,–300,+200,+300). The present value of these cash flo Useful Cancel anytime. theOnly 6.09$4.99/month. percent Chinese yuan cost of debt is equal to (– CNY200m)(1.0609) –1 + (– CNY300m)(1.060 Special offer for students: (+CNY200m)(1.0609) –3 + (+CNY300m)(1.0609) –4 = – CNY50.75 million.
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0.1
Multinational Business Finance
P[expropriation in year 1]
= 0.100
P[expropriation in year 2] = (0.9)(0.1)
= 0.090
0.1
P[expropriation in year 3] = (0.9) 2(0.1)
= 0.081
0.9
P[no expropriation] = (0.9) 3
= 0.729
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0.1 0.9 0.9
The sum of the probabilities of the possible states of nature is 0.100 + 0.090 + 0.081 + 0.7 1.000. The probability of receiving the cash flow in year t is (0.9) t. The expected cash flow presence of expropriation risk is this probability times the expected cash flow from Problem The NPV in yuan is then V 0CNY = – CNY600m + CNY200m(0.9)1/(1.11745) + CNY500m(0.9)2/(1.11 + CNY300m(0.9)3/(1.11745)3 = CNY42.15 million, or V0ILS|iCNY = ( CNY42.15)(ILS 0.5526/CNY) 23.29 million at the spot exchange rate. The value of the expropriation side effect is thus V effect) = V(Project with side effect) – V(Project without side effect) = ( CNY42.15– CNY194.40 CNY 152.24, or (ILS 23.29m – ILS 107.42m) = –ILS 84.13million.
Alternatively, the side effect can be valued explicitly as follows. There is a 0.1 chance of l the first and all later cash flows, an additional (0.1)(0.9) = 0.09 risk of losing the 2nd year flow given the 1st year cash flow was received, and an additional (0.1)(0.9) 2 = 0.081 risk of l the 3rd year cash flow given the 2nd year cash flow was received. Hence, the probability o You're Reading a Preview receiving CFt is (1–(0.9) t): CNY 1 P[losing CF1 ] = 1–(.9) = 0.100 Unlock full access with a free trial. P[losing CF1CNY] = 1–(.9)2 = 0.100 + 0.090 = 0.190 P[losing CF1CNY] = 1–(.9)3 = 0.100 + 0.090 + 0.081 = 0.271 The expected loss in present value due to With expropriation risk is then (0.10) CNY200m/(1.117 Download Free Trial (0.19)CNY500m/(1.11745)2 +(0.271)CNY300m/(1.11745)3 = CNY152.24 million, or ( CNY152.24 0.5526/CNY) = ILS 84.13 million.
14.10 Step 1: Calculate the value of blocked funds assuming they are not blocked. If blocked funds had been invested at the risky croc rate of 40% per year, they would have g in value to Cr8,000(1.40) 3 + Cr13,819.5(1.40)2 + Cr19,573.5(1.40) ≈ Cr76,441. Discounted Read Free Foron 30this Days Signvalue. up to vote title 40% rate, this would have been worth Cr19,898 in present This is equivalent to discou Usefulrisky Notdiscount useful rate, so thi blocked funds back to the beginning of the project at the 40% croc Cancel anytime. zero-NPV investment at the 40% croc interest rate. Special offer for students: Only $4.99/month.
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Step 2: Calculate the opportunity cost of blocked funds.
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Chapter 15 Multinational Capital Structure and Cost of Capital Answers to Conceptual Questions 15.1
Does corporate financial policy matter in a perfect financial market?
In a perfect financial market, investors can replicate any action that the firm can undertake. H corporate financial policy is irrelevant in a perfect financial market. 15.2
What distinguishes an integrated from a segmented capital market?
In an integrated market, real after-tax required returns on equivalent assets are the same everyw the assets are traded. If real after-tax rates of return are different in a particular market, then market is at least partially segmented from other markets. 15.3
What factors could lead to capital market segmentation?
Violations of any of the perfect market conditions can lead to capital market segmentation. T factors include prohibitive transactions costs, differing legal and political systems, regul interference (e.g., barriers to financial flows or to financial innovation), differential taxes o regimes, informational barriers such as disclosure requirements, home asset bias, and differ investor expectations. 15.4
Does the required return on a project depend on who is investing the money or on where the mo being invested?
The required return on an investment project should be an asset-specific discount rate that reflec opportunity cost of capital on the project. That is, it depends on where the money is going an from where it came. You're Reading a Preview 15.5
Does the value of a foreign project depend on the way it is financed? Unlock full access with a free trial.
Yes. Additional debt brings additional tax shields from the tax deductibility of interest paymen well as additional costs of financial distress. The adjusted present value approach to project valu Download Free Trial attempts to separate the value of the unleveredWith project from the value of these financial side-effec 15.6
An important input into the required return on equity in the security market line is the marke premium. How much is the market risk premium?
This is difficult to say, as there is no easy way to identify the exact number. Indeed, the marke premium is likely to change over time. A recent survey of academic financial economists b Free For 30this Days Sign up to vote on title2001, availab Welch (“The Equity Premium Consensus Forecast Read Revisited,” September www.ssrn.com) produced an estimate of 5 to 5.5 percent. Useful Not useful
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Special offer for15.7 students: Onlyis$4.99/month. When the adjusted present value approach to project valuation most useful?
When the financial side-effects are easy to separate from the project. This includes many o
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Kirt C. Butler, Solutions for Multinational Finance, 4th edition
Liberalizations are decisions by governments to allow foreigners to purchase local assets. Be and Harvey (“Foreign Speculators and Emerging Equity Markets,” Journal of Finance 2000) found that liberalizations tend to (a) increase the correlation of emerging and world m returns, (b) have little impact on return volatility, and (c) decrease local firms’ cost of capital to one percent. 15.10 What is a targeted registered offering and why is it useful to the corporation?
Targeted registered offerings are securities sold to foreign financial institutions that then ma market in the corporation’s securities in the foreign market. They are useful for gaining acce foreign investors and their capital. 15.11 What is project financing, and when is it an appropriate source of funds?
Project financing is a way of unbundling a project from the firm’s other assets and liabilitie separate legal entity is created that is heavily financed with debt. Project financing is appropria real assets that generate a steady stream of cash flows that can be used to service the debt. 15.12 What evidence is there on the international determinants of corporate capital structure? How international evidence similar to the domestic U.S. evidence?
Rajan and Zingales (1995) find that leverage is positively related to the tangibility of firm asset the proportion of fixed assets) and firm size. Leverage is negatively related to profitability an presence of growth options (i.e. the asset market-to-book ratio). Several national markets includin domestic U.S. market share these characteristics.
