TEST BANK for International Financial Management 9th Edition by Cheol Eun, Bruce Resnick and Tuugi by ACADEMIAMILL

CHAPTER 1 MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 1) What major dimension sets apart international finance from domestic finance? A) B) C) D)

An example(s) of a political risk is A) B) C) D)

Foreign exchange and political risks Market imperfections Expanded opportunity set all of the options

expropriation of assets. adverse change in tax rules. the opposition party being elected. both the expropriation of assets and adverse changes in tax rules are correct.

Production of goods and services has become globalized to a large extent as a result of

A) natural resources being depleted in one country after another. B) skilled labor being highly mobile. C) multinational corporations' efforts to source inputs and locate production anywhere where costs are lower and profits higher. D) common tastes worldwide for the same goods and services.

Recently, financial markets have become highly integrated. This development A) B) C) D)

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allows investors to diversify their portfolios internationally. allows minority investors to buy and sell stocks. has increased the cost of capital for firms. none of the options

Japan has experienced large trade surpluses. Japanese investors have responded to this by A) B) C) D)

liquidating their positions in stocks to buy dollar-denominated bonds. investing heavily in U.S. and other foreign financial markets. lobbying the U.S. government to depreciate its currency. lobbying the Japanese government to allow the yen to appreciate.

6) Suppose your firm invests $100,000 in a project in Italy. At the time the exchange rate is $1.25 = €1.00. One year later the exchange rate is the same, but the Italian government has expropriated your firm's assets paying only €80,000 in compensation. This is an example of A) B) C) D)

exchange rate risk. political risk. market imperfections. none of the options, since $100,000 = €80,000 × $1.25/€1.00.

7) Suppose you start with $100 and buy stock for £50 when the exchange rate is £1 = $2. One year later, the stock rises to £60. You are happy with your 20 percent return on the stock, but when you sell the stock and exchange your £60 for dollars, you only get $45 since the pound has fallen to £1 = $0.75. This loss of value is an example of A) B) C) D)

exchange rate risk. political risk. market imperfections. weakness in the dollar.

8) Suppose that Great Britain is a major export market for your firm, a U.S.-based MNC. If the British pound depreciates against the U.S. dollar,

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A) your firm will be able to charge more in dollar terms while keeping pound prices stable. B) your firm may be priced out of the U.K. market, to the extent that your dollar costs stay constant and your pound prices will rise. C) to protect U.K. market share, your firm may have to cut the dollar price of your goods to keep the pound price the same. D) your firm may be priced out of the U.K. market, to the extent that your dollar costs stay constant and your pound prices will rise, and to protect U.K. market share, your firm may have to cut the dollar price of your goods to keep the pound price the same.

9) Suppose Mexico is a major export market for your U.S.-based company and the Mexican peso appreciates drastically against the U.S. dollar. This means A) your company's products can be priced out of the Mexican market, as the peso price of American imports will rise following the peso's fall. B) your firm will be able to charge more in dollar terms while keeping peso prices stable. C) your domestic competitors will enjoy a period of facing lessened price competition from Mexican imports. D) your firm will be able to charge more in dollar terms while keeping peso prices stable and your domestic competitors will enjoy a period of facing lessened price competition from Mexican imports.

10) Suppose Mexico is a major export market for your U.S.-based company and the Mexican peso depreciates drastically against the U.S. dollar, as it did in December 1994. This means that A) your company's products can be priced out of the Mexican market, as the peso price of American imports will rise following the peso's fall. B) your firm will be able to charge more in dollar terms while keeping peso prices stable. C) your domestic competitors will enjoy a period of facing little price competition from Mexican imports. D) none of the options

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11) Suppose that you are a U.S. producer of a commodity good competing with foreign producers. Your inputs of production are priced in dollars and you sell your output in dollars. If the U.S. currency depreciates against the currencies of our trading partners, A) B) C) D)

your competitive position is likely improved. your competitive position is likely worsened. your competitive position is unchanged. none of the options

12) Undoubtedly, we are now living in a world where all the major economic functions— consumption, production, and investment— A) B) C) D)

are still inherently local. are still regional in nature. are slowly becoming globalized. are highly globalized.

13) Most governments at least try to make it difficult for people to cross their borders illegally. This barrier to the free movement of labor is an example of A) B) C) D)

information asymmetry. excessive transactions costs. racial discrimination. a market imperfection.

14) Although the world economy is much more integrated today than was the case 10 or 20 years ago, a variety of barriers still hamper free movements of people, goods, services, and capital across national boundaries. These barriers include

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A) B) C) D)

legal restrictions. excessive transportation costs. information asymmetry. all of the options

15) The Japanese automobile company Honda decided to establish production facilities in Ohio, mainly to A) B) C) D)

circumvent trade barriers. reduce transportation costs. reduce transactions costs. all of the options

16) When individual investors become aware of overseas investment opportunities and are willing to diversify their portfolios internationally, A) they trade one market imperfection, information asymmetry, for another, exchange rate risk. B) they benefit from an expanded opportunity set. C) they should not bother to read or to understand the prospectus, since it’s probably written in a foreign language. D) they should invest only in dollars or euros.

17) The Nestlé Corporation, a well-known Swiss MNC, used to issue two different classes of common stock, bearer shares and registered shares, and foreigners were allowed to hold only A) B) C) D)

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registered shares. bearer shares. voting shares. convertible shares.

18) Deregulated financial markets and heightened competition in financial services provided an environment for financial innovations that resulted in the introduction of various instruments. Examples of these innovative instruments include A) B) C) D)

19)

currency futures and options, foreign stock index futures and options. multicurrency bonds. international mutual funds, country funds, exchange traded funds. all of the options

Nestlé, a well-known Swiss corporation,

A) has been a paragon of virtue in its opposition to all forms of political risk. B) at one time placed restrictions on foreign ownership of its stock. When it relaxed these restrictions, the total market value of the firm fell. C) at one time placed restrictions on foreign ownership of its stock. When it relaxed these restrictions, there was a major transfer of wealth from foreign shareholders to domestic shareholders. D) none of the options

20)

The goal of shareholder wealth maximization

A) is not appropriate for non-U.S. business firms. B) means that all business decisions and investments that a firm makes are done for the purpose of making the owners of the firm better off financially. C) is a sub-objective the firm should attempt to achieve after the objective of customer satisfaction is met. D) is in conflict with the privatization process taking place in third-world countries.

21) As capital markets are becoming more integrated, the goal of shareholder wealth maximization

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A) B) C) D)

22)

has been altered to include other goals as well. has lost out to other goals, even in the U.S. has been given increasing importance by managers in Europe. has been shown to be a deterrent to raising funds abroad.

Corporate scandals at firms such as Enron, WorldCom and the Italian firm Parmalat

A) show that managers might be tempted to pursue their own private interests at the expense of shareholders. B) show that Italian shareholders are better at monitoring managerial behavior than U.S. shareholders. C) show that white-collar criminals hardly ever get punished. D) show that socialism is a better way to go than capitalism.

23)

While the corporate governance problem is not confined to the United States,

A) it can actually be a much more serious problem in other parts of the world, where the legal protection of shareholders is weak or nonexistent. B) it has reached its high point in the United States. C) the U.S. legal system, with lawsuits used only as a last resort, ensured that any conflicts of interest would soon be a thing of the past. D) none of the options

24)

The owners of a business are the A) B) C) D)

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taxpayers. workers. suppliers. shareholders.

25) The massive privatization that is currently taking place in developing and formerly socialist countries A) B) C) D)

26)

will eventually enhance the standard of living to these countries' citizens. depends on private investment. increases the opportunity set facing these countries' citizens. all of the options

A firm with concentrated ownership

A) may give rise to conflicts of interest between dominant shareholders and small outside shareholders. B) may enjoy more accounting transparency than firms with diffuse ownership structures. C) is a partnership, never a corporation. D) none of the options

27)

The ultimate guardians of shareholder interest in a corporation are the A) B) C) D)

28)

rank and file workers. senior management. boards of directors. all of the options

In countries like France and Germany,

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A) managers have often made business decisions with regard to maximizing market share to the exclusion of other goals. B) managers have often viewed shareholders as one of the "stakeholders" of the firm, others being employees, customers, suppliers, banks and so forth. C) managers have often regarded the prosperity and growth of their combines, or families of related firms, as their most critical goal. D) managers have traditionally embraced the maximization of shareholder wealth as the only worthy goal.

29)

When corporate governance breaks down A) B) C) D)

30)

shareholders are unlikely to receive fair returns on their investments. managers may be tempted to enrich themselves at shareholder expense. the board of directors is not doing its job. all of the options

Privatization refers to the process of

A) having government operate businesses for the betterment of the public sector. B) government allowing the operation of privately owned business only. C) prohibiting government operated enterprises. D) a country divesting itself of the ownership and operation of a business venture by turning it over to the free market system.

31)

Deregulation of world financial markets

A) provided a natural environment for financial innovations, like currency futures and options. B) has promoted competition among market participants. C) has encouraged developing countries such as Chile, Mexico, and Korea to liberalize by allowing foreigners to directly invest in their financial markets. D) all of the options

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32)

The emergence of global financial markets is due in no small part to A) B) C) D)

33)

The common monetary policy for the euro zone is now formulated by A) B) C) D)

34)

British pound. Japanese yen. Euro. U.S. dollar.

Prior to World War I ending, the dominant global currency was the A) B) C) D)

36)

the Bundesbank in Germany. the Federal Reserve Bank. the World Bank. the European Central Bank.

Since the end of World War I, the dominant global currency has been the A) B) C) D)

35)

advances in computer and telecommunications technology. enforcement of the Soviet system of state ownership of resources of production. government regulation and protection of infant industries. none of the options

German mark. French franc. Japanese yen. British pound.

The ascendance of the dollar reflects several key factors, such as

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A) B) C) D)

37)

the size of the U.S. population. the mature and open capital markets of the U.S. economy. exchange rate stability. all of the options

The euro A) B) C) D)

is the common currency of Europe. is divisible into 100 cents, just like the U.S. dollar. may eventually have a transaction domain larger than the U.S. dollar. all of the options

38) Since its inception the euro has brought about revolutionary changes in European finance. For example, A) by redenominating corporate bonds and stocks from several different currencies into one common currency, the euro has precipitated the emergence of continent-wide capital markets in Europe that are comparable to U.S. markets in depth and liquidity. B) Swiss bank accounts are all denominated in euro. C) the European banking sector has become much more important as a source of financing for European firms. D) there have actually not been any revolutionary changes.

39)

In David Ricardo's theory of comparative advantage,

A) international trade is a zero-sum game in which one trading partner's gain comes at the expense of another's loss. B) liberalization of international trade will enhance the welfare of the world's citizens. C) is a short-run argument, not a long-run argument. D) has been superseded by the now-orthodox view of mercantilism.

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40)

Under the theory of comparative advantage, liberalization of international trade will

A) enhance the welfare of the world's citizens. B) create unemployment and displacement of workers permanently. C) result in higher prices in the long run as monopolist are able to charge higher prices after eliminating their competitors. D) all of the options

41) Privatization is often seen as a cure for bureaucratic inefficiency and waste; some economists estimate that privatization improves efficiency and reduces operating costs by as much as A) B) C) D)

42)

5 percent. 10 percent. 15 percent. 20 percent.

The World Trade Organization, WTO, A) has the power to enforce the rules of international trade. B) covers agriculture and physical goods, but not services or intellectual property

rights. C) recently expelled China for human rights violations. D) ruled that NAFTA is to be the model for world trade integration.

43)

In November 2018, three member countries of NAFTA signed a new accord called the A) B) C) D)

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US-Mexico-Canada-Agreement New NAFTA Agreement North American Agreement none of the above

44)

In March 2018, a free trade area was created among 11 Pacific Rim Countries including” A) B) C) D)

45)

Privatization A) B) C) D)

46)

Australia, Brunei, and Canada Chile, Japan, and Malaysia Mexico, New Zealand, Peru, Singapore, and Vietnam all of the above

has spurred a tremendous increase in cross-border investment. has allowed many governments to have the funds to nationalize important industries. has guaranteed that new ownership will be limited to the local citizens. has generally decreased the efficiency of the enterprise.

The theory of comparative advantage

A) claims that economic well-being is enhanced if each country's citizens produce only a single product. B) claims that economic well-being is enhanced when all countries compare commodity prices after adjusting for exchange rate differences in order to standardize the prices charged all countries. C) claims that economic well-being is enhanced if each country's citizens produce that which they have a comparative advantage in producing relative to the citizens of other countries, and then trade production. D) claims that no country has an absolute advantage over another country in the production of any good or service.

47) Negotiation of the terms of Brexit with the EU include which of the following key agreements?

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A) a customs union between the UK and the EU should be in place until an alternative long-term relationship can be established B) an end to free movement of people C) no hard border between Northern Ireland and the Republic of Ireland D) all of the above

48) Brexit has some serious difficulties associated with free trade and global integration that espouses A) B) C) D)

49)

A multinational firm can be defined as a firm that

A) B) C) D) countries.

50)

free movements of goods, services, capital and people across countries. free movements of goods and services only. free movments of capital and people across countries. none of the above

invests short-term cash inflows in more than one currency. has sales affiliates in several countries. is incorporated in more than one country. incorporated in one country and has production and sales operations in several other

An MNC may gain from its global presence by

A) spreading R&D expenditures and advertising costs over their global sales. B) pooling global purchasing power over suppliers. C) utilizing their technological and managerial know-how globally with minimum additional costs. D) all of the options

51)

MNCs can use their global presence to

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A) countries. B) C) D)

52)

take advantage of underpriced labor services available in certain developing gain access to special R&D capabilities residing in advanced foreign counties. boost profit margins and create shareholder value. all of the options

Financial managers of MNCs should

A) learn how to manage foreign exchange and political risks using proper tools and instruments. B) deal with (and take advantage of) market imperfections. C) benefit from expanded investment and financing opportunities. D) all of the options

53) A purely domestic firm that sources its products, sells its products, and raises its funds domestically A) can face stiff competition from a multinational corporation that can source its products in one country, sell them in several countries, and raise its funds in a third country. B) can be more competitive than an MNC on its home turf due to superior knowledge of the local market. C) can still face exchange rate risk, just like an MNC. D) all of the options

54)

MNC stands for A) B) C) D)

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Multinational Corporation. Multi-Nationalized Corporation. Military National Cooperation. none of the options

55) Which is growing at a faster rate, foreign direct investment by MNCs or international trade? A) B) C) D)

56)

A true MNC, with operations in dozens of different countries A) B) C) D)

57)

FDI by MNCs International trade Since they are linked, they grow at the same rate. none of the options

must effectively manage foreign exchange risk. can ignore foreign exchange risk since it is diversified. will pay taxes in only its home county. none of the options

An MNC can

A) countries. B) C) D)

be a factor that increases the opportunities of the citizens of less developed be a factor that increases the opportunity set of domestic investors. increase economic efficiency. all of the options

58) Today for an MNC to produce merchandise in one country on capital equipment financed by funds raised in a number of different currencies through issuing securities to investors in many countries, and then selling the finished product to customers in yet other countries is A) B) C) D)

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not uncommon. extremely common. uncommon. illegal.

59) A corporation that can source its products in one country, sell them in another country, and raise the funds in a third country A) B) C) D)

is a multinational corporation. is a domestic firm if all of the shareholders are from the same country. enjoys a built-in hedge against exchange rate risk. enjoys a built-in hedge against political risk.

60) Country A can produce 10 yards of textiles or 6 pounds of food per unit of input. Compute the opportunity cost of producing one additional unit of food instead of textiles. A) B) C) D)

61)

1.67 pounds of food per yard of textiles 1.67 yards of textiles per pound of food 0.6 pounds of food per yard of textiles 0.6 yards of textiles per pound of food

The gains from trade

A) are likely realized in the long run when workers and firms have had the time to adjust to the new competitive environment. B) are immediately realized in the short run, when governments drop protectionist policies. C) are smaller than the costs of adjustment. D) none of the options

62)

Restrictions or impediments to free trade include such things as A) B) C) D)

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import quotas. import tariffs. costly transportation. all of the options

63) Suppose that country A is twice as good at producing widgets as country B. If the currency of B is twice as valuable as the currency of A, A) B) C) D)

64)

the comparative advantage will shift to an absolute advantage. trade will be an improved outcome for both A and B. the comparative advantage could be canceled out. none of the options

Comparative advantage

A) is also known as relative efficiency. B) can lead to trade even in the face of absolute efficiency. C) exists when one party can produce a good or service at a lower opportunity cost than another party. D) all of the options

65) Country A can produce 10 yards of textiles or 6 pounds of food per unit of input. Country B can produce 8 yards of textiles or 5 pounds of food per unit of input. Which of the following statements is true? A) B) C) D)

66)

Country A is relatively more efficient than Country B in the production of food. Country B is relatively more efficient than Country A in the production of textiles. Country A is relatively more efficient than Country B in the production of textiles. none of the options

Underlying the theory of comparative advantage are assumptions regarding

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A) free trade between nations. B) that the factors of production (land, labor, capital, and entrepreneurial ability) are relatively immobile. C) that the factors of production (land, labor, capital, and entrepreneurial ability) are relatively mobile. D) free trade between nations and that the factors of production (land, labor, capital, and entrepreneurial ability) are relatively immobile.

67) If one country is twice the size of another country and is better at making almost everything than the benighted citizens of the smaller country, A) B) C) D)

the bigger country enjoys an absolute advantage. the bigger country enjoys an relative advantage. the bigger country enjoys a comparative advantage. there is not enough information to make a determination.

68) Country A can produce 10 yards of textiles or 6 pounds of food per unit of input. Country B can produce 8 yards of textiles or 5 pounds of food per unit of input. A) Country A is relatively more efficient than Country B in the production of food. B) Country B is relatively more efficient than Country A in the production of food. C) Country A has an absolute advantage over Country B in the production of food and textiles. D) Country B is relatively more efficient than Country A in the production of food, but Country A has an absolute advantage over Country B in the production of food and textiles.

69) Country A can produce 10 yards of textiles or 6 pounds of food per unit of input. Country B can produce 8 yards of textiles or 5 pounds of food per unit of input.

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A) B) C) textiles. D)

Country A is relatively more efficient than Country B in the production of textiles. Country B is relatively more efficient than Country A in the production of food. Country A has an absolute advantage over Country B in the production of food and all of the options

70) Consider the no-trade input/output situation presented in the following table and graph for countries A and B. Assuming that free trade is legal; develop a scenario that will benefit the citizens of both countries. Input/Output without Trade Country A

Total

I. Total Potential Output (lbs. or yard; 000,000s) Food

600

500

1,100

1,200

500

1,700

Food

300

400

700

Textiles

200

400

600

Textiles II. Consumption (lbs. or yard; 000,000s)

{MISSING IMAGE} A) B) C) D)

Country B should make all the textiles and trade with Country A for food. Country A should make nothing but textiles and trade with Country B for food. Country B should make all the textiles and Country A should make all the food. Country B should make nothing but textiles and trade with Country A for food.

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71) Countries A and B currently consume 400 units of food and 400 units of textiles each and currently do not trade with one another. The citizens of country A have to give up one unit of food to gain two units of textiles, while the citizens of country B have to give up one unit of textiles to gain two units of food. Their production possibilities curves are shown. {MISSING IMAGE}

Under the theory of comparative advantage

A) The citizens of country A should make food and trade with the citizens of country B for textiles. B) The citizens of country A should make textiles and trade with the citizens of country B for food. C) There are no gains from trade in this example. D) A is twice as good as B at making food and B is twice as good as A at making textiles.

72) Counties A and B currently consume 400 units of food and 400 units of textiles each and currently do not trade with one another. The citizens of country A have to give up one unit of food to gain two units of textiles, while the citizens of country B have to give up one unit of textiles to gain two units of food. Their production possibilities curves are shown. {MISSING IMAGE} Under the theory of comparative advantage, if free trade is allowed, the market clearing price (or exchange rate, if you will) between food and textiles will be A) one unit of food for one unit of textiles. B) somewhere between one unit of food for two units of textiles and two units of food for one unit of textiles. C) one unit of food for two units of textiles. D) two units of food for one unit of textiles.

73) Countries A and B currently consume 400 units of food and 400 units of textiles each and currently do with one another. The citizens of country A have to give up one unit of food to gain two units of textiles, while the not trade citizens of country B have to give up one unit of textiles to gain two units of food. Their production possibilities curves are shown. {MISSING IMAGE} Suppose that trade is allowed and that the international exchange rate between food and textiles is one-for-one. The increased consumption following trade will be

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A) B) C) D)

an increase of 400 units of food and 400 units of textiles. an increase of 1,200 units of food and 1,200 units of textiles. an increase of 800 units of food and 800 units of textiles. there are no gains from trade in this example.

74) In modern times, it is not a country per se but rather a controller of capital and know-how that gives the country in which it is domiciled a comparative advantage over another country. These controllers of capital and technology are A) B) C) D)

75)

the state. the multinational corporations (MNCs). portfolio managers of international mutual funds. none of the options

International trade is

A) a "zero-sum" game in which one country benefits at the expense of another country. B) an "increasing-sum" game at which all players become winners. C) prone to both countries being worse off than had they not participated in international trade. D) none of the options

76)

The doctrine of comparative advantage was first put forth by A) B) C) D)

77)

Adam Smith. David Ricardo. Ricky Ricardo. none of the options

The comparative advantage argument in free trade

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A) B) C) D)

78)

If you can make a good product at a low opportunity cost, A) B) C) D)

79)

ignores the cost of readjustment. is a short-run argument. only works for two goods at a time. none of the options

you would be well served to produce that good and trade for other goods. you should make something else that has a higher value. you should make something else that has a higher opportunity cost. none of the options

A country like North Korea

A) likely rejects the notion of increased opportunity presented by free trade. B) engages in free trade. C) lies on a production possibilities curve superior to South Korea, since North Korea protects its international producers. D) none of the options

80) The table below shows the bushels of wheat and the bottles of beer that North and South Dakota can produce per day of labor under two different hypothetical situations (Cases I and II). Case I

Case II

South Dakota North Dakota South Dakota North Dakota Wheat (bushels)

Beer (bottles)

Which state has an absolute advantage in producing wheat in Case I?

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A) B) C) D)

South Dakota North Dakota Neither state Both states

81) The table below shows the bushels of wheat and the bottles of beer that North and South Dakota can produce per day of labor under two different hypothetical situations (Cases I and II). Case I

Case II

South Dakota North Dakota South Dakota North Dakota Wheat (bushels)

Beer (bottles)

Which state has an absolute advantage in producing beer in Case I? A) B) C) D)

South Dakota North Dakota Neither state Both states

82) The table below shows the bushels of wheat and the bottles of beer that North and South Dakota can produce per day of labor under two different hypothetical situations (Cases I and II). Case I

Case II

South Dakota North Dakota South Dakota North Dakota Wheat (bushels)

Beer (bottles)

Which state has an absolute advantage in producing beer in Case II?

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A) B) C) D)

South Dakota North Dakota Neither state Both states

83) The table below shows the bushels of wheat and the bottles of beer that North and South Dakota can produce per day of labor under two different hypothetical situations (Cases I and II). Case I

Case II

South Dakota North Dakota South Dakota North Dakota Wheat (bushels)

Beer (bottles)

Which state has a comparative advantage in producing beer in Case I? A) B) C) D)

South Dakota North Dakota Neither state Both states

84) The table below shows the bushels of wheat and the bottles of beer that North and South Dakota can produce per day of labor under two different hypothetical situations (Cases I and II). Case I

Case II

South Dakota North Dakota South Dakota North Dakota Wheat (bushels)

Beer (bottles)

Which state has a comparative advantage in wheat production in Case I?

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A) B) C) D)

South Dakota North Dakota Neither state Both states

85) The table below shows the bushels of wheat and the bottles of beer that North and South Dakota can produce per day of labor under two different hypothetical situations (Cases I and II). Case I

Case II

South Dakota North Dakota South Dakota North Dakota Wheat (bushels)

Beer (bottles)

Which state has a comparative advantage in wheat production in Case II? A) B) C) D)

South Dakota North Dakota Neither state Both states

86) The table below shows the bushels of wheat and the bottles of beer that North and South Dakota can produce per day of labor under two different hypothetical situations (Cases I and II). Case I

Case II

South Dakota North Dakota South Dakota North Dakota Wheat (bushels)

Beer (bottles)

What is the relative price of wheat in North Dakota prior to trade in Case II?

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A) B) C) D)

2 bushels of wheat = ½ bottle of beer ½ bushel of wheat = 2 bottles of beer 1 bushel of wheat = ½ bottle of beer 1 bushel of wheat = 2 bottles of beer

87) The table below shows the bushels of wheat and the bottles of beer that North and South Dakota can produce per day of labor under two different hypothetical situations (Cases I and II). Case I

Case II

South Dakota North Dakota South Dakota North Dakota Wheat (bushels)

Beer (bottles)

For case II, in what range must the "international" price of wheat fall? ( i.e., if North and South Dakota trade only with each other, what is the possible range of prices?) A) Between 1 bushel of wheat = 4/3 bottles of beer and 1 bushel of wheat = 2 bottles of beer B) Between 1 bushel of wheat = 3/4 bottles of beer and 1 bushel of wheat = 2 bottles of beer C) Between 1 bushel of wheat = 3/4 bottles of beer and 1 bushel of wheat = ½ bottles of beer D) none of the options

88) The table below shows the bushels of wheat and the bottles of beer that North and South Dakota can produce per day of labor under two different hypothetical situations (Cases I and II). Case I

Case II

South Dakota North Dakota South Dakota North Dakota Wheat (bushels)

Beer (bottles)

For case II, let the international price be 1 bottle = 1 bushel. Derive South Dakota's "trading possibilities curve."

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South Dakota A

Wheet (bushels)

Beer (bottles)

A) B) C) D)

Option A Option B Option C Option D

89) The table below shows the bushels of wheat and the bottles of beer that North and South Dakota can produce per day of labor under two different hypothetical situations (Cases I and II). Case I

Case II

South Dakota North Dakota South Dakota North Dakota Wheat (bushels)

Beer (bottles)

For case II, let the international price be 1 bottle = 1 bushel. Derive North Dakota's "trading possibilities curve." North Dakota A

Wheat (bushels)

Beer (bottles)

A) B) C) D)

Option A Option B Option C Option D

90) The first two columns give the maximum daily amounts of beer and whiskey that Southern Ireland and Northern Ireland can produce when they completely specialize in one or another product. The last two columns give each country's consumption without trade.

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Maximum beer production Northern Ireland Southern Ireland

500 kegs

Maximum whiskey production 1500 kegs

Beer consumption without trade 300 kegs

Beer consumption without trade 600 bottles

1200 kegs

800 kegs

600 kegs

400 bottles

What is the price of beer without trade in Southern Ireland? A) B) C) D)

2 bottles of whiskey = 3 kegs of beer 5 bottles of whiskey = 12 kegs of beer 1 bottle of whiskey = 1 kegs of beer none of the options

91) The first two columns give the maximum daily amounts of beer and whiskey that Southern Ireland and Northern Ireland can produce when they completely specialize in one or another product. The last two columns give each country's consumption without trade. Maximum beer production Northern Ireland Southern Ireland

500 kegs

Maximum whiskey production 1500 kegs

Beer consumption without trade 300 kegs

Beer consumption without trade 600 bottles

1200 kegs

800 kegs

600 kegs

400 bottles

What is the price of beer without trade in Northern Ireland? A) B) C) D)

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2 bottles of whiskey = 3 kegs of beer 5 bottles of whiskey = 12 kegs of beer 2 bottles of whiskey = 1 keg of beer none of the options

92) The first two columns give the maximum daily amounts of beer and whiskey that Southern Ireland and Northern Ireland can produce when they completely specialize in one or another product. The last two columns give each country's consumption without trade. Maximum beer production Northern Ireland Southern Ireland

500 kegs

Maximum whiskey production 1500 kegs

Beer consumption without trade 300 kegs

Beer consumption without trade 600 bottles

1200 kegs

800 kegs

600 kegs

400 bottles

In which product does Northern Ireland have a comparative advantage in producing? A) B) C) D)

Beer Whiskey Neither Both

93) The first two columns give the maximum daily amounts of beer and whiskey that Southern Ireland and Northern Ireland can produce when they completely specialize in one or another product. The last two columns give each country's consumption without trade. Maximum beer production Northern Ireland Southern Ireland

500 kegs

Maximum whiskey production 1500 kegs

Beer consumption without trade 300 kegs

Beer consumption without trade 600 bottles

1200 kegs

800 kegs

600 kegs

400 bottles

Suppose that trade occurs. Each country completely specializes and 500 kegs of beer are traded for 500 bottles of whiskey. What is the international price of beer?

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A) B) C) D)

1 bottle of whiskey = 1 keg of beer 3 bottles of whiskey = 1 keg of beer 2/3 bottle of whiskey = 1 keg of beer 1 bottle of whiskey = 3 kegs of beer

94) The first two columns give the maximum daily amounts of beer and whiskey that Southern Ireland and Northern Ireland can produce when they completely specialize in one or another product. The last two columns give each country's consumption without trade. Maximum beer production Northern Ireland Southern Ireland

500 kegs

Maximum whiskey production 1500 kegs

Beer consumption without trade 300 kegs

Beer consumption without trade 600 bottles

1200 kegs

800 kegs

600 kegs

400 bottles

What is the cost of Northern Ireland producing one additional bottle of whiskey? A) B) C) D)

0.33 kegs of beer 0.66 kegs of beer 1 kegs of beer 3 kegs of beer

95) The first two columns give the maximum daily amounts of beer and whiskey that Southern Ireland and Northern Ireland can produce when they completely specialize in one or another product. The last two columns give each country's consumption without trade. Maximum beer production Northern Ireland Southern Ireland

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500 kegs

Maximum whiskey production 1500 kegs

Beer consumption without trade 300 kegs

Beer consumption without trade 600 bottles

1200 kegs

800 kegs

600 kegs

400 bottles

What is the increased number of goods available in Northern Ireland after trade? A) B) C) D)

400 more bottles of whiskey and 200 more kegs of beer 1,000 more bottles of whiskey and 500 more kegs of beer 200 more bottles of whiskey and 400 more kegs of beer 300 more bottles of whiskey and 300 more kegs of beer

96) The first two columns give the maximum daily amounts of beer and whiskey that Southern Ireland and Northern Ireland can produce when they completely specialize in one or another product. The last two columns give each country's consumption without trade. Maximum beer production Northern Ireland Southern Ireland

500 kegs

Maximum whiskey production 1500 kegs

Beer consumption without trade 300 kegs

Beer consumption without trade 600 bottles

1200 kegs

800 kegs

600 kegs

400 bottles

Suppose that Northern Ireland and Southern Ireland each have 1,000 hours of labor per day. Southern workers are paid €1 per day and Northern workers are paid £1 per day. What is the approximate exchange rate associated with an international price of one keg of beer = 1 bottle of whiskey? A) B) C) D)

€1.14 = £1 €0.80 = £1 €1 = £1 none of the options

97) Consider a dentist and a 14-year old boy. The dentist can make $100 per hour drilling teeth and the 14-year old boy can make $2 per hour picking up used aluminum cans. The dentist can mow his half-acre lot in one hour. The 14-year old boy can mow the lawn in two hours. If the dentist hires the boy to mow his lawn at any price less than $100, but more than $4

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A) B) C) D)

both he and the boy are better off. the dentist would be exploiting the boy. the boy would be exploiting the dentist. all of the options

98) Consider the no-trade input/output situation presented in the following table and graph for South and North Carolina. Assume that free trade is legal. Input/Output without Trade Country South Carolina

North Carolina

Total

Guns

500

250

750

Butter

1,000

750

1,750

Guns

250

200

450

Butter

500

150

650

I. Total Potential Output (lbs. or yards; 000,000s)

II. Consumption (lbs. or yards; 000,000s)

Which state is better at making guns? A) South Carolina B) North Carolina C) The states are equally good at making guns.

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99) Consider the no-trade input/output situation presented in the following table and graph for South and North Carolina. Assume that free trade is legal. Input/Output without Trade Country South Carolina

North Carolina

Total

Guns

500

250

750

Butter

1,000

750

1,750

Guns

250

200

450

Butter

500

150

650

I. Total Potential Output (lbs. or yards; 000,000s)

II. Consumption (lbs. or yards; 000,000s)

How much does it cost for North Carolina to produce one gun? A) B) C) D)

3 pounds of butter .33 pounds of butter 1.33 pounds of butter none of the options

100) Consider the no-trade input/output situation presented in the following table and graph for South and North Carolina. Assume that free trade is legal. Input/Output without Trade Country South Carolina

Version 1

North Carolina

Total

I. Total Potential Output (lbs. or yards; 000,000s) Guns

500

250

750

Butter

1,000

750

1,750

Guns

250

200

450

Butter

500

150

650

II. Consumption (lbs. or yards; 000,000s)

What is the relative price of a gun in terms of butter in South Carolina? A) B) C) D)

1 gun costs 3 pounds of butter. 3 guns cost 1 pounds of butter. 1 gun costs 2 pounds of butter. 2 guns cost 1 pounds of butter.

101) Consider the no-trade input/output situation presented in the following table and graph for South and North Carolina. Assume that free trade is legal. Input/Output without Trade Country South Carolina

North Carolina

Total

Guns

500

250

750

Butter

1,000

750

1,750

I. Total Potential Output (lbs. or yards; 000,000s)

II. Consumption (lbs. or yards; 000,000s)

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Guns

250

200

450

Butter

500

150

650

What is the relative price of a pound of butter in terms of guns in North Carolina? A) B) C) D)

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1 pound of butter costs 0.33 guns. 1 gun costs 0.33 pounds of butter. 1 pound of butter costs 0.66 guns. 2 guns costs 0.66 pounds of butter.

