Solutions Manual CHAPTER 31
I NTERNATI ONALASPECTS OF CORPORATE F I NANCE
SUGGESTED ANSWERS TO THE R EVIEW EVIEW QUESTIONS AND PROBLEMS I.
Questions
1. The U.S. U.S. dollar dollar.. The primar primary y reason reason why the dollar dollar was was used is that it provided a relatively stable benchmark, and it was accepted universally for transaction purposes. 2. Under Under the fixed exchan exchange ge rate system system,, the fluctu fluctuati ations ons were were limite limited d to 1! and " 1!. Under the floating exchange rate system, there are no agreed#upon limits. $. % dollar dollar will will buy mo more re &renc &rench h franc francs. s. '. Ther Theree will will be an exces excesss supp supply ly of doll dollar arss in the forei foreign gn excha exchang ngee markets, and thus, will tend to drive down the value of the dollar. &oreign investments in the United States will increase. (. Takin Taking g into into accoun accountt diffe differen rentia tiall labor labor costs costs abroad abroad,, transp transport ortati ation, on, tax advantages, and so forth, )hilippine corporations can maximi*e long#run profits. There are also nonprofit behavioral and strategic considerations, such as maximi*ing market share and enhancing the prestige of corporate officers. +. The foreign foreign proectproect-ss cash flows flows have have to be converted converted to local local currency currency,, since the shareholders of the )hilippine corporation assuming they are mainly )hilippine residents/ are interested in peso returns. This subects them to exchange rate risk, and therefore re0uires an additional risk premium. There is also a risk premium for political risk mainly the risk of expropriation/. . % urodo urodolla llarr is a dollar dollar deposi depositt in a foreign foreign bank, bank, normal normally ly a urop uropean ean bank. The foreign bank need not be owned by foreigners 3 it only has to be located in a foreign country. country. &or example, a 4itibank subsidiary in )aris accepts urodollar deposits. The &renchman-s deposit at 4hase 5anhattan 6ank in 7ew 8ork 8ork is not a urodollar deposit. 9owever, if he transfers his deposit to a bank in :ondon or )aris, it would be. The 31-1
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International Aspects of Corporate Finance
existence of the urodollar market makes the &ederal ;eserve-s ob of controlling U.S. interest rates more difficult. urodollars are outside the direct control of the U.S. monetary authorities. 6ecause of this, interest rates in the U.S. cannot be insulated from those in other parts of the world. Thus, any domestic policies the &ederal ;eserve might take toward interest rates would be affected by the urodollar market. <. % dollar will buy more euros. =. The foreign proect-s cash flows have to be converted to )hilippine peso, since the shareholders of the )hilippine corporation assuming they are mainly )hilippine residents/ are interested in peso returns. This subects them to exchange rate risk, and therefore re0uires an additional risk premium. There is also a risk premium for political risk mainly the risk of expropriation/ that should be included. 1>. 7o, interest rate parity implies that an investment in the )hilippines with the same risk as a similar investment in a foreign country should have the same return. ?nterest rate parity is expressed as follows@
Forwardexchangerate 1 + rh = . Spotexchangerate 1 + rf ?nterest rate parity shows why a particular currency might be at a forward premium or discount. % currency is at a forward premium whenever domestic interest rates are higher than foreign interest rates. Aiscounts prevail if domestic interest rates are lower than foreign interest rates. ?f these conditions do not hold, then arbitrage will soon force interest rates back to parity. 11. )urchasing power parity assumes there are neither transactions costs nor regulations that limit the ability to buy and sell goods across different countries. ?n many cases, these assumptions are incorrect, which explains why ))) is often violated. %n additional complication, when empirically testing to see whether ))) holds, is that products in different countries are rarely identical. &re0uently, there are real or perceived differences in 0uality, which can lead to price differences in different countries. II. Multiple Choice Questions
1. 2. $.
% 6 4
+. . <.
6 6 4
11. 12. 1$. 31-2
A 4 6
1+. 1. 1<.
% A %
International Aspects of Corporate Finance
'. % (. A III. Problems
=. 1>.
4 4
1'. 1(.
% 4
1=.
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A
P"o%l!& $
Aollars should sell for 1B1.(>, or >.+++ pound per dollar. P"o%l!& '
C1 D '.> ?sraeli shekelsE C1 D => Fapanese yenE 4ross#exchange rate, yenBshekel D G 4ross ;ate@
Aollars Shekel
×
8en Aollar
=
8en Sheke
7ote that an indirect 0uotation is given for ?sraeli shekelE however, the cross rate formula re0uires a direct 0uotation. The indirect 0uotation is the reciprocal of the direct 0uotation. Since C1 D '.> shekels, then 1 shekel D C>.2(. 8enBShekel D C>.2( per shekel × => yen per dollar D 22.(> yen per shekel P"o%l!& #
r 7H5, +#month T#bills D '!E r 7H5 of similar default#free +#month Fapanese bonds D 2.(!E Spot exchange rate@ 1 yen D C>.>1>E +#month forward exchange rate D G
&orward exchange rate Spot exchange rate
=
1 + r h 1 + r f
r f D 2.(! B 2 D 1.2(! r h D '! B 2 D 2!