Problem Solutions
You're Reading a Preview 15.1 a. r = r F + β (E[r W] – r F) = 5% + (1.2)(12%–5%) = 13.4% Unlock full access with a free trial. b. r = r F + β (E[r M] – r F) = 5% + (1.4)(11%–5%) = 13.4% 15.2
a. r = r F + β (E[r W] – r F) = 5% + (0.8)(10%–5%) = 9% Download With Free Trial b. r = r F + β (E[r M] – r F) = 5% + (1.2)(10%–5%) = 11%
The required return on Oilily’s equity within the French market is r F+β(E[r M]–r F) = (1.4)(11%–5%) = 13.4%. Oilily’s weighted average cost of capital is i WACC = (B/V TC)+(S/VL)iS = (0.4)(7%)(1–0.33)+(0.6)(13.4%) = 9.916%. b. Required return on Oilily’s stock is r = 5%+(1.2)(12%–5%) = 13.4% for an interna )i (1– investor. Using international sources, Oilily’s cost of up capital ison i WACC = (B/V L B Read Free For 30 Days Sign to vote this title (S/VL)iS = (½)(6%)(1–0.33) + (½)(13.4%) = 8.710%. Not useful Useful Cancel anytime. c. The operating cash flow is before interest expense. In France, Oilily’s value is V 0 = CF Special offer for students: Only $4.99/month. = (€10million)/(0.09916–0.04) = €169,033,130. If the global market, Oilily’s value is CF /(i–g) = €10,000,000/(0.08710–0.04) = €212,314,225. Oilily can increase its value by 15.3
a.
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Kirt C. Butler, Solutions for Multinational Finance, 4th edition V0 = CF1 / (i–g) = £1,000,000,000/(0.13755–0.03) = £9,298,000,000. If Grand Pet can raise funds in the global market, Grand Pet’s value is V0 = CF1 / (i–g) = £1,000,000,000/(0.07117–0.03) = £24,291,000,000. Grand Pet can increase its value by over 150% by raising funds internationally. 15.5
a.
All-equity value is APV = VU –CF0 = (CF1 )/(1+iU)–Initial investment = (BFr112 million/1.10)–BFr100 million = BFr1,818,182. b. Borrowing €50 million at 6% results in an interest payment of iBB = €3 million. The pr value of the tax shield is (T CiBB)/1+iB) = (€990,000/1.06) ≈ €933,962. The APV o investment is then €1,818,182 + €933,962 = €2,752,144. c. All-equity value is APV = VU –CF0 = €12 million/0.10–€100 million = €20,000,000. The of the perpetual tax shield is T CB = (0.33)(€50 million) = €16,500,000. The levered firm w €36,500,000.
15.6
a.
All-equity value is APV = VU –CF0 = (CF1 )/(1+iU)–Initial investment = (£108 million/1.08)–£100 million = £0. b. APV = VU + PV(financing side effects)–Initial investment. Borrowing £25 million at 6% results in interest of i BB = £1.5 million. The annual tax shi TCiBB = £500,000. The PV of the tax shield is (T CiBB)/(1+iB) ≈ £467,000. Since the unle investment has zero value, £467,000 is the APV of the one-year investment after includin interest tax shield from the debt. c. As a perpetuity, the all-equity value is still £0. The levered value is: APV = VU + (TCiBB)/iB –CF0 = VU + TCB–CF0 = £100,000,000 + £8,250,000 – £100,000,000 = £8,250,000. You're Reading a Preview The value continues to arise solely from the interest tax shield.
15.7
a.
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The required return should depend on the use and not on the source of funds. Firms shoul an asset-specific discount rate that reflects the opportunity cost of capital. The governmen Download With Trial borrowing cost has little relevance toward howFree these funds are used. Riskier projects shou have higher required returns. b. In the CAPM, the security market line (SML) identifies the required return as a function systematic risk of an asset. Consider the two investments L (low risk) and H (high risk) be Each has an expected return of 10 percent, although their required returns from the securi market line are 7.50 percent at β = 0.5 and 12.5 percent at β = 1.5, respectively.
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Kirt C. Butler, Solutions for Multinational Finance, 4th edition
projects (such as project H) will be value-destroying. c. At the government’s 5 percent hurdle rate, this investment has an “apparent” NPV of (0.1m)/0.05 – 1.5m = 0.5 million yuan. However, this fails to account for the investment risk. At the market required return of 10 percent (with β = 1), this asset’s value is (0.1m) = 1 million yuan at a cost of 1.5 million yuan, for a risk-adjusted loss in value of NPV = 500,000 yuan. d. Without close monitoring of the returns on investment, the manager has an incentive to accept the government’s funds on this negative-NPV project because it increases the mar value of her division by 1 million yuan. With a larger empire, the manager might be able justify a higher salary. 15.8
a. E[r Br ] = r F + βBr (E[r W]–r F) = 3% + 1.2(5%) = 9% b. E[r Br ] = r F + βBr (E[r W]–r F) + δBr (E[r Region]–E[r W]) = 3% + 1.2(5%) + 1.5(4%) = 15% c. E[r Br ] = E[r W] + CR Br = {r F+(E[r W]–r F)} + CRABr = (3%+5%) + 4% = 12% d. E[r Br ] = E[r W] + SBr = {r F+(E[r W]–r F)} + SBr = (3%+5%) + 2% = 10% e. E[r Br ] = r F + ½[1+(σBr /σUK )](E[r W]–r F) = 3% + ½[1+(51.93/15.68)](5%) ≈ 13.8%
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Chapter 16 Taxes and Multinational Corporate Strategy Answers to Conceptual Questions 16.1
What is tax neutrality? Why is it important to the multinational corporation? Is tax neutrali achievable objective?
A neutral tax is one that does not interfere with the natural flow of capital toward its most produ use. Domestic tax neutrality is intended to ensure that incomes arising from operations (wh foreign or domestic) are taxed similarly by the domestic government. Foreign tax neutral intended to ensure that taxes imposed on the foreign operations of domestic companies are simi those facing local competitors in the host countries. 16.2
What is the difference between an implicit and an explicit tax? In what way do before-tax req returns react to changes in explicit taxes?
Explicit taxes are taxes that are explicitly assessed on income of various forms. Examples in corporate and personal income taxes, dividend taxes, interest taxes, sales and property taxes, a forth. Implicit taxes come in the form of higher pre-tax required returns in higher tax jurisdiction increase in an explicit tax tends to be associated with an implicit tax in the form of an increase in tax required return. 16.3
How are foreign branches and foreign subsidiaries taxed in the United States?
Income from foreign branches is taxed as it is earned. Income from a controlled foreign corporat subsidiary that is incorporated in a foreign country and more than 50% owned by a U.S. pare taxed only when funds are repatriated to the U.S. parent. Income from foreign corporations th between 10% and 50% owned byYou're a U.S. Reading parent is called Subpart F income and is taxed as it is ea a Preview on a pro rata basis according to sales or gross profit. 16.4
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How has the U.S. Internal Revenue Code limited the ability of the multinational corporati reduce taxes through multinational tax planning and management?
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There are two principal limitations on multinational tax planning: the overall foreign tax credit ( limitation and the use of income baskets for active and passive income. The overall FTC limitat equal to total foreign-source income times the U.S. tax rate. Excess foreign tax credits may be ca two years back or five years forward. Income baskets limit the usefulness of excess FTCs, be FTCs from one income basket may not be used to reduce taxes in another income basket.