Answer Key Test name: Chap 01_9e 1) D 2) D 3) C 4) A 5) B 6) B 7) A 8) D 9) D 10) A 11) A 12) D 13) D 14) D 15) A 16) B 17) B 18) D 19) C 20) B 21) C 22) A 23) A 24) D 25) D 26) A Version 1

27) C 28) B 29) D 30) D 31) D 32) A 33) D 34) D 35) D 36) B 37) D 38) A 39) B 40) A 41) D 42) A 43) A 44) D 45) A 46) C 47) D 48) A 49) D 50) D 51) D 52) D 53) D 54) A 55) A 56) A Version 1

57) D 58) A 59) A 60) B 61) A 62) D 63) C 64) D 65) C 66) D 67) A 68) D 69) D 70) B 71) B 72) B 73) A 74) B 75) B 76) B 77) A 78) A 79) A 80) A 81) B 82) A 83) B 84) A 85) A 86) D Version 1

87) A 88) C 89) D 90) A 91) C 92) B 93) A 94) A 95) A 96) A 97) A 98) A 99) A 100) C 101) A

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CHAPTER 2 MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 1) The international monetary system can be defined as the institutional framework within which A) B) C) D)

international payments are made. movement of capital is accommodated. exchange rates among currencies are determined. all of the options

2) Corporations today are operating in an environment in which exchange rate changes may adversely affect their competitive positions in the marketplace. This situation, in turn, makes it necessary for many firms to A) B) C) D)

carefully manage their exchange risk exposure. carefully measure their exchange risk exposure. carefully manage and measure their exchange risk exposure. none of the options

3) The international monetary system went through several distinct stages of evolution. These stages are summarized, in alphabetic order, as follows:(i) Bimetallism(ii) Bretton Woods system(iii) Classical gold standard(iv) Flexible exchange rate regime(v) Interwar periodThe chronological order that they actually occurred is: A) B) C) D)

(iii), (i), (iv), (ii), and (v) (i), (iii), (v), (ii), and (iv) (vi), (i), (iii), (ii), and (v) (v), (ii), (i), (iii), and (iv)

4) In the United States, bimetallism was adopted by the Coinage Act of 1792 and remained a legal standard until 1873,

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A) B) minted. C) D)

when Congress dropped the silver dollar from the list of coins to be minted. when Congress dropped the twenty-dollar gold piece from the list of coins to be when gold from the California gold rush drove silver out of circulation. when gold from the California gold rush drove gold out of circulation.

5) The monetary system of bimetallism is unstable. Due to the fluctuation of the commercial value of the metals, A) the metal with a commercial value lower than the currency value tends to be used as metal and is withdrawn from circulation as money (Gresham's Law). B) the metal with a commercial value higher than the currency value tends to be used as money (Gresham's Law). C) the metal with a commercial value higher than the currency value tends to be used as metal and is withdrawn from circulation as money (Gresham's Law). D) none of the options

6) In the 1850s the French franc was valued by both gold and silver, under the official French ratio which equated a gold franc to a silver franc 15½ times as heavy. At the same time, the gold from newly discovered mines in California poured into the market, depressing the value of gold. As a result, A) the franc effectively became a silver currency. B) the franc effectively became a gold currency. C) silver became overvalued under the French official ratio. D) the franc effectively became a silver currency and silver became overvalued under the French official ratio.

Gresham's Law states that

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A) bad money drives good money out of circulation. B) good money drives bad money out of circulation. C) if a country bases its currency on both gold and silver, at an official exchange rate, it will be the more valuable of the two metals that circulate. D) none of the options.

8) Suppose that the pound is pegged to gold at £20 per ounce and the dollar is pegged to gold at $35 per ounce. This implies an exchange rate of $1.75 per pound. If the current market exchange rate is $1.80 per pound, how would you take advantage of this situation? Hint: assume that you have $350 available for investment. A) Start with $350. Buy 10 ounces of gold with dollars at $35 per ounce. Convert the gold to £200 at £20 per ounce. Exchange the £200 for dollars at the current rate of $1.80 per pound to get $360. B) Start with $350. Exchange the dollars for pounds at the current rate of $1.80 per pound. Buy gold with pounds at £20 per ounce. Convert the gold to dollars at $35 per ounce. C) both of the options D) none of the options

9) Suppose that the pound is pegged to gold at £20 per ounce and the dollar is pegged to gold at $35 per ounce. This implies an exchange rate of $1.75 per pound. If the current market exchange rate is $1.60 per pound, how would you take advantage of this situation? Hint: assume that you have $350 available for investment. A) Start with $350. Buy 10 ounces of gold with dollars at $35 per ounce. Convert the gold to £200 at £20 per ounce. Exchange the £200 for dollars at the current rate of $1.80 per pound to get $360. B) Start with $350. Exchange the dollars for pounds at the current rate of $1.60 per pound. Buy gold with pounds at £20 per ounce. Convert the gold to dollars at $35 per ounce. C) both of the options D) none of the options

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10) Suppose that the United States is on a bimetallic standard at $30 to one ounce of gold and $2 for one ounce of silver. If new silver mines open and flood the market with silver, A) only the silver currency will circulate. B) only the gold currency will circulate. C) no change will take place since citizens could exchange their gold currency for silver currency at any time. D) none of the options.

11) Suppose that your country officially defines gold as ten times more valuable than silver (i.e., the central bank stands ready to redeem the currency in gold and silver and the official price of gold is ten times the official price of silver). If the market price of gold is only eight times as much as silver, A) the central bank could go broke if enough arbitrageurs attempt to take advantage of the pricing disparity. B) the central bank will make money since they are overpricing gold. C) the central bank could go broke if enough arbitrageurs attempt to take advantage of the pricing disparity, but will more likely make money since they are overpricing gold D) none of the options.

12) Prior to the 1870s, both gold and silver were used as international means of payment and the exchange rates among currencies were determined by either their gold or silver contents. Suppose that the dollar was pegged to gold at $30 per ounce, the French franc is pegged to gold at 90 francs per ounce and to silver at 9 francs per ounce of silver, and the German mark pegged to silver at 1 mark per ounce of silver. What would the exchange rate between the U.S. dollar and German mark be under this system? A) B) C) D)

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1 German mark = $2 1 German mark = $0.50 1 German mark = $3 1 German mark = $1

13) Prior to the 1870s, both gold and silver were used as international means of payment and the exchange rates among currencies were determined by either their gold or silver contents. Suppose that the dollar was pegged to gold at $30 per ounce, the French franc is pegged to gold at 90 francs per ounce and to silver at 6 francs per ounce of silver, and the German mark pegged to silver at 1 mark per ounce of silver. What would the exchange rate between the U.S. dollar and German mark be under this system? A) B) C) D)

1 German mark = $2 1 German mark = $0.50 1 German mark = $3 1 German mark = $1

14) Suppose that country A and country B are both on a bimetallic standard. In country A the ratio is 15 to one (i.e., an ounce of gold is worth 15 times as much as an ounce of silver in that currency), while in country B the ratio is ten to one. If the free flow of capital is allowed between countries A and B, is this a sustainable framework? A) Yes B) No C) There is not enough information to make an informed determination.

15) Suppose that both gold and silver are used as international means of payment and the exchange rates among currencies are determined by either their gold or silver contents. Suppose that the dollar was pegged to gold at $20 per ounce, the Japanese yen is pegged to gold at 120,000 yen per ounce and to silver at 8,000 yen per ounce of silver, and the Australian dollar is pegged to silver at $5 per ounce of silver. What would the exchange rate between the U.S. dollar and Australian dollar be under this system? A) B) C) D)

16)

$1 U.S. = $1 Australian $1 U.S. = $2 Australian $1 U.S. = $3.75 Australian none of the options

The United States adopted the gold standard in

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A) B) C) D)

17)

The gold standard still has ardent supporters who believe that it provides A) B) C) D)

18)

1776. 1879. 1864. 1973.

an effective hedge against price inflation. fixed exchange rates between all currencies. monetary policy autonomy. all of the options

One potential drawback of the gold standard is that

A) the world economy can be subject to deflationary pressure due to the limited supply of monetary gold. B) the world economy can be subject to inflationary pressure without changes in the supply of monetary gold. C) gold is scarce. D) all of the options

19)

The first full-fledged gold standard

A) was not established until 1821 in Great Britain, when notes from the Bank of England were made fully redeemable for gold. B) was not established until 1780 in the United States, when notes from the Continental Army were made fully redeemable for gold. C) was established in 986 during the Han dynasty in China. D) none of the options

20)

An "international" gold standard can be said to exist when

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A) B) C) D)

gold alone is assured of unrestricted coinage. there is two-way convertibility between gold and national currencies at stable ratios. gold may be freely exported or imported. all of the options

21) Under a gold standard, if Britain exports more to France than France exports to Great Britain, A) B) C) direction. D)

such international imbalances of payment will be corrected automatically. this type of imbalance will not be able to persist indefinitely. net export from Britain will be accompanied by a net flow of gold in the opposite all of the options

22) Suppose that Britain pegs the pound to gold at six pounds per ounce, whereas the exchange rate between pounds and U.S. dollars is $5 = £1. What would an ounce of gold be worth in U.S. dollars? A) B) C) D)

23)

$29.40 $30.00 $0.83 $1.20

During the period of the classical gold standard (1875-1914) there were A) B) C) D) E)

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highly volatile exchange rates. volatile exchange rates. moderately volatile exchange rates. stable exchange rates. no exchange rates.

24)

The majority of countries got off the gold standard in 1914 when A) B) C) D)

the American Civil War ended. World War I broke out. World War II started. none of the options

25) Suppose that Britain pegs the pound to gold at six pounds per ounce, whereas the exchange rate between pounds and U.S. dollars is $1 = £5. What would an ounce of gold be worth in U.S. dollars? A) B) C) D)

$0.42 $1.20 $1.22 $1.74

26) Suppose that Britain pegs the pound to gold at the market price of £6 per ounce, and the United States pegs the dollar to gold at the market price of $36 per ounce. If the official exchange rate between pounds and U.S. dollars is $5 = £1. Which of the following trades is profitable? A) Start with £100 and trade for $500 at the official exchange rate. Redeem the $500 for 13.89 ounces of gold. Trade the gold for £83.33. B) Start with $100 and buy gold. Sell the gold for £16.67. Sell the pounds at the official exchange rate. C) Start with £100 and buy gold. Sell the gold for $600. D) Start with $500 and trade for £100 at the official exchange rate. Redeem the £100 for 16 2/3 ounces of gold. Trade the gold for $600.

27) Assume that a country is on the gold standard. In order to support unrestricted convertibility into gold, banknotes need to be backed by a gold reserve of some minimum stated ratio. In addition,

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A) the domestic money stock should rise and fall as gold flows in and out of the country. B) the central bank can control the money supply by buying or selling the foreign currencies. C) the domestic money stock should rise and fall as gold flows in and out of the country and the central bank can control the money supply by buying or selling the foreign currencies. D) none of the options

28) Under the gold standard, international imbalances of payment will be corrected automatically under the A) B) C) D)

29)

Gresham Exchange Rate regime. European Monetary System. Price-specie-flow mechanism. Bretton Woods Accord.

During the period between World War I and World War II,

A) the major European powers and the U.S. returned to the gold standard and fixed exchange rates. B) while most countries abandoned the gold standard during World War I, international trade and investment flourished during the interwar period under a coherent international monetary system. C) the U.S. dollar emerged as the dominant world currency, gradually replacing the British pound for the role. D) none of the options

30) During the period between World War I and World War II, many central banks followed a policy of sterilization of gold

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A) by restricting the rate of growth in the supply of gold. B) by matching inflows and outflows of gold respectively with reductions and increases in domestic money and credit. C) by matching inflows and outflows of gold respectively with increases and reductions in domestic money and credit. D) none of the options

31) The price-specie-flow mechanism will work only if governments are willing to play by the rules of the game by letting the money stock rise and fall as gold flows in and out. Once the government demonetizes (neutralizes) gold, the mechanism will break down. In addition, the effectiveness of the mechanism depends on A) B) C) D)

the income elasticity of the demand for imports. the price elasticity of the demand for imports. the price elasticity of the supply of imports. the income elasticity of the supply of imports.

32) During the period between World War I and World War II, the political reality was characterized by A) B) C) D)

33)

halfhearted attempts and failure to restore the gold standard. political instabilities and bank failures. panicky flights of capital across borders. all of the options

At the outbreak of World War I

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A) major countries such as Great Britain, France, Germany and Russia suspended redemption of banknotes in gold. B) major countries such as Great Britain, France, Germany and Russia imposed embargoes on the export of gold. C) the classical gold standard was abandoned. D) all of the options

34)

The core of the Bretton Woods system was the A) B) C) D)

35)

World Bank. IMF. United Nations. Interstate Commerce Commission.

The Bretton Woods system was named after

A) the treasury secretary of the United States in 1945, Bretton Woods. B) Bretton Woods, New Hampshire, where the Articles of Agreement of the International Monetary Fund (IMF) were hammered out. C) the treasury secretary of the United States in 1945, Bretton Woods, as well as Bretton Woods, New Hampshire, where the Articles of Agreement of the International Monetary Fund (IMF) were hammered out. D) none of the options

36)

The Bretton Woods agreement resulted in the creation of A) B) C) D)

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the bancor as an international reserve asset. the World Bank. the Exim bank. the Federal Reserve Bank.

37)

The Triffin paradox

A) was first proposed by Professor Robert Triffin. B) warned that the gold-exchange system of the Bretton Woods agreement was programmed to collapse in the long run. C) was indeed responsible for the eventual collapse of the dollar-based gold-exchange system in the early 1970s. D) all of the options

38)

Under the Bretton Woods system

A) there was an explicit set of rules about the conduct of international monetary policies. B) each country was responsible for maintaining its exchange rate within 1 percent of the adopted par value by buying or selling foreign exchanges as necessary. C) the U.S. dollar was the only currency that was fully convertible to gold. D) All the choices are correct.

39) Under the Bretton Woods system each country established a par value for its currency in relation to the dollar. And the U.S. dollar was pegged to gold at A) B) C) D)

$1 per ounce. $35 per ounce. $350 per ounce. $900 per ounce.

40) Under the Bretton Woods system, each country was responsible for maintaining its exchange rate within ±1 percent of the adopted par value by

Version 1

A) B) C) D)

41)

buying or selling foreign exchanges as necessary. buying or selling gold as necessary. expanding or contracting the supply of loanable funds as necessary. increasing or decreasing their money supply as necessary.

Under the Bretton Woods system,

A) the U.S. dollar was the only currency that was fully convertible to gold; other currencies were not directly convertible to gold. B) all currencies of member states were fully convertible to gold. C) all currencies of member states were fully convertible to gold or silver. D) none of the options

42) In 1963, President John Kennedy imposed the Interest Equalization Tax (IET) on U.S. purchases of foreign securities. The IET was designed to A) B) C) D)

43)

decrease the cost of foreign borrowing in the U.S. bond market. increase the cost of foreign borrowing in the U.S. bond market. decrease the cost of domestic borrowing in the U.S. bond market. increase the cost of domestic borrowing in the U.S. bond market.

The growth of the Eurodollar market, which is a transnational, unregulated fund market A) was encouraged by U.S. legislation designed to stem the outflow of dollars from the

U.S. B) was discouraged by U.S. legislation designed to stem the outflow of dollars from the U.S. C) was neither encouraged nor discouraged by U.S. legislation designed to stem the outflow of dollars from the U.S. D) none of the options

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44)

In the years leading to the collapse of the Bretton Woods system A) it became clear that the dollar was undervalued. B) it became clear that the dollar was overvalued.

45)

Under the Bretton Woods system

A) each country established a par value for its currency in relation to the dollar. B) the U.S. dollar was pegged to gold at $35 per ounce. C) each country was responsible for maintaining its exchange rate within 1 percent of the adopted par value by buying or selling foreign exchanges as necessary. D) all of the options

46)

Special Drawing Rights (SDR) are

A) an artificial international reserve allotted to the members of the International Monetary Fund (IMF), who can then use it for transactions among themselves or with the IMF. B) a "portfolio" of currencies, and its value tends to be more stable than the currencies that it is comprised of. C) used in addition to gold and foreign exchanges, to make international payments. D) All of these choices are correct.

47)

The Bretton Woods system ended in A) B) C) D)

48)

1945. 1973. 1981. 2001.

Since the end of the fixed exchange rate system of the Smithsonian agreement

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A) B) C) D)

49)

exchange rates were revalued in the Bretton Woods agreement. exchange rates have been allowed to float. the United States returned to a gold standard. the zone of monetary stability has been limited to the U.S., Canada, and Mexico.

Since the SDR is a "portfolio" of currencies

A) its value tends to be more stable than the value of any of the individual currencies included in the SDR. B) its value tends to be less stable than the value of any of the individual currencies included in the SDR. C) its value tends to be as stable as the average of the individual currencies included in the SDR. D) none of the options

50)

Which of the following statements regarding the gold-exchange standard are true?

A) A country on the gold-exchange standard holds very little of its reserves in the form of currency of a country. B) Advocates in favor argue that the system economizes on gold because countries cannot use gold in foreign exchanges as an international means of payment. C) A country on the gold-exchange standard holds most of its reserves in the form of currency of a country and advocates in favor argue that the system economizes on gold because countries can use gold in foreign exchanges as an international means of payment are correct. D) none of the options are true

51)

Put the following in correct date order: A) B) C) D)

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Jamaica Agreement, Bretton Woods Agreement, Smithsonian Agreement. Smithsonian Agreement, Bretton Woods Agreement, Jamaica Agreement. Bretton Woods Agreement, Smithsonian Agreement, Jamaica Agreement. Bretton Woods Agreement, Jamaica Agreement, Smithsonian Agreement.

52)

Put the following in correct date order: A) B) C) D)

53)

The G-7 is composed of A) B) C) D)

54)

Canada, France, Japan, Germany, Italy, the U.K., and the United States. Switzerland, France, Japan, Germany, Italy, the U.K., and the United States. Switzerland, France, North Korea, Germany, Italy, the U.K., and the United States. Switzerland, France, Japan, Germany, Canada, the U.K., and the United States.

Gold was officially abandoned as an international reserve asset A) B) C) D)

55)

Jamaica Agreement, Plaza Agreement, Louvre Accord. Plaza Agreement, Jamaica Agreement, Louvre Accord. Louvre Accord, Jamaica Agreement, Plaza Agreement. Jamaica Agreement, Louvre Accord, Plaza Agreement.

in the January 1976 Jamaica Agreement. in the 1971 Smithsonian Agreement. in the 1944 Bretton Woods Agreement. none of the options

Following the demise of the Bretton Woods system, the IMF

A) created a new role for itself, providing loans to countries facing balance-ofpayments and exchange rate difficulties. B) ceased to exists, since the era of fixed exchange rates had ended. C) became the sole agent responsible for maintaining fixed exchange rates. D) became the central bank of the United Nations.

56) Under a flexible exchange rate regime, governments can retain monetary policy independence because the external balance will be achieved by Version 1

A) B) C) D)

the exchange rate adjustments. the price-specie flow mechanism. the Triffin paradox. none of the options

57) The choice between the alternative exchange rate regimes (fixed or floating) is likely to involve a trade-off between A) B) C) D)

58)

national monetary policy autonomy and international economic integration. exchange rate uncertainty and national policy autonomy. balance of payments autonomy and inflation. unemployment and inflation.

Under a purely flexible exchange rate system A) B) C) D)

supply and demand set the exchange rates. governments can set the exchange rate by buying or selling reserves. governments can set exchange rates with fiscal policy. governments can set the exchange rate by buying or selling reserves and with fiscal

policy.

59)

A currency board arrangement is

A) when the currency of another country circulates as the sole legal tender. B) when the country belongs to a monetary or currency union in which the same legal tender is shared by the members of the union. C) a monetary regime based on an explicit legislative commitment to exchange domestic currency for a specified foreign currency at a fixed exchange rate, combined with restrictions on the issuing authority to ensure the fulfillment of its legal obligation. D) where the country pegs its currency at a fixed rate to a major currency where the exchange rate fluctuates within a narrow margin of less than one percent.

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60)

A conventional peg refers to.

A) involves the confirmation of the country authorities’ de jure exchange rate arrangement. B) when a country formally pegs its currency at a fixed rate to another currency or basket of currencies where the basket reflects the geographic distribution of trade, services, or capital flows. C) where the exchange rate remains within a narrow margin of 2 percent relative to a statistically identified trend for six months or more, and the exchange rate arrangement cannot be considered as floating. D) where the exchange rate is largely market determined without an ascertainable or predictable path for the rate.

61)

A crawl-like arrangement refers to:

62)

A floating exchange rate is:

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63)

A crawling peg is:

64) Ecuador does not have its own national currency, circulating the U.S. dollar instead. About how many countries do not have their own national currency? A) B) C) D)

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10 20 30 40

65) With regard to the current exchange rate arrangement between the U.S. and the U.K., it is best characterized as A) B) C) D)

independent floating (market determined). managed float. currency board. pegged exchange rate within a horizontal band.

66) With regard to the current exchange rate arrangement between Italy and Germany, it is best characterized as A) B) C) D)

independent floating (market determined). managed float. an exchange arrangement with no separate legal tender. pegged exchange rate within a horizontal band.

67) On January 1, 1999, an epochal event took place in the arena of international finance when A) B) C) D)

all EU countries adopted a common currency called the euro. eight of 15 EU countries adopted a common currency called the euro. nine of 15 EU countries adopted a common currency called the euro. eleven of 15 EU countries adopted a common currency called the euro.

68) The advent of the euro marks the first time that sovereign countries have voluntarily given up their A) B) C) D)

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national borders to foster economic integration. monetary independence to foster economic integration. fiscal policy independence to foster economic integration. national debt to foster economic integration.

69) To pave the way for the European Monetary Union, the member countries of the European Monetary System agreed to achieve a convergence of their economies. Which of the following is not a condition of convergence: A) B) C) D)

70)

The European Monetary System (EMS) has the chief objective(s) A) B) C) D)

71)

keep the ratio of government budget deficits to GDP below 3 percent. keep gross public debts below 60 percent of GDP. achieve a high degree of price stability. maintain its currency at a fixed exchange rate to the ERM.

to establish a "zone of monetary stability" in Europe. to coordinate exchange rate policies vis-à-vis the non-EMS currencies. to pave the way for the eventual European monetary union. all of the options

The Exchange Rate Mechanism (ERM) is A) the procedure by which ERM member countries collectively manage their exchange

rates. B) based on a "parity-grid" system, which is a system of par values among ERM countries. C) the procedure by which ERM member countries collectively manage their exchange rates and is based on a "parity-grid" system, which is a system of par values among ERM countries. D) none of the options

72)

The Maastricht Treaty

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A) irrevocably fixed exchange rates among the member currencies. B) commits the members of the European Union to political union as well as monetary union. C) was signed and subsequently ratified by the 12 member states. D) all of the options

73) The single European currency, the euro, was adopted by 11 member nations on January 1 of what year? A) B) C) D)

74)

Benefits from adopting a common European currency include A) B) C) D)

75)

reduced transaction costs. elimination of exchange rate risk. increased price transparency, which promotes Europe-wide competition. all of the options

Monetary policy for the countries using the euro as a currency is now conducted by A) B) C) D)

76)

1984 1991 1999 2001

the Federal Reserve. the Bundesbank. European Central Bank. none of the options

Following the introduction of the euro, the national central banks of the euro-12 nations

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A) disbanded. B) formed the EIB, which is analogous to the Federal Reserve System in the U.S. C) ceased to perform important functions in their jurisdictions. D) formed the ESCB, which is analogous to the Federal Reserve System in the U.S., and continue to perform important functions in their jurisdictions.

77)

The main cost of European monetary union is A) B) C) D)

78)

The euro zone is remarkably comparable to the United States in terms of A) B) C) D)

79)

the loss of national monetary and exchange rate policy independence. increased exchange rate uncertainty. lessened political integration. none of the options

population size. GDP. international trade share. all of the options

Which country is not using the euro? A) B) C) D)

Greece Italy Sweden Portugal

80) Once the changeover to the euro was completed by July 1, 2002, the legal-tender status of national currencies in the euro zone

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A) B) C) D)

81)

was canceled, leaving the euro as the sole legal tender in the euro zone countries. was affirmed at the fixed exchange rate. was tied to gold. none of the options

According to the theory of optimum currency areas,

A) the relevant criterion for identifying and designing a common currency zone is the degree of factor (i.e., capital and labor) mobility within the zone. B) exchange rates should reflect the degree to which workers are willing to move to get a better job. C) exchange rates are determined by portfolio managers seeking the highest return. D) none of the options

82) Willem Duisenberg, the first president of the European Central Bank, defined "price stability" as an annual inflation rate of A) B) C) D)

83)

"no more than five percent." "less than but close to 2 percent." "absolutely no more than zero percent." "no more than three percent."

Robert A. Mundell won the Nobel Memorial Prize in Economic Science. He was

A) one of the intellectual fathers of both the new European common currency and Reagan-era supply-side economics. B) one of the intellectual fathers of both the new European common currency and Reagan-era Keynesian economics. C) one of the intellectual fathers of both the Bretton Woods currency agreement and Keynesian economics. D) none of the options

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84)

In the EU, there is a A) low degree of fiscal integration among EU countries. B) high degree of fiscal integration among EU countries.

85)

When money can move freely across borders, policy makers must choose between A) B) C) D)

86)

exchange-rate stability and an economic growth. exchange-rate stability and inflation. exchange-rate stability and an independent monetary policy. exchange-rate stability and capital controls.

The Mexican Peso Crisis was touched off by

A) an unsurprising announcement by the Mexican government to devalue the peso against the dollar by 14 percent. B) an unexpected announcement by the Mexican government to devalue the peso against the dollar by 14 percent. C) an announcement by the Mexican government to enact a currency board arrangement with the U.S. dollar. D) contagion from other Latin American and Asian financial markets.

87) Prior to the peso crisis, Mexico depended on foreign portfolio capital to finance its economic development. This foreign capital influx A) B) C) D)

88)

caused higher domestic inflation. led to an overvalued peso. helped Mexico's trade balances. caused higher domestic inflation and led to an

overvalued peso.

The Mexican peso crisis is significant in that

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A) it is perhaps the first serious international financial crisis touched off by crossborder flight of portfolio capital. B) selling by international portfolio managers had a highly destabilizing, contagious effect on the world financial system. C) it provides a cautionary tale that as the world's financial markets are becoming more integrated, this type of contagious financial crisis is likely to occur more often. D) all of the options

89)

The Asian Currency Crisis

A) happened just prior to the Mexican peso crisis. B) turned out to be far more serious than the Mexican peso crisis in terms of the extent of contagion. C) was limited to Asian currencies. D) was almost over before anyone outside the Pacific Rim noticed.

90) Generally speaking, liberalization of financial markets when combined with a weak, underdeveloped domestic financial system tends to A) B) C) D)

strengthen the domestic financial system in the short run. create an environment susceptible to currency and financial crises. raise interest rates and lead to domestic recession. none of the options

91) According to the "Trilemma" a country can attain only two of the following three conditions: (1) A fixed exchange rate, (2) free international flows of capital, and (3) an independent monetary policy. This difficulty is also known as A) B) C) D)

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the incompatible trinity. the Iron Triangle. the Tobin tax. none of the options

92)

Another name for the incompatible trinity is the A) B) C) D)

93) a

To avoid currency crisis in the face of fully integrated capital markets, a country can have

A) B) C) D)

94)

Tobin Tax. Triffin Paradox. Trilemma. none of the options

floating exchange rate only. fixed exchange rate only. fixed exchange rate that adjusts. floating and fixed exchange rates can both help to avoid currency crises.

During the 1990s there A) B) C) D)

were three major currency crises. were two major currency crises. was only one currency crisis. were no major currency crises.

95) Which factors are related to the collapse of the Argentine currency board system and ensuing economic crisis? A) B) C) D)

96)

The lack of fiscal discipline on the part of the Argentine government Labor market inflexibility Contagion from the financial crises in Russia and Brazil all of the options

Prior to the Argentine Peso Crisis

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A) Argentina had a "dirty float" where the government allowed the exchange rate to float within wide bands. B) Argentina had a currency board arrangement with the peso pegged to the U.S. dollar at parity. C) the Argentine government defaulted on its international debts. D) weakening of the U.S. dollar led the Argentine government to abandon dollarization.

97)

A "good" (or ideal) international monetary system should provide A) B) C) D)

98)

A central bank can fix an exchange rate A) B) C) D)

99)

in perpetuity. only for as long as the market believes that it has the political will to do so. only for as long as it has reserves of gold. only for as long as it has independence of monetary policy.

A booming economy with a fixed or stable nominal exchange rate A) B) C) D)

100)

liquidity, elasticity, and flexibility. elasticity, sensitivity, and reliability. liquidity, adjustments, and confidence. none of the options

inevitably brings about an appreciation of the real exchange rate. inevitably brings about a depreciation of the real exchange rate. inevitably brings about a stabilization of the real exchange rate. inevitably brings about increased volatility of the real exchange rate.

Advantages of a flexible exchange rate include which of the following?

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A) National policy autonomy. B) Easier external adjustments. C) The government can use monetary and fiscal policies to pursue whatever economic goals it chooses. D) all of the options

101)

Advantages of a fixed exchange rate include A) B) C) D)

102)

reduction in exchange rate risk for businesses. reduction in transactions costs. reduction in trading frictions. all of the options

Generally speaking, a country would be more prone to asymmetric shocks A) B) C) D)

the more diversified and less trade-dependent its economy is. the less diversified and more trade-dependent its economy is. the less diversified and less trade-dependent its economy is. the more diversified and more trade-dependent its economy is.

103) Once capital markets are integrated, it is difficult for a country to maintain a fixed exchange rate. Why? A) The market forces may be stronger than the exchange rate intervention that the government can muster. B) Portfolio managers will not invest in countries with fixed exchange rates. C) Because of the Tobin Tax. D) none of the options

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104) Consider the supply-demand framework for the British pound relative to the U.S. dollar shown in the following chart. The exchange rate is currently $1.80 = £1.00. Which of the following is correct?

A) At an exchange rate of $1.80 = £1.00, demand for British pounds exceeds supply. B) At an exchange rate of $1.80 = £1.00, supply for British pounds exceeds demand. C) Under a flexible exchange rate regime, the U.S. dollar will depreciate to an exchange rate of $1.90 = £1.00. D) At an exchange rate of $1.80 = £1.00, demand for British pounds exceeds supply. Additionally, under a flexible exchange rate regime, the U.S. dollar will depreciate to an exchange rate of $1.90 = £1.00.

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105) Consider the supply-demand framework for the British pound relative to the U.S. dollar shown in the following chart. The exchange rate is currently $1.80 = £1.00. Which of the following is correct?

A) To "fix" the exchange rate at $1.80 = £1.00, the Federal Reserve could use contractionary monetary policy to shift the demand curve to the left. B) To "fix" the exchange rate at $1.80 = £1.00, the U.S. government could use contractionary fiscal policy to shift the demand curve to the left. C) The British Government could use fiscal or monetary policy to shift the supply curve to the right to fix the exchange rate to $1.80 = £1.00. D) all of the options

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Answer Key Test name: Chap 02_9e 1) D 2) C 3) B 4) A 5) C 6) B 7) A 8) A 9) B 10) A 11) A 12) C 13) A 14) B 15) C 16) B 17) A 18) A 19) A 20) D 21) D 22) B 23) D 24) B 25) B 26) D Version 1

27) A 28) C 29) C 30) B 31) B 32) C 33) B 34) A 35) B 36) B 37) D 38) D 39) B 40) A 41) A 42) B 43) A 44) B 45) D 46) D 47) B 48) B 49) A 50) C 51) C 52) A 53) A 54) A 55) A 56) A Version 1

57) A 58) A 59) C 60) B 61) C 62) D 63) A 64) D 65) A 66) C 67) D 68) B 69) D 70) D 71) C 72) D 73) C 74) D 75) C 76) D 77) A 78) A 79) C 80) A 81) A 82) B 83) A 84) A 85) C 86) B Version 1

87) D 88) D 89) B 90) B 91) A 92) C 93) D 94) A 95) D 96) D 97) C 98) B 99) A 100) D 101) D 102) B 103) A 104) D 105) D

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CHAPTER 3 TRUE/FALSE - Write 'T' if the statement is true and 'F' if the statement is false. 1) If the United States imports more than it exports, one possible outcome is the supply of dollars is likely to exceed the demand in the foreign exchange market, ceteris parius. ⊚ ⊚

true false

MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 2) The current account balance, which is the difference between a country's exports and imports, is a component of the country's GNP. Other components of GNP include A) B) C) D)

consumption and investment and government expenditure. consumption and government expenditure and net exports. consumption and net exports and government expenditure. consumption less imports.

Balance of payments

A) is defined as the statistical record of a country's international transactions over a certain period of time presented in the form of a double-entry bookkeeping. B) provides detailed information concerning the demand and supply of a country's currency. C) can be used to evaluate the performance of a country in international economic competition. D) all of the options

4) If a country is grappling with a major balance-of-payment difficulty, it may not be able to expand imports from the outside world. Instead, the country may be tempted to

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A) B) C) D)

impose measures to restrict imports but encourage capital outflows. impose measures to discourage capital outflows but encourage imports. impose measures to restrict imports and discourage capital outflows. none of the options

If the United States imports more than it exports, then

A) the supply of dollars is likely to exceed the demand in the foreign exchange market, ceteris paribus. B) one can infer that the U.S. dollar would be under pressure to depreciate against other currencies. C) both options are correct D) none of the options

Generally speaking, any transaction that results in a receipt from foreigners A) B) C) D)

Generally speaking, any transaction that results in a payment to foreigners A) B) C) D)

will be recorded as a debit, with a negative sign, in the U.S. balance of payments. will be recorded as a debit, with a positive sign, in the U.S. balance of payments. will be recorded as a credit, with a negative sign, in the U.S. balance of payments. will be recorded as a credit, with a positive sign, in the U.S. balance of payments.