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International Aspects of Corporate Finance
Spot exchange rate D C>.>1> orward exchange rate C>.>1>
D
1.02 1.012
1.>12( &orward exchange rate D C>.>1>2 &orward exchange rate D C>.>1>>' The +#month forward exchange rate is 1 yen D C>.>1>>' P"o%l!& (
The spot exchange rate between the euro and the dollar is@ U.S. T.I. D C(>>E 5U T.I. D $12.( eurosE Spot rate between euro and dollar D G )h
D )f Spot rate/
C(>>
D $12.( euros Spot rate/
(>> B $12.( D Spot rate C1.+>
D Spot rate
1 euro
D C1.+>
or
C1
D >.+2( euro
P"o%l!& )
The dollars re0uired to purchase 1,>>> units for each of the following currency is as follows@
4urrency 6ritish pound 4anadian dollar 5U euro Fapanese yen
U.S. Aollars ;e0uired to 6uy Hne Unit of &oreign 4urrency 1.(2<2 >.=(+= 1.2<=$ >.>11'$ 31-4
1,>>> D × 1,>>> D × 1,>>> D × 1,>>> D × 1,>>> D ×
)urchase )rice in Aollars C1,(2<.2> =(+.=> 1,2<=.$> 11.''
International Aspects of Corporate Finance
5exican peso Swedish krona
>.><2 >.1$(=
1,>>> D × 1,>>> D ×
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<.2> 1$(.=>
P"o%l!& *
The price of krones is C>.1( today. % 1>! appreciation will make it worth C>.1+(> tomorrow. % dollar will buy 1 B >.1+(> D +.>+>+ krones tomorrow. P"o%l!& +
The exchange rate between Swedish kronas and pounds is@ Jronas B pound D
kronas B dollar × dollars B pound
D
.( × 1.(
D
11.2( kronas per pound
P"o%l!& ,
Spot rate@ 1 yen D C>.>11'E &orward rate@ 1 yen D C>.>11'E r 7H5 of =>#day Fapanese risk#free securities D 2!E r 7H5 of =>#day U.S. risk#free securities D G r f D 2.>! B ' D >.(>! r h D G
1 + rh Forwardexchangerate D Spotexchangerate 1 + rf $0.0114 $0.0114
D
1 D
1 + rh 1.005 1 + rh 1.005
1 r h D 1.>>( r h D >.>>( r 7H5 D >.(>! × ' D 2! 31-5
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International Aspects of Corporate Finance
P"o%l!& -
a. r 7H5 of =>#day U.S. risk#free securities D $!E r 7H5 of =>#day 6ritish risk#free securities D $.(!E Spot rate@ 1 pound D C1.(>E forward rate selling at premium or discount D G Forwardexchange rate D Spotexchange rate
1 + rh 1 + rf
r h D $! B ' D >.(! r f D $.(! B ' D >.<(! Spot rate D C1.(> Forwardexchange rate 1.0075 D $1.50 1.0087 Forwardexchange rate
D >.==<+
$1.50
&orward exchange rate D C1.'=<1 The forward rate is selling at a discount, since a pound buys fewer dollars in the forward market than it does in the spot. ?n other words, in the spot market C1 would buy >.+++ 6ritish pounds, but at the forward rate C1 would buy >.++( 6ritish poundsE therefore, the forward currency is said to be selling at a discount. b. The =>#day forward rate is C1.'=<1. P"o%l!& $
a. 4C',>>>,>>> B 4C1.>(>> D C$,<>=,(2$.<1 ≈ C$,<>=,(2', or 4C',>>>,>>> × C>.=(2' D C$,<>=,+>> Aifference is due to rounding./ 31-6
International Aspects of Corporate Finance
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b. 4C',>>>,>>> B 4C1.>((> D C$,=1,'+=.1= ≈ C$,=1,'+=, or 4C',>>>,>>> × C>.='= D C$,=1,+>> c. ?f the exchange rate is 4C1.>2( to C1 when payment is due in $ months, the 4C',>>>,>>> will cost@ 4C',>>>,>>> B 4C1.>2( D C$,=>2,'$=, which is C=2,=1( more than the spot price today and C11>,=> more than purchasing a forward contract for => days. P"o%l!& $$
The U.S. dollar liability of the corporation falls from C1.>((,>>>,>>>/ D C(,2(>,>>> to C>.=((,>>>,>>>/ D C',(>,>>>, corresponding to a gain of (>>,>>> U.S. dollars for the corporation. 9owever, the real economic situation might be somewhat different. &or example, the loan is presumably a long#term loan. The exchange rate will surely change again before the loan is paid. Khat really matters, in an economic sense, is the expected present value of future interest and principal payments denominated in U.S. dollars. There are also possible gains and losses on inventory and other assets of the firm. P"o%l!& $'
a. The automobile-s value has increased because the dollar has declined in value relative to the yen. b. 2'( B <.( D 2.<>>>, so C=,>>> × 2.<>>> D C2(,2>>. 7ote that this represents a $.<<! compound annual increase over 2 years. P"o%l!& $#
A1 D $ poundsE xchange rate D C1.(>BpoundE )ound depreciates (! against C1. Aividend grows at 1>! and r s D 1$!. 1> million shares outstanding. g D
1.10 1.05
3 1 D '.+1=!
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International Aspects of Corporate Finance
)> D
D1 rs
−
g
D
× $1.50 !0.1− 0.047619 )
D
$4.50 0.0828
D C('.+2'2'(<< Total e0uity
D C('.+2'2'(<< × 1> million shares D C('+,2'2,'(=
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