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explicit tax rates generally result in low pre-tax rates of return because investors’ demand for
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Here are parts a, b, and c:
Part a. Part b. Part Hungary Germany Hungary Germany Hungary a Dividend payout ratio 100% 100% 100% 100% 100% b Foreign dividend withholding tax rate 5% 5% 5% 5% 5% c Foreign tax rate 16% 38% 16% 38% 16% d e f g h i
Foreign income before tax Foreign income tax (d*c) After-tax foreign earnings (d–e) Declared as dividends (f*a) Foreign dividend withholding tax (g*b) Total foreign tax (e+h) j Dividend to U.S. parent (d–i)
10000 10000 20000 1600 3800 3200 8400 6200 16800 8400 6200 16800 420 310 840 2020 4110 4040 7980 5890 15960
0 0 0 0 0 0
k l m n
Gross foreign income before tax (line d) Tentative U.S. income tax (k*35%) Foreign tax credit (i) Net U.S. taxes payable [max(l–m,0)]
10000 3500 2020 1480
0 0 0 0
10000 3500 4110 0
20000 7000 4040 2960
o Total taxes paid (i+n) 3500 4110 p Net amount to U.S. parent (k–o) 6500 5890 q Total taxes as separate subsidiaries (sum(o)) $7,610
0 0 0 0 0 0 0
7000 0 13000 $7,000
0 0 0 0 0 0
Parent’s consolidated tax statement r s t u d.
Overall FTC limitation (sum(k)*35%) $7,000 Total FTCs on a consolidated basis (sum(i)) $6,130 Additional U.S. taxes due [max(0, r–s)] $870 Excess tax credits [max(0,s–r)] $0 You're Reading a Preview (carried back 1 year or forward 10 years)
$7,000 $4,040 $2,960 $0
Unlock access withreturns a free trial. In equilibrium, implicit taxes will forcefull lower pretax in Hungary. Implicit taxes often result i sales (perhaps from higher competition), higher wages, and higher asset values in low-tax countries, relative to what these countries would experience with higher tax rates.
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16.3
a.
Low transfer price ($1/btl) High transfer price ($10/btl) H.K. U.S. Consolidated H.K. U.S. Consolidated Revenue 100,000 1,000,000 1,000,000 1,000,000 1,000,000 1,000,000 COGS 100,000 100,000 100,000 100,000 1,000,000 100,000 Taxable income 0 900,000 900,000 900,000 0 900,000 Taxes 0 315,000 315,000 Read 45,000 45,000 Free Foron 30this Days Sign up to vote title0 Net income 0 585,000 585,000 0 Useful 855,000 Not useful
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35.0%
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5.0%
b. If produced in the U.S., Quack’s U.S. tax liability would be: (Revenue–Expenses)(tax rate)
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Chapter 17 Real Options and Cross-Border Investment Answers to Conceptual Questions 17.1
What is a real option? A real option is an option on a real asset.
17.2
In what ways can managers’ actions seem inconsistent with the “accept all positive-NPV pro rule? Are these actions truly inconsistent with the NPV decision rule?
The text discusses three apparent violations of the NPV rule: 1) use of inflated hurdle rates, 2) f to abandon investments that are losing money, and 3) entry into new or emerging market technologies. Each of these apparent violations arises when the NPV decision rule is applied nai without considering all of the opportunity costs of investing and without considering mana flexibility in the face of high uncertainty and changing market conditions. The inconsistencies from a failure to take into account all of the opportunity costs of investing. Once all opportunity are included, managers’ actions are less likely to be inconsistent with the NPV rule. 17.3
Are managers who do not appear to follow the NPV decision rule irrational?
Managers must consider how they might respond to future events. Managers are not acting irratio if, through attempting to value their flexibility in responding to an uncertain world, their ac appear to be inconsistent with the NPV decision rule. They are irrational (or at least near-sight they apply the NPV decision rule in an inflexible way that does not take into account all o opportunity costs of investing. 17.4
Why is the timing option important in investment decisions?
You're Reading a Preview
Investments must compete not only with other projects but with versions of themselves initia each future date. Unlock full access with a free trial. 17.5
What is exogenous uncertainty? What is endogenous uncertainty? What difference does the fo uncertainty make to the timing ofDownload investment?With Free Trial
Exogenous uncertainty is outside the control of the firm. Endogenous uncertainty exists when th of investing reveals information about price or cost. Exogenous uncertainty creates an incenti delay investment whereas endogenous uncertainty creates an incentive to speed up investment.
17.6 In what ways are the investment and abandonment options similar? Master your semester with Scribd Free Foron 30this Days Sign up toEach vote title The abandonment option is the flip side of the investmentRead option. entails an upfront invest changes the stream of future cash flows. & The New that York Times Useful Not useful Cancel anytime.
Special offer for17.7 students: Only What is $4.99/month. a switching option? What is hysteresis? Is hysteresis a switching option?
A switching option is a sequence of alternating puts and calls. For example, hysteresis occurs w
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Kirt C. Butler, Solutions for Multinational Finance, 4th edition 17.10 What are the shortcomings of option pricing methods for valuing real assets?
Difficulties include: a) identifying the underlying asset or assets; b) specifying the return-gener process of the underlying asset(s); and c) the fact that the values of real options are not di observable in the marketplace.
Problem Solutions 17.1
a.
A decision tree represents possible paths to future states of the world as branches on a tre Grolsch’s invest in Dubiety, the decision tree looks like: Invest today
D
NPV0 = ? D
Invest at P beer = 75
D
⏐(P beer =
D
⏐(P beer =
NPV0
Invest in one year D
Invest at P beer = 25
NPV0
D
75) = ?
D
25) = ?
b. Equation (17.2) from the text must be modified to include fixed costs: INVEST TODAY: NPV = [(P–V)Q–F]/i – I0 NPV(invest today) = [((D50/btl– D10/btl)(1,000,000 btls) – D10,000,000)/0.10] – D200,000,000 = D100,000,000 ⇒ invest today? c.
Equation (17.3) from the text must be modified to include fixed costs: WAIT ONE YEAR: NPV = [[(P–V)Q–F]/i] / (1+i) – I 0
You're Reading a Preview
NPV⏐P beer = 75 D with a free trial. Unlock full access = [(((D75/btl– D10/btl)(1,000,000 btls)– 10,000,000)/0.10)/(1.10)]– D200,000,000 = D300,000,000 ⇒ invest D
Download With Free Trial NPV⏐P beer =D25 D D = [((( 25/btl– 10/btl)(1,000,000 btls)– D10,000,000)/0.10) / (1.10)]– D200,000,000 = – D154,545,455 < $0 ⇒ don’t invest NPV(wait one year) = [Prob(P1=D75)](NPV⏐P1=D75)+[Prob(P1=D25)](NPV⏐P1=D25) = (½) (D300,000,000) + (½)(D0) Read Free Foron 30this Days Sign up to vote title = +D150,000,000 > NPV(invest today) > D0
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NPV(wait one year) D 150,000,000
+ = NPV(invest today) + D = 100,000,000 +
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Time Value Opportunity cost of investing today D 50,000,000
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Kirt C. Butler, Solutions for Multinational Finance, 4th edition NPV(abandon today) = –[((D25/btl– D20/btl)(1,000,000 btls)– D10,000,000)/0.10]–D10,000,000 = D40,000,000 > D0 ⇒ abandon today? c.