The balance of payments records

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A) B) C) D)

only international trade, (exports and imports). only cross-border investments (FDI and portfolio investment). not only international trade, (exports and imports) but also cross-border investments. none of the options

Credit entries in the U.S. balance of payments

A) result from foreign sales of U.S. goods and services, goodwill, financial claims, and real assets. B) result from U.S. purchases of foreign goods and services, goodwill, financial claims, and real assets. C) give rise to the demand for dollars. D) give rise to the supply of dollars. E) result from foreign sales of U.S. goods and services, goodwill, financial claims, and real assets, and give rise to the demand for dollars.

10)

A country experiencing a significant balance-of-payments surplus would be likely to

A) expand imports, offering marketing opportunities for domestic enterprises. B) encourage imposing foreign exchange restrictions. C) expand exports, offering international marketing opportunities for domestic enterprises. D) expand imports, offering marketing opportunities for foreign enterprises, and encourage imposing foreign exchange restrictions.

11) Suppose the McDonalds Corporation imports Canadian beef, paying for it by transferring the funds to a New York bank account kept by the Canadian beef producer. A) B) C) D)

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Payment by McDonalds will be recorded as a debit. The deposit of the funds by the seller will be recorded as a debit. Payment by McDonalds will be recorded as a credit. The deposit of the funds by the buyer will be credit.

12)

Since the balance of payments is presented as a system of double-entry bookkeeping,

A) every credit in the account is balanced by a double-matching debit. B) every debit in the account is balanced by a double-matching credit. C) every credit in the account is balanced by a matching debit and every debit in the account is balanced by a matching credit. D) none of the options

13) Suppose the InBev Corporation (a non-U.S. MNC) buys the Anheuser-Busch Corporation, paying the U.S. shareholders cash. A) B) C) D)

14)

Payment by InBev will be recorded as a debit. The deposit of the funds by the sellers will be recorded as a debit. Payment by InBev will be recorded as a credit. The deposit of the funds by the buyer will be credit.

The current account includes

A) the export and import of goods and services. B) all purchases and sales of assets such as stocks, bonds, bank accounts, real estate, and businesses. C) all purchases and sales of international reserve assets such as dollars, foreign exchanges, gold, and special drawing rights (SDRs). D) capital transfers and the cross-border acquisition and disposal of nonproduced non¬financial assets such as natural resources and marketing assets

15)

A country with a current account surplus

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A) acquires IOUs from foreigners, thereby increasing its net foreign wealth. B) must borrow from foreigners or draw down on its previously accumulated foreign wealth. C) will experience a reduction in the country's net foreign wealth. D) must borrow from foreigners or draw down on its previously accumulated foreign wealth and will experience a reduction in the country's net foreign wealth.

16)

The capital account includes

A) the export and import of goods and services. B) capital transfers and acquisitions and disposals of nonpro¬duced, nonfinancial assets between U.S. residents and foreigners. C) all purchases and sales of international reserve assets such as dollars, foreign exchanges, gold, and special drawing rights (SDRs). D) goods trade, services, primary income, and secondary income

17)

The official reserve account includes

18)

A country's international transactions can be grouped into the following three main types: A) B) C) D)

current account, medium term account, and long term capital account. current account, long term capital account, and official reserve account. current account, capital account, financial account and official reserve account. capital account, official reserve account, trade account.

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19)

Invisible trade:refers to A) B) C) D)

20)

services that avoid tax payments. the underground economy. trades in legal, consulting, and engineering services. the export and import of tangible goods.

A country that gives foreign aid to another country can be viewed as A) importing goodwill from the latter. B) exporting goodwill to the latter.

21) In 2012, the United States had a current account deficit. The current account deficit implies that the United States A) B) C) D)

22)

The current account is divided into four finer categories: A) B) C) D)

23)

had a surplus on legal consulting and engineering services. produced more output than it consumed. consumed more output than it produced. had a financial account surplus

goods trade, services, primary incom, and statistical discrepancy. goods trade, services, primary income and secondary income goods trade, services, foreign direct investment, and portfolio investment. goods trade, services, factor income, and direct investment.

Primary income

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A) consists largely of payments and receipts of interest, dividends, and other income on foreign investments. B) involve “unrequited payments” such as foreign aid and gifts. C) do not generally involve commercial entities. D) includes payments and receipts for legal, consulting, financial and engineering services.

24)

The "J-curve effect" shows

A) the initial deterioration and the eventual improvement of a country's trade balance following a currency depreciation. B) the initial improvement and the eventual depreciation of a country's trade balance following a currency depreciation. C) the trade balance's lack of responsiveness to the exchanges rate changes. D) none of the options

25)

A currency depreciation will begin to improve the trade balance immediately A) B) C) D)

26)

When a country's currency depreciates against the currencies of major trading partners, A) B) C) D)

27)

if the demand for imports and exports are inelastic. if the demand for imports and exports are elastic. if imports decrease and exports decrease. if imports and exports increase

the country's exports tend to rise and imports fall. the country's exports tend to fall and imports rise. the country's exports tend to rise and imports rise. the country's exports tend to fall and imports fall.

A depreciation will begin to improve the trade balance immediately if

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A) imports and exports are responsive to the exchange rate changes. B) imports and exports are inelastic to the exchange rate changes. C) consumers exhibit brand loyalty and price inelasticity. D) imports and exports are inelastic to the exchange rate changes and consumers exhibit brand loyalty and price inelasticity.

28)

In the short run a currency depreciation can make a trade balance worse if A) B) C) D)

29)

In the long run, both exports and imports tend to be A) B) C) D)

30)

there is no domestic producer of an import. there is no domestic buyer for an import. there is no export market for a country's output. none of the options

unresponsive to changes in exchange rates. responsive to changes in exchange rates. negative influences on the trade balance. of no influence to the trade balance.

The difference between Foreign Direct Investment and Portfolio Investment is that

A) Portfolio Investment mostly represents the sale and purchase of foreign financial assets such as stocks and bonds that do not involve a transfer of control. B) Foreign Direct Investment mostly represents the sale and purchase of foreign financial assets such as stocks whereas Portfolio Investment mostly involves the sales and purchase of foreign bonds. C) Portfolio Investment takes place as firms attempt to take advantage of various market imperfections. D) all of the options

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31)

In the latter half of the 1980s, with a strong yen, Japanese firms A) faced difficulty exporting. B) could better afford to acquire U.S. assets that had become less expensive in terms of

yen. C) financed a sharp increase in Japanese FDI in the United States. D) all of the options

32)

International portfolio investments have boomed in recent years, as a result of A) B) C) D)

33)

If the interest rate rises in the U.S. while other variables remain constant A) B) C) D)

34)

a depreciating U.S. dollar. increased gasoline and other commodity prices. the general relaxation of capital controls and regulation in many countries. none of the options

capital inflows into the U.S. will increase. capital inflows into the U.S. may not materialize. capital will flow out of the U.S. none of the options

The financial account measures

A) the sum of U.S. sales of assets to foreigners and U.S. purchases of foreign assets. B) the difference between U.S. sales of assets to foreigners and U.S. purchases of foreign assets. C) the difference between U.S. sales of manufactured goods to foreigners and U.S. purchases of foreign products. D) none of the options

35)

When Honda, a Japanese auto maker, built a factory in Ohio,

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A) B) C) D)

36)

it was engaged in foreign direct investment. it was engaged in portfolio investment. it was engaged in a cross-border acquisition. none of the options.

Government controlled investment funds, known as sovereign wealth funds,

A) are playing a less-important role in international finance following the end of the fixed exchange rate era. B) are mostly domiciled in Asian and Middle Eastern countries. C) do not play a positive role in stabilizing the global banking system D) none of the options

37)

Foreign direct investment (FDI) occurs

A) when an investor acquires a measure of control of a foreign business. B) when there is an acquisition, by a foreign entity in the U.S., of 10 percent or more of the voting shares of a business. C) with sales and purchases of foreign stocks and bonds that do not involve a transfer of control. D) Both A and B.

38)

The financial account may be divided into three categories— A) B) C) D)

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cross-border mergers and acquisitions, portfolio investment, and other investment. direct investment, portfolio investment, and cross-border mergers and acquisitions. direct investment, mergers and acquisitions, and other investment. direct investment, portfolio investment, and other investment.

39) When Nestlé, a Swiss firm, bought the American firm Carnation, it was engaged in foreign direct investment. If Nestlé had only bought a non-controlling number of shares of the firm, A) B) C) D)

40)

Nestlé would have been engaged in portfolio investment. Nestlé would have been engaged in a cross-border acquisition. it would depend if they bought the shares from an American or a Canadian. none of the options

Transactions in currency, bank deposits and so forth

A) tend to be insensitive to both changes in relative interest rates and the anticipated change in exchange rate. B) tend to be sensitive to both changes in relative interest rates and the anticipated change in exchange rate. C) tend to be sensitive to changes in relative interest rates but insensitive to the anticipated change in exchange rate. D) tend to be insensitive to changes in relative interest rates but sensitive to the anticipated change in exchange rate.

41)

Since security returns tend to have low correlations among countries,

A) investors can reduce risk more effectively if they diversify their portfolio holdings internationally rather than purely domestically. B) investors who have a domestically diversified portfolio, with exposures across industry types will not gain much from diversifying abroad. C) investors who diversify internationally will likely underperform investors who keep all their investments in one country. D) none of the options

42)

The world's largest debtor nation and creditor nation, respectively, are

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A) B) C) D)

43)

Japan and the U.S. The U.S. and Japan. The U.S. and Canada. Great Britain and Mexico.

Statistical discrepancy, which, by definition, represents errors and omissions,

A) cannot be calculated directly. B) is calculated by taking into account the balance-of-payments identity. C) probably has some elements that are honest mistakes, it can't all be money laundering and drugs. D) all of the options

44)

The statistical discrepancy in the balance-of-payments accounts

A) arise since recordings of payments and receipts are done at different times, in different places, possibly using different methods. B) arise because some transactions (illegal transactions) occur "off the books." C) represents omitted and misreported transactions. D) all of the options

45) Which of the following is significant because it indicates a country’s international payment gap that must be accommodated with a government’s official reserve transactions? A) B) C) D)

46)

The current account The capital account The statistical discrepancies The official settlement balance

The United States is considered

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A) a net creditor nation. B) a net debtor nation.

47)

Regarding the statistical discrepancy in the balance-of-payments accounts,

A) there is some evidence that financial transactions may be mainly responsible for the discrepancy. B) the sum of the balance on the financial account and the statistical discrepancy is very close to the balance of the current account in magnitude. C) it tends to be positive one year and negative in others, so it's safe to ignore it. D) Both A and B.

48)

The central bank of the United States is A) B) C) D)

the New York Fed. the Federal Reserve System. the EXIM bank. none of the options—the U.S. does not have a central bank.

49) When a country must make a net payment to foreigners because of a balance-ofpayments deficit, the central bank of the country A) should do nothing. B) should run down its official reserve assets (e.g., gold, foreign exchanges, and SDRs) only. C) should borrow anew from foreign central banks only. D) should either run down its official reserve assets (e.g., gold, foreign exchanges, and SDRs) or borrow anew from foreign central banks.

50) Continued U.S. trade deficits coupled with foreigners' desire to diversify their currency holdings away from U.S. dollars Version 1

A) could further diminish the position of the dollar as the dominant reserve currency. B) could affect the value of U.S. dollar (e.g., through the currency diversification decisions of Asian central banks). C) could lend steam to the emergence of the euro as a credible reserve currency. D) all of the options

51)

Currently, international reserve assets are comprised of

A) gold, platinum, foreign exchanges, and special drawing rights (SDRs). B) gold, foreign exchanges, special drawing rights (SDRs), and reserve positions in the International Monetary Fund (IMF). C) gold, diamonds, foreign exchanges, and special drawing rights (SDRs). D) reserve positions in the International Monetary Fund (IMF), only.

52)

International reserve assets include "foreign exchanges". These are A) B) C) D)

Special Drawing Rights (SDRs) at the IMF. reserve positions in the International Monetary Fund (IMF). foreign currencies held by a country's central bank. none of the options

53) The most important international reserve asset, comprising 94 percent of the total reserve assets held by IMF member countries is A) B) C) D)

54) in

gold. foreign exchanges. special Drawing Rights (SDRs). reserve positions in the International Monetary Fund (IMF).

The vast majority of the foreign exchange reserves held by central banks are denominated

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A) B) C) D)

local currencies. U.S. dollars. Japanese Yen. Euro.

55) Which of the following would not count as a foreign exchange reserve held by a central bank? A) B) C) D)

The local currency U.S. dollar Euro None of the above

56) When the balance-of-payments accounts are recorded correctly, the combined balance of the current account, the capital account, the financial account, and the reserves account must be zero and are illustrated by the equation: A) B) C) D)

BCA + BKA + BFA + BRA = 0 BCA + BFA = −BKA BCA + BKA + BFA = BRA BRA = −BCA

57) Under the fixed exchange rate regime, the combined balance on the current accounts will be equal in size, but opposite in sign and are illustrated by the equation: A) B) C) D)

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BCA + BKA + BFA − BRA = 0 BCA + BKA + BFA = −BRA BCA + BKA + BFA = BRA BRA = −BCA

58) When the balance-of-payments accounts are recorded correctly, the combined balance of the current account, the capital account, the financial account and the reserves account must be A) B) C) D)

equal in magnitude to the country's national debt. zero. equal in magnitude to the trade deficit or surplus. none of the options

59) Under the pure flexible exchange rate regime, a current account surplus or deficit (assuming the capital account is negligible) must be matched by a financial account deficit or surplus, and vice versa. this is illustrated by the equation: A) B) C) D)

BCA + BKA + BFA + BRA = 0 BCA + BKA + BFA = −BRA BCA + BKA = −BFA BRA = −BCA

60) If the central banks of the world chose to diversify their foreign exchange reserves away from the dollar and into the euro, A) this would have the result of a strengthening of the value of the dollar. B) could further diminish the position of the U.S. dollar as the dominant reserve currency C) this would not have much impact, as the information would be lost in the day-to-day volatility of exchange rates. D) none of the options

61)

The U.S. trade deficit

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A) B) C) D)

62)

As of 2018, gold accounted for A) B) C) D)

63)

is a capital account surplus only. is a current account deficit only. is both a capital account surplus and a current account deficit. none of the options

90 percent of the total reserve assets held by IMF member countries. 70 percent of the total reserve assets held by IMF member countries. approximately 50 percent of the total reserve assets held by IMF member countries. less than one percent of the total reserve assets held by IMF member countries.

The most dominant currency in the World’s Foerign Exchange Reserves is: A) B) C) D)

U.S. dollar. Euro. Japanese Yen. none of the options

64) Suppose a country is currently experiencing a trade deficit. In the long run, this could be self-correcting if A) the deficit exists because of the import demand for capital goods. B) the deficit exists because of the import demand for consumption goods. C) the deficit exists because foreigners want to buy the country's currency as an investment. D) none of the options

65) The financial account is divided into three subcategories: direct investment, portfolio investment, and other investment. Direct investment involves

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A) B) C) D)

acquisitions of controlling interests in foreign businesses. investments in foreign stocks and bonds that do not involve acquisitions of control. bank deposits, currency investment, trade credit, and the like. all of the options

66) The financial account is divided into three subcategories: direct investment, portfolio investment, and other investment. Portfolio investment involves A) B) C) D)

67) The financial account is divided into three subcategories: direct investment, portfolio investment, and other investment. Other investment involves A) B) C) D)

68)

Which of the following statements are true regarding the 2017 Tax Cuts and Jobs Act?

A) generally eliminated taxes on repatriated earnings B) illustrated a net decrease of direct investment in 2018 due to the repatriation of accumulated prior earnings of foreign affiliates by their US parent companies C) neither A or B are true. D) both A or B are true.

69)

Over the last several years, the U.S. has run persistent

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A) B) C) D)

70)

balance-of-payments deficits. balance-of-payments surpluses. current account deficits. capital account deficits.

Under the pure flexible exchange rate regime,

A) or surplus B) in sign. C) surplus. D) or surplus.

a current account surplus or deficit will not be matched by a financial account deficit the balance on the current and financial accounts will be equal in size, but opposite a current account surplus or deficit must be matched by an official reserves deficit or a financial account surplus or deficit must be matched by an official reserves deficit

71) The notation isY = GNP = national income C = consumption I = private investment G = government spending X = exports M = imports T = taxes The current account balance is given by A) B) C) D)

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C+I+G+X+M X−M I+X+M M−X

72) The notation isY = GNP = national income C = consumption I = private investment G = government spending X = exports M = imports T = taxes Which of the following is a true statement? A) B) C) D)

BCA ≡ X − M BKA ≡ X − M BKA − BCA ≡ X − M BKA ≡ M − X

73) The notation isY = GNP = national income C = consumption I = private investment G = government spending X = exports M = imports T = taxesThere is an intimate relationship between a country's BCA and how the country finances its domestic investment and pays for government expenditures. Given this, which of the following is a true statement? A) If (S − I) < 0, it implies that a country's domestic savings is insufficient to finance domestic investment. B) If (T − G) < 0, it implies that a country's tax revenue is insufficient to finance government spending. C) When BCA is negative, it implies that government budget deficits and/or part of domestic investment are being finance with foreign-controlled capital. D) All of the options

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74) The notation isY = GNP = national income C = consumption I = private investment G = government spending X = exports M = imports T = taxes There is an intimate relationship between a country's BCA and how the country finances its domestic investment and pays for government expenditures. This relationship is given by BCA ≡ X − M ≡ (S − I) + (T − G). Given this, in order for a country to reduce a BCA deficit, which of the following must occur? A) B) C) D)

75)

Which country does the United States currently maintain the largest trade deficit with? A) B) C) D)

76)

Canada Mexico China United Kingdom

Secondary income A) B) C) D)

77)

For a given level of S and I, the government budget deficit (T − G) must be reduced. For a given level of I and (T − G), S must be increased. For a given level of S and (T − G), I must fall. All of the options would work to reduce a BCA deficit.

is the fourth category of the current account involves “unrequited” payments called current transfers examples include foreign aid, reparations, official and private grants, and gifts. all of the above

Which of the following statements regarding the 2018 U.S. current account are not true?

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A) B) C) D)

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The U.S. maintains a surplus on trade in services. The U.S. maintains a deficit on trade in goods. The U.S. maintains a deficit on the overall trade balance. The U.S. maintains a deficit on trade in services.

Answer Key Test name: Chap 03_9e 1) TRUE 2) A 3) D 4) C 5) C 6) D 7) A 8) C 9) E 10) D 11) A 12) C 13) C 14) A 15) A 16) B 17) C 18) C 19) C 20) A 21) C 22) B 23) A 24) A 25) B 26) A Version 1

27) A 28) A 29) B 30) A 31) D 32) C 33) A 34) B 35) A 36) B 37) D 38) D 39) A 40) B 41) A 42) B 43) D 44) D 45) D 46) B 47) D 48) B 49) D 50) D 51) B 52) C 53) B 54) B 55) A 56) A Version 1

57) B 58) B 59) C 60) B 61) C 62) D 63) A 64) A 65) A 66) B 67) C 68) D 69) C 70) B 71) B 72) A 73) D 74) D 75) C 76) D 77) D

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CHAPTER 4 TRUE/FALSE - Write 'T' if the statement is true and 'F' if the statement is false. 1) Countries with strong shareholder protection tend to have more valuable stock markets and more companies listed on stock exchanges per capita than countries with weak protection. ⊚ ⊚

true false

MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 2) Corporate governance can be defined as A) the economic, legal, and institutional framework in which corporate control and cash flow rights are distributed among shareholders, managers and other stakeholders of the company. B) the general framework in which company management selects and monitors the Board of Directors. C) the rules and regulations adopted by boards of directors specifying how to manage companies. D) the government-imposed rules and regulations affecting corporate management.

When managerial self-dealings are excessive and left unchecked, A) B) C) D)

they can have serious negative effects on share values. they can impede the proper functions of capital markets. they can impede such measures as GDP growth. all of the options

Corporate governance structure

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A) B) C) D)

varies a great deal across countries. has become homogenized following the integration of capital markets. has become homogenized due to cross-listing of shares of many public corporations. none of the options

5) The genius of public corporations stems from their capacity to allow efficient sharing or spreading of risk among many investors, who can buy and sell their ownership shares on liquid stock exchanges and let professional managers run the company on behalf of shareholders. This risk sharing stems from A) B) C) D)

In a public company with diffused ownership, the board of directors is entrusted with A) B) C) D)

monitoring the auditors and safeguarding the interests of shareholders. monitoring the shareholders and safeguarding the interests of management. monitoring the management and safeguarding the interests of shareholders. none of the options

The key weakness of the public corporation is A) B) C) D)

the illiquidity of the shares. the limited liability of shareholders. the limited liability of bondholders. the limited ability of shareholders.

too many shareholders, which makes it difficult to make corporate decisions. relatively high corporate income tax rates. conflicts of interest between managers and shareholders. conflicts of interests between shareholders and bondholders.

When company ownership is diffuse,

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A) a "free rider" problem encourages shareholder activism. B) the large number of shareholders ensures strong monitoring of managerial behavior because with a large enough group, there's almost always someone who will to incur the costs of monitoring management. C) most shareholders will have a strong enough incentive to incur the costs of monitoring management. D) a "free rider" problem discourages shareholder activism and few shareholders have a strong enough incentive to incur the costs of monitoring management.

In many countries with concentrated ownership

A) the conflicts of interest between shareholders and managers are worse than in countries with diffuse ownership of firms. B) the conflicts of interest are greater between large controlling shareholders and small outside shareholders than between managers and shareholders. C) the conflicts of interest are greater between managers and shareholders than between large controlling shareholders and small outside shareholders. D) corporate forms of business organization with concentrated ownership are rare.

10) In what country do the three largest shareholders control, on average, about 60 percent of the shares of a public company? A) B) C) D)

11)

United States Canada Great Britain Italy

The public corporation

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A) B) C) D)

12)

The key strength(s) of the public corporation is/are A) B) C) D)

13)

their capacity to allow efficient risk sharing among many investors. their capacity to raise large amounts of funds at relatively low cost. their capacity to consolidate decision-making. all of the options

The central issue of corporate governance is A) B) C) D)

14)

is jointly owned by a (potentially) large number of shareholders. offers shareholders limited liability. separates the ownership and control of a firm’s assets. all of the options

how to protect creditors from managers and controlling shareholders. how to protect outside investors from the controlling insiders. how to alleviate the conflicts of interest between managers and shareholders. how to alleviate the conflicts of interest between shareholders and bondholders.

In theory,

A) managers are hired by the shareholders at the annual stockholders meeting. If the managers turn in a bad year, new ones get hired. B) shareholders hire the managers to oversee the board of directors. C) managers are hired by the board of directors; the board is accountable to the shareholders. D) none of the options

15)

In the reality of corporate governance at the turn of this century,

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A) boards of directors are often dominated by management-friendly insiders. B) a typical board of directors often has relatively few outside directors who can independently and objectively monitor the management. C) managers of one firm often sit on the boards of other firms, whose managers are on the board of the first firm. Due to the interlocking nature of these boards, there can exist a culture of "I'll overlook your problems if you overlook mine." D) all of the options have been true to a greater or lesser extent in the recent past.

16)

The strongest protection for investors is provided by A) B) C) D)

17)

The public corporation has a key weakness which is A) B) C) D)

18)

English common law countries, such as Canada, the United States, and the U.K. French civil law countries, such as Belgium, Italy, and Mexico. a weak board of directors. socialized firms.

the conflicts of interest between bondholders and shareholders. the conflicts of interest between managers and bondholders. the conflicts of interest between stakeholders and shareholders. the conflicts of interest between managers and shareholders.

The separation of the company's ownership and control,

A) is especially prevalent in such countries as the United States and the United Kingdom, where corporate ownership is highly diffused. B) is especially prevalent in such countries as Italy and Mexico, where corporate ownership is highly concentrated. C) is a rational response to the agency problem. D) none of the options

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19)

In the United States, managers are legally bound by the "duty of loyalty" to A) B) C) D)

the board of directors. the shareholders. the bondholders. the government.

20) In the United States, managers are bound by the "duty of loyalty" to serve the shareholders. A) B) C) D)

21)

Outside the United States and the United Kingdom, A) B) C) D)

22)

This is an ethical, not legal, obligation. This is a legal obligation. This is only a moral obligation; there are no penalties. none of the options

concentrated ownership of the company is more the exception than the rule. diffused ownership of the company is more the exception than the rule. partnerships are more important than corporations. none of the options

A complete contract between shareholders and managers

A) would specify exactly what the manager will do under each of all possible future contingencies. B) would be an expensive contract to write and a very expensive contract to monitor. C) would eliminate any conflicts of interest (and managerial discretion). D) all of the options

23)

Residual control right refers to:

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A) the rights or control to make decisions under contingencies that are not specifically covered by complete contracts B) the portion of the complete contract that deals with future contingencies forseen C) neither the rights or control to make decisions under contingencies that are not specifically covered by complete contracts or the portion of the complete contract that deals with future contingencies forseen D) both the rights or control to make decisions under contingencies that are not specifically covered by complete contracts and the portion of the complete contract that deals with future contingencies forseen

24) Why is it rational to make shareholders "weak" by giving control to the managers of the firm? A) This may be rational when shareholders may be neither qualified nor interested in making business decisions. B) This may be rational since many shareholders find it easier to sell their shares in an underperforming firm than to monitor the management. C) This may be rational to the extent that managers are answerable to the board of directors. D) All of the options are explanations for the separation of ownership and control.

25)

Free cash flow refers to A) B) C) D)

a firm's cash reserve in excess of tax obligation. a firm's funds in excess of what's needed for undertaking all profitable projects. a firm's cash reserve in excess of interest and tax payments. a firm's income tax refund that is due to interest payments on borrowing.

26) The investors supply funds to the company but are not involved in the company's daily decision making. As a result, many public companies come to have

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A) B) C) D)

27)

strong shareholders and weak managers. strong managers and weak shareholders. strong managers and strong shareholders. weak managers and weak shareholders.

The agency problem refers to the possible conflicts of interest between A) self-interested managers as principals and shareholders of the firm who are the

agents. B) altruistic managers as agents and shareholders of the firm who are the principals. C) self-interested managers as agents and shareholders of the firm who are the principals. D) dutiful managers as principals and shareholders of the firm who are the agents.

28)

Self-interested managers may be tempted to

A) indulge in expensive perquisites at company expense. B) adopt anti-takeover measures for their company to ensure their personal job security. C) waste company funds by undertaking unprofitable projects that benefit themselves but not shareholders. D) All of the options are potential abuses that self-interested managers may be tempted to visit upon shareholders.

29) Suppose in order to defraud the shareholders, a manager sets up an independent company that he owns and sells the main company's output to this company. He would be tempted to set the transfer price A) B) C) D)

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below market prices. above market prices. at the market price. in accordance with GAAP.

30) Suppose in order to defraud the shareholders, a manager sets up an independent company that he owns and buys one of the main company's inputs of production from this company. He would be tempted to set the transfer price A) B) C) D)

31)

below market prices. above market prices. at the market price. in accordance with GAAP.

Why do managers tend to retain free cash flow?

A) Managers are in the best position to decide the best use of those funds. B) These funds are needed for undertaking profitable projects and the issue costs are less than new issues of stocks or bonds. C) Managers may not be acting in the shareholders best interest, and for a variety of reasons, want to use the free cash flow. D) none of the options

32)

Managerial entrenchment efforts are clear signs of the agency problem. They include A) anti-takeover defenses. B) poison pills. C) changes in the voting procedures to make it more difficult for the firm to be taken

over. D) all of the options

33) In high-growth industries where companies' internally generated funds fall short of profitable investment opportunities, A) managers are less likely to waste funds in unprofitable projects. B) managers are more likely to waste funds in unprofitable projects.

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34)

The agency problem tends A) B) C) D)

35)

Governance mechanisms that exist to alleviate or remedy the agency problem include: A) B) C) D)

36)

to be more serious in firms with free cash flows. to be more serious in firms with excessive amounts of excess cash. to be less serious in firms with few numbers of shareholders. all of the options

independent board of directors & incentive contracts. concentrated ownership & Accounting transparency shareholder activism & overseas stock listings all of the options

In the graph, X, Y, and Z represent

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A) B) C) D)

entrenchment, alignment, entrenchment. alignment, entrenchment, alignment. misalignment and alignment. agency costs of debt and equity.

37) Morck, Shleifer, and Vishny (1988) studied the relationship between managerial ownership share and firm value for Fortune 500 U.S. companies. The results of their analysis suggested that the first turning point (the first vertical, dashed line between X and Y) is reached at __________ percent and the second turning point (the second vertical, dashed line between Y and Z) at about __________ percent, respectively.

A) B) C) D)

38)

5; 25. 15; 50. 50; 75. none of the options

Which of the following is true regarding leveraged buy-outs (LBOs)?

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A) LBOs involve managers or buyout partners acquiring controlling interests in public companies, usually financed by partners' equity. B) Concentrated ownership and low levels of debt associated with LBOs are the mechanism for solving the agency problem. C) LBOs improve a company's free cash flow and this is the mechanism by which they can solve the agency problem. D) LBOs involve managers or buyout partners acquiring controlling interests in public companies (usually financed by heavy borrowing), and concentrated ownership and high levels of debt associated with LBOs are the mechanism for solving the agency problem.

39)

Tobin's Q is A) the ratio of the market value of company assets to the replacement costs of the

assets. B) a means to find overvalued stocks: If Q is high it means that the cost to replace a firm's assets is greater than the value of its stock. C) the same as the price-to-book ratio. D) the ratio of the market value of company assets to the replacement costs of the assets, as well as a means to find overvalued stocks: If Q is high it means that the cost to replace a firm's assets is greater than the value of its stock.

40)

Which of the following statements describes “activist investors”?

A) invests in stocks of a company for the explicit purpose of influencing the company’s management B) plays an important role in promoting shareholder’s interests. C) can influence a company to repurchase stocks. D) all of the above

41)

Which of the following statements describes “activist shareholders”?

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A) wish to persuade the companies to make commitments to corporate social responsibilities, including increasing gender and ethnic diversity on the board of directors B) pursue their social and political agenda by promoting changes in companies’ environmental, social, and governance practices. C) both A and B D) none of the above

42) It is important for society as a whole to solve the agency problem, since the agency problem A) B) C) D)

43)

In the U.S., the chief role of the board of directors is A) B) C) D)

44)

leads to waste of scarce resources. hampers capital market functions. retards economic growth. all of the options

to hire the management team. to decide on the annual capital budget. to design an effective incentive compatible compensation scheme for themselves. none of the options

In the United Kingdom, the majority of public companies

A) voluntarily abide by the Code of Best Practice on corporate governance. B) are compelled by law to abide by the Code of Best Practice on corporate governance. C) do not abide by the Code of Best Practice on corporate governance. D) none of the options

45)

In Germany, the corporate board is

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A) legally charged with representing the interests of shareholders exclusively. B) legally charged with looking after the interests of stakeholders (e.g., workers, creditors, etc.) in general, not just shareholders. C) legally charged as a supervisory board only. D) legally charged as a management board only.

46)

In the United States,

A) boards of directors are legally responsible for representing the interests of the shareholders. B) due to the diffused ownership structure of the public company, management often gets to choose board members who are likely to be friendly to management. C) there is a correlation between underperforming firms and boards of directors who are not fully independent. D) all of the options

47) In the United States, it is not uncommon for the same person to serve as both CEO and chairman of the board. A) B) C) D)

This situation must not have much conflict of interest since it is common. This situation has a built-in conflict of interest. This is only legal if that individual owns a controlling number of shares in the firm. none of the options

48) Suppose you are the CEO of company A, and you serve on the board of company B, while the CEO of B is on your board. A) This is a potential conflict of interest for both parties. B) This is normal and even a desirable situation since it allows for efficient information sharing between the firms. C) There is a potential conflict for the shareholders of the two firms. D) all of the options

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49)

In the United States, it is well documented that A) B) C) D)

50)

The board of directors may grant stock options to managers. These are A) B) C) D)

51)

boards dominated by their chief executives are prone to trouble. public scrutiny can help improve corporate governance. as public firms improve their corporate governance, the stock price goes up. all of the options

call options. put options. both of the options none of the options

If an incentive contract specifies certain accounting performance,

A) that accounting number will likely be the focus of managers. B) managers will set aside the accounting goal if it conflicts with the goal of maximizing shareholder wealth. C) managers will be unable to manipulate the GAAP, so shareholders can be confident of having their wealth maximized. D) none of the options

52)

The board of directors may grant stock options to managers A) B) C) D)

53)

to save executive compensation costs. to use as a substitute for bonus. to align the interest of managers with that of shareholders. none of the options

When designing an incentive contract,

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A) it is important for the board of directors to set up an independent compensation committee that can carefully design the contract and diligently monitor manager's actions. B) senior executives can be trusted to not abuse incentive contracts by artificially manipulating accounting numbers since the auditors should look in to that. C) the presence of any incentive is enough, whether it is accounting based or stockprice based. D) the board of directors should always give the managers a "heads I win, tails you lose" type of option.

54)

Concentrated ownership of a public company A) is normal in the United States, following the well-publicized scandals of recent

years. B) is relatively rare in the United States and common in many other parts of the world. C) leads to a free-rider problem with the minority shareholders relying on the majority shareholders to assume an undue burden in monitoring the management. D) is the norm in Great Britain.

55)

Concentrated ownership of a public company

A) can be an effective way to alleviate the agency problem between shareholders and managers. B) is the norm in Great Britain. C) tends to be an ineffective way to alleviate conflicts of interest between groups of shareholders. D) none of the options

56)

The goal of greater accounting transparency

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A) is to impose more rules and harsher penalties for their violation. B) is to reduce the information symmetry between corporate insiders and the public. C) is to encourage managerial self-dealings. D) is to reduce the information asymmetry between corporate insiders and the public, as well as discourage managerial self-dealings.

57)

Accounting transparency

A) can only be achieved when managers commit to serving on their own audit committee. B) occurs when the accounting department has translucent cubicles for their workers. C) promises to reduce the information asymmetry between corporate insiders and the public. D) none of the options

58)

While debt can reduce agency costs between shareholders and management, A) B) C) D)

59)

debt can create its own agency costs. this only happens at extreme levels of debt. this does not work for firms in mature industries with large cash reserves. none of the options

While debt can reduce agency costs between shareholders and management,

A) excessive debt may also induce the risk-averse managers to engage in extra risky investment projects, causing an underinvestment problem. B) with debt financing, companies cannot misuse debt to finance corporate empire building. C) excessive debt may also induce the risk-averse managers to forgo profitable but risky investment projects, causing an underinvestment problem. Additionally, with debt financing, companies can misuse debt to finance corporate empire building. D) none of the options

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60)

For firms with free cash flows,

A) debt can be a stronger mechanism than stocks for credibly bonding managers to release cash flows to investors. B) equity dividends can be a stronger mechanism than bonds for credibly bonding managers to release cash flows to investors. C) preferred stock dividends can be a stronger mechanism than bonds for credibly bonding managers to release cash flows to investors. D) none of the options

61)

Debt can reduce agency costs between shareholders and management, but

A) only if the firm is totally up to its eyeballs in debt. B) only to the extent that the firm can commit all of its free cash flow. C) excessive debt can create its own agency conflicts. D) debt is best used as a corporate governance mechanism by young companies with limited cash reserves.

62) Companies domiciled in countries with weak investor protection can reduce agency costs between shareholders and management A) B) C) D)

63)

by moving to a better county. by listing their stocks in countries with strong investor protection. by voluntarily complying with the provisions of the U.S. Sarbanes-Oxley Act. by having a press conference and promising to be nice to their investors.

Benetton, an Italian clothier, is listed on the New York Stock Exchange.

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A) This decision provides their shareholders with a higher degree of protection than is available in Italy. B) This decision can be a signal of the company's commitment to shareholder rights. C) This may make investors both in Italy and abroad more willing to provide capital and to increase the value of the pre-existing shares. D) all of the options

64)

In the United States and the United Kingdom, hostile takeovers A) B) C) D)

65)

are illegal. can serve as a drastic corporate governance mechanism of the last resort. reinforce the notion that managers can take their control of the company for granted. require management approval.

In many countries, hostile takeovers are relatively rare. This is so partly because of

A) the language barrier. B) dispersed ownership in these countries. C) cultural values and economic environments disapproving hostile corporate takeovers. D) concentrated ownership in these countries, as well as cultural values and political environments disapproving hostile corporate takeovers.

66)

After a hostile takeover, A) B) C) D)

67)

the existing management team is usually fired. the existing management team is usually retained at a higher wage. a combination of Answers A and B. none of the options

In a hostile takeover attempt, the bidder typically

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A) makes a tender offer to the target shareholders at a price substantially less than the prevailing share price. B) makes a tender offer to the target shareholders at the prevailing share price. C) makes a tender offer to the target shareholders at a price substantially exceeding the prevailing share price. D) seeks to merge with the target company with an exchange of shares.

68) Suppose the managers of a company have driven the stock price down because they have spent the investors' money on lavish perquisites like golf club memberships. A) This situation may prompt a corporate raider to buy up the shares of the firm in a hostile takeover. B) If the hostile takeover is successful, the managers will probably lose their jobs in the ensuing restructuring. C) If the restructuring is successful, the corporate raider can sell his shares at a profit. D) all of the options

69)

Private benefits of corporate control will tend to be higher in A) B) C) D)

French civil law countries than in English common law countries. English common law countries than in French civil law countries. French civil law countries than in Scandinavian civil law countries. English common law countries than in German civil law countries.

70) English common law countries tend to provide a stronger protection of shareholder rights than French civil law countries because A) B) C) D)

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the former countries tend to be more democratic than the latter. the former countries tend to protect property rights better than the latter. the former countries tend to have more separation of power than the latter. all of the options

71) Many companies issue shares with differential voting rights, deviating from the one-share one-vote principle. A) By accumulating superior voting shares, investors can acquire cash flow rights exceeding control rights. B) The price of the voting shares is usually twice the price of the voting shares. C) By accumulating superior voting shares, investors can acquire control rights exceeding cash flow rights. D) none of the options

72) Studies show that the quality of law enforcement, as measured by the rule of law index, will tend to be A) B) C) D)

higher in French civil law countries than in English common law countries. higher in English common law countries than in Scandinavian civil law countries. highest in Scandinavian civil law countries and German civil law countries. highest in English common law countries.

73) Suppose Mr. Lee and his relatives hold 30 percent of shares outstanding of Samsung Life, which in turn holds 20 percent of Samsung Electronics. What is the cash flow right of the Lee family in Samsung Electronics? A) B) C) D)

74)

50 percent 10 percent 20 percent 6 percent

Concentrated corporate ownership is most prevalent in

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A) B) C) D)

75)

Italy. the U.K. the U.S. Australia.

In countries with concentrated ownership, A) hostile takeovers are quite rare. B) hostile takeovers are quite common.

76)

A pyramidal ownership structure is one in which

A) a shareholder controls a holding company that owns a controlling block of another company, which in turn owns controlling interests in yet another company, and so on. B) equity cross-holdings among a group of companies, such as keiretsu and chaebols, can be used to concentrate and leverage voting rights to acquire control. C) a combination of these schemes may also be used to leverage control in a pyramidal ownership structure. D) none of the options

77)

What is the difference between control rights and cash flow rights?

A) Since all shareholders benefit only from pro-rata cash flows, control rights and cash flow rights are the same thing. B) Large investors may be able to derive private benefits from control, thus control rights can exceed cash flow rights. C) Cash flow rights are more important than control rights since the only reason to invest in anything is to generate cash. D) none of the options

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78) The key to extracting private benefits of control that are not shared by other shareholders on a pro rata basis is to A) B) C) D)

become a large shareholder and acquire control rights exceeding cash flow rights. buy a large block of nonvoting shares. sell your shares in a tender offer. force the firm into bankruptcy.

79) The voting premium, defined as the total vote value (value of a vote times the number of votes) as a proportion of the firm's equity market value is only about 2 percent in the United States and 36 percent in Mexico, suggesting that in Mexico, A) B) C) D)

80)

Unless investors can derive significant private benefits of control, A) B) C) D)

81)

dominant shareholders extract substantial private benefits of control. dominant shareholders overpay and thus fail to extract substantial private benefits. minority shareholders share in the private benefits of control. none of the options

they will pay small premiums for voting shares over nonvoting shares. they will pay moderate premiums for voting shares over nonvoting shares. they will pay substantial premiums for voting shares over nonvoting shares. they will not pay substantial premiums for voting shares over nonvoting shares.

The formula to compute the value of the "block premium" is

A) Price per share paid for the control block – the exchange price after the control transaction the exchange price after the announcement of the control transaction

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Price per share paid for the control block – the exchange price after the control transaction price per share paid for the control block

C) the exchange price after the control transaction – price per share paid for the control block price per share paid for the control block

D) Price per share paid for the control block – the exchange price after the control transaction the exchange price prior to the announcement of the control transaction

82)

The value of private benefits of control may be measured using

A) the difference in value between non-voting shares and voting shares. B) "block premium," the difference between the price per share paid for a control block of shares versus the exchange price of regular shares. C) the difference in value between non-voting shares and voting shares or "block premium," the difference between the price per share paid for a control block of shares versus the exchange price of regular shares. D) none of the options

83)

Several studies document the empirical link between A) B) C) D)

84)

weak investor protection and GDP growth. financial development and economic growth. growth in GDP and concentrated ownership. none of the options

Financial development can contribute to economic growth in what way(s)?

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A) Financial development enhances savings. B) Financial development channels savings toward real investments in productive capacities. C) Financial development enhances the efficiency of investment allocation through the monitoring and signaling functions of capital markets. D) all of the options

85)

Comparing the U.S. with the German and Japanese corporate governance systems, A) B) C) D)

86)

the U.S. system is "market centered." the German and Japanese systems are "bank centered." it seems fair to say that no country has a perfect system. all of the options.

The objective of corporate governance reform should be what?

A) Strengthen the protection of outside investors from expropriation by managers. B) Strengthen the protection of outside investors from expropriation by controlling insiders. C) Strengthen the protection of outside investors from expropriation by managers and controlling insiders. D) none of the options

87)

One of the objectives of corporate governance reform is to,

A) introduce expensive and burdensome accounting reforms. B) strengthen the protection of outside investors from expropriation by managers and controlling insiders. C) provide taxpayer financing for corporate raiders to strengthen the discipline of the marketplace. D) none of the options

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88)

In the U.S., corporate governance reform has included all of the following except A) B) C) D)

89)

The Sarbanes-Oxley Act of 2002 stipulates that A) B) C) D)

90)

a public accounting oversight board be created. the company should appoint independent financial experts to its audit committee. both CEO and CFO sign off on the company's financial statements. all of the options

The Sarbanes-Oxley Act of 2002 A) B) C) D)

91)

strengthen the independence of boards of directors. enhancing the transparency and disclosure of financial statements. energizing the regulatory and monitoring functions of the SEC. requiring auditors to sit on the boards of directors.

applies to all U.S. firms. applies to listed companies. applies to issuers whose securities are traded on an over-the-counter bulletin board. all of the options

The Sarbanes-Oxley Act of 2002

A) has had the consequence that many foreign firms have de-listed in the U.S. exchanges and listed their shares on the London Stock Exchange and other European exchanges. B) has increased the pace of foreign firms listing their shares in the U.S. C) has increased the pace of foreign firms listing their shares in the U.S. and has also had the consequence that many foreign firms have de-listed in the U.S. exchanges and listed their shares on the London Stock Exchange and other European exchanges. D) all of the options

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92)

The cost of compliance with the Sarbanes-Oxley Act A) B) C) D)

is a small amount, since most firms were playing by rules to begin with. disproportionately affects small firms. is paid for with tax credits for firms found to be in compliance. all of the options

93) One implication of the Sarbanes-Oxley Act is that companies must appoint independent "financial experts" to their committees. Which of the major components is associated with this objective? A) B) C) D)

94)

Accounting regulation Audit committee Internal control assessment Executive responsibility

The major components of the Sarbanes-Oxley Act are

A) accounting regulation: The creation of a public accounting oversight board charged with overseeing the auditing of public companies, and restricting the consulting services that auditors can provide to clients. B) audit committee: The company should appoint independent "financial experts" to its audit committee. C) internal control assessment: Public companies and their auditors should assess the effectiveness of internal control of financial record keeping and fraud prevention. D) executive responsibility: Chief executive and finance officers (CEO and CFO) must sign off on the company's quarterly and annual financial statements. If fraud causes an overstatement of earnings, these officers must return any bonuses. E) all of the options

95)

The key requirements of the Sarbanes-Oxley Act state that

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A) boards of directors should include at least three outside directors. B) the positions of CEO and chairman of the board should not reside in the same individual. C) compliance is mandatory for public corporations, optional for listed non-public corporations. D) none of the options.

96)

Since the passage of the Sarbanes-Oxley Act,

A) some foreign firms have chosen to list their shares on the London Stock Exchange and other European exchanges, instead of U.S. exchanges, to avoid the costly compliance. B) the pace of foreign firms listing their shares in the U.S. has increased. C) the firms have passed this increased cost on to their customers. D) none of the options

97)

The major components of the Sarbanes-Oxley Act include all of the following except

98)

The Dodd-Frank Act was passed A) B) C) D)

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in 1933. in 2010. in 1933 and repealed in 2010. none of the options

99) The Cadbury Code has not been legislated into law, and compliance with the code is voluntary. A) However, the London Stock Exchange (LSE) currently requires that each listed company show whether the company is in compliance with the code and explain why if it is not. B) This "comply or explain" approach has apparently persuaded many companies to comply rather than explain. C) Currently, 90 percent of all LSE-listed companies have adopted the Cadbury Code. D) all of the options

100) Following the adoption of the Cadbury Code of Best Practice joint CEO/COB positions declined A) B) C) D)

101)

from 27 percent of the companies before the adoption to 15 percent afterwards. from 37 percent of the companies before the adoption to 15 percent afterwards. from 47 percent of the companies before the adoption to 15 percent afterwards. from 57 percent of the companies before the adoption to 15 percent afterwards.

Following the adoption of the Cadbury Code of Best Practice,

A) joint CEO/COB (chief executive officer and chairman of the board) positions declined. B) there has been a significant impact on the internal governance mechanisms of U.K. companies. C) CEOs have become more sensitive to company performance, strengthening managerial accountability and weakening managerial entrenchment. D) all of the options

102)

Even though compliance with the Cadbury Code of Best Practice is voluntary,

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A) the Cadbury Code has made a significant impact on the internal governance mechanisms of U.K. companies. B) the job security of U.K. chief executives has become more sensitive to the company performance, strengthening managerial accountability and weakening its entrenchment. C) joint CEO/COB (chief executive officer and chairman of the board) positions declined. D) all of the options

103)

The key requirements of the Cadbury Code of Best Practice state that

A) boards of directors should include no more than three outside directors. B) the positions of CEO and chairman of the board must be the same individual. C) Both Answers A and B are correct D) boards of directors should include at least three outside directors and the positions of CEO and chairman of the board should not reside in the same individual.

104)

The key requirements of the Cadbury Code of Best Practice state that

A) the compensation, nominating, and audit committees to be entirely composed of independent directors. B) the positions of CEO and chairman of the board should not reside in the same individual. C) listed companies to have boards of directors with a majority of independents. D) none of the options

105) In May 2018, the U.S. congress passed a new law called the Economic Growth, Regulatory Relief, and Consumer Protection act that significantly weakened which previous Act? A) B) C) D)

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the Dodd-Frank Act the Volker Rule Act the previous Consumer Protection Act none of the options

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Answer Key Test name: Chap 04_9e 1) TRUE 2) A 3) D 4) A 5) B 6) C 7) C 8) D 9) B 10) D 11) D 12) D 13) B 14) C 15) D 16) A 17) D 18) A 19) B 20) B 21) B 22) D 23) A 24) D 25) B 26) B Version 1

27) C 28) D 29) A 30) B 31) C 32) D 33) A 34) D 35) D 36) B 37) A 38) D 39) A 40) D 41) C 42) D 43) A 44) A 45) B 46) D 47) B 48) A 49) D 50) A 51) A 52) C 53) A 54) B 55) A 56) D Version 1

57) C 58) A 59) C 60) A 61) C 62) B 63) D 64) B 65) D 66) A 67) C 68) D 69) A 70) B 71) C 72) C 73) D 74) A 75) A 76) C 77) B 78) A 79) A 80) D 81) A 82) C 83) B 84) D 85) D 86) C Version 1

87) B 88) D 89) D 90) B 91) A 92) B 93) B 94) E 95) D 96) A 97) C 98) B 99) D 100) B 101) D 102) D 103) D 104) B 105) A

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CHAPTER 5 MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 1) The world's largest foreign exchange trading center is A) B) C) D)

On average, worldwide daily trading of foreign exchange is closest to A) B) C) D)

$100 million. $15 billion. $504 billion. $6.19 trillion.

The foreign exchange market closes A) B) C) D)

New York. Tokyo. London. Hong Kong.

never. 4:00 p.m. EST (New York time). 4:00 p.m. GMT (London time). 4:00 p.m. (Tokyo time).

Most foreign exchange transactions are for A) B) C) D)

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intervention by central banks. interbank trades between international banks or nonbank dealers. retail trade. purchase of hard currencies.

The difference between a broker and a dealer is

A) dealers sell drugs; brokers sell houses. B) brokers bring together buyers and sellers, but carry no inventory; dealers stand ready to buy and sell from their inventory. C) brokers transact in stocks and bonds; currency is bought and sold through dealers. D) none of the options

Most interbank trades are A) B) C) D)

At the wholesale level, A) B) C) D)

speculative or arbitrage transactions. simple order processing for the retail client. overnight loans from one bank to another. brokered by dealers.

most trading takes place OTC between individuals on the floor of the exchange. most trading takes place over the phone. most trading flows over Reuters and EBS platforms. most trading flows through specialized "broking" firms.

Intervention in the foreign exchange market is the process of A) a central bank requiring the commercial banks of that country to trade at a set price

level. B) commercial banks in different countries coordinating efforts in order to stabilize one or more currencies. C) a central bank buying or selling its currency in order to influence its value. D) the government of a country prohibiting transactions in one or more currencies.

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The standard size foreign exchange transactions are for A) B) C) D)

$10 million USD. $1 million USD. €1 million. none of the options

10) Consider a U.S. importer desiring to purchase merchandise from a Dutch exporter invoiced in euros, at a cost of €512,100. The U.S. importer will contact his U.S. bank (where of course he has an account denominated in U.S. dollars) and inquire about the exchange rate, which the bank quotes as €1.0242/$1.00. The importer accepts this price, so his bank will __________ the importer's account in the amount of __________. A) B) C) D)

debit; $500,000 debit; $524,492 credit; $500,000 debit; €512,100

11) The current exchange rate is £1.00 = $2.00. Compute the correct balances in Bank A's correspondent account(s) with Bank B if a currency trader employed at Bank A buys £45,000 from a currency trader at Bank B for $90,000 using its correspondent relationship with Bank B. A) B) C) D) E)

Bank A's dollar-denominated account at B will fall by $90,000. Bank B's dollar-denominated account at A will rise by $90,000. Bank A's pound-denominated account at B will rise by £45,000. Bank B's pound-denominated account at A will fall by £45,000. all of the options

12) The current exchange rate is £1.00 = $2.00. Compute the correct balances in Bank A's correspondent account(s) with Bank B if a currency trader employed at Bank A buys £45,000 from a currency trader at Bank B for $90,000 using its correspondent relationship with Bank B.

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A) B) C) D)

Bank A's dollar-denominated account at B will rise by $90,000. Bank B's dollar-denominated account at A will fall by $90,000. Bank A's pound-denominated account at B will rise by £45,000. Bank B's pound-denominated account at A will rise by £45,000.

13) The current exchange rate is €1.00 = $1.50. Compute the correct balances in Bank A's correspondent account(s) with Bank B if a currency trader employed at Bank A buys €100,000 from a currency trader at Bank B for $150,000 using its correspondent relationship with Bank B. A) B) C) D)

14)

The spot market A) B) C) D)

15)

Bank A's dollar-denominated account at B will fall by $150,000. Bank B's dollar-denominated account at A will fall by $150,000. Bank A's euro-denominated account at B will fall by €100,000. Bank B's euro-denominated account at A will rise by €100,000.

involves the almost-immediate purchase or sale of foreign exchange. involves the sale of futures, forwards, and options on foreign exchange. takes place only on the floor of a physical exchange. all of the options

Spot foreign exchange trading A) B) C) D)

accounted for about 5 percent of all foreign exchange trades in 2019. accounted for about 26 percent of all foreign exchange trades in 2019. accounted for about 32 percent of all foreign exchange trades in 2019. accounted for about 61 percent of all foreign exchange trades in 2019.

16) Country

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U.S. $ equiv.

Currency per U.S. $

Tuesday

Monday

Tuesday

Monday

U.K.(Pound) £62,500

1.6000

1.6100

0.6250

0.6211

1 Month Forward

1.6100

1.6300

0.6211

0.6173

3 Months Forward

1.6300

1.6600

0.6173

0.6024

6 Months Forward

1.6600

1.7200

0.6024

0.5814

12 Months Forward

1.7200

1.8000

0.5814

0.5556

Using the table shown, what is the most current spot exchange rate shown for British pounds? Use a direct quote from a U.S. perspective. A) B) C) D)

$1.61 = £1.00 $1.60 = £1.00 $1.00 = £0.625 $1.72 = £1.00

17) Suppose that the current exchange rate is €0.80 = $1.00. The direct quote, from the U.S. perspective is A) B) C) D)

€1.00 = $1.25. €0.80 = $1.00. £1.00 = $1.80. none of the options

18) Suppose that the current exchange rate is €1.00 = $1.60. The indirect quote, from the U.S. perspective is A) B) C) D)

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€1.00 = $1.60. €0.6250 = $1.00. €1.60 = $1.00. none of the options

19) Suppose that the current exchange rate is £1.00 = $2.00. The indirect quote, from the U.S. perspective is A) B) C) D)

20)

£1.00 = $2.00. £1.00 = $0.50. £0.50 = $1.00. none of the options

Indirect exchange rate quotations from the U.S. perspective are A) B) C) D)

the price of one unit of the foreign currency in terms of the U.S. dollar. the price of one U.S. dollar in the foreign currency. the price of one foreign currency in terms of another foreign currency none of the above

21) It is common practice among currency traders worldwide to both price and trade currencies against the U.S. dollar. In fact, 2019 BIS statistics indicate that about __________ of currency trading in the world involves the U.S. dollar on one side of the transaction. A) B) C) D)

88 percent 75 percent 45 percent 15 percent

22) It is common practice among currency traders worldwide to both price and trade currencies against the U.S. dollar. Consider a currency dealer who makes a market in 5 currencies against the dollar. If he were to supply quotes for each currency in terms of all of the others, how many quotes (including both indirect and direct quotes) would he have to provide?

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A) B) C) D) E)

23)

36 30 60 120 none of the options

The bid price

A) is the price that the dealer has just paid for something, his historical cost of the most recent trade. B) is the price that a dealer stands ready to pay. C) refers only to auctions like eBay, not over-the-counter transactions with dealers. D) is the price that a dealer stands ready to sell at.

24) Suppose the spot ask exchange rate, S a($|£), is $1.90 = £1.00 and the spot bid exchange rate, S b($|£), is $1.89 = £1.00. If you were to buy $10,000,000 worth of British pounds and then sell them five minutes later, how much of your $10,000,000 would be "eaten" by the bid-ask spread? A) B) C) D)

$1,000,000 $52,910 $100,000 $52,632

25) If the $/€ bid and ask prices are $1.50/€ and $1.51/€, respectively, the corresponding €/$ bid and ask prices are A) B) C) D)

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€0.6667 and €0.6623. $1.51 and $1.50. €0.6623 and €0.6667. cannot be determined with the information given.

26) In conversation, interbank foreign exchange traders use a shorthand abbreviation in expressing spot currency quotations. Consider a $/£ bid-ask quote of $1.2519-$1.2523. The "big figure," assumed to be known to all traders is __________. A) B) C) D)

1.2523 1 1.25 23

27) In conversation, interbank foreign exchange traders use a shorthand abbreviation in expressing spot currency quotations. Consider a $/£ bid-ask quote of $1.2519-$1.2523. The currency dealer would likely quote that as __________. A) B) C) D)

19-23 23-19 4 points none of the options

28) In the interbank market, the standard size of a trade among large banks in the major currencies is A) B) C) D)

29)

for the U.S.-dollar equivalent of $10,000,000,000. for the U.S.-dollar equivalent of $10,000,000. for the U.S.-dollar equivalent of $100,000. for the U.S.-dollar equivalent of $1,000.

A dealer in British pounds who thinks that the pound is about to appreciate

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A) B) C) D)

30)

A dealer in British pounds who thinks that the pound is about to depreciate A) B) C) D)

31)

may want to widen his bid-ask spread by raising his ask price. may want to lower his bid price. may want to lower his ask price. none of the options

may want to widen his bid-ask spread by raising his ask price and lowering his bid. may want to lower both his bid price and his ask price. may want to lower his ask price while raising his bid. none of the options

A dealer in pounds who thinks that the exchange rate is about to increase in volatility A) B) C) D)

may want to widen his bid-ask spread. may want to decrease his bid-ask spread. may want to lower his ask price. none of the options

32) Country

U.S. $ equiv.

Currency per U.S. $

Tuesday

Monday

Tuesday

Monday

U.K. (Pound) £62,500

2.0000

1.9800

0.5000

0.5051

1 Month Forward

2.0100

1.9900

0.4975

0.5025

3 Months Forward

2.0200

2.0000

0.4950

0.5000

6 Months Forward

2.0300

2.0100

0.4926

0.4975

12 Months Forward

2.0400

2.0200

0.4902

0.4950

Euro £62,500

1.5000

1.4800

0.6667

0.6757

1 Month Forward

1.5100

1.4900

0.6623

0.6711

3 Months Forward

1.5200

1.5000

0.6579

0.6667

6 Months Forward

1.5300

1.5100

0.6536

0.6623

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12 Months Forward

1.5400

1.5200

0.6494

0.6579

Using the table shown, what is the spot cross-exchange rate between pounds and euro on Tuesday? A) B) C) D)

€1.00 = £0.75 £1.33 = €1.00 £1.00 = €0.75 none of the options

33) The dollar-euro exchange rate is $1.25 = €1.00 and the dollar-yen exchange rate is ¥100 = $1.00. What is the euro-yen cross rate? A) B) C) D)

€125 = ¥1.00 €1.00 = ¥125 €1.00 = ¥0.80 none of the options

34) Suppose you observe the following exchange rates: €1 = $1.25 and £1 = $2.00. Calculate the euro-pound cross-rate. A) B) C) D)

£1 = €1.60 £1 = €0.625 £2.50 = €1 £1 = €2.50

35) The AUD/$ spot exchange rate is AUD1.60/$ and the SF/$ is SF1.25/$. The AUD/SF cross exchange rate is __________.

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A) B) C) D)

0.7813 2.0000 1.2800 0.3500

36) Suppose you observe the following exchange rates: €1 = $1.50 and £1 = $2.00. Calculate the euro-pound cross-rate. A) B) C) D)

€1.3333 = £1.00 £1.3333 = €1.00 €3.00 = £1 €1.25 = £1.00

37) Suppose you observe the following exchange rates: €1 = $1.60 and £1 = $2.00. Calculate the euro-pound cross-rate. A) B) C) D)

€1.3333 = £1.00 £1.3333 = €1.00 €3.00 = £1 €1.25 = £1.00

38) Suppose you observe the following exchange rates: €1 = $1.50 and ¥120 = $1.00. Calculate the euro-yen cross-rate. A) B) C) D)

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¥133.33 = €1.00 €1 = ¥180 ¥80 = €1.00 €1 = £2.50

39) Suppose you observe the following exchange rates: €1 = $1.45 and £1 = $1.90. Calculate the euro-pound cross-rate. A) B) C) D)

€1.3103 = £1.00 £1.3333 = €1.00 €2.00 = £1 €3 = £1

40) USD equivalent Country

BID

ASK

Switzerland (Franc) CHF

0.7648

0.7652

Euro €

1.4000

1.4200

What is the BID cross-exchange rate for Swiss Francs priced in euro? Hint: Find the price that a currency dealer will pay in euros to buy Swiss francs. A) B) C) D)

€0.5386/CHF €0.5389/CHF €0.5463/CHF €0.5466/CHF

41) USD equivalent Country

BID

ASK

Switzerland (Franc) CHF

0.7648

0.7652

Euro €

1.4000

1.4200

What is the ASK cross-exchange rate for Swiss Francs priced in euro? Hint: Find the price that a currency dealer will take in euros to sell Swiss francs.

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A) B) C) D)

€0.5386/CHF €0.5389/CHF €0.5463/CHF €0.5466/CHF

42) Find the no-arbitrage cross exchange rate. The dollar-euro exchange rate is quoted as $1.60 = €1.00 and the dollar-pound exchange rate is quoted at $2.00 = £1.00. A) B) C) D)

€1.25/£1.00 $1.25/£1.00 £1.25/€1.00 €0.80/£1.00

43) USD equivalent Country

BID

ASK

Canada (Dollar)

0.8653

0.8667

Euro €

1.4000

1.4200

What is the BID cross-exchange rate for Canadian dollars priced in euro? Hint: Find the price that a currency dealer will pay in euros to buy Canadian dollars. A) B) C) D)

€0.6094/CAD €0.6104/CAD €0.6181/CAD €0.6191/CAD

44) USD equivalent Country

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BID

ASK

Canada (Dollar)

0.8653

0.8667

Euro €

1.4000

1.4200

What is the ASK cross-exchange rate for Canadian dollars priced in euro? Hint: Find the price that a currency dealer will take in euros to sell Canadian dollars. A) B) C) D)

€0.6094/CAD €0.6104/CAD €0.6181/CAD €0.6191/CAD

45) Find the no-arbitrage cross exchange rate. The dollar-euro exchange rate is quoted as $1.60 = €1.00 and the dollar-yen exchange rate is quoted at $1.00 = ¥120. A) B) C) D)

46)

¥192/¥€1.00 €1.92/¥100 €1.25/¥1.00 €1.00/¥1.92

The euro-pound cross exchange rate can be computed as: A) S(€/£) = S($/£) ×

S(€/$)

B) C) D) all of the options

47)

Suppose a bank customer wishes to trade out of British pounds and into Swiss francs.

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A) In dealer jargon, this is a currency against currency trade. B) The bank will frequently handle such a trade by buying British pounds for U.S. dollars and then selling Swiss francs with U.S. dollars. C) The bank would typically sell the British pounds directly for Swiss francs. D) Both A and B

48) Including the transaction costs of the bid-ask spread, the euro-pound cross exchange rate for a customer who wants to sell euro and buy pounds can be computed as A) Sb(£/€) = Sb($/€) × Sb(£/$) B) Sa(€/£) = Sa(€/$) × Sa($/£) C) D) all of the options

49) Suppose a bank customer with €1,000,000 wishes to trade out of euro and into Japanese yen. The dollar-euro exchange rate is quoted as $1.60 = €1.00 and the dollar-yen exchange rate is quoted at $1.00 = ¥120. How many yen will the customer get? A) B) C) D)

¥192,000,000 ¥5,208,333 ¥75,000,000 ¥5,208.33

50) American Terms

European Terms

Bank Quotations

Bid

Ask

Bid

Ask

British pounds

$ 1.9712

$ 1.9717

£ 0.5072

£ 0.5073

Euros

$ 1.4738

$ 1.4742

€ 0.6783

€ 0.6785

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Using the table above, what is the bid price of pounds in terms of euro? A) B) C) D)

€1.3371/£ €1.3378/£ £0.7475/€ £0.7479/€

51) American Terms

European Terms

Bank Quotations

Bid

Ask

Bid

Ask

British pounds

$ 1.9712

$ 1.9717

£ 0.5072

£ 0.5073

Euros

$ 1.4738

$ 1.4742

€ 0.6783

€ 0.6785

Using the table above, what is the ask price of pounds in terms of euro? A) B) C) D)

€1.3371/£ €1.3378/£ £0.7475/€ £0.7479/€

52) American Terms

European Terms

Bank Quotations

Bid

Ask

Bid

Ask

British pounds

$ 1.9712

$ 1.9717

£ 0.5072

£ 0.5073

Euros

$ 1.4738

$ 1.4742

€ 0.6783

€ 0.6785

Version 1

Using the table above, what is the bid price of euro in terms of pounds? A) B) C) D)

€1.3371/£ €1.3378/£ £0.7475/€ £0.7479/€

53) American Terms

European Terms

Bank Quotations

Bid

Ask

Bid

Ask

British pounds

$ 1.9712

$ 1.9717

£ 0.5072

£ 0.5073

Euros

$ 1.4738

$ 1.4742

€ 0.6783

€ 0.6785

Using the table above, what is the ask price of euro in terms of pounds? A) B) C) D)

54)

€1.3371/£ €1.3378/£ £0.7475/€ £0.7479/€

Which of the following statements regarding triangular arbitrage true?

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A) The purpose is to earn an arbitrage profit via trading among three currencies, where the direct cross-exchange rate between the second and the third currency is not in alignment with the implied cross-exchange rate. B) It can involve trading out of the US dollar into a second currency, then trading it for a third currency, which is in turn traded for US dollars. C) Both A and B D) Neither A or B

55) You are a U.S.-based treasurer with $1,000,000 to invest. The dollar-euro exchange rate is quoted as $1.20 = €1.00 and the dollar-pound exchange rate is quoted at $1.80 = £1.00. If a bank quotes you a cross rate of £1.00 = €1.50, how much money can an astute trader make? A) B) C) D)

No arbitrage is possible $1,160,000 $500,000 $250,000

56) You are a U.S.-based treasurer with $1,000,000 to invest. The dollar-euro exchange rate is quoted as $1.60 = €1.00 and the dollar-pound exchange rate is quoted at $2.00 = £1.00. If a bank quotes you a cross rate of £1.00 = €1.20 how much money can an astute trader make? A) B) C) D)

No arbitrage is possible $1,160,000 $41,667 $40,000

57) You are a U.S.-based treasurer with $1,000,000 to invest. The dollar-euro exchange rate is quoted as $1.60 = €1.00 and the dollar-pound exchange rate is quoted at $2.00 = £1.00. If a bank quotes you a cross rate of £1.00 = €1.20 how can you make money?