If Grolsch management waits one year before making its abandonment decision, beer price be either D15 or D35 with certainty. NPV⏐P1=D35 = –[(((D35/btl– D20/btl)(1,000,000 btls)– D10,000,000) /0.10)/(1.10)]– D10,000,000 = – D55,454,545 ⇒ don’t abandon if price rises to D35 NPV⏐P1=D15 = –[(((D15/btl– D20/btl)(1,000,000 btls)– D10,000,000) /0.10)/(1.10)]– D10,000,000 = D126,363,636 ⇒ abandon if price falls to D15 NPV(wait 1 year)
17.3
= [Prob(P1=D35)](NPV⏐P1=D35)+[Prob(P1=D15)](NPV⏐P1=D15) = (½) (D126,363,636) + (½)($0) = D63,181,818 > NPV(abandon today) > D0
d.
Option Value NPV(wait one year) +D63,181,818
= Intrinsic Value + Time Value = NPV(abandon today) + Opportunity cost of abandoning today D = +D40,000,000 + 23,181,818
e.
Wait one year before making the abandonment decision.
We know from Problem 17.1 that investment in a single brewery today has value. The is whether to invest in all five breweries today or invest in a single exploratory brewery and make a decision on the four additional breweries in one year after receiving information abou You're Reading a Preview price of beer produced by the exploratory brewery. a.
Unlock full access with a free trial.
Decision tree:
Invest in all five breweries today
Download With Free Trial
D
D
Invest in 4 more if P beer = 75
D
NPV0 = 500 million D
D
D
D
NPV0
⏐(P beer =
75) = ?
Invest in one brewery D
Don’t invest if P beer = 25
NPV0
⏐(P beer =
25) = ?
Master your b. semester with Scribd as in Pro At the expected end-of-year price of 50/btl, the NPV of a single brewery is 100m Read Free Foron 30this Days Sign up to vote title 17.1. The PV of the perpetual stream of cash inflows is either [(( 75– 10)(1m)– 10m)/0 & The New York Times Useful Not useful 550m or [(( 25– 10)(1m)– 10m)/0.10] = 50m with equal probability, for an expected va D
D
D
D
D
D
D
D
D
Cancel anytime.
D
D Special offer for students: Only $4.99/month. 300m. Net of the required D200m investment, this has a net present value of D100m. Theref
NPV(invest in all 5 breweries today) = 5*NPV(invest in 1 today) = D500 million.
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Kirt C. Butler, Solutions for Multinational Finance, 4th edition + [Prob(P beer =$75)](NPV⏐P beer =$75) = (½) [((D25– D10)(1m)– D10m)/(.1)– D200m] + (½) [ (((D75– D10)(1m)– D10m)/(.1)– D200m) + (4)(D300m) ] = (½) [– D150m] + (½)[(D350m) + (4)(D300m)] = D700 million > D0 ⇒ Invest in an exploratory brewery d. Option Value NPV(wait one year) D
700,000,000
= Intrinsic Value + Time Value = NPV(invest today) + Opportunity cost of investing in four additional breweries today D D = 500,000,000 + 200,000,000
The NPV of investing in all 5 breweries today is – D200,000,000. By investing today, Gr would forego the flexibility provided by the timing option on this sequential investment.
17.4
e.
Invest in an exploratory brewery today and continue to invest if warranted by the quality hence market price) of the output.
a.
NPV(invest today) = [((R18,000/car–R15,000/car)(10,000cars))/0.20] – R100 million = R50 million ⇒ invest today? If you wait one year before deciding, then NPV will be either: NPV⏐C1=R12,000 = [((R18,000/car–R12,000/car)(10,000cars)/0.20]/1.20] – R100 million = R150 million ⇒ invest, or NPV⏐C1=R18,000 = [((R18,000/car–R18,000/car)(10,000cars)/0.20]/1.20] – R100 million = –R100 million ⇒ do not invest (so that NPV = R0). You're Reading a Preview NPV(wait one year) ⏐C1full = [Prob(C1=R12,000)](NPV =R12,000) Unlock access with a free trial. + [Prob(C1=R18,000)](NPV⏐C1=R18,000) = (½)(R150,000,000) + (½)(R0) Download With Free Trial = 75,000,000 > NPV(invest today) =R50,000 > R0 The time value of this real option reflects the opportunity cost of investing today: Time value = option value – intrinsic value = R75 million – R50 million = R25 million.
NPV(invest in 10 plants today) = 10*NPV(invest in one plant today) = R500 million Master your b. semester with Scribd Free For 30this Days NPV(invest in an exploratory plant and then invest inRead 9 additional plants if NPV>0) Sign up to vote on title =R12,000)](NPV⏐C =R12,000) & The New York= [Prob(C Times Useful Not useful 1
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= (½)[(R200 million)+(9)(R150 million)] + (½)(–R100 million)
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Kirt C. Butler, Solutions for Multinational Finance, 4th edition
b. If you invest in an exploratory mine and then reconsider based on the revealed informatio yield, then the NPV of the first mine is ¥0. The NPV of each additional mine can be calculat conditional on the yield of the first mine: NPV⏐(Q=200 oz) = [(¥5,000/oz–¥1,000/oz)(200 oz)] – ¥600,000 = ¥200,000 NPV⏐(Q=100 oz) = [(¥5,000/oz–¥1,000/oz)(100 oz)] – ¥600,000 = –¥200,000 so don’t invest at the lower guano yield. Then, NPV(sequential investment) = NPV (exploratory mine) + Prob(Q=200 oz)*(4)*NPV⏐(Q=200 oz) = ¥0 + (½)[(4)(¥200,000)] = ¥400,000.
17.6
c.
The best strategy is to invest in an exploratory mine today and continue to invest if yield is h
a.
At expected production of 150 oz, the NPV of investment in a single mine is NPV(now-or-never) = [(¥5,000/oz–¥1,000/oz)(150 oz)(1–0.3)+¥600,000(0.3)]/(1.10) – ¥600,000 ≈ –¥54,545 The NPV of investing in all 5 mines as a now-or-never decision is –¥272,727
b. If you invest in an exploratory mine and then reconsider based on the revealed informatio yield, then the NPV of the first mine is –¥54,545. The NPV of each additional mine can be calculated conditional on the yield of the first mine: NPV⏐(Q=200 oz) = [(¥5,000/oz–¥1,000/oz)(200 oz)(1–0.3)+¥600,000(0.3)]/(1.10) 2 – ¥600,000/(1.10) You're Reading a Preview ≈ ¥66,116 NPV⏐(Q=100 oz) Unlock full access with a free trial. = [(¥5,000/oz–¥1,000/oz)(100 oz)(1–0.3)+¥600,000(0.3)]/(1.10) 2 – ¥600,000/(1.10) ≈ –¥165,289
With Free Trial You won’t invest at the lowerDownload guano yield. Then,
NPV(sequential investment) = NPV (exploratory mine) + Prob(Q=200 oz)*(4)*NPV⏐(Q=200 oz) ≈ –¥54,545 + (½)[(4)(¥66,116)] ≈ ¥77,686
Although taxes reduce the value of this real option, the optimal strategy is still to invest in an Master yourc. semester with Scribd exploratory mine and continue to invest if yield is high. Read Free Foron 30this Days Sign up to vote title & The New York Usefulresulting lattice, Notinuseful 17.7 a. ThereTimes are 2 = 4 equally-likely price paths in the price three possible outc 2
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Kirt C. Butler, Solutions for Multinational Finance, 4th edition Expected revenue = (KS20m)(0.25)+(KS40m)(0.5)+(KS80m)(0.25) = KS 45 million Expected variable production costs are (KS10k)[(1k+2k)/2] = KS 15m NPV(all 5 mines as now-or-never investment) = 5*[KS 45m – KS 15m – KS 20m] = 5*[KS 10m] = KS 50 million Alternatively, NPV(5) = 5[[¼(20k–10k)(1k)+¼(20k–10k)(2k)+¼(40k–10k)(1k)+¼(40k–10k)(2k)]–20m] = 5*[KS 10m] = KS 50 million
b. If you invest in an exploratory mine and then reconsider your investment decision based on t revealed information, then the NPV of the first mine is KS 10 million. The NPV of each additional mine is then one of the following: NPV| (Q=1k oz and P=20k) = [(20k/ct–10k/ct)(1k ct)] – 20m = –10m so don’t invest NPV| (Q=2k oz and P=20k) = [(20k/ct–10k/ct)(2k ct)] – 20m = 0m so don’t invest NPV| (Q=1k oz and P=40k) = [(40k/ct–10k/ct)(1k ct)] – 20m = +10m so invest NPV| (Q=2k oz and P=40k) = [(40k/ct–10k/ct)(2k ct)] – 20m = +40m so invest NPV(sequential investment) = 10m + 4*[(0.25)(10m)+(0.25)(40m)] = KS 60 million c.
17.8
The NPV of immediate investment in all 5 mines is KS 50 million. This is KS 10 million les the NPV of the sequential investment opportunity. The foregone time value of KS 10 million the opportunity cost of investing in all 5 mines today.
This provocative question goes well beyond the material in the chapter. It turns out that the of a real investment opportunity depends on whether it is firm-specific or shared with other in an industry. If a firm has a real investment option that only it can exercise, such as a pa protected drug that effectively combats prostate cancer, then the analysis in this chap appropriate. There will be an optimal to invest and perhaps to exit, and it may pay to m You'retime Reading a Preview sequential investment to gain more information.
full access with a free trial. In a situation in which the entireUnlock industry shares an investment option (such as Grolsch’s prop investment in Eastern Europe), investment returns are sensitive to competitors’ actions. When costs are zero, the effect of a Download shared investment opportunity is spread across all firms i With Free Trial industry and results in a lower value to each firm. When there are exit costs, competitive resp to uncertainty is asymmetric and firms must be more cautious in their investment decisions. the case of hysteresis, firms might stay invested in unprofitable situations in the hope that less-profitable firms will exit first.
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Chapter 18 Corporate Governance and the International Market for Corporate Contr Answers to Conceptual Questions 18.1
Define corporate governance. Why is it important in international finance?
Corporate governance refers to the way in which major stakeholders influence and control the corporation. Typically, there is a supervisory board (e.g., the Board of Directors in the U.S. represents the most influential stakeholders (debtholders in bank-based systems and equity in m based systems). The supervisory board monitors the management team which manages the day-t operations of the corporation. The form of corporate governance determines the part stakeholders that are represented on the board and has a major large influence on top exec turnover and the market for corporate control. 18.2
In what ways can one firm gain control over the assets of another firm?
Direct means of acquiring control over another firm’s assets include an outright purchase of assets, a purchase of equity, and through merger or consolidation. Indirect means include ventures or other collaborative alliances. 18.3
What is synergy? When the whole is greater than the sum of the parts in a corporate acquisition.
18.4
Describe several differences in the role of commercial banks in corporate governance in Germ Japan, and the United States.
Commercial governance in the U.S. is dominated by capital markets. Commercial banks in the have been constrained by the You're U.S. Congress the influence that they can exert over Reading in a Preview corporations. For example, the Glass-Steagall Act of 1933 prohibited banks from owning stock e in trust, actively voting shares held in trust for their or acting as investment bankers or e Unlock full access withclients, a free trial. brokers. Banks in Germany are not constrained in any of these ways. While banks in Japan c own more than 5% of the equity of any single company, the share cross-holdings in Japan’s kei Download With Free Trial place Japanese banks in a more prominent role than their counterparts in the United States. For reasons, German banks are more influential in corporate governance than Japanese banks Japanese banks are more influential than U.S. banks in corporate governance. 18.5
Describe four ways that banks can influence corporate boardrooms in countries – such as Germ that offer universal banking?
Master your semester with Scribd Read Free Foron Days Sign up tooffer vote this title Universal banking refers to a financial system in which banks a30 full range of banking They can influence corporate boardrooms in four ways: supply debt capit & The New financial York services. Times Not1) useful Useful Cancel anytime.
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Kirt C. Butler, Solutions for Multinational Finance, 4th edition cooperation of this major stakeholder or stakeholders. The relatively dispersed equity ownership U.K. and U.S. allow hostile suitors to appeal directly to the public markets through a tender Tender offers in the U.K. and U.S. may or may not be in cooperation with current management. 18.8
How is turnover in the ranks of top executives similar in China, Germany, Japan and the U States? How is it different?
The why and when of top executive turnover is similar in these countries. Top executives in performing companies are likely to be replaced. The how of top executive turnover differs, how Top executive turnover is initiated and executed by the lead bank in Germany, by the ke (perhaps by the main bank) in Japan, and by the public market for corporate control in China an United States. State-owned companies in China are an exception, in that politically-connected C in state-owned enterprises are more entrenched than similar CEOs in the private sector. 18.9
Who are the likely winners and losers in domestic mergers and acquisitions that involve two incorporated in the same country? How are the returns to acquiring firm shareholders related t method of payment (cash versus stock) and the acquiring firm’s free cash flow or profitability?
In the United States, target shareholders gain while acquiring firm shareholders may or may no Acquiring shareholders are more likely to win than lose in non-U.S. domestic markets. Bidding shareholders are more likely to win: a) when cash is offered rather than stock, and b) when the does not have a lot of free cash flow
18.10 In what ways are the winners and losers in cross-border mergers and acquisitions different th domestic U.S. mergers and acquisitions?
Shareholders of the bidding firm are more likely to win in a cross-border merger or acquisition You're a Preview firm shareholders win in either case. As Reading with domestic acquisitions, bidders are more likely to w the bidding firm does not have a great deal of free cash flow or profitability. Unlock full access with a free trial.
18.11 Why might the shareholders of bidding firms lose when the bidding firm has excess free cash fl profitability?
Download With Free Trial
Jensen’s “free cash flow hypothesis” suggests that managers are more likely to waste shareho capital on poor investments when there is a lot of free cash flow (or profitability) around. When t are tight, capital constraints are more likely to be imposed by the market and managers cann easily rationalize wasteful expenditures.
18.12 How are gains to bidding firms Scribd related to exchange rates? Master your semester with Read Free Foron 30this Days Sign up to vote title studies find that a strong domestic currency leads to both more foreign acquisitions a & The New Empirical York Times Useful Not useful higher bidder returns. Special offer for students: Only $4.99/month.
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Kirt C. Butler, Solutions for Multinational Finance, 4th edition 18.3
Managers like free cash flow because it makes expansion possible without resort to ex capital markets for financing. Unfortunately, the existence of free cash flow also makes it likely that management will waste resources on new ventures in which it has no business (Je [1986]). When cash flow is scarce, managers are more likely to pick winning ventures.