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A) B) C) D)

No arbitrage is possible Buy euro at $1.60/€, buy £ at €1.20/£, sell £ at $2/£ Buy £ $2/£, buy € at €1.20/£, sell € at $1.60/€ none of the options

58) The Singapore dollar—U.S. dollar (S$/$) spot exchange rate is S$1.60/$, the Canadian dollar—U.S. dollar (CAD/$) spot rate is CAD1.33/$ and S$/CAD1.15.Determine the triangular arbitrage profit that is possible if you have $1,000,000. A) B) C) D)

$44,063 profit $46,093 loss No profit is possible $46,093 profit

59) You are a U.S.-based treasurer with $1,000,000 to invest. The dollar-euro exchange rate is quoted as $1.50 = €1.00 and the dollar-pound exchange rate is quoted at $2.00 = £1.00. If a bank quotes you a cross rate of £1.00 = €1.25 how can you make money? A) B) C) D)

60)

No arbitrage is possible. Buy euro at $1.50/€, buy £ at €1.25/£, sell £ at $2/£. Buy £ $2/£, buy € at €1.25/£, sell € at $1.50/€. none of the options

The FX market is not only the largest financial market in the world, but also:

Version 1

A) a centralized market with a wide variety of market participants and increased transparency. B) a centralized market with a narrow variety of market participants and limited transparency. C) a decentralized market with a wide variety of market participants and limited transparency. D) none of the options

61)

Market microstructure refers to A) B) C) D)

the basic mechanics of how a marketplace operates. the basics of how to make small (micro-sized) currency trades. how macroeconomic variables such as GDP and inflation are determined. none of the options

62) A recent survey of U.S. foreign exchange traders measured traders’ perceptions about how fast news events that cause movements in exchange rates actually change the exchange rate. The survey respondents claim that the bulk of the adjustment to economic announcements regarding unemployment, trade deficits, inflation, GDP, and the Federal funds rate takes place within A) B) C) D)

63)

one second. one minute. one hour. one day.

The forward price A) B) C) D)

Version 1

may be higher than the spot price. may be the same as the spot price. may be less than the spot price. all of the options

64)

Relative to the spot price, the forward price is A) B) C) D)

usually less than the spot price. usually more than the spot price. usually equal to the spot price. usually less than or more than the spot price more often than it is equal to the spot

price.

65) For a U.S. trader working with American quotes, if the forward price is higher than the spot price A) B) C) arbitrage. D)

66)

the currency is trading at a premium in the forward market. the currency is trading at a discount in the forward market. then you should buy at the spot, hold on to it and sell at the forward—it's a built-in all of the options

The forward market

A) involves contracting today for the future purchase or sale of foreign exchange at the spot rate that will prevail at the maturity of the contract. B) involves contracting today for the future purchase or sale of foreign exchange at a price agreed upon today. C) involves contracting today for the right but not the obligation for the future purchase or sale of foreign exchange at a price agreed upon today. D) none of the options

67) The $/CAD spot bid-ask rates are $0.7560–$0.7625. The 3-month forward points are 12– 16. Determine the $/CAD 3-month forward bid-ask rates.

Version 1

A) B) C) D)

$0.7548–$0.7609 $0.7572–$0.7641 $0.7512–$0.7616 Cannot be determined with the information given.

68) Restate the following one-, three-, and six-month outright forward American term bid-ask quotes in forward points: S($/SFr)

0.8500

−

0.8505

F1($/SFr)

0.8505

−

0.8510

F3($/SFr)

0.8510

−

0.8520

F6($/SFr)

0.8515

−

0.8530

A) Forward Point Quotations One-Month

05-05

Three-Month

10-15

Six-Month

15-25

B) Forward Point Quotations One-Month

05-05

Three-Month

05-10

Six-Month

05-10

C) Forward Point Quotations One-Month

00-05

Three-Month

05-10

Six-Month

05-10

D) none of the options Version 1

69)

If one has agreed to buy a foreign exchange forward, A) you have a short position in the forward contract. B) you have a long position in the forward contract. C) until the exchange rate moves, you haven't made money, so you're neither short nor

long. D) you have a long position in the spot market.

70) The current spot exchange rate is $1.55/€ and the three-month forward rate is $1.50/€. You enter into a short position on €1,000. At maturity, the spot exchange rate is $1.60/€. How much have you made or lost? A) B) C) D)

Loss of $100 Gain of €100 Loss of $50 Gain of $150

71) The current spot exchange rate is $1.55/€ and the three-month forward rate is $1.50/€. Based on your analysis of the exchange rate, you are confident that the spot exchange rate will be $1.52/€ in three months. Assume that you would like to buy or sell €1,000,000. What actions do you need to take to speculate in the forward market? A) B) C) D)

Take a long position in a forward contract on €1,000,000 at $1.50/€. Take a short position in a forward contract on €1,000,000 at $1.50/€. Buy euro today at the spot rate, sell them forward. Sell euro today at the spot rate, buy them forward.

72) The current spot exchange rate is $1.45/€ and the three-month forward rate is $1.55/€. Based upon your economic forecast, you are pretty confident that the spot exchange rate will be $1.50/€ in three months. Assume that you would like to buy or sell €100,000. What actions would you take to speculate in the forward market? How much will you make if your prediction is correct?

Version 1

A) Take a short position in a forward. If you're right you will make $15,000. B) Take a long position in a forward contract on euro. If you're right you will make $5,000. C) Take a short position in a forward contract on euro. If you're right you will make $5,000. D) Take a long position in a forward contract on euro. If you're right you will make $15,000.

73) Consider a trader who takes a long position in a six-month forward contract on the euro. The forward rate is $1.75 = €1.00; the contract size is €62,500. At the maturity of the contract the spot exchange rate is $1.65 = €1.00. A) B) C) D)

The trader has lost $625. The trader has lost $6,250. The trader has made $6,250. The trader has lost $66,287.88.

74) The current spot exchange rate is $1.55/€ and the three-month forward rate is $1.50/€. Based on your analysis of the exchange rate, you are confident that the spot exchange rate will be $1.62/€ in three months. Assume that you would like to buy or sell €1,000,000. What actions do you need to take to speculate in the forward market? What is the expected dollar profit from speculation? A) Sell €1,000,000 forward for $1.50/€. B) Buy €1,000,000 forward for $1.50/€. C) Wait three months, if your forecast is correct buy €1,000,000 at $1.52/€. D) Buy €1,000,000 today at $1.55/€; wait three months, if your forecast is correct sell €1,000,000 at $1.62/€.

75)

Which of the following are correct?

Version 1

A) B) C) D) all of the options

76)

Which of the following are correct?

A) B) C) D) all of the options

77)

Which of the following are correct?

A) B) C) D) all of the options

78)

Which of the following are correct?

A) B) C) D) all of the options

Version 1

79) When a foreign currency trades at a premium in the forward market (Assume that exchange rates are quoted in American terms) A) B) C) D)

the exchange rate is more than one dollar. the exchange rate is less than one dollar. the forward rate is less than the spot rate. the forward rate is more than the spot rate.

80) When a foreign currency trades at a discount in the forward market (Assume that exchange rates are quoted in American terms) A) B) C) D)

the forward rate is less than the spot rate. the forward rate is more than the spot rate. the forward exchange rate is less than one dollar the exchange rate is less than it was yesterday.

81) The SF/$ spot exchange rate is SF1.25/$ and the 180-day forward exchange rate is SF1.30/$. The forward premium (discount) on annualized basis is A) B) C) D)

the dollar trading at an 8% premium to the Swiss franc. the dollar trading at a 4% premium to the Swiss franc. the dollar trading at an 8% discount to the Swiss franc. the dollar trading at a 4% discount to the Swiss franc.

82) The $/€ spot exchange rate is $1.50/€ and the 120-day forward exchange rate is $1.45/€. The forward premium (discount) is A) B) C) D)

Version 1

the dollar trading at an 8% premium to the euro. the dollar trading at a 5% premium to the Swiss franc. the dollar trading at a 1% discount to the euro. the dollar trading at a 5% discount to the euro.

83) The $/€ spot exchange rate is $1.50/€ and the 90-day forward premium for the euro is 10 percent. Find the 90-day forward price for the euro. A) B) C) D)

$1.65/€ $1.50375/€ $1.9125/€ none of the options

84) The SF/$ spot exchange rate is SF1.25/$ and the 180-day forward premium is 8 percent. What is the outright 180-day forward exchange rate? A) B) C) D)

SF1.30/$ SF1.35/$ SF6.25/$ none of the options

85) The SF/$ 180-day forward exchange rate is SF1.30/$ and the 180-day forward premium is 8 percent. What is the spot exchange rate? A) B) C) D)

SF1.30/$ SF1.35/$ SF1.25/$ none of the options

86) Consider the following spot and forward rate quotations for the Swiss franc.S($/SFr) = 0.85F1($/SFr) = 0.86F2($/SFr) = 0.87F3($/SFr) =0.88Which of the following is true? A) B) C) D)

Version 1

The Swiss franc is definitely going to be worth more dollars in six months. The Swiss franc is probably going to be worth less in dollars in six months. The Swiss franc is trading at a forward discount. The Swiss franc is trading at a forward premium.

87) Consider the following spot and forward rate quotations for the Swiss franc.S($/SFr) = 0.85F1($/SFr) = 0.86F2($/SFr) = 0.87F3($/SFr) =0.88Calculate the 3-month forward premium in American terms. Assume 30-day months and 360-day years. A) B) C) D)

0.353. 0.4235. 0.1364. 0.1412.

88) Bank dealers in conversations among themselves use a shorthand notation to quote bid and ask forward prices in terms of forward points. This is convenient because A) forward points may change faster than spot and forward quotes. B) forward points may remain constant for long periods of time, even if the spot rates change frequently. C) in swap transactions where the trader is attempting to minimize currency exposure, the actual spot and outright forward rates are often of no consequence. D) Both B and C

89) Bank dealers in conversations among themselves use a shorthand notation to quote bid and ask forward prices in terms of forward points. Complete the following table: Spot

Forward Point Quotations

1.9072-1.9077

One-month

32-30

Three-month

57-54

1.9015-1.9023

Six-month

145-138

1.8927-1.8939

A) B) C) D)

90)

1.9040–1.9047 1.9042–1.9049 1.9032–1.9030 none of the options

An exchange-traded fund (ETF) is

Version 1

A) an uncovered speculative position in a currency. B) a portfolio of financial assets in which shares of the fund are sold and redeemed solely by the fund sponsor. C) a portfolio of financial assets in which shares representing fractional ownership of the fund trade on an organized exchange. D) none of the options

91)

Which of the following statements regarding ETF are not true?

A) Assets invested in the global ETF industry reached a new record of $5.4 trillion at the end of March 2019 B) Currency ETFs are a segment within the broader ETF industry C) ETFs allow small investors the opportunity to invest in portfolios of financial assets that they would find difficult to construct individually. D) none of the above are not true

92)

The largest and most active financial market in the world is A) B) C) D)

the London Stock Exchange. the New York Stock Exchange the FX market. none of the options

SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question. 93) Consider the balance sheets of Bank A and Bank B. Bank A is in Milan, Bank B is in New York. The current exchange rate is €1.00 = $1.25. Show the correct balances in each account if a currency trader employed at Bank A buys €100,000 from a currency trader at Bank B for $125,000 using its correspondent relationship with Bank B. Assets

Version 1

Bank A (Milan) 000s Liabilities and Equity

OLD

NEW

OLD

NEW

€ deposit at B

€

500

B's Eurodollar deposit

900

$ deposit at B

800

B's € deposit

€

220

Cash in the Vault €

200 € 200

Other Liabilities

€

300 € 300

Other Assets

€

400 € 400

Owners Equity

€

500 € 500

Total Assets @ €1.00 = $1.25

€ 1,740

Total Liabilities & Equity @ €1.00 = $1.25

€ 1,740

Bank B (NYC) 000s Liabilities and Equity

Assets OLD Eurodollar Deposit at A € deposit at A

NEW

OLD

NEW

€

900

A's euro deposit

500

220

A's $ deposit

€

800

Cash in the Vault €

200 € 200

Other Liabilities

€

200 € 200

Other Assets

€

600 € 600

Owners Equity

€

350 € 350

Total Assets @ €1.00 = $1.25

€ 1,975

Total Liabilities & Equity @ €1.00 = $1.25

€ 1,975

94) Consider the balance sheets of Bank A and Bank B. Bank A is in London, Bank B is in New York. The current exchange rate is £1.00 = $2.00. Show the correct balances in each account if a currency trader employed at Bank A buys £45,000 from a currency trader at Bank B for $90,000 using its correspondent relationship with Bank B. Assets

Version 1

Bank A (London) 000s Liabilities and Equity

OLD £ deposit at B

$ deposit at B

NEW

500

OLD B's Eurodollar deposit $

850

$ 1,000

B's £ deposit

100

Cash in the Vault

200

Other Liabilities

300

Other Assets

400

Owners Equity

775

Total Assets

£ 1,600

Total Liabilities & Equity

£ 1,600

NEW

Bank B (NYC) 000s Liabilities and Equity

Assets OLD

NEW

OLD

Eurodollar Deposit $ at A £ deposit at A £

850

A's £ deposit

100

A's $ deposit

$ 1,000

Cash in the Vault

200

Other Liabilities

200

Other Assets

$ 1,000

Owners Equity

Total Assets

$ 2,250

Total Liabilities & Equity

$ 2,250

NEW

500

95) Consider the balance sheets of Bank A and Bank B. Bank A is in London, Bank B is in New York. The current exchange rate is & pound;1.00 = $2.00. Show the correct balances in each account if a currency trader employed at Bank A buys £50,000 from a currency trader at Bank B for $100,000 using its correspondent relationship with Bank B. Assets

Version 1

Bank A (London) 000s Liabilities and Equity

OLD £ deposit at B

$ deposit at B

NEW

OLD

500

B's Eurodollar deposit $

850

$ 1,000

B's £ deposit

100

Cash in the Vault

200

Other Liabilities

300

Other Assets

400

Owners Equity

775

Total Assets

£ 1,600

Total Liabilities & Equity

£ 1,600

NEW

Bank B (NYC) 000s Liabilities and Equity

Assets OLD

NEW

OLD

Eurodollar Deposit $ at A £ deposit at A £

850

A's £ deposit

100

A's $ deposit

$ 1,000

Cash in the Vault

200

Other Liabilities

200

Other Assets

$ 1,000

Owners Equity

Total Assets

$ 2,250

Total Liabilities & Equity

$ 2,250

NEW

500

96) Country

USD equiv.

Currency per USD

Tuesday

Monday

Tuesday

Monday

U.K. (Pound)

1.7368

1.7424

0.5758

0.5739

1 Month Forward

1.7369

1.7425

0.5757

0.5739

Version 1

3 Months Forward

1.738

1.7434

0.5754

0.5736

6 Months Forward

1.7409

1.7461

0.5744

0.5727

Canada (Dollar)

0.8667

0.8653

1.1538

1.1557

1 Month Forward

0.8674

0.866

1.1529

1.1547

3 Months Forward

0.8688

0.8674

1.151

1.1529

6 Months Forward

0.8708

0.8693

1.1484

1.1504

Japan (Yen)

0.008518

0.008495

117.3985

117.7163

1 Month Forward

0.008548

0.008525

116.0631

117.3021

3 Months Forward

0.008616

0.008593

116.0631

116.3738

6 Months Forward

0.008724

0.0087

114.6263

114.9425

Switzerland (Franc)

0.7648

0.7652

1.3075

1.3068

1 Month Forward

0.767

0.7674

1.3038

1.3031

3 Months Forward

0.7718

0.7722

1.2957

1.295

6 Months Forward

0.7791

0.7794

1.2835

1.283

Euro

1.2000

1.1906

0.8333

0.8399

Using the table, what is the Canadian dollar–euro spot cross-exchange rate from Tuesday?

97) Country

U.K. (Pound)

Version 1

USD equiv.

Currency per USD

Tuesday

Monday

Tuesday

Monday

1.7368

1.7424

0.5758

0.5739

1 Month Forward

1.7369

1.7425

0.5757

0.5739

3 Months Forward

1.738

1.7434

0.5754

0.5736

6 Months Forward

1.7409

1.7461

0.5744

0.5727

Canada (Dollar)

0.8667

0.8653

1.1538

1.1557

1 Month Forward

0.8674

0.866

1.1529

1.1547

3 Months Forward

0.8688

0.8674

1.151

1.1529

6 Months Forward

0.8708

0.8693

1.1484

1.1504

Japan (Yen)

0.008518

0.008495

117.3985

117.7163

1 Month Forward

0.008548

0.008525

116.0631

117.3021

3 Months Forward

0.008616

0.008593

116.0631

116.3738

6 Months Forward

0.008724

0.0087

114.6263

114.9425

Switzerland (Franc)

0.7648

0.7652

1.3075

1.3068

1 Month Forward

0.767

0.7674

1.3038

1.3031

3 Months Forward

0.7718

0.7722

1.2957

1.295

6 Months Forward

0.7791

0.7794

1.2835

1.283

Euro

1.2000

1.1906

0.8333

0.8399

Using the table what is the 6-month forward pound–yen cross-exchange rate from Tuesday?

98) Country

Version 1

USD equiv.

Currency per USD

Tuesday

Monday

Tuesday

Monday

U.K. (Pound)

1.7368

1.7424

0.5758

0.5739

1 Month Forward

1.7369

1.7425

0.5757

0.5739

3 Months Forward

1.738

1.7434

0.5754

0.5736

6 Months Forward

1.7409

1.7461

0.5744

0.5727

Canada (Dollar)

0.8667

0.8653

1.1538

1.1557

1 Month Forward

0.8674

0.866

1.1529

1.1547

3 Months Forward

0.8688

0.8674

1.151

1.1529

6 Months Forward

0.8708

0.8693

1.1484

1.1504

Japan (Yen)

0.008518

0.008495

117.3985

117.7163

1 Month Forward

0.008548

0.008525

116.0631

117.3021

3 Months Forward

0.008616

0.008593

116.0631

116.3738

6 Months Forward

0.008724

0.0087

114.6263

114.9425

Switzerland (Franc)

0.7648

0.7652

1.3075

1.3068

1 Month Forward

0.767

0.7674

1.3038

1.3031

3 Months Forward

0.7718

0.7722

1.2957

1.295

6 Months Forward

0.7791

0.7794

1.2835

1.283

Euro

1.2000

1.1906

0.8333

0.8399

Using the table, what is 3-month forward premium or discount (expressed as an annual percentage rate) for the British pound in American terms?

Version 1

Answer Key Test name: Chap 05_9e 1) C 2) D 3) A 4) B 5) B 6) A 7) C 8) C 9) A 10) A 11) E 12) C 13) A 14) A 15) C 16) B 17) A 18) B 19) C 20) B 21) A 22) B 23) B 24) D 25) C 26) C Version 1

27) A 28) B 29) D 30) B 31) A 32) A 33) A 34) B 35) C 36) A 37) D 38) B 39) A 40) A 41) D 42) A 43) A 44) D 45) A 46) D 47) D 48) D 49) A 50) A 51) B 52) C 53) D 54) C 55) A 56) C Version 1

57) B 58) D 59) B 60) C 61) A 62) B 63) D 64) D 65) A 66) B 67) B 68) A 69) B 70) A 71) A 72) C 73) B 74) B 75) D 76) B 77) C 78) C 79) D 80) A 81) A 82) C 83) B 84) A 85) C 86) D Version 1

87) D 88) D 89) A 90) C 91) D 92) C 93) Bank A (Milan) 000s Liabilities and Equity

Assets OLD

NEW

OLD

NEW

€ deposit at B €

500 €

600

B's Eurodollar deposit $

900 $ 1,025

$ deposit at B $

800 $

675

B's € deposit

€

220 €

120

Cash in the Vault Other Assets

€

200 €

200

Other Liabilities

€

300 €

300

€

400 €

400

Owners Equity

€

500 €

500

Total Assets @ € 1,740 € 1,740 €1.00 = $1.25

Total Liabilities & € 1,740 € 1,740 Equity @ €1.00 = $1.25

Bank B (NYC) 000s Liabilities and Equity

Assets OLD

NEW

OLD

NEW

Eurodollar Deposit at A € deposit at A

€

900 $ 1,025

A's euro deposit

500 €

600

220 €

120

A's $ deposit

€

800 $

675

Cash in the Vault Other Assets

€

200 €

200

Other Liabilities

€

200 €

200

€

600 €

600

Owners Equity

€

350 €

350

Total Assets @ €1.00 = $1.25

€ 1,975 $ 1,975

Total Liabilities & Equity @ €1.00 = $1.25

€ 1,975 $ 1,975

Version 1

94) Bank A (London) 000s Liabilities and Equity

Assets OLD £ deposit at B £

NEW

OLD

500 £

545

$ deposit at B $ 1,000 $ Cash in the Vault Other Assets

£ £

Total Assets

£ 1,600 £ 1,600

850 $

940

910

B's Eurodollar deposit B's £ deposit

100 £

200 £

200

Other Liabilities

300 £

300

400 £

400

Owners Equity

775 £

775

Total Liabilities & Equity

£ 1,600 £ 1,600

Bank B (NYC) 000s Liabilities and Equity

Assets OLD Eurodollar Deposit at A £ deposit at A

NEW

OLD

NEW

850 $

940

A's £ deposit

500 £

545

100 £

A's $ deposit

$ 1,000 $

910

Cash in the Vault $

200 $

200

Other Liabilities

200 $

200

50 $

Other Assets

$ 1,000 $ 1,000

Owners Equity

Total Assets

$ 2,250 $ 2,250

Total Liabilities & $ 2,250 $ 2,250 Equity

95) Assets OLD

Version 1

Bank A (London) 000s Liabilities and Equity NEW

OLD

NEW

£ deposit at B £

500 £

550

850 $

950

900

B's Eurodollar deposit B's £ deposit

$ deposit at B $ 1,000 $

100 £

Cash in the Vault Other Assets

200 £

200

Other Liabilities

300 £

300

400 £

400

Owners Equity

775 £

775

Total Assets

£ 1,600 £ 1,600

Total Liabilities & Equity

£ 1,600 £ 1,600

Bank B (NYC) 000s Liabilities and Equity

Assets OLD Eurodollar Deposit at A £ deposit at A

NEW

OLD

NEW

850 $

950

A's £ deposit

500 £

550

100 £

A's $ deposit

$ 1,000 $

900

Cash in the Vault $

200 $

200

Other Liabilities

200 $

200

50 $

Other Assets

$ 1,000 $ 1,000

Owners Equity

Total Assets

$ 2,250 $ 2,250

Total Liabilities & $ 2,250 $ 2,250 Equity

96) CAD1.3846 €1.00

CAD1.00 $0.8667

$1.20 €1.00

£1.00 $1.7409

$0.008724 ¥1.00

97) £0.0050 ¥1.00

¥200/£ is ok too 98) 0.28%

Version 1

$1.738 − $1.7368 $1.7368

360 90

2.8% is a grievous error.

Version 1

CHAPTER 6 MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 1) The law of one price (LOP) is referring to A) a legal condition imposed by the U.S. Commodity Futures Trading Commission. B) the same or equivalent things trading at the same price across different locations or markets, precluding profitable arbitrage opportunities. C) the act of simultaneously buying and selling the same or equivalent assets or commodities for the purpose of making certain guaranteed profits. D) the composition of a standard commodity basket.

An arbitrage is best defined as

A) a legal condition imposed by the U.S. Commodity Futures Trading Commission. B) the act of simultaneously buying and selling the same or equivalent assets or commodities for the purpose of making reasonable profits. C) the act of simultaneously buying and selling the same or equivalent assets or commodities for the purpose of making certain guaranteed profits. D) a parity relationship that should hold in equilibrium.

Interest Rate Parity (IRP) is best defined as

A) occurring when a government brings its domestic interest rate in line with other major financial markets. B) occurring when the central bank of a country brings its domestic interest rate in line with its major trading partners. C) an arbitrage condition that must hold when international financial markets are in equilibrium. D) the act of simultaneously buying and selling the same or equivalent assets or commodities for the purpose of making certain guaranteed profits.

When Interest Rate Parity (IRP) does not hold

Version 1

A) there is usually a high degree of inflation in at least one country. B) the financial markets are in equilibrium. C) there are opportunities for covered interest arbitrage. D) the financial markets are in equilibrium and there are opportunities for covered interest arbitrage.

5) Suppose you observe a spot exchange rate of $1.0500/€. If interest rates are 5% per annum in the U.S. and 3% per annum in the euro zone, what is the no-arbitrage one-year forward rate? A) B) C) D)

€1.0704/$ $1.0704/€ €1.0300/$ $1.0300/€

6) Suppose you observe a spot exchange rate of $1.0500/€. If interest rates are 3 percent per annum in the U.S. and 5 percent per annum in the euro zone, what is the no-arbitrage one-year forward rate? A) B) C) D)

€1.0704/$ $1.0704/€ €1.0300/$ $1.0300/€

7) Suppose you observe a spot exchange rate of $2.00/£. If interest rates are 5 percent per annum in the U.S. and 2 percent per annum in the U.K., what is the no-arbitrage one-year forward rate?

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A) B) C) D)

£2.0588/$ $2.0588/£ £1.9429/$ $1.9429/£

A formal statement of IRP is

A) B)

C) D)

9) The two main reasons that IRP may not hold precisely at all time, especially over short periods is: A) B) C) D)

transaction costs and capital controls. transaction costs and inflation rates inflation rates and capital controls inflation rates and interest rates

10) Suppose that the one-year interest rate is 5.0 percent in the United States. The spot exchange rate is $1.20/€, and the one-year forward exchange rate is $1.16/€. What must the oneyear interest rate be in the euro zone to avoid arbitrage opportunities?

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A) B) C) D)

5.0% 6.09% 8.62% none of the options

11) Suppose that the one-year interest rate is 3.0 percent in Italy. The spot exchange rate is $1.20/€, and the one-year forward exchange rate is $1.18/€. What must the one-year interest rate be in the United States to avoid arbitrage opportunities? A) B) C) D)

1.2833% 1.0128% 4.75% none of the options

12) Suppose that the one-year interest rate is 4.0 percent in Italy. The spot exchange rate is $1.60/€, and the one-year forward exchange rate is $1.58/€. What must the one-year interest rate be in the United States to avoid arbitrage opportunities? A) B) C) D)

13)

2% 2.7% 5.32% none of the options

Covered Interest Arbitrage (CIA) transactions will result in A) B) C) D)

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unstable international financial markets. restoring equilibrium prices quickly. higher interest rates across all international financial markets. no effect on the market.

14) Suppose that the one-year interest rate is 5.0 percent in the United States and 3.5 percent in Germany, and that the spot exchange rate is $1.12/€ and the one-year forward exchange rate is $1.16/€. Assume that an arbitrageur can borrow up to $1,000,000. A) This is an example where interest rate parity holds. B) This is an example of an arbitrage opportunity; interest rate parity does not hold. C) This is an example of a Purchasing Power Parity violation and an arbitrage opportunity. D) none of the options

15) Suppose that you are the treasurer of IBM with an extra $1,000,000 to invest for six months. You are considering the purchase of U.S. T-bills that yield 1.810 percent over a sixmonth period. The spot exchange rate is $1.00 = ¥100, and the six-month forward rate is $1.00 = ¥110. Alternatively, the six-month interest rate in Japan on an investment of comparable risk is 13 percent. What is your strategy to maximize guaranteed dollar proceeds in six months? A) Take $1mn and invest in U.S. T-bills. B) Take $1mn, convert them into yen at the spot rate, invest in Japan, and repatriate your yen earnings back into dollars at the spot rate prevailing in six months. C) Take $1mn, convert them into yen at the spot rate, invest in Japan, and hedge with a short position on the forward contract. D) Take $1mn, convert them into yen at the forward rate, invest in Japan, and hedge with a short position on the spot contract.

16) Suppose that the annual interest rate is 2.0 percent in the United States and 4 percent in Germany, and that the spot exchange rate is $1.60/€ and the forward exchange rate, with oneyear maturity, is $1.58/€. Assume that an arbitrager can borrow up to $1,000,000 or €625,000. If an astute trader finds an arbitrageopportunity, what is the net cash flow in one year? A) B) C) D)

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$238.65 $14,000 $46,207 $7,000

17) An American currency dealer has good credit and can borrow either $1,000,000 or €800,000 for one year. The one-year interest rate is i$ = 2% in the U.S. and i€ = 6% in the euro zone, respectively. The spot exchange rate is $1.25 = €1.00 and the one-year forward exchange rate is $1.20 = €1.00. Show how you can realize a certain dollar profit via covered interest arbitrage. A) Borrow $1,000,000 at 2%; trade $1,000,000 for €800,000 at the spot rate; invest euros at i€ = 6%; translate euro proceeds back to dollars at the forward rate of $1.20 = €1.00. Gross proceeds will be $1,017,600. B) Borrow $1,000,000 at 2%; trade $1,000,000 for €800,000 at the spot rate; invest euros at i€ = 6%; translate euro proceeds back to dollars at the forward rate of $1.20 = €1.00. Net profit will be $17,600. C) Borrow €800,000 at i€ = 6%; translate euros to dollars at the spot rate, invest dollars in the U.S. at i$ = 2% for one year; translate dollars back to €850,000 at the forward rate of $1.20 = €1.00. Net profit will be €2,000. D) Borrow €800,000 at i€ = 6%; translate euros to dollars at the spot rate, invest dollars in the U.S. at i$ = 2% for one year; translate dollars back to €848,000 at the forward rate of $1.20 = €1.00. Net profit will be $2,400.

18) Currently, interest rate is 2 percent per annum in the U.S. and 6 percent per annum in the euro zone, respectively. The spot exchange rate is $1.25 = €1.00, and the one-year forward exchange rate is $1.20 = €1.00. As informed traders recognize the deviation from IRP and start carrying out covered interest arbitrage transactions to earn a certain profit, how will IRP be restored as a result? A) Interest rate in the euro zone will rise; interest rate in the U.S. will fall; euro will appreciate in the spot market; euro will appreciate in the forward market B) Interest rate in the euro zone will fall; interest rate in the U.S. will rise; euro will depreciate in the spot market; euro will depreciate in the forward market C) Interest rate in the euro zone will rise; interest rate in the U.S. will fall; euro will depreciate in the spot market; euro will appreciate in the forward market D) Interest rate in the euro zone will fall; interest rate in the U.S. will rise; euro will appreciate in the spot market; euro will depreciate in the forward market

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19) An Italian currency dealer has good credit and can borrow either $1,000,000 or €800,000 for one year. The one-year interest rate in the U.S. is i$ = 2% and in the euro zone the one-year interest rate is i€ = 6%. The spot exchange rate is $1.25 = €1.00 and the one-year forward exchange rate is $1.20 = €1.00. Show how you can realize a certain euro profit via covered interest arbitrage. A) Borrow $1,000,000 at 2%; trade $1,000,000 for €800,000 at the spot rate; invest euros at i€ = 6%; translate euro proceeds back to dollars at the forward rate of $1.20 = €1.00. Gross proceeds will be $1,017,600. B) Borrow $1,000,000 at 2%; trade $1,000,000 for €800,000 at the spot rate; invest euros at i€ = 6%; translate euro proceeds back to dollars at the forward rate of $1.20 = €1.00. Net profit will be $17,600. C) Borrow €800,000 at i€ = 6%; translate euros to dollars at the spot rate, invest dollars in the U.S. at i$ = 2% for one year; translate dollars back to €850,000 at the forward rate of $1.20 = €1.00. Net profit will be €2,000. D) Borrow €800,000 at i€ = 6%; translate euros to dollars at the spot rate, invest dollars in the U.S. at i$ = 2% for one year; translate dollars back to €848,000 at the forward rate of $1.20 = €1.00. Net profit will be $2,400.

20) A Polish currency dealer has good credit and can borrow either €1,600,000 or $2,000,000 for one year. The one-year interest rate in the U.S. is i$ = 6% and in the euro zone the one-year interest rate is i€ = 2%. The spot exchange rate is $1.20 = €1.00 and the one-year forward exchange rate is $1.25 = €1.00. Show how you can realize a certain euro profit via covered interest arbitrage. A) Borrow $2,000,000 at 6%; trade $2,000,000 for €1,666,667 at the spot rate; invest euros at i€ = 2%; translate euro proceeds back to dollars at the forward rate of $1.25 = €1.00 for gross proceeds of $2,125,000. Net profit will be $5,000 B) Borrow $2,000,000 at 6%; trade $2,000,000 for €800,000 at the spot rate; invest euros at i€ = 2%; translate euro proceeds back to dollars at the forward rate of $1.20 = €1.00. Net profit will be $17,600. C) Borrow €1,600,000 at i€ = 2%; translate euros to dollars at the spot rate, invest dollars in the U.S. at i$ = 6% for one year; translate dollars back to $2,000,000 at the forward rate of $1.20 = €1.00. Net profit will be €2,000. D) Arbitrage opportunity does not exit

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21) A Polish currency dealer has good credit and can borrow either €1,600,000 or $2,000,000 for one year. The one-year interest rate in the U.S. is i$ = 6.25% and in the euro zone the oneyear interest rate is i€ = 2%. The spot exchange rate is $1.20 = €1.00 and the one-year forward exchange rate is $1.25 = €1.00. Show how you can realize a certain euro profit via covered interest arbitrage. A) Borrow $2,000,000 at 6.25%; trade $2,000,000 for €1,666,667 at the spot rate; invest euros at i€ = 2%; translate euro proceeds back to dollars at the forward rate of $1.25 = €1.00 for gross proceeds of $2,125,000. Net profit will be $5,000 B) Borrow $2,000,000 at 6.25%; trade $2,000,000 for €800,000 at the spot rate; invest euros at i€ = 2%; translate euro proceeds back to dollars at the forward rate of $1.20 = €1.00. Net profit will be $17,600. C) Borrow €1,600,000 at i€ = 2%; translate euros to dollars at the spot rate, invest dollars in the U.S. at i$ = 6.25% for one year; translate dollars back to $2,000,000 at the forward rate of $1.20 = €1.00. Net profit will be €2,000. D) Arbitrage opportunity does not exit

22) Suppose that the annual interest rate is 5.0 percent in the United States and 3.5 percent in Germany. The spot exchange rate is $1.12/€, and the forward exchange rate with one-year maturity is $1.16/€. Assume that an arbitrager can borrow up to $1,000,000. If an astute trader finds an arbitrage opportunity, what is the net cash flow in one year? A) B) C) D)

$10,690 $15,000 $46,207 $21,964

23) How high does the lending rate in the euro zone have to be before an arbitrageur would not consider borrowing dollars, trading them for euro at the spot rate, investing those euros in the euro zone, and hedging with a short position in the forward euro contract?

S0($/€)

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Bid

Ask

$1.40-€1.00

$1.43-€1.00

Borrowing

Lending

i$ 4.20%APR

4.10%APR

F360($/€)

A) B) C) D)

$1.44-€1.00

$1.49-€1.00

i€

The bid-ask spreads are too wide for any profitable arbitrage when i€> 0 3.47% −2.09% none of the options

24) Suppose that the one-year interest rate is 5.0 percent in the United States and 3.5 percent in Germany, and the one-year forward exchange rate is $1.16/€. What must the spot exchange rate be according to the IRP? A) B) C) D)

25) in

$1.1768/€ $1.1434/€ $1.12/€ none of the options

A higher U.S. interest rate (i$) relative to interest rates abroad, ceteris paribus, will result

A) B) C) D)

a stronger dollar. a weaker dollar. a lower spot exchange rate (expressed as foreign currency per U.S. dollar). a higher spot exchange rate (expressed as U.S. dollar per foreign currency).

26) If the interest rate in the U.S. is i$ = 5 percent for the next year and interest rate in the U.K. is i£ = 8 percent for the next year, uncovered IRP suggests that

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A) B) C) D)

the pound is expected to depreciate against the dollar by about 3 percent. the pound is expected to appreciate against the dollar by about 3 percent. the dollar is expected to depreciate against the pound by about 3 percent. exchange rate will remain unchanged.

27) A currency dealer has good credit and can borrow either $1,000,000 or €800,000 for one year. The one-year interest rate in the U.S. is i$ = 2% and in the euro zone the one-year interest rate is i€ = 6%. The one-year forward exchange rate is $1.20 = €1.00; what must the spot rate be to eliminate arbitrage opportunities? A) B) C) D)

28)

$1.2471 = €1.00 $1.20 = €1.00 $1.1547 = €1.00 none of the options

Will an arbitrageur facing the following prices be able to make money? Borrowing

Lending

4.5%

€

5.5%

Bid

Ask

Spot

$1.00 = €1.00

$1.01 = €1.00

Forward

$0.99 = €1.00

$1.00 = €1.00

A) Yes, borrow $1,000 at 5 percent; trade for € at the ask spot rate $1.01 = €1.00; Invest €990.10 at 5.5 percent; hedge this with a forward contract on €1,044.55 at $0.99 = €1.00; receive $1.034.11. B) Yes, borrow €1,000 at 6 percent; trade for $ at the bid spot rate $1.00 = €1.00; invest $1,000 at 4.5 percent; hedge this with a forward contract on €1,045 at $1.00 = €1.00. C) No; the transactions costs are too high. D) none of the options

29)

If IRP fails to hold,

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A) pressure from arbitrageurs should bring exchange rates and interest rates back into line. B) it may fail to hold due to transactions costs. C) it may be due to government-imposed capital controls. D) all of the options

30)

Although IRP tends to hold, it may not hold precisely all the time

A) due to transactions costs, like the bid-ask spread only. B) due to arbitrage transactions only C) due to capital controls imposed by governments only. D) due to transactions costs, like the bid-ask spread, as well as capital controls imposed by governments.

31) The interest rate at which the arbitrager borrows tends to be higher than the rate at which he lends, reflecting the A) B) C) D)

capital controls midpoint. bid-ask spread. none of the options

32) Governments sometimes restrict capital flows, inbound and/or outbound. They achieve this objective by means of A) B) C) D)

33)

jawboning. imposing taxes on capital flows. bans on cross-border capital movements. all of the options

Will an arbitrageur facing the following prices be able to make money?

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S0($/€) F360($/€)

Bid

Ask

$1.40 / €1.00 $1.44 / €1.00

$1.43 / €1.00 $1.49 / €1.00

Borrowing

Lending

4.20%

4.10%

i€

3.65%

3.50%

A) Yes, borrow €1,000,000 at 3.65 percent; trade for $ at the bid spot rate of $1.40 = €1.00; invest $ at 4.1 percent; hedge the maturity value by going long on a forward contract and agreeing to buy € at the ask price of $1.49/€ in one year. The net cash flow will be positive in one year. B) Yes, borrow $1,000,000 at 4.2 percent; trade for € at the spot ask exchange rate of $1.43 = €1.00; invest €699,300.70 at 3.5 percent; hedge the maturity value by going short on a forward and agreeing to sell € at the bid price of $1.44/€ in one year. The net cash flow will be positive in one year. C) No; the transactions costs are too high. D) none of the options

34)

If a foreign county experiences a hyperinflation, A) B) C) D)

its currency will depreciate against stable currencies. its currency may appreciate against stable currencies. its currency may be unaffected; it's difficult to say. none of the options

35) As of today, the spot exchange rate is €1.00 = $1.25 and the rates of inflation expected to prevail for the next year in the U.S. is 2 percent and 3 percent in the euro zone. What is the oneyear forward rate that should prevail? A) B) C) D)

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€1.00 = $1.2379 €1.00 = $1.2623 €1.00 = $0.9903 $1.00 = €1.2623

36)

Purchasing Power Parity (PPP) theory states that

A) the exchange rate between currencies of two countries should be equal to the ratio of the countries' price levels. B) as the purchasing power of a currency sharply declines (due to hyperinflation) that currency will depreciate against stable currencies. C) the prices of standard commodity baskets in two countries are not related. D) Both A and B are correct.

37) As of today, the spot exchange rate is €1.00 = $1.60 and the rates of inflation expected to prevail for the next year in the U.S. is 2 percent and 3 percent in the euro zone. What is the oneyear forward rate that should prevail? A) B) C) D)

€1.00 = $1.6157 €1.6157 = $1.00 €1.00 = $1.5845 $1.00 × 1.03 = €1.60 × 1.02

38) If the annual inflation rate is 5.5 percent in the United States and 4 percent in the U.K., and the dollar depreciated against the pound by 3 percent, then the real exchange rate, assuming that PPP initially held, is A) B) C) D)

0.07. 0.9849. −0.0198. 4.5.

39) In view of the fact that PPP is the manifestation of the law of one price applied to a standard commodity basket,

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A) it will hold only if the prices of the constituent commodities are equalized across countries in a given currency. B) it will hold only if the composition of the consumption basket is the same across countries. C) both of the options D) none of the options

40) If PPP holds for tradables and the relative prices between tradables and nontradables are maintained, then: A) B) C) D)

41)

Some commodities never enter into international trade. Examples include A) B) C) D)

42)

nontradables. haircuts. housing. all of the options

Generally unfavorable evidence on PPP suggests that

A) B) evidence. C) D)

43)

PPP can hold in its relative version PPP will increase PPP will decrease none of the options

substantial barriers to international commodity arbitrage exist. tariffs and quotas imposed on international trade can explain at least some of the shipping costs can make it difficult to directly compare commodity prices. all of the options

The price of a McDonald's Big Mac sandwich

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A) B) C) D)

44)

is about the same in the 120 countries that McDonalds does business in. varies considerably across the world in dollar terms. supports PPP. none of the options.

The Fisher effect can be written for the United States as:

A. is = ρs + E(πs) +ρs × E(πs)

B. ρs = is + E(πs) + is × E(πs)

A) B) C) D)

45)

Option A Option B Option C Option D

Forward parity states that A) any forward premium or discount is equal to the expected change in the exchange

rate. B) any forward premium or discount is equal to the actual change in the exchange rate. C) the nominal interest rate differential reflects the expected change in the exchange rate. D) an increase (decrease) in the expected inflation rate in a country will cause a proportionate increase (decrease) in the interest rate in the country.

46)

The International Fisher Effect suggests that

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A) any forward premium or discount is equal to the expected change in the exchange rate. B) any forward premium or discount is equal to the actual change in the exchange rate. C) the nominal interest rate differential reflects the expected change in the exchange rate. D) an increase (decrease) in the expected inflation rate in a country will cause a proportionate increase (decrease) in the interest rate in the country.

47)

The Fisher effect states that A) any forward premium or discount is equal to the expected change in the exchange

48)

The main approaches to forecasting exchange rates are A) B) C) D)

49)

Efficient market, fundamental, and technical approaches. Efficient market and technical approaches only. Efficient market and fundamental approaches only. Fundamental and technical approaches only.

The benefit to forecasting exchange rates

A) are greatest during periods of fixed exchange rates. B) are nonexistent now that the euro and dollar are the biggest game in town. C) accrue to, and are a vital concern for, MNCs formulating international sourcing, production, financing, and marketing strategies. D) all of the options

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50)

The Efficient Markets Hypothesis states

A) markets tend to evolve to low transactions costs and speedy execution of orders. B) current asset prices (e.g., exchange rates) fully reflect all the available and relevant information. C) current exchange rates cannot be explained by such fundamental forces as money supplies, inflation rates and so forth. D) none of the options

51)

Good, inexpensive, and fairly reliable predictors of future exchange rates include

A) B) C) explain. D)

52)

today's exchange rate. current forward exchange rates esoteric fundamental models that take an econometrician to use and that no one can today's exchange rate, as well as current forward exchange rates

Which of the following is a true statement?

A) While researchers found it difficult to reject the random walk hypothesis for exchange rates on empirical grounds, there is no theoretical reason why exchange rates should follow a pure random walk. B) While researchers found it easy to reject the random walk hypothesis for exchange rates on empirical grounds, there are strong theoretical reasons why exchange rates should follow a pure random walk. C) While researchers found it difficult to reject the random walk hypothesis for exchange rates on empirical grounds, there are compelling theoretical reasons why exchange rates should follow a pure random walk. D) none of the options

53)

If an exchange rate follows a random walk

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A) the future exchange rate is unpredictable. B) the future exchange rate is expected to be the same as the current exchange rate, St = E(St+ 1). C) the best predictor of future exchange rates is the forward rate Ft = E(St+ 1|It). D) the future exchange rate is expected to be the same as the current exchange rate, St = E(St+ 1), and the best predictor of future exchange rates is the forward rate Ft = E(St+ 1|It).

54)

One implication of the random walk hypothesis is

A) given the efficiency of foreign exchange markets, it is difficult to outperform the market-based forecasts unless the forecaster has access to private information that is not yet reflected in the current exchange rate. B) given the efficiency of foreign exchange markets, it is difficult to outperform the market-based forecasts unless the forecaster has access to private information that is already reflected in the current exchange rate. C) given the relative inefficiency of foreign exchange markets, it is difficult to outperform the technical forecasts unless the forecaster has access to private information that is not yet reflected in the current futures exchange rate. D) none of the options

55)

The random walk hypothesis suggests that A) B) C) D)

56)

the best predictor of the future exchange rate is the current exchange rate. the best predictor of the future exchange rate is the current interest rate differential. the best predictor of the future exchange rate is the current inflation differential. none of the options

With regard to fundamental forecasting versus technical forecasting of exchange rates

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A) B) C) D)

57)

the technicians tend to use "cause and effect" models. the fundamentalists tend to believe that "history will repeat itself" is the best model. the fundamentalists tend to believe that exchange rates follow a random walk. none of the options

Generating exchange rate forecasts with the fundamental approach involves

A) looking at charts of the exchange rate and extrapolating the patterns into the future. B) estimation of a cyclical model. C) substituting the estimated values of the dependent variables into the estimated structural model to generate the forecast. D) estimation of a structural model and substitution of the estimated values of the independent variables into the estimated structural model to generate the forecast.

58) Which of the following issues are difficulties for the fundamental approach to exchange rate forecasting? A) One has to forecast a set of independent variables to forecast the exchange rates. Forecasting the former will certainly be subject to errors and may not be necessarily easier than forecasting the latter. B) The parameter values, that is the α's and β's, that are estimated using historical data may change over time because of changes in government policies and/or the underlying structure of the economy. Either difficulty can diminish the accuracy of forecasts even if the model is correct. C) The model itself can be wrong. D) All of the options

59)

Researchers have found that the fundamental approach to exchange rate forecasting

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A) outperforms the efficient market approach. B) fails to more accurately forecast exchange rates than either the random walk model or the forward rate model. C) fails to more accurately forecast exchange rates than the random walk model but is better than the forward rate model. D) outperforms the random walk model, but fails to more accurately forecast exchange rates than the forward rate model.

60) Academic studies tend to discredit the validity of technical analysis. Which of the following is true? A) This can be viewed as support for technical analysis. B) It can be rational for individual traders to use technical analysis. If enough traders use technical analysis, the predictions based on technical analysis can become self-fulfilling to some extent, at least in the short-run. C) The statement can be explained by the difficulty professors may have in differentiating between technical analysis and fundamental analysis. D) none of the options

61)

The moving average crossover rule

A) is a fundamental approach to forecasting exchange rates. B) states that a crossover of the short-term moving average above the long-term moving average signals that the foreign currency is appreciating. C) states that a crossover of the short-term moving average above the long-term moving average signals that the foreign currency is depreciating. D) none of the options

62)

According to the technical approach, what matters in exchange rate determination

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A) B) C) D)

63)

is the past behavior of exchange rates. is the velocity of money. is the future behavior of exchange rates. is the beta.

Studies of the accuracy of paid exchange rate forecasters

A) tend to support the view that "you get what you pay for". B) tend to support the view that forecasting is easy, at least with regard to major currencies like the euro and Japanese yen. C) tend to support the view that banks do their best forecasting with the yen. D) none of the options

64)

According to the research in the accuracy of paid exchange rate forecasters,

A) as a group, they do not do a better job of forecasting the exchange rate than the forward rate does. B) the average forecaster is better at forecasting than the forward rate. C) the forecasters do a better job of predicting the future exchange rate than the market does. D) none of the options

65)

According to the monetary approach, what matters in exchange rate determination are A) B) C) D)

66)

the relative money supplies. the relative velocities of monies. the relative national outputs. all of the options

According to the monetary approach, the exchange rate can be expressed as

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A) B) C) D) none of the options

67) According to a survey study conducted by Rossi (2013), the exchange rate predictability depends on: A) B) C) D)

the choice of predictor forecast horizon and evaluation method sample period and model all of the options

SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question. 68) Use the information below to answer the following question. Exchange Rate

Interest Rate

APR

S0($/€)

$ 1.60

€ 1.00

F360($/€)

$ 1.58

€ 1.00

i€

If you borrowed €1,000,000 for one year, how much money would you owe at maturity?

69)

Use the information below to answer the following question. Exchange Rate

Version 1

Interest Rate

APR

S0($/€)

$ 1.60

€ 1.00

F360($/€)

$ 1.58

€ 1.00

i€

If you borrowed $1,000,000 for one year, how much money would you owe at maturity?

70)

Use the information below to answer the following question. Exchange Rate

Interest Rate

APR

S0($/€)

$ 1.60

€ 1.00

F360($/€)

$ 1.58

€ 1.00

i€

If you had borrowed $1,000,000, traded them for euro at the spot rate, and invested those euros in Europe, how many euros will you receive in one year?

71)

Use the information below to answer the following question. Exchange Rate

Interest Rate

APR

S0($/€)

$ 1.60

€ 1.00

F360($/€)

$ 1.58

€ 1.00

i€

If you had €1,000,000, traded them for USD at the spot rate, and invested those dollars in the U.S., how many USD will you get in one year?

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72)

Use the information below to answer the following question. Exchange Rate

Interest Rate

APR

S0($/€)

$ 1.45

€ 1.00

F360($/€)

$ 1.48

€ 1.00

i€

If you borrowed €1,000,000 for one year, how much money would you owe at maturity?

73)

Use the information below to answer the following question. Exchange Rate

Interest Rate

APR

S0($/€)

$ 1.45

€ 1.00

F360($/€)

$ 1.48

€ 1.00

i€

If you borrowed $1,000,000 for one year, how much money would you owe at maturity?

74)

Use the information below to answer the following question. Exchange Rate S0($/€)

Version 1

$ 1.45

€ 1.00

Interest Rate i$

APR 4%

F360($/€)

$ 1.48

€ 1.00

i€

If you had borrowed $1,000,000, traded them for euros at the spot rate, and invested those euros in Europe, how many euros do you receive in one year?

75)

Use the information below to answer the following question. Exchange Rate

Interest Rate

APR

S0($/€)

$ 1.45

€ 1.00

F360($/€)

$ 1.48

€ 1.00

i€

If you had €1,000,000, traded them for USD at the spot rate, and invested those dollars in the U.S., how many USD will you get in one year?

76) Assume that you are a retail customer. Use the information below to answer the following question. Bid

Ask

APR

S0($/€)

$ 1.42

€ 1.00

$ 1.45

€ 1.00

F360($/€)

$ 1.48

€ 1.00

$ 1.50

€ 1.00

i€

If you borrowed €1,000,000 for one year, how much money would you owe at maturity?

Version 1

77) Assume that you are a retail customer. Use the information below to answer the following question.

Bid

Ask

APR

S0($/€)

$ 1.42

€ 1.00

$ 1.45

€ 1.00

F360($/€)

$ 1.48

€ 1.00

$ 1.50

€ 1.00

i€

If you borrowed $1,000,000 for one year, how much money would you owe at maturity?

78) Assume that you are a retail customer. Use the information below to answer the following question. Bid

Ask

APR

S0($/€)

$ 1.42

€ 1.00

$ 1.45

€ 1.00

F360($/€)

$ 1.48

€ 1.00

$ 1.50

€ 1.00

i€

If you had borrowed $1,000,000, traded them for euros at the spot rate, and invested those euros in Europe, how many euros do you receive in one year?

Version 1

79) Assume that you are a retail customer. Use the information below to answer the following question. Bid

Ask

APR

S0($/€)

$ 1.42

€ 1.00

$ 1.45

€ 1.00

F360($/€)

$ 1.48

€ 1.00

$ 1.50

€ 1.00

i€

If you had €1,000,000 and traded it for USD at the spot rate, how many USD will you get?

80) Assume that you are a retail customer. Use the information below to answer the following question. Bid

Ask

Borrowing

Lending

S0($/€) $1.42 = €1.00

$1.45 = €1.00

4.25% APR

4% APR

F360($/€) $1.48 = €1.00

$1.50 = €1.00

i€

3.10% APR

3% APR

If you borrowed €1,000,000 for one year, how much money would you owe at maturity?

81) Assume that you are a retail customer. Use the information below to answer the following question. Bid

Version 1

Ask

Borrowing

Lending

S0($/€) $1.42 = €1.00

$1.45 = €1.00

4.25% APR

4% APR

F360($/€) $1.48 = €1.00

$1.50 = €1.00

i€

3.10% APR

3% APR

If you borrowed $1,000,000 for one year, how much money would you owe at maturity?

82) Assume that you are a retail customer. Use the information below to answer the following question. Bid

Ask

Borrowing

Lending

S0($/€) $1.42 = €1.00

$1.45 = €1.00

4.25% APR

4% APR

F360($/€) $1.48 = €1.00

$1.50 = €1.00

i€

3.10% APR

3% APR

If you had borrowed $1,000,000, traded them for euros at the spot rate, and invested those euros in Europe, how many euros do you receive in one year?

83) Assume that you are a retail customer. Use the information below to answer the following question. Bid

Ask

Borrowing

Lending

S0($/€) $1.42 = €1.00

$1.45 = €1.00

4.25% APR

4% APR

F360($/€) $1.48 = €1.00

$1.50 = €1.00

i€

3.10% APR

3% APR

Version 1

If you had €1,000,000, traded those euros for USD at the spot rate, and invested the dollars in the U.S., how many USD will you get in one year?

84) Assume that you are a retail customer. Use the information below to answer the following question. Bid

Ask

Borrowing

Lending

S0($/€) $1.40 = €1.00

$1.43 = €1.00

4.20% APR

4.10% APR

F360($/€) $1.44 = €1.00

$1.49 = €1.00

i€

3.65% APR

3.50% APR

If you borrowed €1,000,000 for one year, how much money would you owe at maturity?

85) Assume that you are a retail customer. Use the information below to answer the following question. Bid

Ask

Borrowing

Lending

S0($/€) $1.40 = €1.00

$1.43 = €1.00

4.20% APR

4.10% APR

F360($/€) $1.44 = €1.00

$1.49 = €1.00

i€

3.65% APR

3.50% APR

If you borrowed $1,000,000 for one year, how much money would you owe at maturity?

Version 1

86) Assume that you are a retail customer. Use the information below to answer the following question. Bid

Ask

Borrowing

Lending

S0($/€) $1.40 = €1.00

$1.43 = €1.00

4.20% APR

4.10% APR

F360($/€) $1.44 = €1.00

$1.49 = €1.00

i€

3.65% APR

3.50% APR

If you had borrowed $1,000,000 and traded for euro at the spot rate, how many € do you receive?

87) Assume that you are a retail customer. Use the information below to answer the following question. Bid

Ask

Borrowing

Lending

S0($/€) $1.40 = €1.00

$1.43 = €1.00

4.20% APR

4.10% APR

F360($/€) $1.44 = €1.00

$1.49 = €1.00

i€

3.65% APR

3.50% APR

If you had €1,000,000, traded them for USD at the spot rate, and invested the dollars in the U.S., how many USD will you get in one year?

Version 1

Answer Key Test name: Chap 06_9e 1) B 2) C 3) C 4) C 5) B 6) D 7) B 8) A 9) A 10) C 11) A 12) B 13) B 14) B 15) C 16) D 17) D 18) C 19) C 20) A 21) D 22) D 23) B 24) B 25) A 26) A Version 1

27) A 28) C 29) D 30) D 31) C 32) D 33) B 34) A 35) A 36) D 37) C 38) B 39) C 40) A 41) D 42) D 43) B 44) A 45) A 46) C 47) D 48) A 49) C 50) B 51) D 52) A 53) B 54) A 55) A 56) D Version 1

57) D 58) D 59) B 60) B 61) B 62) A 63) D 64) A 65) D 66) A 67) D 68) €1,000,000 × 1.04 = €1,040,000 69) $1,000,000 × 1.02 = €1,020,000 70) $1,000,000

€1 $1.60

€625,000

$1.60 €1.00

$1,600,000

71) €1,000,000

72) €1,000,000 × 1.03 = €1,030,000 73) $1,000,000 × 1.04 = €1,040,000 74) $1,000,000

€1 $1.45

€689,655.17

$1.45 €1.00

$1,450,000

75) €1,000,000

76) €1,000,000 × 1.03 = €1,030,000 77) $1,000,000 × 1.04 = €1,040,000 78) $1,000,000

€1 $1.45

€689,655.17

79) Version 1

€1,000,000

$1.42 €1.00

$1,420,000

80) €1,000,000 × 1.031 = €1,031,000 81) $1,000,000 × 1.0425 = $1,042,500 82) $1,000,000

€1 $1.45

€689,655.17

$1.42 €1.00

€1,420,000

83) €1,000,000

84) €1,000,000 × 1.0365 = €1,036,500 85) $1,000,000 × 1.0420 = €1,042,000 86) $1,000,000

€1 $1.43

€699,300.70

$1.40 €1.00

€1,400,000

87) €1,000,000

Version 1

CHAPTER 7 TRUE/FALSE - Write 'T' if the statement is true and 'F' if the statement is false. 1) A put option on $15,000 with a strike price of €0.666/$ is the same thing as a call option on €10,000 with a strike price of $1.50/€. ⊚ ⊚

true false

MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 2) A CME contract on €125,000 with September delivery A) B) C) D)

Which of the following does not describe a futures contract?

A) B) systems. C) D)

is an example of a forward contract. is an example of a futures contract. is an example of a put option. is an example of a call option.

Traded competitively on organized exchanges. Traded by bank dealers via a network of telephones and computerized dealing Standardized amount of the underlying asset. Standardized deliver dates.

Which of the following does describe a forward contract?

A) B) systems. C) D)

Traded competitively on organized exchanges. Traded by bank dealers via a network of telephones and computerized dealing

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Standardized amount of the underlying asset. Standardized deliver dates.

5) Yesterday, you entered into a futures contract to buy €62,500 at $1.50 per €. Suppose the futures price closes today at $1.46. How much have you made/lost? A) B) C) D)

Depends on your margin balance. You have made $2,500.00. You have lost $2,500.00. You have neither made nor lost money, yet.

In reference to the futures market, a "speculator"

A) attempts to profit from a change in the futures price. B) wants to avoid price variation by locking in a purchase price of the underlying asset through a long position in the futures contract or a sales price through a short position in the futures contract. C) stands ready to buy or sell contracts in unlimited quantity. D) wants to avoid price variation by locking in a purchase price of the underlying asset through a long position in the futures contract or a sales price through a short position in the futures contract, and also stands ready to buy or sell contracts in unlimited quantity.

Comparing "forward" and "futures" exchange contracts, we can say that

A) they are both "marked-to-market" daily. B) their major difference is in the way the underlying asset is priced for future purchase or sale: futures settle daily and forwards settle at maturity. C) a futures contract is traded on an organized exchange, while forward contract is tailor-made by an international bank for its clients and is traded OTC. D) their major difference is in the way the underlying asset is priced for future purchase or sale: futures settle daily and forwards settle at maturity, and a futures contract is traded on an organized exchange, while a forward contract is tailor-made by an international bank for its clients and is traded OTC.

Comparing "forward" and "futures" exchange contracts, we can say that

Version 1

A) delivery of the underlying asset is seldom made in futures and forward contracts. B) delivery of the underlying asset is usually made in futures and forward contracts. C) delivery of the underlying asset is never made in either contract—they are typically cash settled at maturity. D) delivery of the underlying asset is seldom made in futures contracts and delivery of the underlying asset is usually made in forward contracts.

In which market does a clearinghouse serve as a third party to all transactions? A) B) C) D)

Futures Forwards Swaps none of the options

10) A limit as to how much the settlement price an increase or decrease from the previous day’s settlement describes a? A) B) C) D)

11)

commission clearinghouse daily price limit none of the options

In the event of a default on one side of a futures trade,

A) the clearing member stands in for the defaulting party. B) the clearing member will seek restitution for the defaulting party. C) if the default is on the short side, a randomly selected long contract will not get paid. That party will then have standing to initiate a civil suit against the defaulting short. D) the clearing member stands in for the defaulting party and will seek restitution for the defaulting party.

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12) Yesterday, you entered into a futures contract to buy €62,500 at $1.50 per €. Your initial performance bond is $1,500 and your maintenance level is $500. At what settle price will you get a demand for additional funds to be posted? A) B) C) D)

$1.5160 per €. $1.208 per €. $1.1920 per €. $1.4840 per €.

13) Yesterday, you entered into a futures contract to sell €75,000 at $1.79 per €. Your initial performance bond is $1,500 and your maintenance level is $500. At what settle price will you get a demand for additional funds to be posted? A) B) C) D)

$1.7767 per €. $1.2084 per €. $1.6676 per €. $1.1840 per €.

14) Yesterday, you entered into a futures contract to buy €62,500 at $1.50/€. Your initial margin was $3,750 (= 0.04 × €62,500 × $1.50/€ = 4 percent of the contract value in dollars). Your maintenance margin is $2,000 (meaning that your broker leaves you alone until your account balance falls to $2,000). At what settle price (use 4 decimal places) do you get a margin call? A) B) C) D)

$1.4720/€ $1.5280/€ $1.500/€ none of the options

15) Three days ago, you entered into a futures contract to sell €62,500 at $1.50 per €. Over the past three days the contract has settled at $1.50, $1.52, and $1.54. How much have you made or lost?

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A) B) C) D)

Lost $0.04 per € or $2,500 Made $0.04 per € or $2,500 Lost $0.06 per € or $3,750 none of the options

16) Today's settlement price on a Chicago Mercantile Exchange (CME) yen futures contract is $0.8011/¥100. Your margin account currently has a balance of $2,000. The next three days' settlement prices are $0.8057/¥100, $0.7996/¥100, and $0.7985/¥100. (The contractual size of one CME yen contract is ¥12,500,000). If you have a short position in one futures contract, the changes in the margin account from daily marking-to-market will result in the balance of the margin account after the third day to be A) B) C) D)

$1,425. $2,000. $2,325. $3,425.

17) Today's settlement price on a Chicago Mercantile Exchange (CME) yen futures contract is $0.8011/¥100. Your margin account currently has a balance of $2,000. The next three days' settlement prices are $0.8057/¥100, $0.7996/¥100, and $0.7985/¥100. (The contractual size of one CME yen contract is ¥12,500,000). If you have a long position in one futures contract, the changes in the margin account from daily marking-to-market, will result in the balance of the margin account after the third day to be A) B) C) D)

$1,425. $1,675. $2,000. $3,425

18) Suppose the futures price is below the price predicted by IRP. What steps would a speculator take to attempt to profit?

Version 1

A) B) C) D)

19)

Go long in the futures contract. Go short in the futures contract. Go short in the spot market. Go long in the spot market.

What paradigm is used to define the futures price? A) B) C) D)

IRP Hedge Ratio Black Scholes Risk Neutral Valuation

20) Suppose you observe the following one-year interest rates, spot exchange rates and futures prices. Futures contracts are available on €10,000. How much risk-free arbitrage profit could you make on one contract at maturity from this mispricing?

S0($/€) F360($/€)

A) B) C) D)

21)

Exchange Rate

Interest Rate

APR

$1.45 = €1.00 $1.48 = €1.00

i$ i€

4% 3%

$159.22 $153.10 $439.42 none of the options

Which equation is used to define the futures price?

Version 1

A) B) C) D)

22)

Which equation is used to define the futures price?

A) B) C) D)

23) If a currency futures contract (direct quote) is priced below the price implied by Interest Rate Parity (IRP), arbitrageurs could take advantage of the mispricing by simultaneously A) going short in the futures contract, borrowing in the domestic currency, and going long in the foreign currency in the spot market. B) going short in the futures contract, lending in the domestic currency, and going long in the foreign currency in the spot market. C) going long in the futures contract, borrowing in the domestic currency, and going short in the foreign currency in the spot market. D) going long in the futures contract, borrowing in the foreign currency, and going long in the domestic currency, investing the proceeds at the local rate of interest.

24)

Open interest in currency futures contracts

Version 1

A) tends to be greatest for the near-term contracts, and typically increases with the term to maturity of most futures contracts. B) tends to be greatest for the longer-term contracts. C) typically increases with the term to maturity of most futures contracts. D) tends to be greatest for the near-term contracts, and typically decreases with the term to maturity of most futures contracts.

25)

The "open interest" shown in currency futures quotations is A) the total number of people indicating interest in buying the contracts in the near

future. B) the total number of people indicating interest in selling the contracts in the near future. C) the total number of people indicating interest in buying or selling the contracts in the near future. D) the total number of long or short contracts outstanding for the particular delivery month.

26)

If you think that the dollar is going to appreciate against the euro, you should A) B) C) D)

buy put options on the euro. sell call options on the euro. buy call options on the euro. none of the options

27) From the perspective of the writer of a put option written on €62,500. If the strike price is $1.55/€, and the option premium is $1,875, at what exchange rate do you start to lose money?

Version 1

A) B) C) D)

28)

$1.52/€ $1.55/€ $1.58/€ none of the options

A European option is different from an American option in that

A) one is traded in Europe and one in traded in the United States. B) European options can only be exercised at maturity; American options can be exercised prior to maturity. C) European options tend to be worth more than American options, ceteris paribus. D) American options have a fixed exercise price; European options' exercise price is set at the average price of the underlying asset during the life of the option.

29)

An "option" is

A) a contract giving the seller (writer) of the option the right, but not the obligation, to buy (call) or sell (put) a given quantity of an asset at a specified price at some time in the future. B) a contract giving the owner (buyer) of the option the right, but not the obligation, to buy (call) or sell (put) a given quantity of an asset at a specified price at some time in the future. C) a contract giving the owner (buyer) of the option the right, but not the obligation, to buy (put) or sell (call) a given quantity of an asset at a specified price at some time in the future. D) a contract giving the owner (buyer) of the option the right, but not the obligation, to buy (put) or sell (sell) a given quantity of an asset at a specified price at some time in the future.

30) An investor believes that the price of a stock, say IBM's shares, will increase in the next 60 days. If the investor is correct, which combination of the following investment strategies will show a profit in all the choices?(i) buy the stock and hold it for 60 days(ii) buy a put option(iii) sell (write) a call option(iv) buy a call option(v) sell (write) a put option

Version 1

A) B) C) D)

31)

Most exchange traded currency options A) B) C) D)

32)

(i), (ii), and (iii) (i), (ii), and (iv) (i), (iv), and (v) (ii) and (iii)

mature every month, with daily resettlement. have original maturities of 1, 2, and 3 years. have original maturities of 3, 6, 9, and 12 months. mature every month, without daily resettlement.