18.4
A real increase in the value of the domestic currency increases the purchasing power of do residents. Froot and Stein [1991] suggest that an informational asymmetry between i managers and outside investors can make outside capital more expensive than inside capital, w can preferentially benefit bidders that see their currency rise in real terms. If an increase in th value of the domestic currency forces foreign companies to access capital markets to acquisitions whereas domestic companies can fund acquisitions with cash, then dom companies enjoy an advantage in the presence of this informational asymmetry.
18.5
The biggest auto deal in 2007 was private equity fund Cerberus Capital Management’s acqui of 80.1 percent of the equity of Chrysler from Daimler-Chrysler for $7.4billion. Daimler AG surviving firm – retained the other 19.9 percent of the equity.
18.6
Non-performing loans in Japan forced consolidation of Japanese banking in the 2000s. The largest financial institutions in Japan at the time of this writing were Mitsubishi UFJ Fina Group (including the former Bank of Tokyo-Mitsubishi, UFJ, Sanwa Bank, Tokai Bank, & T Trust), Sumitomo Mitsui Banking Corp (Sumitomo Bank and Sakura Bank), and Mizuho Ho Financial Group (Fuji Bank, Dai-Ichi Kangyo Bank, and Industrial Bank of Japan).
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PART V International Portfolio Investment and Asset Pricing Chapter 19 International Capital Markets Answers to Conceptual Questions 19.1
What are the characteristics of a domestic bond? an international bond? a foreign bond? a Eu a global bond?
Domestic bonds are issued and traded within the internal market of a single country an denominated in the currency of that country. International bonds are traded outside the country issuer. The two kinds of international bonds are foreign bonds and Eurobonds. Foreign bond issued in a domestic market by a foreign borrower, denominated in domestic currency, market domestic residents, and regulated by the domestic authorities. Eurobonds are denominated in o more currencies but are traded in external markets outside the borders of the countries issuing currencies. A global bond trades in the Eurobond market as well as in one or more national markets. 19.2
What are the benefits and drawbacks of offering securities in bearer form relative to registered fo
Bearer bonds have the advantage of retaining the anonymity of the owner. However, owners of b bonds must ensure that they do not lose the bonds or the bond coupons since the bearer is assum be the legal owner of the bond. 19.3
What is the difference between a continuous quotation system and a periodic call auction?
In a continuous quotation system, buy and sell orders are matched as they arrive with market-m assuring liquidity in individual shares. In a periodic call auction, shares are bought and sold on You're Reading a Preview pre-specified times. Continuous quotation systems are more appropriate for actively traded s Periodic call auction systems are Unlock frequently usedwith for thinly traded shares. full access a free trial. 19.4
What is the difference between a spot and a forward stock market?
Free Trial Spot (or cash basis) stock marketsDownload settle tradesWith immediately (typically within a few days). Forwa futures) stock markets settle trades on a specified future date. 19.5
What is the EU’s “single passport”? How can a financial market or institution qualify?
The “single passport” of the EU Investment Securities Directive of 1993 provides EU invest firms a “passport” to operate in other EU countries if they have the approval of regulatory autho in their home country. Firms must satisfy three conditions. Read Free Foron 30this Days Sign up to vote title 1. The firm must meet the EU’s capital adequacy requirements. Not useful Useful Cancel anytime. 2. The firm’s directors must be sufficiently experienced. Special offer for students: Only $4.99/month. 3. The firm must appropriately safeguard their clients’ funds.
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Kirt C. Butler, Solutions for Multinational Finance, 4th edition 19.8
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Do MNCs provide international portfolio diversification benefits? If so, do they provide the diversification benefits as direct ownership of companies located in the countries in whic MNC does business?
Owning shares in an internationally diversified multinational corporation provides some ind diversification benefits. Unfortunately, MNC share prices move more with the home market with foreign markets, so MNCs do not provide the same diversification benefits as d investment in foreign shares. 19.9
What is the difference between a passive and an active investment philosophy?
Passive strategies do not try to shift assets in anticipation of market shifts. Rather, they foll ‘buy-and-hold’ philosophy that identifies the types of assets that are to be held and then advantage of diversification to achieve optimal performance. Active strategies try to shift bet asset classes or between individual securities in an effort to anticipate changes in market value 19.10 What makes cross-border financial statement analysis difficult?
Barriers include differences in language, accounting measurement conventions (such as accou for cash, goodwill, discretionary reserves, pension liabilities, and inflation), and fina disclosure requirements.
19.11 What alternatives does a multinational corporation have when investors in a foreign co demand accounting and financial information?
The MNC can (1) do nothing, (2) prepare convenience translations, (3) prepare suppleme financial statements using different accounting principles, such as U.S. GAAP or the IAS.
Problem Solutions
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19.1
No interest accrues on the 31st of the month with the 30/360 convention.
19.2
With the actual/365 convention, 31 days out With of 182.5 days would have accrued by July 31st. Download Free Trial (31/182.5) = 16.986% of the semiannual interest payment.
19.3
Three days of interest accrue on the 28th of February during years that are not leap years. Durin years, one day of interest accrues on the 28th of February and two days of interest accrue on the of February.
Master your semester with Scribd 19.4 Matsushita’s global bonds selling at par: Read Free Foron 30this Days Sign up to vote title sel According to the U.S. bond equivalent yield convention, the promised yield of a bond & The New a.York Times Useful Not useful par is equal to the coupon yield. For the Matsushita bond, this is 7¼% compo Special offer for students: Only $4.99/month. semiannually (or 3.626% semiannually).
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b. According to the effective annual yield quotation commonly used in Europe, the promised y
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Kirt C. Butler, Solutions for Multinational Finance, 4th edition
19.7 a. NAVWon = (W8,000/share)(1,000,000 shares) + (W4,000/share)(1,000,000 share (W8,000/share)(500,000 shares) = W16 billion b. (W16 billion) / (W800/$) = $20 million NAV c. The fund is worth ($22/share)(1,000,000 shares) = $22 million in the U.S., or a 10 pe premium to NAV. As to whether this is a good investment, the answer is “it depends.” I fund is to be open-ended or if investment restrictions into South Korea are likely to be rel in the near future, then the U.S. price is likely to fall back to NAV and this is not a investment. On the other hand, the premium may be justified if restrictions on fo investment into South Korea are expected to be retained or even tightened. Perhap investment into other Southeast Asian companies that are not subject to these invest restrictions could provide similar diversification benefits without the high cost of the K Foods fund. 19.8 a.
The major argument for regulation of hedge funds is that they are exerting an incre influence over financial markets and hence should be regulated to avoid a situation in w they precipitate or acerbate a market collapse. The major argument against regulation is they are private investment partnerships and hence should not be subject to public disclo requirements. b. The arguments for and against public disclosure are the same as those for and against in regulation. The Securities and Exchange Commission was established to protect investors fraud and misrepresentation in public securities issues. The legal rules could be loosen include hedge funds in the definition of a public issue. Ultimately, a line must be draw distinguish private from public investment funds.
19.9
Use key words such as “stock exchange and alliance” or “international and exchange and (al You're Reading a Preview joint venture).” You’ll find the NYSE-Euronext alliance of exchanges in New York, Amste Brussels, Lisbon, Paris, London’s LIFFE (stocks and derivatives), and the NASDAQ. Deriva Unlock full access with a free trial. only alliances include Eurex (Deutsche Borse and Switzerland’s SOFFIX) and Globex (C Singapore, and others). As time goes on, new alliances will be formed as well.
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Kirt C. Butler, Solutions for Multinational Finance, 4th edition
Chapter 20 International Portfolio Diversification Answers to Conceptual Questions 20.1
How is portfolio risk measured? What determines portfolio risk?
Portfolio risk is measured by the standard deviation (or variance) of return. Portfolio risk depen the variances and covariances of the assets in the portfolio. 20.2
What happens to portfolio risk as the number of assets in the portfolio increases?
As the number of assets held in a portfolio increases, the variance of return on the por becomes more dependent on the covariances between the individual securities and less depen on the variances of the individual securities. 20.3
What happens to the relevant risk measure for an individual asset when it is held in portfolio rather than in isolation? The risk of an individual asset in a large portfolio depends on its return covariance with assets in the portfolio and not on its return variance. This is called systematic risk.
20.4
In words, what does the Sharpe Index measure?
Sharpe’s measure captures the ex post return/risk performance of an asset by dividing retu excess of the riskfree rate by the asset’s standard deviation of return. In other words, it mea the asset’s “bang for the buck.” 20.5
Name two synonyms for “systematic risk.”
Systematic risk is the same as non-diversifiable risk. In the context of the CAPM, the only syste You're Reading a Preview risk is market risk (that is, risk related to the market factor). 20.6
Unlock full access with a free trial. Name two synonyms for “unsystematic risk.”
Diversifiable risk is asset-specific (company- or country-specific) or unique risk. In the context o With Free Trialrisk unrelated to the market factor). CAPM, diversifiable risk includesDownload only non-market risk (i.e., 22.7
Which portfolio has the most to gain from currency hedging - a portfolio of international stock portfolio of international bonds? Why?
Nearly all of the variation in bond returns within a country come from changes in interest rates i country. Stocks have a much larger random component. Without the additional security-sp variability of stocks, the percentage of currency risk in Read the variance oftitle an international Free Foron 30this Days Signreturn up to vote portfolio is much higher than in an international stock portfolio. Currency risk hedging is much Not useful Useful effective in reducing the variability of foreign bond investmentsCancel than anytime. of foreign stock investment
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20.8
Is international diversification effective in reducing portfolio risk? Why?
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Kirt C. Butler, Solutions for Multinational Finance, 4th edition 20.11 Describe some of the barriers to international portfolio diversification.
Barriers include a) market frictions such as government controls, taxes, and transactions cos unequal access to market prices in foreign markets, and c) unequal access to information on fo assets. Investor irrationality also can be a barrier to international portfolio diversification. 20.12 What is home asset bias? What might be its cause?
Home asset bias is the preference of investors for local assets. Some international asset pricing m suggest that domestic assets are preferred because they serve as a hedge against domestic infl Other explanations revolve around market imperfections including market frictions, inv irrationality, or unequal access to market prices or information. 20.13 What is “free float”?
Free float capitalization refers to the market value of shares that are available for trade; th adjusted for controlling shareholders (such as a founding family) or other investors that do not their shares.
Problem Solutions 20.1
E[r P] = (½)(0.144)+(½)(0.138) = 0.141, or 14.1% Var(r P) = (½)2(0.279)2+(½)2(0.298)2 + 2(½)(½)(0.665)(0.279)(0.298) = 0.0693 ⇒ σP = (0.0693)1/2 = 0.2633, or 26.3% SI = (r P – r F)/σP = (0.141–0.068)/(0.263) = 0.277, which is superior in return/risk performan either the French (0.272) or Germany (0.235) markets alone.
20.2
E[r P] = (½)(0.138)+(½)(0.157) =You're 14.75% Reading a Preview 2 2 2 2 Var(r P) = (½) (0.298) +(½) (0.346) + 2(½)(½)(0.355)(0.298)(0.346) = 0.0704 full access with a free trial. or 26.5% ⇒ σP = (0.0704)1/2 = 0.2654,Unlock SI = (0.1475–0.068)/(0.265) = 0.300, which is superior in return/risk performance to eithe German (0.235) or Japanese (0.257) marketsWith alone. Download Free Trial
20.3
E[r P] = (½)(0.113)+(½)(0.084) = 9.85% Var(r P) = (½)2(0.170)2+(½)2(0.108)2 + 2(½)(½)(0.360)(0.170)(0.108) = 0.0134 ⇒ σP = (0. 0134)1/2 = 0.1160, or 11.6% SI = (0.985–0.068)/(0.116) = 0.263, which is superior to the performance of globally diver stocks (0.265) or bonds (0.148) alone.
Master your semester with Scribd Read Free Foron 30this Days Sign up to vote title 20.4 E[r ] = (⅓)[(0.157)+(0.145)+(0.111)] = 0.1377, or 13.8% & The New Var(r York) = Times Useful Not useful (⅓) [(0.346) +(0.275) +(0.169) ] P
P
2
2
2
2
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Special offer for students: $4.99/month. +2(Only ⅓)2[(0.361)(0.346)(0.275)+(0.302)(0.346)(0.169)+(0.534)(0.275)(0.169)] = 0.0420
⇒σ
= (0. 0420)1/2 = 0.2048, or about 20.5%
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Kirt C. Butler, Solutions for Multinational Finance, 4th edition 20.8
sd/f = (Std/f /St–1d/f )–1= (€0.7182/$)/(€0.7064/$)–1 = 1.0168–1 = 1.68% r € = r $ + s €/$ + r f s €/$ = 0.1600 + 0.0168 + (0.1600)(0.0168) = 17.95%
20.9
(1+r $) = (1+r Peso)(1+s$/Peso ) ⇒ r $ = (1.12 )[($.0440/Peso)/($.0425/Peso)]–1 = (1.12)(1.0353)–1 = 15.95%.
20.10 Var(r $) = Var(r Peso) + Var(s$/Peso) = (0.248)2 + (0.327)2 = 0.1684, so the standard deviation of return on the Philippine stock market is (0.1684) 1/2 = 0.4104, or 41.04 percent.
20.11 From Table 20.3, about 80 percent the return variance on a foreign stock investment is like come from variation in the foreign stock market and about 25 percent from the variation i exchange rate? About 25 percent the return variance on a foreign stock investment is like come from variation in the foreign bond market and about 67 percent from the variation i exchange rate?
20.12 Because the Greenland economy has less industrial diversification than the U.S. economy, s in Greenland are relatively highly correlated with other domestic stocks. Hence, more of the risk (variance) of individual stocks within Greenland will be systematic and less wi diversifiable. The extent to which international diversification can eliminate diversifiable depends on the correlation of Greenland stocks with the rest of the world.
20.13 As a start, you should collect data on mean returns, variances, and covariances in the world’s national debt and equity markets. Keep in mind that past performance is no guarantee of f investment success. Expected returns, variances and covariances of international debt and e returns are variable, especially over the short run.
20.14 First of all, your return statistics You're will have a great adeal of statistical precision in the sense that Reading Preview have a large number of observations. However, these statistics won’t be very timely in the sens they’ll be estimated over periods (war, expansion, depression, oil crisis, etc. Unlock fullrapid accesseconomic with a free trial. might not match the current period. Market returns vary with the business cycle, and return sta (correlations in particular) markedly fluctuate over time. Second, past performance is no guaran Download With Free Trial future results. Even if your return statistics are accurate, your performance over the coming yea have a large element of chance and will almost surely diverge from the past.