The volume of OTC currency options trading is

A) much smaller than that of organized-exchange currency option trading. B) much larger than that of organized-exchange currency option trading. C) larger, because the exchanges are only repackaging OTC options for their customers. D) none of the options

33) In the CURRENCY TRADING section of The Wall Street Journal, the following appeared under the heading OPTIONS:

Philadelphia Exchange

Puts

Swiss Franc

69.33

62,500 Swiss Francs-cents per unit

Version 1

Vol.

Last

68 May

0.30

69 May

0.50

Which combination of the following statements are true? (i) The time values of the 68 May and 69 May put options are respectively .30 cents and .50 cents.(ii) The 68 May put option has a lower time value (price) than the 69 May put option.(iii) If everything else is kept constant, the spot price and the put premium are inversely related.(iv) The time values of the 68 May and 69 May put options are, respectively, 1.63 cents and 0.83 cents.(v) If everything else is kept constant, the strike price and the put premium are inversely related. A) B) C) D)

34)

With currency futures options the underlying asset is A) B) C) D)

35)

(i), (ii), and (iii) (ii), (iii), and (iv) (iii) and (iv) (iv) and (v)

foreign currency. a call or put option written on foreign currency. a futures contract on the foreign currency. none of the options

Exercise of a currency futures option results in A) B) C) D)

a long futures position for the call buyer or put writer. a short futures position for the call buyer or put writer. a long futures position for the put buyer or call writer. a short futures position for the call buyer or put buyer.

36) A currency futures option amounts to a derivative on a derivative. Why would something like that exist?

Version 1

A) For some assets, the futures contract can have lower transaction costs and greater liquidity than the underlying asset. B) Tax consequences matter as well, and for some users an option contract on a future is more tax efficient. C) Transaction costs and liquidity D) all of the options

37) The current spot exchange rate is $1.55 = €1.00 and the three-month forward rate is $1.60 = €1.00. Consider a three-month American call option on €62,500. For this option to be considered at-the-money, the strike price must be A) B) C) D)

$1.60 = €1.00. $1.55 = €1.00. $1.55 × (1 + i$)3/12 = €1.00 × (1 + i€)3/12. none of the options

38) The current spot exchange rate is $1.55 = €1.00 and the three-month forward rate is $1.60 = €1.00. Consider a three-month American call option on €62,500 with a strike price of $1.50 = €1.00. Immediate exercise of this option will generate a profit of A) B) C) D)

$6,125. $6,125/(1 + i$)3/12. negative profit, so exercise would not occur. $3,125.

39) The current spot exchange rate is $1.55 = €1.00 and the three-month forward rate is $1.60 = €1.00. Consider a three-month American call option on €62,500 with a strike price of $1.50 = €1.00. If you pay an option premium of $5,000 to buy this call, at what exchange rate will you break-even?

Version 1

A) B) C) D)

$1.58 = €1.00 $1.62 = €1.00 $1.50 = €1.00 $1.68 = €1.00

40) Consider this graph of a call option. The option is a three-month American call option on €62,500 with a strike price of $1.50 = €1.00 and an option premium of $3,125. What are the values of A, B, and C, respectively?{MISSING IMAGE} A) B) C) D)

A = $3,125 (or $.05 depending on your scale); B = $1.50; C = $1.55 A = €3,750 (or €.06 depending on your scale); B = $1.50; C = $1.55 A = $.05; B = $1.55; C = $1.60 none of the options

41) Which of the lines is a graph of the profit at maturity of writing a call option on €62,500 with a strike price of $1.20 = €1.00 and an option premium of $3,125?{MISSING IMAGE} A) B) C) D)

A B C D

42) The current spot exchange rate is $1.55 = €1.00; the three-month U.S. dollar interest rate is 2 percent. Consider a three-month American call option on €62,500 with a strike price of $1.50 = €1.00. What is the least that this option should sell for? A) B) C) D)

Version 1

$0.05 × 62,500 = $3,125 $3,125/1.02 = $3,063.73 $0.00 none of the options

43) Which of the following options strategies is consistent with its implications about the future behavior of the underlying asset price? A) B) C) D)

44)

American call and put premiums A) B) C) D)

45)

should be at least as large as their intrinsic value. should be no larger than their intrinsic value. should be exactly equal to their time value. should be no larger than their speculative value.

Which of the following is correct? A) B) C) D)

46)

Selling calls and selling puts Buying calls and buying puts Buying calls and selling puts none of the options

Time value = intrinsic value + option premium Intrinsic value = option premium + time value Option premium = intrinsic value− time value Option premium = intrinsic value + time value

Which of the following is correct? A) B) C) D)

Version 1

European options can be exercised early. American options can be exercised early. Asian options can be exercised early. all of the options

47)

Assume that the dollar–euro spot rate is $1.28 and the six-month forward rate is

The six-month U.S. dollar rate is 5 percent and the Eurodollar rate is 4 percent. The minimum price that a six-month American call option with a striking price of $1.25 should sell for in a rational market is A) B) C) D)

48)

For European options, what is the effect of an increase in St? A) B) C) D)

49)

Decrease the value of calls and puts ceteris paribus Increase the value of calls and puts ceteris paribus Decrease the value of calls, increase the value of puts ceteris paribus Increase the value of calls, decrease the value of puts ceteris paribus

For an American call option, A and B in the graph are{MISSING IMAGE} A) B) C) D)

50)

0 cents. 3.47 cents. 3.55 cents. 3 cents.

time value and intrinsic value. intrinsic value and time value. in-the-money and out-of-the money. none of the options

For European options, what is the effect of an increase in the strike price E? A) B) C) D)

Version 1

51) For European currency options written on euro with a strike price in dollars, what is the effect of an increase in r$ relative to r€? A) B) C) D)

52) For European currency options written on euro with a strike price in dollars, what is the effect of an increase in r$? A) B) C) D)

53) For European currency options written on euro with a strike price in dollars, what is the effect of an increase in r€? A) B) C) D)

54) For European currency options written on euro with a strike price in dollars, what is the effect of an increase in the exchange rate S($/€)? A) B) C) D)

Version 1

Decreases the value of calls and puts ceteris paribus Increases the value of calls and puts ceteris paribus Decreases the value of calls, increases the value of puts ceteris paribus Increases the value of calls, decreases the value of puts ceteris paribus

55) For European currency options written on euro with a strike price in dollars, what is the effect of an increase in the exchange rate S(€/$)? A) B) C) D)

56) The equation for a European Call Option is a function of which variables? A. The exchange rate and the exercise priceB. The foreign interest rate and the dollar interest rate A) B) C) D)

57)

A B Both A and B Neither A or B

The hedge ratio

A) Is the size of the long (short) position the investor must have in the underlying asset per option the investor must write (buy) to have a risk-free offsetting investment that will result in the investor perfectly hedging the option. B){MISSING IMAGE} C) Is related to the number of options that an investor can write without unlimited loss while holding a certain amount of the underlying asset. D) all of the options

58) Find the value of a call option written on €100 with a strike price of $1.00 = €1.00. In one period, there are two possibilities: the exchange rate will move up by 15 percent or down by 15 percent (i.e. $1.15 = €1.00 or $0.85 = €1.00). The U.S. risk-free rate is 5 percent over the period. The risk-neutral probability of dollar depreciation is 2/3 and the risk-neutral probability of the dollar strengthening is 1/3.{MISSING IMAGE}

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A) B) C) D)

$9.5238 $0.0952 $0 $3.1746

59) Use the binomial option pricing model to find the value of a call option on £10,000 with a strike price of €12,500. The current exchange rate is €1.50/£1.00 and in the next period the exchange rate can increase to €2.40/£ or decrease to €0.9375/€1.00 (i.e. u = 1.6 and d = 1/u = 0.625). The current interest rates are i€ = 3% and are i£ = 4%. Choose the answer closest to yours. A) B) C) D)

€3,275 €2,500 €3,373 €3,243

60) Find the hedge ratio for a call option on £10,000 with a strike price of €12,500. The current exchange rate is €1.50/£1.00 and in the next period the exchange rate can increase to €2.40/£ or decrease to €0.9375/€1.00 (i.e. u = 1.6 and d = 1/u = 0.625).The current interest rates are i€ = 3% and are i£ = 4%.Choose the answer closest to yours. A) B) C) D) E)

5/9 8/13 2/3 3/8 none of the options

61) You have written a call option on £10,000 with a strike price of $20,000. The current exchange rate is $2.00/£1.00 and in the next period the exchange rate can increase to $4.00/£1.00 or decrease to $1.00/€1.00 (i.e. u = 2 and d = 1/u = 0. 5). The current interest rates are i$ = 3% and are i£ = 2%. Find the hedge ratio and use it to create a position in the underlying asset that will hedge your option position.

Version 1

A) Enter into a short position in a futures contract on £6,666.67 B) Lend the present value of £6,666.67 today at i£ = 2% C) Enter into a long position in a futures contract on £6,666.67 D) Lending the present value of £6,666.67 today at i£ = 2% or entering into a long position in a futures contract on £6,666.67 would both work.

62) Draw the tree for a put option on $20,000 with a strike price of £10,000. The current exchange rate is £1.00 = $2.00 and in one period the dollar value of the pound will either double or be cut in half. The current interest rates are i$ = 3% and are i£ = 2%. A) [MISSING IMAGE: "", "" ] B) [MISSING IMAGE: "", "" ] C) both of the options D) none of the options

63) Draw the tree for a call option on $20,000 with a strike price of £10,000. The current exchange rate is £1.00 = $2.00 and in one period the dollar value of the pound will either double or be cut in half. The current interest rates are i$ = 3% and are i£ = 2%. A) B) C) D)

64)

[MISSING IMAGE: "", "" ] [MISSING IMAGE: "", "" ] both of the options none of the options

A binomial call option premium is calculated as A) B) C) D)

Version 1

C0 = [qCuT + (1 − q)CdT] / (1 + i$) C0 = [qCdT + (1 − q)CuT] / (1 + i$) C0 = [qCuT + (1 − q)CdT] / (1− i$) C0 = [qCdT + (1 − q)CuT] / (1 − i$)

65) The one-step binomial model assumes that at the end of the option period, the call will have appreciated to SuT = S0u or depreciated to SdT = S0d. How is u calculated? A) B) C) D)

1/d e^(σt0.5) both 1/d and e^(σt0.5) none of these options

66) Find the dollar value today of a 1-period at-the-money call option on €10,000. The spot exchange rate is €1.00 = $1.25. In the next period, the euro can increase in dollar value to $2.00 or fall to $1.00. The interest rate in dollars is i$ = 27.50%; the interest rate in euro is i€ = 2%. A) B) C) D)

$3,308.82 $0 $3,294.12 $4,218.75

67) Suppose that you have written a call option on €10,000 with a strike price in dollars. Suppose further that the hedge ratio is 1/2. Which of the following would be an appropriate hedge for a short position in this call option? A) Buy €5,000 today at today's spot exchange rate. B) Agree to buy €5,000 at the maturity of the option at the forward exchange rate for the maturity of the option that prevails today (i.e., go long in a forward contract on €5,000). C) Buy the present value of €5,000 discounted at i€ for the maturity of the option. D) Both B and C are correct.

68)

With regard to expiration date,

Version 1

A) B) C) D)

69)

futures contracts do not have delivery dates. forward contracts have standardized delivery dates. futures contracts have tailor-made delivery dates that meet the needs of the investor. futures contracts have standardized delivery dates.

With regard to trading location,

A) forward contracts are traded competitively on organized exchanges. B) futures contracts are traded competitively on organized exchanges. C) futures contracts are traded by bank dealers via a network of telephones and computerized dealing systems. D) none of the options

70)

With regard to contractual size, A) forward contracts are characterized by a standardized amount of the underlying

asset. B) futures contracts are tailor-made to the needs of the participant. C) futures contracts are characterized by a standardized amount of the underlying asset. D) none of the options

71)

With regard to trading costs,

A) forward contracts involve the bid-ask spread plus the broker’s commission. B) futures contracts involve the bid-ask spread plus the broker’s commission. C) futures contracts involve the bid-ask spread plus indirect bank charges via compensating balance requirements. D) none of the options

72)

Which of the following is correct?

Version 1

A) The value (in dollars) of a call option on £5,000 with a strike price of $10,000 is equal to the value (in dollars) of a put option on $10,000 with a strike price of £5,000 only when the spot exchange rate is $2 = £1. B) The value (in dollars) of a call option on £5,000 with a strike price of $10,000 is equal to the value (in dollars) of a put option on $10,000 with a strike price of £5,000.

73) Find the input d1 of the Black-Scholes price of a six-month call option written on €100,000 with a strike price of $1.25 = €1.00. The current exchange rate is $1.25 = €1.00. The U.S. risk-free rate is 5% over the period and the euro-zone risk-free rate is 4%. The volatility of the underlying asset is 10.7 percent. A) B) C) D)

d1 = 0.1039 d1 = 2.9871 d1 = 0.0283 none of the options

74) Find the input d1 of the Black-Scholes price of a six-month call option on Japanese yen. The strike price is $1 = ¥100. The current spot rate is $1 = ¥100. The volatility is 25 percent per annum; i$ = 5.5% and i¥ = 6%. A) B) C) D)

75)

d1 = 0.074246 d1 = 0.005982 d1 = $0.006137/¥ none of the options

The Black-Scholes option pricing formula

Version 1

A) is used widely in practice, especially by international banks in trading OTC options. B) is not widely used outside of the academic world. C) works well enough, but is not used in the real world because no one has the time to flog their calculator for five minutes on the trading floor. D) none of the options

76) Find the Black-Scholes price of a six-month call option written on €100,000 with a strike price of $1.25 = €1.00. The current exchange rate is $1.25 = €1.00. The U.S. risk-free rate is 5 percent over the period and the euro-zone risk-free rate is 4 percent. The volatility of the underlying asset is 10.7 percent. A) B) C) D)

Ce = $0.0400 Ce = $0.0998 Ce = $1.6331 none of the options

77) Use the European option pricing formula to find the value of a six-month call option on Japanese yen. The strike price is $1 = ¥100. The spot rate is $1 = ¥100. The volatility is 25 percent per annum; i$ = 5.5% and i¥ = 6%. A) B) C) D)

78)

$0.005395/¥100 $0.005982/¥ $0.0672/100 none of the options

Empirical tests of the Black-Scholes option pricing formula

Version 1

A) shows that binomial option pricing is used widely in practice, especially by international banks in trading OTC options. B) works poorly for pricing American currency options that are at-the-money. C) work well for pricing in-the-money calls and puts. D) works well for pricing American currency options that are at-the-money or out-ofthe-money, but does not do well in pricing in-the-money calls and puts.

79)

Empirical tests of the Black-Scholes option pricing formula

A) have faced difficulties due to nonsynchronous data. B) suggest that when using simultaneous price data and incorporating transaction costs they conclude that the PHLX American currency options are efficiently priced. C) suggest that the European option-pricing model works well for pricing American currency options that are at- or out-of-the money, but does not do well in pricing in-the-money calls and puts. D) all of the options

80)

Which of the following statements is true regarding the European option-pricing model?

A) was developed by Biger and Hull (1983) B) was developed by Garman, Kohlhage and Grabbe (1983). C) the evolution of the model can be traced back to European option-pricing models developed by Merton (1973) and Black (1976) D) all of the options are true.

SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question. 81) Consider an option to buy £10,000 for €12,500. In the next period, if the pound appreciates against the dollar by 37.5 percent then the euro will appreciate against the dollar by ten percent. On the other hand, the euro could depreciate against the pound by 20 percent. Big hint: don't round, keep exchange rates out to at least 4 decimal places.

Version 1

Spot Rates

Risk-free Rates

S0($/€)

$1.60 = €1.00

3.00%

S0($/£)

$2.00 = £1.00

i€

4.00%

S0(€/£)

€1.25 = £1.00

i£

4.00%

Calculate the current €/£ spot exchange rate.

82) Consider an option to buy £10,000 for €12,500. In the next period, if the pound appreciates against the dollar by 37.5 percent then the euro will appreciate against the dollar by ten percent. On the other hand, the euro could depreciate against the pound by 20 percent. Big hint: don't round, keep exchange rates out to at least 4 decimal places. Spot Rates

Risk-free Rates

S0($/€)

$1.60 = €1.00

3.00%

S0($/£)

$2.00 = £1.00

i€

4.00%

S0(€/£)

€1.25 = £1.00

i£

4.00%

Find the risk neutral probability of an "up" move.

Version 1

83) Consider an option to buy £10,000 for €12,500. In the next period, if the pound appreciates against the dollar by 37.5 percent then the euro will appreciate against the dollar by ten percent. On the other hand, the euro could depreciate against the pound by 20 percent. Big hint: don't round, keep exchange rates out to at least 4 decimal places. Spot Rates

Risk-free Rates

S0($/€)

$1.60 = €1.00

3.00%

S0($/£)

$2.00 = £1.00

i€

4.00%

S0(€/£)

€1.25 = £1.00

i£

4.00%

USING RISK NEUTRAL VALUATION (i.e., the binomial option pricing model) find the value of the call (in euro).

84) Consider an option to buy £10,000 for €12,500. In the next period, if the pound appreciates against the dollar by 37.5 percent then the euro will appreciate against the dollar by ten percent. On the other hand, the euro could depreciate against the pound by 20 percent. Big hint: don't round, keep exchange rates out to at least 4 decimal places. Spot Rates

Risk-free Rates

S0($/€)

$1.60 = €1.00

3.00%

S0($/£)

$2.00 = £1.00

i€

4.00%

S0(€/£)

€1.25 = £1.00

i£

4.00%

Calculate the hedge ratio.

Version 1

85) Consider an option to buy £10,000 for €12,500. In the next period, if the pound appreciates against the dollar by 37.5 percent then the euro will appreciate against the dollar by ten percent. On the other hand, the euro could depreciate against the pound by 20 percent. Big hint: don't round, keep exchange rates out to at least 4 decimal places. Spot Rates

Risk-free Rates

S0($/€)

$1.60 = €1.00

3.00%

S0($/£)

$2.00 = £1.00

i€

4.00%

S0(€/£)

€1.25 = £1.00

i£

4.00%

State the composition of the replicating portfolio; your answer should contain "trading orders" of what to buy and what to sell at time zero.

86) Consider an option to buy £10,000 for €12,500. In the next period, if the pound appreciates against the dollar by 37.5 percent then the euro will appreciate against the dollar by ten percent. On the other hand, the euro could depreciate against the pound by 20 percent. Big hint: don't round, keep exchange rates out to at least 4 decimal places. Spot Rates

Risk-free Rates

S0($/€)

$1.60 = €1.00

3.00%

S0($/£)

$2.00 = £1.00

i€

4.00%

S0(€/£)

€1.25 = £1.00

i£

4.00%

Find the value today of your replicating today’s portfolio in euro.

Version 1

87) Consider an option to buy £10,000 for €12,500. In the next period, if the pound appreciates against the dollar by 37.5 percent then the euro will appreciate against the dollar by ten percent. On the other hand, the euro could depreciate against the pound by 20 percent. Big hint: don't round, keep exchange rates out to at least 4 decimal places. Spot Rates

Risk-free Rates

S0($/€)

$1.60 = €1.00

3.00%

S0($/£)

$2.00 = £1.00

i€

4.00%

S0(€/£)

€1.25 = £1.00

i£

4.00%

If the call finishes out-of-the-money what is your replicating portfolio cash flow?

88) Consider an option to buy £10,000 for €12,500. In the next period, if the pound appreciates against the dollar by 37.5 percent then the euro will appreciate against the dollar by ten percent. On the other hand, the euro could depreciate against the pound by 20 percent. Big hint: don't round, keep exchange rates out to at least 4 decimal places. Spot Rates

Risk-free Rates

S0($/€)

$1.60 = €1.00

3.00%

S0($/£)

$2.00 = £1.00

i€

4.00%

S0(€/£)

€1.25 = £1.00

i£

4.00%

Version 1

If the call finishes in-the-money what is your replicating portfolio cash flow?

89) Consider an option to buy £10,000 for €12,500. In the next period, if the pound appreciates against the dollar by 37.5 percent then the euro will appreciate against the dollar by ten percent. On the other hand, the euro could depreciate against the pound by 20 percent. Big hint: don't round, keep exchange rates out to at least 4 decimal places. Spot Rates

Risk-free Rates

S0($/€)

$1.60 = €1.00

3.00%

S0($/£)

$2.00 = £1.00

i€

4.00%

S0(€/£)

€1.25 = £1.00

i£

4.00%

Find the value of the call.

90) Consider an option to buy €12,500 for £10,000. In the next period, the euro can strengthen against the pound by 25 percent (i.e., each euro will buy 25 percent more pounds) or weaken by 20 percent. Big hint: don't round, keep exchange rates out to at least 4 decimal places. Spot Rates

Risk-free Rates

S0($/€)

$1.60 = €1.00

3.00%

S0($/£)

$2.00 = £1.00

i€

4.00%

S0(€/£)

€1.25 = £1.00

i£

4.00%

Version 1

Calculate the current €/£ spot exchange rate.

91) Consider an option to buy €12,500 for £10,000. In the next period, the euro can strengthen against the pound by 25 percent (i.e., each euro will buy 25 percent more pounds) or weaken by 20 percent. Big hint: don't round, keep exchange rates out to at least 4 decimal places. Spot Rates

Risk-free Rates

S0($/€)

$1.60 = €1.00

3.00%

S0($/£)

$2.00 = £1.00

i€

4.00%

S0(€/£)

€1.25 = £1.00

i£

4.00%

Find the risk neutral probability of an "up" move.

92) Consider an option to buy €12,500 for £10,000. In the next period, the euro can strengthen against the pound by 25 percent (i.e., each euro will buy 25 percent more pounds) or weaken by 20 percent. Big hint: don't round, keep exchange rates out to at least 4 decimal places. Spot Rates

Risk-free Rates

S0($/€)

$1.60 = €1.00

3.00%

S0($/£)

$2.00 = £1.00

i€

4.00%

Version 1

S0(€/£)

€1.25 = £1.00

i£

4.00%

USING RISK NEUTRAL VALUATION, find the value of the call (in pounds)

93) Consider an option to buy €12,500 for £10,000. In the next period, the euro can strengthen against the pound by 25 percent (i.e., each euro will buy 25 percent more pounds) or weaken by 20 percent. Big hint: don't round, keep exchange rates out to at least 4 decimal places. Spot Rates

Risk-free Rates

S0($/€)

$1.60 = €1.00

3.00%

S0($/£)

$2.00 = £1.00

i€

4.00%

S0(€/£)

€1.25 = £1.00

i£

4.00%

Calculate the hedge ratio.

94) Consider an option to buy €12,500 for £10,000. In the next period, the euro can strengthen against the pound by 25 percent (i.e., each euro will buy 25 percent more pounds) or weaken by 20 percent. Big hint: don't round, keep exchange rates out to at least 4 decimal places. Spot Rates S0($/€)

Version 1

$1.60 = €1.00

Risk-free Rates i$

3.00%

S0($/£)

$2.00 = £1.00

i€

4.00%

S0(€/£)

€1.25 = £1.00

i£

4.00%

State the composition of the replicating portfolio; your answer should contain "trading orders" of what to buy and what to sell at time zero.

95) Consider an option to buy €12,500 for £10,000. In the next period, the euro can strengthen against the pound by 25 percent (i.e., each euro will buy 25 percent more pounds) or weaken by 20 percent. Big hint: don't round, keep exchange rates out to at least 4 decimal places. Spot Rates

Risk-free Rates

S0($/€)

$1.60 = €1.00

3.00%

S0($/£)

$2.00 = £1.00

i€

4.00%

S0(€/£)

€1.25 = £1.00

i£

4.00%

Find the cost today of your hedge portfolio in pounds.

96) Consider an option to buy €12,500 for £10,000. In the next period, the euro can strengthen against the pound by 25 percent (i.e., each euro will buy 25 percent more pounds) or weaken by 20 percent. Big hint: don't round, keep exchange rates out to at least 4 decimal places.

Version 1

Spot Rates

Risk-free Rates

S0($/€)

$1.60 = €1.00

3.00%

S0($/£)

$2.00 = £1.00

i€

4.00%

S0(€/£)

€1.25 = £1.00

i£

4.00%

If the call finishes out-of-the-money what is your portfolio cash flow?

97) Consider an option to buy €12,500 for £10,000. In the next period, the euro can strengthen against the pound by 25 percent (i.e., each euro will buy 25 percent more pounds) or weaken by 20 percent. Big hint: don't round, keep exchange rates out to at least 4 decimal places. Spot Rates

Risk-free Rates

S0($/€)

$1.60 = €1.00

3.00%

S0($/£)

$2.00 = £1.00

i€

4.00%

S0(€/£)

€1.25 = £1.00

i£

4.00%

If the call finishes in-the-money what is your portfolio cash flow?

Version 1

98) Consider an option to buy €12,500 for £10,000. In the next period, the euro can strengthen against the pound by 25 percent (i.e., each euro will buy 25 percent more pounds) or weaken by 20 percent. Big hint: don't round, keep exchange rates out to at least 4 decimal places. Spot Rates

Risk-free Rates

S0($/€)

$1.60 = €1.00

3.00%

S0($/£)

$2.00 = £1.00

i€

4.00%

S0(€/£)

€1.25 = £1.00

i£

4.00%

Find the value of the call.

99) Find the dollar value today of a 1-period at-the-money call option on ¥300,000. The spot exchange rate is ¥100 = $1.00. In the next period, the yen can increase in dollar value by 15 percent or decrease by 15 percent. The risk-free rate in dollars is i$ = 5%; The risk-free rate in yen is i¥ = 1%.

Version 1

Answer Key Test name: Chap 07_9e 1) TRUE 2) B 3) B 4) B 5) C 6) A 7) D 8) D 9) A 10) C 11) D 12) D 13) A 14) A 15) A 16) C 17) B 18) A 19) A 20) A 21) A 22) A 23) D 24) D 25) D 26) C Version 1

27) A 28) B 29) B 30) C 31) C 32) B 33) A 34) C 35) A 36) D 37) B 38) D 39) A 40) A 41) B 42) A 43) C 44) A 45) D 46) B 47) C 48) D 49) B 50) C 51) D 52) D 53) C 54) D 55) C 56) C Version 1

57) D 58) A 59) A 60) B 61) D 62) B 63) B 64) A 65) C 66) A 67) D 68) D 69) B 70) C 71) B 72) B 73) A 74) A 75) A 76) A 77) C 78) D 79) D 80) D 81) %media:formula24.mml% 82) %media:formula27.mml% 83) %media:formula29.mml% 84) %media:formula32.mml% 85) Buy the present value of 5/9 × £10,000 partly financed by borrowing the pv of 5/9 × €10,000 Version 1

86) €1,335.47 = €6,677.35 − €5,341.88 where the cost of the euro is %media:formula55.mml% less the borrowing inflow %media:formula56.mml% 87) We own 5/9 × £10,000 at the exchange rate of €1/£1 that is worth €5,555,56 = £5,555.56 × €1/£1 We also owe €5,555,56 to our banker, so the portfolio cash flow = €0 88) We own 5/9 × £10,000 at the exchange rate of €1.5625/£1 that is worth €8,680.56 = £5,555.56 × €1.5625/£1 We also owe €5,555,56 to our banker, so the portfolio cash flow = €3,125 89) %media:formula60.mml% The value of our option is correct, computed both with risk neutral valuation and with the replicating portfolio. 90) %media:formula24.mml% 91) %media:formula35.mml% 92) %media:formula38.mml% 93) %media:formula40.mml% 94) Buy the present value of 5/9 × €12,500 at the spot rate of £1 = €1.25 Borrow the present value of 5/9 × £8,000 95) %media:formula42.mml% 96) Sell the 5/9 × €12,500 at the exchange rate of €1/£1.5625, receive £4,444.44 = (5/9 × €12,500) × £1/€1.5625 Repay the banker £4,444.44 Portfolio cash flow = £0

Version 1

97) Sell the 5/9 × €12,500 at the exchange rate of €1/£1, receive £6,944.44 = (5/9 × €12,500) × £1/€1.00 Repay the banker £4,444.44 portfolio cash flow = £2,500 98) %media:formula64.mml%%media:formula65.mml% The value of our option is correct, computed both with rise neutral valuation and with the replicating portfolio. 99) To find the risk neutral probability, equate the value of ¥300,000 at the IRP forward rate to the expected value p × $3,450 + (1 − p) × $2,550[MISSING IMAGE: , ]

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CHAPTER 8 MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 1) Transaction exposure is defined as A) the sensitivity of realized domestic currency values of the firm's contractual cash flows denominated in foreign currencies to unexpected exchange rate changes. B) the extent to which the value of the firm would be affected by unanticipated changes in exchange rate. C) the potential that the firm's consolidated financial statement can be affected by changes in exchange rates. D) ex post and ex ante currency exposures.

Which of the following is not a type of foreign currency exposure? A) B) C) D)

Exchange rate exposure Economic exposure Translation exposure none of the options

3) __________ type of exposure is defined as the extent to which the value of the firm would be affected by unanticipated changes in exchange rates. A) B) C) D)

Exchange rate exposure Economic exposure Translation exposure none of the options

Which of the following is not a type of financial contract?

Version 1

A) B) C) D)

Which of the following is not a type of operational technique? A) B) C) D)

exchange-traded futures options. currency forward contracts. foreign currency warrants. borrowing and lending in the domestic and foreign money markets.

If you have a long position in a foreign currency, you can hedge with A) B) C) D)

Swap strategy Choice of the invoice currency Lead/lag strategy Exposure netting

The most direct and popular way of hedging transaction exposure is by A) B) C) D)

Forward contract Money market instrument Options contract none of the options

a short position in an exchange-traded futures option. a short position in a currency forward contract. a short position in foreign currency warrants. borrowing (not lending) in the domestic and foreign money markets.

If you owe a foreign currency denominated debt, you can hedge with

Version 1

A) a short position in a currency forward contract. B) a short position in an exchange-traded futures option. C) buying the foreign currency today and investing it in the foreign county. D) a long position in a currency forward contract, or buying the foreign currency today and investing it in the foreign county.

If you own a foreign currency denominated bond, you can hedge with A) B) C) D)

a long position in a currency forward contract. a long position in an exchange-traded futures option. buying the foreign currency today and investing it in the foreign county. a swap contract where pay the cash flows of the bond in exchange for dollars.

10) The sensitivity of "realized" domestic currency values of the firm's contractual cash flows denominated in foreign currency to unexpected changes in the exchange rate is A) B) C) D)

transaction exposure. translation exposure. economic exposure. none of the options

11) The sensitivity of the firm's consolidated financial statements to unexpected changes in the exchange rate is A) B) C) D)

transaction exposure. translation exposure. economic exposure. none of the options

12) The extent to which the value of the firm would be affected by unexpected changes in the exchange rate is Version 1

A) B) C) D)

13)

transaction exposure. translation exposure. economic exposure. none of the options

With any hedge,

A) your losses on one side should about equal your gains on the other side. B) you should try to make money on both sides of the transaction; that way you make money coming and going. C) you should spend at least as much time working the hedge as working the underlying deal itself. D) you should agree to anything your banker puts in front of your face.

14)

With any successful hedge, A) you are guaranteed to lose money on one side. B) you can avoid the accounting ramifications of a loss on one side by keeping it off the

books. C) you are guaranteed to lose money on one side, but you can avoid the accounting ramifications of a loss on one side by keeping it off the books. D) none of the options

15) The choice between a forward market hedge and a money market hedge often comes down to A) B) C) D)

Version 1

interest rate parity. option pricing. flexibility and availability. none of the options

16)

Since a corporation can hedge exchange rate exposure at low cost A) B) C) D)

17)

A CFO should be least worried about A) B) C) D)

18)

transaction exposure. translation exposure. economic exposure. none of the options

Exchange rate risk of a foreign currency payable is an example of A) B) C) D)

19)

there is no benefit to the shareholders in an efficient market. shareholders would benefit from the risk reduction that hedging offers. the corporation's banker would benefit from the risk reduction that hedging offers. none of the options

transaction exposure. translation exposure. economic exposure. none of the options

A stock market investor would pay attention to

A) anticipated changes in exchange rates that have been already discounted and reflected in the firm's value. B) unanticipated changes in exchange rates that have not been discounted and reflected in the firm's value. C) anticipated changes in exchange rates that have been already discounted and reflected in the firm's value, as well as unanticipated changes in exchange rates that have not been discounted and reflected in the firm's value. D) none of the options

Version 1

20) Suppose that Boeing Corporation exported a Boeing 747 to Lufthansa and billed €10 million payable in one year. The money market interest rates and foreign exchange rates are given as follows:

The U.S. one-year interest rate:

6.10 % per annum

The euro zone one-year interest rate:

9.00 % per annum

The spot exchange rate: The one-year forward exchange rate

$ 1.50 /€ $ 1.46 /€

Assume that Boeing sells a currency forward contract of €10 million for delivery in one year, in exchange for a predetermined amount of U.S. dollars. Which of the following is/are true? On the maturity date of the contract Boeing will(i) have to deliver €10 million to the bank (the counter party of the forward contract).(ii) take delivery of $14.6 million(iii) have a zero net euro exposure(iv) have a profit, or a loss, depending on the future changes in the exchange rate, from this British sale. A) B) C) D)

(i) and (iv) (ii) and (iv) (ii), (iii), and (iv) (i), (ii), and (iii)

21) Suppose that Boeing Corporation exported a Boeing 747 to Lufthansa and billed €10 million payable in one year. The money market interest rates and foreign exchange rates are given as follows:

The U.S. one-year interest rate:

6.10 % per annum

The euro zone one-year interest rate:

9.00 % per annum

The spot exchange rate: The one-year forward exchange rate

Version 1

$ 1.50 /€ $ 1.46 /€

Assume that Boeing sells a currency forward contract of €10 million for delivery in one year, in exchange for a predetermined amount of U.S. dollars. Suppose that on the maturity date of the forward contract, the spot rate turns out to be $1.40/€ (i.e. less than the forward rate of $1.46/€). Which of the following is true? A) Boeing would have received $14.6 million, rather than $14.0 million, had it not entered into the forward contract. B) Boeing lost $0.6 million from forward hedging. C) Boeing would have received only $14.0 million, rather than $14.6 million, had it not entered into the forward contract. Additionally, Boeing gained $0.6 million from forward hedging. D) none of the options

22) Your firm is a U.K.-based exporter of British bicycles. You have sold an order to an Italian firm for €1,000,000 worth of bicycles. Payment from the Italian firm (in €) is due in twelve months. Your firm wants to hedge the receivable into pounds. Not dollars. Use the following table for exchange rate data. Country

Britain(pound)£62,500 1 Month Forward 3 Months Forward 6 Months Forward 12 Months Forward Euro €62,500 1 Month Forward 3 Months Forward 6 Months Forward 12 Months Forward

U.S.S equiv. Tuesday Monday 1.6000 1.6100 1.6300 1.6600 1.7200 1.2000 1.2100 1.2300 1.2600 1.2900

1.6100 1.6300 1.6600 1.7200 1.8000 1.2000 1.2100 1.2300 1.2600 1.3200

Currency per U.S.$ Tuesday Monday 0.625 0.6211 0.6173 0.6024 0.5814 0.833333 0.82645 0.813008 0.793651 0.775194

0.6211 0.6173 0.6024 0.5814 0.5556 0.833333 0.82645 0.813008 0.793651 0.7575758

Detail a strategy using futures contracts that will hedge your exchange rate risk. Have an estimate of how many contracts of what type.