Appendix 20-A Continuous Compounding and Emerging Market Returns 20A.1 a. semester with Scribd Master your & The New York Times 4
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Kirt C. Butler, Solutions for Multinational Finance, 4th edition 20A.2 a. 600
Israel 500
Jordan
400
World
300 200 100 0 D-
D-
D-
D-
D-
D-
D-
D-
D-
D-
D-
D-
D-
D-
D-
92
93
94
95
96
97
98
99
00
01
02
03
04
05
06
The Israeli index seems to move with the market during most years, and the index for Jo seems to be somewhat independent of the world market portfolio.
Return statistics are reported below and interpreted in parts b-d. Each country’s correlation the all-country world index also is reported. Holding period return Continuously compounded return Israel Jordan World Israel Jordan World 1993 15.60% 20.90% 24.90% 14.50% 18.98% 22.23% 1994 –32.35% –8.68% 5.04% –39.09% –9.09% 4.92% 1995 23.53% 7.43% 19.44% 21.13% 7.16% 17.76% You're Reading 1996 –2.28% –8.43% 13.21%a Preview –2.30% –8.81% 12.41% 1997 25.00% 1.57% 14.99% 22.31% 1.55% 13.97% Unlock full access with a free trial. 1998 –5.08% –10.97% 21.96% –5.22% –11.62% 19.85% 1999 59.64% 6.21% 26.81% 46.78% 6.03% 23.75% Download With Free Trial 2000 27.74% –23.20% –13.95% 24.48% –26.40% –15.02% 2001 –31.13% 34.58% –15.91% –37.29% 29.70% –17.33% 2002 –31.21% 4.55% –18.97% –37.42% 4.45% –21.03% 2003 57.58% 57.68% 34.65% 45.48% 45.54% 29.75% 2004 20.29% 61.34% 15.74% 18.48% 47.83% 14.61% 2005 27.45% 73.84% 11.38% 24.26% 55.30% 10.78% 2006 –4.86% –30.88% 21.52% Read Free For–36.93% 30this Days Sign–4.98% up to vote on title 19.49% Mean 10.71% 13.28% 11.49% 6.51% 8.84% 9.72% Not useful Useful Cancel anytime. Stdev 29.96% 32.32% 16.70% 28.72% 27.78% 16.13% Special offer for students: Only $4.99/month. ρIsrael,Jordan 0.3301 0.2828 0.6174 0.1638 1.000 0.6250 0.1450 1.000
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Kirt C. Butler, Solutions for Multinational Finance, 4th edition
Chapter 21 International Asset Pricing Answers to Conceptual Questions 21.1
What is the capital market line? Why is it important? The capital market line describes the most efficient combination of risky and riskless assets.
21.2
What is the security market line? Why is it important? The security market line describes a linear relation between systematic risk and required return.
21.3
What is beta? Why is it important? Beta measures an asset’s sensitivity to changes in the market portfolio.
21.4
Does political risk affect required returns?
If political risk is country-specific, then it is diversifiable and does not affect required retu political risk is related to returns on the relevant (domestic or international) market portfolio, th does affect required returns. 21.5
What assumptions must be added to the traditional CAPM in order to derive the interna version of the CAPM?
Two additional assumptions are necessary: a) investors in each country have the same consum basket so that inflation is measured against the same benchmark in every country, and b) purch power parity holds so that both real prices and real interest rates are the same in every country an every individual. 21.6
You're Reading a Preview What is the hedge portfolio in the IAPM?
The hedge portfolio in the international version theaCAPM Unlock full accessof with free trial.is a combination of domestic T-bil a hedge against the currency risk of the world market portfolio. (While the text does not go into d one way to construct the currency hedge is through forward currency contracts.) 21.7
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What is the difference between an integrated and a segmented capital market?
An integrated capital market is one in which the law of one price holds. Some sort of m imperfection is necessary for there to be segmented capital markets.
21.8 What is the APT? In what ways is it both better or worse than the IAPM? Master your semester with Scribd acco The arbitrage pricing model assumes that individual security are related to K factors Read Free Foron 30this Days Signreturns up to vote title the linear relationship r = μ + β F + ... + β F + e . TheUseful that APT is not a taut & The New tolike York Times Not useful good news is the CAPM and hence is not subject to Roll’s Critique. The bad news is that APT says no j
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about what systematic risk factors are priced. (The CAPM is constructed such that the only rel systematic risk factor is the return on the market portfolio.)
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Kirt C. Butler, Solutions for Multinational Finance, 4th edition 21.11 What is the value premium? What is the size effect? Do international stocks exhibit characteristics? Are these factors evidence of market inefficiency?
The value premium refers to the tendency of value (high equity book-to-market) stocks to outpe growth (low equity book-to-market) stocks. The size effect refers to the tendency of small stoc outperform large stocks. Fama and French [1998] found that these factors are present in a study national stock markets. Size and value premiums are not necessarily evidence of informa inefficiency, as they could reflect systematic (nondiversifiable) risks such as relative financial dis
21.12 What is momentum? Can it lead to profitable investment opportunities for international invest
Momentum refers to the tendency of recent winners (stocks with positive returns over a recent pe to outperform recent losers. Momentum effects have been found in U.S. (Jegadeesh and Ti 1992) and European (Rouwenhorst, 1998) stock markets. In particular, recent winners outper recent losers for about one year, after which time the winners tend to underperform losers. Beca the curious reversal of fortunes after one year, momentum effects are harder to reconcile wi efficient market hypothesis. If momentum effects persist in the future, they offer the possibili positive risk-adjusted investment opportunities. 21.13 Are individual stocks exposed to currency risk? Does currency risk affect required returns?
Individual stocks (especially firms with international operations) are often exposed to currency Jorion’s and De Santis and Gérard’s studies (presented in the text) suggest that currency risk priced in the U.S. stock market, but does appear to be priced in non-U.S. stock markets. In any managers will continue to care about currency risk because - as employees of the firm - they c diversify their wealth in the same way that outside shareholders can.
Problem Solutions 21.1 21.2
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full–access with a=free trial. a. r S = r F + βS (r M – r F) = 8% +Unlock [16.5% 8%] (1.5) 20.75%. b. Sr = r F + βS (r M – r F) = 4% + [12.5% – 4%] (1.2) = 14.2%.
Download With Free Trial≈ 1.00 relative to the Frankfurt ßBMW = ρBMW,DAX (σBMW/σDAX ) = (0.44)(0.105/0.046) stock market index. b. BMW r = r F + βBMW (E[r M]–r F) = 0.05 + (1.00)(0.06) ≈ 0.110, or 11.0% c. ßDAX,World = ρDAX,Worl d (σDAX/σWorld) = (0.494) (0.0413/0.0526) = 0.3879 relative to the w market index. a.
Master your semester with Scribd Read Free Foron 30 Days Sign up to vote this title 21.3 a. According to BP’s factor sensitivities, BP shares should rise with an increase in industrial production, a decrease in the price of oil, or Useful an increase in the value of currenc & The New York Times useful Not BP’s trading basket in the denominator of the spot rate. Special offer for students: Only $4.99/month. b. E(r) =μ + βProdFProd+βOilFOil+βSpotFSpot
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