Version 1

A) Borrow €970,873.79 in one year you owe €1m, which will be financed with the receivable. Convert €970,873.79 to dollars at spot, receive $1,165,048.54. Convert dollars to pounds at spot, receive £728,155.34. B) Sell €1m forward using 16 contracts at $1.20 per €1. Buy £750,000 forward using 12 contracts at $1.60 per £1. C) Sell €1m forward using 16 contracts at the forward rate of $1.29 per €1. D) Sell €1m forward using 16 contracts at the forward rate of $1.29 per €1. Buy £750,000 forward using 12 contracts at the forward rate of $1.72 per £1.

23) A Japanese exporter has a €1,000,000 receivable due in one year. Spot and forward exchange rate data is given: Spot exchange rates

1-year Forward Rates

Contract size

$ 1.20 = € 1.00

$ 1.25 = € 1.00

€

$ 1.00 = ¥ 100

$ 1.00 = ¥ 120

¥ 12,500,000

62,500

The one-year risk free rates are i$ = 4.03%; i€ = 6.05%; and i¥ = 1%. Detail a strategy using forward contracts A) Borrow €970,873.79 today; in one year you owe €1m, which will be financed with the receivable. Convert €970,873.79 to dollars at spot, receive $1,165,048.54. Convert dollars to yen at spot, receive ¥116,504,854. B) Sell €1m forward using 16 contracts at the forward rate of $1.20 per €1. Buy ¥150,000,000 forward using 11.52 contracts, at the forward rate of $1.00 = ¥120. C) Sell €1m forward using 16 contracts at the forward rate of $1.25 per €1. Buy ¥150,000,000 forward using 12 contracts, at the forward rate of $1.00 = ¥120. D) none of the options

24) Your firm has a British customer that is willing to place a $1 million order, but wants to pay in pounds instead of dollars. The spot exchange rate is $1.85 = £1.00 and the one-year forward rate is $1.90 = £1.00. The lead time on the order is such that payment is due in one year. What is the fairest exchange rate to use? Version 1

A) B) C) D)

$1.85 = £1.00 $1.8750 = £1.00 $1.90 = £1.00 none of the options

25) Your firm has a British customer that is willing to place a $1 million order (with payment due in 6 months), but insists upon paying in pounds instead of dollars. A) The customer essentially wants you to discount your price by the value of a put option on pounds. B) The customer essentially wants you to discount your price by the value of a call option on pounds. C) The customer essentially wants you to discount your price by the sum of the values of a call and put option on pounds. D) none of the options

26) Your firm is a U.K.-based exporter of British bicycles. You have sold an order to an American firm for $1,000,000 worth of bicycles. Payment from the American firm (in U.S. dollars) is due in six months. Detail a strategy using futures contracts that will hedge your exchange rate risk. Country

Britain(pound)£62,500 1 Month Forward 3 Months Forward 6 Months Forward 12 Months Forward

Version 1

U.S.$ equiv. Tuesday Monday

Currency per U.S.$ Tuesday Monday

1.8000 1.8100 1.8300 1.8600 1.8200

0.5556 0.5525 0.5464 0.5376 0.5495

1.8100 1.8300 1.8600 1.8200 1.8000

0.5525 0.5464 0.5376 0.5495 0.5556

A) B) C) D)

Go short 12 six-month forward contracts; pay £555,600. Go short 9 six-month forward contracts. Pay approximately £537,600. Go long 12 six-month forward contracts. Receive approximately £549,500. Go long 9 six-month forward contracts; raise approximately £537,600.

27) Your firm is a U.S.-based exporter of bicycles. You have sold an order to a French firm for €1,000,000 worth of bicycles. Payment from the French firm (in euro) is due in three months. Detail a strategy using futures contracts that will hedge your exchange rate risk. Have an estimate of how many contracts of what type and how much (in $) your firm will have. Country

Britain(pound)£62,500 1 Month Forward 3 Months Forward 6 Months Forward 12 Months Forward

A) B) C) D)

U.S.$ equiv. Tuesday Monday

Currency per U.S.$ Tuesday Monday

1.6000 1.6100 1.6300 1.6600 1.7200

0.625 0.6211 0.6173 0.6024 0.5814

1.6100 1.6300 1.6600 1.7200 1.8000

0.6211 0.6173 0.6024 0.5814 0.5556

Go short 12 six-month forward contracts; pay $1,630,000. Go short 16 six-month forward contracts; pay $1,630,000. Go long 16 six-month forward contracts; raise $1,660,000. Go long 12 six-month forward contracts; receive $1,660,000.

28) Your firm is a U.K.-based exporter of bicycles. You have sold an order to a French firm for €1,000,000 worth of bicycles. Payment from the French firm (in euro) is due in 12 months. Detail a strategy using futures contracts that will hedge your exchange rate risk. Have an estimate of how many contracts of what type and maturity. U.S. $ equiv. Contract Size £ 10,000

Version 1

Country

Tuesday

Monday

Britain (pound) $ 1.9600 $ 1.9400

Currency per U.S. $ Tuesday

Monday

£ 0.5102

£ 0.5155

€ 10,000

SFr. 10,000

1 month forward $ 1.9700 $ 1.9500

£ 0.5076

£ 0.5128

3 months forward 6 months forward 12 months forward Euro

$ 1.9800 $ 1.9600

£ 0.5051

£ 0.5102

$ 1.9900 $ 1.9700

£ 0.5025

£ 0.5076

$ 2.0000 $ 1.9800

£ 0.5000

£ 0.5051

$ 1.5600 $ 1.5400

€ 0.6410

€ 0.6494

1 month forward $ 1.5700 $ 1.5500

€ 0.6369

€ 0.6452

3 months forward 6 months forward 12 months forward Swiss franc

$ 1.5800 $ 1.5600

€ 0.6329

€ 0.6410

$ 1.5900 $ 1.5700

€ 0.6289

€ 0.6369

$ 1.6000 $ 1.5800

€ 0.6250

€ 0.6329

$ 0.9200 $ 0.9000 SFr. 1.0870 SFr. 1.1111

1 month forward $ 0.9400 $ 0.9200 SFr. 1.0638 SFr. 1.0870 3 months forward 6 months forward 12 months forward

A) contracts. B) contracts. C) contracts. D) contracts. E)

Version 1

$ 0.9600 $ 0.9400 SFr. 1.0417 SFr. 1.0638 $ 0.9800 $ 0.9600 SFr. 1.0204 SFr. 1.0417 $ 1.0000 $ 0.9800 SFr. 1.0000 SFr. 1.0204

Go short 100 12-month euro futures contracts; and short 80 12-month pound futures Go long 100 12-month euro futures contracts; and long 80 12-month pound futures Go long 100 12-month euro futures contracts; and short 80 12-month pound futures Go short 100 12-month euro futures contracts; and long 80 12-month pound futures none of the options

29) Your firm is a U.K.-based importer of bicycles. You have placed an order with an Italian firm for €1,000,000 worth of bicycles. Payment (in euro) is due in 12 months. Detail a strategy using futures contracts that will hedge your exchange rate risk. Have an estimate of how many contracts of what type and maturity. U.S. $ equiv. Contract Size £ 10,000

€ 10,000

SFr. 10,000

Country

Tuesday

Monday

Currency per U.S. $ Tuesday

Monday

Britain (pound) $ 1.9600 $ 1.9400

£ 0.5102

£ 0.5155

1 month forward $ 1.9700 $ 1.9500

£ 0.5076

£ 0.5128

3 months forward 6 months forward 12 months forward Euro

$ 1.9800 $ 1.9600

£ 0.5051

£ 0.5102

$ 1.9900 $ 1.9700

£ 0.5025

£ 0.5076

$ 2.0000 $ 1.9800

£ 0.5000

£ 0.5051

$ 1.5600 $ 1.5400

€ 0.6410

€ 0.6494

1 month forward $ 1.5700 $ 1.5500

€ 0.6369

€ 0.6452

3 months forward 6 months forward 12 months forward Swiss franc

$ 1.5800 $ 1.5600

€ 0.6329

€ 0.6410

$ 1.5900 $ 1.5700

€ 0.6289

€ 0.6369

$ 1.6000 $ 1.5800

€ 0.6250

€ 0.6329

$ 0.9200 $ 0.9000 SFr. 1.0870 SFr. 1.1111

1 month forward $ 0.9400 $ 0.9200 SFr. 1.0638 SFr. 1.0870 3 months forward 6 months forward 12 months forward

Version 1

$ 0.9600 $ 0.9400 SFr. 1.0417 SFr. 1.0638 $ 0.9800 $ 0.9600 SFr. 1.0204 SFr. 1.0417 $ 1.0000 $ 0.9800 SFr. 1.0000 SFr. 1.0204

A) contracts. B) contracts. C) contracts. D) contracts. E)

30) Your firm is a Swiss exporter of bicycles. You have sold an order to a French firm for €1,000,000 worth of bicycles. Payment from the French firm (in euro) is due in 12 months. Detail a strategy using futures contracts that will hedge your exchange rate risk. Have an estimate of how many contracts of what type and maturity. U.S. $ equiv. Contract Size £ 10,000

€ 10,000

SFr. 10,000

Version 1

Country

Tuesday

Monday

Currency per U.S. $ Tuesday

Monday

Britain (pound) $ 1.9600 $ 1.9400

£ 0.5102

£ 0.5155

1 month forward $ 1.9700 $ 1.9500

£ 0.5076

£ 0.5128

3 months forward 6 months forward 12 months forward Euro

$ 1.9800 $ 1.9600

£ 0.5051

£ 0.5102

$ 1.9900 $ 1.9700

£ 0.5025

£ 0.5076

$ 2.0000 $ 1.9800

£ 0.5000

£ 0.5051

$ 1.5600 $ 1.5400

€ 0.6410

€ 0.6494

1 month forward $ 1.5700 $ 1.5500

€ 0.6369

€ 0.6452

3 months forward 6 months forward 12 months forward Swiss franc

$ 1.5800 $ 1.5600

€ 0.6329

€ 0.6410

$ 1.5900 $ 1.5700

€ 0.6289

€ 0.6369

$ 1.6000 $ 1.5800

€ 0.6250

€ 0.6329

$ 0.9200 $ 0.9000 SFr. 1.0870 SFr. 1.1111

1 month forward $ 0.9400 $ 0.9200 SFr. 1.0638 SFr. 1.0870 3 months forward 6 months forward 12 months forward

$ 0.9600 $ 0.9400 SFr. 1.0417 SFr. 1.0638 $ 0.9800 $ 0.9600 SFr. 1.0204 SFr. 1.0417 $ 1.0000 $ 0.9800 SFr. 1.0000 SFr. 1.0204

A) Go short 100 12-month euro futures contracts; and short 160 12-month Swiss franc futures contracts. B) Go long 100 12-month euro futures contracts; and long 160 12-month Swiss franc futures contracts. C) Go long 100 12-month euro futures contracts; and short 160 12-month Swiss franc futures contracts. D) Go short 100 12-month euro futures contracts; and long 160 12-month Swiss franc futures contracts. E) none of the options

31) Your firm is a Swiss importer of bicycles. You have placed an order with an Italian firm for €1,000,000 worth of bicycles. Payment (in euro) is due in 12 months. Detail a strategy using futures contracts that will hedge your exchange rate risk. Have an estimate of how many contracts of what type and maturity. U.S. $ equiv. Contract Size £ 10,000

€ 10,000

Version 1

Country

Tuesday

Monday

Currency per U.S. $ Tuesday

Monday

Britain (pound) $ 1.9600 $ 1.9400

£ 0.5102

£ 0.5155

1 month forward $ 1.9700 $ 1.9500

£ 0.5076

£ 0.5128

3 months forward 6 months forward 12 months forward Euro

$ 1.9800 $ 1.9600

£ 0.5051

£ 0.5102

$ 1.9900 $ 1.9700

£ 0.5025

£ 0.5076

$ 2.0000 $ 1.9800

£ 0.5000

£ 0.5051

$ 1.5600 $ 1.5400

€ 0.6410

€ 0.6494

SFr. 10,000

1 month forward $ 1.5700 $ 1.5500

€ 0.6369

€ 0.6452

3 months forward 6 months forward 12 months forward Swiss franc

$ 1.5800 $ 1.5600

€ 0.6329

€ 0.6410

$ 1.5900 $ 1.5700

€ 0.6289

€ 0.6369

$ 1.6000 $ 1.5800

€ 0.6250

€ 0.6329

$ 0.9200 $ 0.9000 SFr. 1.0870 SFr. 1.1111

1 month forward $ 0.9400 $ 0.9200 SFr. 1.0638 SFr. 1.0870 3 months forward 6 months forward 12 months forward

$ 0.9600 $ 0.9400 SFr. 1.0417 SFr. 1.0638 $ 0.9800 $ 0.9600 SFr. 1.0204 SFr. 1.0417 $ 1.0000 $ 0.9800 SFr. 1.0000 SFr. 1.0204

32) Your firm is an Italian exporter of bicycles. You have sold an order to a British firm for £1,000,000 worth of bicycles. Payment from the customer (in pounds sterling) is due in 12 months. Detail a strategy using futures contracts that will hedge your exchange rate risk. Have an estimate of how many contracts of what type and maturity. U.S. $ equiv. Contract Size £ 10,000

Version 1

Country

Tuesday

Monday

Britain (pound) $ 1.9600 $ 1.9400

Currency per U.S. $ Tuesday

Monday

£ 0.5102

£ 0.5155

€ 10,000

SFr. 10,000

1 month forward $ 1.9700 $ 1.9500

£ 0.5076

£ 0.5128

3 months forward 6 months forward 12 months forward Euro

$ 1.9800 $ 1.9600

£ 0.5051

£ 0.5102

$ 1.9900 $ 1.9700

£ 0.5025

£ 0.5076

$ 2.0000 $ 1.9800

£ 0.5000

£ 0.5051

$ 1.5600 $ 1.5400

€ 0.6410

€ 0.6494

1 month forward $ 1.5700 $ 1.5500

€ 0.6369

€ 0.6452

3 months forward 6 months forward 12 months forward Swiss franc

$ 1.5800 $ 1.5600

€ 0.6329

€ 0.6410

$ 1.5900 $ 1.5700

€ 0.6289

€ 0.6369

$ 1.6000 $ 1.5800

€ 0.6250

€ 0.6329

$ 0.9200 $ 0.9000 SFr. 1.0870 SFr. 1.1111

1 month forward $ 0.9400 $ 0.9200 SFr. 1.0638 SFr. 1.0870 3 months forward 6 months forward 12 months forward

$ 0.9600 $ 0.9400 SFr. 1.0417 SFr. 1.0638 $ 0.9800 $ 0.9600 SFr. 1.0204 SFr. 1.0417 $ 1.0000 $ 0.9800 SFr. 1.0000 SFr. 1.0204

A) Go long 100 12-month pound futures contracts; and long 125 12-month euro futures contracts. B) Go short 100 12-month pound futures contracts; and short 125 12-month euro futures contracts. C) Go long 100 12-month pound futures contracts; and short 125 12-month euro futures contracts. D) Go short 100 12-month pound futures contracts; and long 125 12-month euro futures contracts. E) none of the options

Version 1

33) Your firm is an Italian importer of bicycles. You have placed an order with a British firm for £1,000,000 worth of bicycles. Payment (in pounds sterling) is due in 12 months. Detail a strategy using futures contracts that will hedge your exchange rate risk. Have an estimate of how many contracts of what type and maturity. U.S. $ equiv. Contract Size £ 10,000

€ 10,000

SFr. 10,000

Country

Tuesday

Monday

Currency per U.S. $ Tuesday

Monday

Britain (pound) $ 1.9600 $ 1.9400

£ 0.5102

£ 0.5155

1 month forward $ 1.9700 $ 1.9500

£ 0.5076

£ 0.5128

3 months forward 6 months forward 12 months forward Euro

$ 1.9800 $ 1.9600

£ 0.5051

£ 0.5102

$ 1.9900 $ 1.9700

£ 0.5025

£ 0.5076

$ 2.0000 $ 1.9800

£ 0.5000

£ 0.5051

$ 1.5600 $ 1.5400

€ 0.6410

€ 0.6494

1 month forward $ 1.5700 $ 1.5500

€ 0.6369

€ 0.6452

3 months forward 6 months forward 12 months forward Swiss franc

$ 1.5800 $ 1.5600

€ 0.6329

€ 0.6410

$ 1.5900 $ 1.5700

€ 0.6289

€ 0.6369

$ 1.6000 $ 1.5800

€ 0.6250

€ 0.6329

$ 0.9200 $ 0.9000 SFr. 1.0870 SFr. 1.1111

1 month forward $ 0.9400 $ 0.9200 SFr. 1.0638 SFr. 1.0870 3 months forward 6 months forward 12 months forward

Version 1

$ 0.9600 $ 0.9400 SFr. 1.0417 SFr. 1.0638 $ 0.9800 $ 0.9600 SFr. 1.0204 SFr. 1.0417 $ 1.0000 $ 0.9800 SFr. 1.0000 SFr. 1.0204

34) Your firm is a U.K.-based exporter of bicycles. You have sold an order to a Swiss firm for SFr. 1,000,000 worth of bicycles. Payment from the Swiss firm (in Swiss francs) is due in 12 months. Detail a strategy using futures contracts that will hedge your exchange rate risk. Have an estimate of how many contracts of what type and maturity. U.S. $ equiv. Contract Size £ 10,000

€ 10,000

SFr. 10,000

Version 1

Country

Tuesday

Monday

Currency per U.S. $ Tuesday

Monday

Britain (pound) $ 1.9600 $ 1.9400

£ 0.5102

£ 0.5155

1 month forward $ 1.9700 $ 1.9500

£ 0.5076

£ 0.5128

3 months forward 6 months forward 12 months forward Euro

$ 1.9800 $ 1.9600

£ 0.5051

£ 0.5102

$ 1.9900 $ 1.9700

£ 0.5025

£ 0.5076

$ 2.0000 $ 1.9800

£ 0.5000

£ 0.5051

$ 1.5600 $ 1.5400

€ 0.6410

€ 0.6494

1 month forward $ 1.5700 $ 1.5500

€ 0.6369

€ 0.6452

3 months forward 6 months forward 12 months forward Swiss franc

$ 1.5800 $ 1.5600

€ 0.6329

€ 0.6410

$ 1.5900 $ 1.5700

€ 0.6289

€ 0.6369

$ 1.6000 $ 1.5800

€ 0.6250

€ 0.6329

$ 0.9200 $ 0.9000 SFr. 1.0870 SFr. 1.1111

1 month forward $ 0.9400 $ 0.9200 SFr. 1.0638 SFr. 1.0870 3 months forward 6 months forward 12 months forward

$ 0.9600 $ 0.9400 SFr. 1.0417 SFr. 1.0638 $ 0.9800 $ 0.9600 SFr. 1.0204 SFr. 1.0417 $ 1.0000 $ 0.9800 SFr. 1.0000 SFr. 1.0204

A) Go short 100 12-month Swiss franc futures contracts; and long 50 12-month pound futures contracts. B) Go long 100 12-month Swiss franc futures contracts; and short 50 12-month pound futures contracts. C) Go short 100 12-month Swiss franc futures contracts; and short 50 12-month pound futures contracts. D) Go long 100 12-month Swiss franc futures contracts; and long 50 12-month pound futures contracts. E) none of the options

35) Your firm is a U.K.-based importer of bicycles. You have placed an order with a Swiss firm for SFr. 1,000,000 worth of bicycles. Payment (in Swiss francs) is due in 12 months. Detail a strategy using futures contracts that will hedge your exchange rate risk. Have an estimate of how many contracts of what type and maturity. U.S. $ equiv. Contract Size £ 10,000

€ 10,000

Version 1

Country

Tuesday

Monday

Currency per U.S. $ Tuesday

Monday

Britain (pound) $ 1.9600 $ 1.9400

£ 0.5102

£ 0.5155

1 month forward $ 1.9700 $ 1.9500

£ 0.5076

£ 0.5128

3 months forward 6 months forward 12 months forward Euro

$ 1.9800 $ 1.9600

£ 0.5051

£ 0.5102

$ 1.9900 $ 1.9700

£ 0.5025

£ 0.5076

$ 2.0000 $ 1.9800

£ 0.5000

£ 0.5051

$ 1.5600 $ 1.5400

€ 0.6410

€ 0.6494

SFr. 10,000

1 month forward $ 1.5700 $ 1.5500

€ 0.6369

€ 0.6452

3 months forward 6 months forward 12 months forward Swiss franc

$ 1.5800 $ 1.5600

€ 0.6329

€ 0.6410

$ 1.5900 $ 1.5700

€ 0.6289

€ 0.6369

$ 1.6000 $ 1.5800

€ 0.6250

€ 0.6329

$ 0.9200 $ 0.9000 SFr. 1.0870 SFr. 1.1111

1 month forward $ 0.9400 $ 0.9200 SFr. 1.0638 SFr. 1.0870 3 months forward 6 months forward 12 months forward

$ 0.9600 $ 0.9400 SFr. 1.0417 SFr. 1.0638 $ 0.9800 $ 0.9600 SFr. 1.0204 SFr. 1.0417 $ 1.0000 $ 0.9800 SFr. 1.0000 SFr. 1.0204

36) Your firm is a Swiss exporter of bicycles. You have sold an order to a British firm for £1,000,000 worth of bicycles. Payment from the British firm (in pounds sterling) is due in 12 months. Detail a strategy using futures contracts that will hedge your exchange rate risk. Have an estimate of how many contracts of what type and maturity. U.S. $ equiv. Contract Size £ 10,000

Version 1

Country

Tuesday

Monday

Britain (pound) $ 1.9600 $ 1.9400

Currency per U.S. $ Tuesday

Monday

£ 0.5102

£ 0.5155

€ 10,000

SFr. 10,000

1 month forward $ 1.9700 $ 1.9500

£ 0.5076

£ 0.5128

3 months forward 6 months forward 12 months forward Euro

$ 1.9800 $ 1.9600

£ 0.5051

£ 0.5102

$ 1.9900 $ 1.9700

£ 0.5025

£ 0.5076

$ 2.0000 $ 1.9800

£ 0.5000

£ 0.5051

$ 1.5600 $ 1.5400

€ 0.6410

€ 0.6494

1 month forward $ 1.5700 $ 1.5500

€ 0.6369

€ 0.6452

3 months forward 6 months forward 12 months forward Swiss franc

$ 1.5800 $ 1.5600

€ 0.6329

€ 0.6410

$ 1.5900 $ 1.5700

€ 0.6289

€ 0.6369

$ 1.6000 $ 1.5800

€ 0.6250

€ 0.6329

$ 0.9200 $ 0.9000 SFr. 1.0870 SFr. 1.1111

1 month forward $ 0.9400 $ 0.9200 SFr. 1.0638 SFr. 1.0870 3 months forward 6 months forward 12 months forward

$ 0.9600 $ 0.9400 SFr. 1.0417 SFr. 1.0638 $ 0.9800 $ 0.9600 SFr. 1.0204 SFr. 1.0417 $ 1.0000 $ 0.9800 SFr. 1.0000 SFr. 1.0204

A) Go short 100 12-month pound futures contracts; and long 200 12-month SFr. futures contracts. B) Go long 100 12-month pound futures contracts; and short 200 12-month SFr. futures contracts. C) Go short 100 12-month pound futures contracts; and short 200 12-month SFr. futures contracts. D) Go long 100 12-month pound futures contracts; and long 200 12-month SFr. futures contracts. E) none of the options

Version 1

37) Your firm is a Swiss importer of bicycles. You have placed an order with a British firm for £1,000,000 worth of bicycles. Payment (in pounds sterling) is due in 12 months. Detail a strategy using futures contracts that will hedge your exchange rate risk. Have an estimate of how many contracts of what type and maturity. U.S. $ equiv. Contract Size £ 10,000

€ 10,000

SFr. 10,000

Country

Tuesday

Monday

Currency per U.S. $ Tuesday

Monday

Britain (pound) $ 1.9600 $ 1.9400

£ 0.5102

£ 0.5155

1 month forward $ 1.9700 $ 1.9500

£ 0.5076

£ 0.5128

3 months forward 6 months forward 12 months forward Euro

$ 1.9800 $ 1.9600

£ 0.5051

£ 0.5102

$ 1.9900 $ 1.9700

£ 0.5025

£ 0.5076

$ 2.0000 $ 1.9800

£ 0.5000

£ 0.5051

$ 1.5600 $ 1.5400

€ 0.6410

€ 0.6494

1 month forward $ 1.5700 $ 1.5500

€ 0.6369

€ 0.6452

3 months forward 6 months forward 12 months forward Swiss franc

$ 1.5800 $ 1.5600

€ 0.6329

€ 0.6410

$ 1.5900 $ 1.5700

€ 0.6289

€ 0.6369

$ 1.6000 $ 1.5800

€ 0.6250

€ 0.6329

$ 0.9200 $ 0.9000 SFr. 1.0870 SFr. 1.1111

1 month forward $ 0.9400 $ 0.9200 SFr. 1.0638 SFr. 1.0870 3 months forward 6 months forward 12 months forward

Version 1

$ 0.9600 $ 0.9400 SFr. 1.0417 SFr. 1.0638 $ 0.9800 $ 0.9600 SFr. 1.0204 SFr. 1.0417 $ 1.0000 $ 0.9800 SFr. 1.0000 SFr. 1.0204

A) contracts. B) contracts. C) D) contracts. E)

Go short 100 12-month pound futures contracts; and long 200 12-month SFr. futures Go long 100 12-month pound futures contracts; and short 200 12-month SFr. futures Go short 100 12-month pound futures contracts. Go long 100 12-month pound futures contracts; and long 200 12-month SFr. futures none of the options

38) Your firm is an Italian exporter of bicycles. You have sold an order to a Swiss firm for SFr. 2,000,000 worth of bicycles. Payment from the customer (in Swiss francs) is due in 12 months. Detail a strategy using futures contracts that will hedge your exchange rate risk. Have an estimate of how many contracts of what type and maturity. U.S. $ equiv. Contract Size £ 10,000

€ 10,000

SFr. 10,000

Version 1

Country

Tuesday

Monday

Currency per U.S. $ Tuesday

Monday

Britain (pound) $ 1.9600 $ 1.9400

£ 0.5102

£ 0.5155

1 month forward $ 1.9700 $ 1.9500

£ 0.5076

£ 0.5128

3 months forward 6 months forward 12 months forward Euro

$ 1.9800 $ 1.9600

£ 0.5051

£ 0.5102

$ 1.9900 $ 1.9700

£ 0.5025

£ 0.5076

$ 2.0000 $ 1.9800

£ 0.5000

£ 0.5051

$ 1.5600 $ 1.5400

€ 0.6410

€ 0.6494

1 month forward $ 1.5700 $ 1.5500

€ 0.6369

€ 0.6452

3 months forward 6 months forward 12 months forward Swiss franc

$ 1.5800 $ 1.5600

€ 0.6329

€ 0.6410

$ 1.5900 $ 1.5700

€ 0.6289

€ 0.6369

$ 1.6000 $ 1.5800

€ 0.6250

€ 0.6329

$ 0.9200 $ 0.9000 SFr. 1.0870 SFr. 1.1111

1 month forward $ 0.9400 $ 0.9200 SFr. 1.0638 SFr. 1.0870 3 months forward 6 months forward 12 months forward

$ 0.9600 $ 0.9400 SFr. 1.0417 SFr. 1.0638 $ 0.9800 $ 0.9600 SFr. 1.0204 SFr. 1.0417 $ 1.0000 $ 0.9800 SFr. 1.0000 SFr. 1.0204

A) Go long 200 12-month Swiss franc futures contracts; and long 125 12-month euro futures contracts. B) Go short 200 12-month Swiss franc futures contracts; and short 125 12-month euro futures contracts. C) Go long 200 12-month Swiss franc futures contracts; and short 125 12-month euro futures contracts. D) Go short 200 12-month Swiss franc futures contracts; and long 125 12-month euro futures contracts. E) none of the options

39) Your firm is an Italian importer of bicycles. You have placed an order with a Swiss firm for SFr. 2,000,000 worth of bicycles. Payment (in francs) is due in 12 months. Detail a strategy using futures contracts that will hedge your exchange rate risk. Have an estimate of how many contracts of what type and maturity. U.S. $ equiv. Contract Size £ 10,000

€ 10,000

Version 1

Country

Tuesday

Monday

Currency per U.S. $ Tuesday

Monday

Britain (pound) $ 1.9600 $ 1.9400

£ 0.5102

£ 0.5155

1 month forward $ 1.9700 $ 1.9500

£ 0.5076

£ 0.5128

3 months forward 6 months forward 12 months forward Euro

$ 1.9800 $ 1.9600

£ 0.5051

£ 0.5102

$ 1.9900 $ 1.9700

£ 0.5025

£ 0.5076

$ 2.0000 $ 1.9800

£ 0.5000

£ 0.5051

$ 1.5600 $ 1.5400

€ 0.6410

€ 0.6494

SFr. 10,000

1 month forward $ 1.5700 $ 1.5500

€ 0.6369

€ 0.6452

3 months forward 6 months forward 12 months forward Swiss franc

$ 1.5800 $ 1.5600

€ 0.6329

€ 0.6410

$ 1.5900 $ 1.5700

€ 0.6289

€ 0.6369

$ 1.6000 $ 1.5800

€ 0.6250

€ 0.6329

$ 0.9200 $ 0.9000 SFr. 1.0870 SFr. 1.1111

1 month forward $ 0.9400 $ 0.9200 SFr. 1.0638 SFr. 1.0870 3 months forward 6 months forward 12 months forward

$ 0.9600 $ 0.9400 SFr. 1.0417 SFr. 1.0638 $ 0.9800 $ 0.9600 SFr. 1.0204 SFr. 1.0417 $ 1.0000 $ 0.9800 SFr. 1.0000 SFr. 1.0204

40) Your firm is a U.K.-based exporter of bicycles. You have sold an order to a French firm for €1,000,000 worth of bicycles. Payment from the French firm (in euro) is due in 12 months. Use a money market hedge to redenominate this one-year receivable into a pound-denominated receivable with a one-year maturity. Contract Size £ 10,000

Version 1

Country Britain (pound)

U.S. $ equiv. $ 1.9600

Currency per U.S. $ £ 0.5102

interest

12 months

$ 2.0000

£ 0.5000

rates

APR

€ 10,000

SFr. 10,000

forward Euro

$ 1.5600

€ 0.6410

i$ = 1 %

12 months forward Swiss franc

$ 1.6000

€ 0.6250

i€ = 2 %

$ 0.9200

SFr. 1.0870

i£ = 3 %

12 months forward

$ 1.0000

SFr. 1.0000

iSFr. = 4 %

The following were computed without rounding. Select the answer closest to yours. A) B) C) D)

£803,721.49 €800,000 £780,312.13 £72,352.94

41) Your firm is a U.K.-based importer of bicycles. You have placed an order with an Italian firm for €1,000,000 worth of bicycles. Payment (in euro) is due in 12 months. Use a money market hedge to redenominate this one-year receivable into a pound-denominated receivable with a one-year maturity. Contract Size

Country

U.S. $ equiv. $ 1.9600

Currency per U.S. $ £ 0.5102

interest rates

£ 10,000

Britain (pound)

$ 2.0000

£ 0.5000

€ 10,000

12 months forward Euro

$ 1.5600

€ 0.6410

i$ = 1 %

12 months forward Swiss franc

$ 1.6000

€ 0.6250

i€ = 2 %

$ 0.9200

SFr. 1.0870

i£ = 3 %

12 months forward

$ 1.0000

SFr. 1.0000

iSFr. = 4 %

SFr. 10,000

The following were computed without rounding. Select the answer closest to yours.

Version 1

APR

A) B) C) D)

£803,721.49 €800,000 £780,312.13 £72,352.94

42) Your firm is a Swiss exporter of bicycles. You have sold an order to a French firm for €1,000,000 worth of bicycles. Payment from the French firm (in euro) is due in 12 months. Use a money market hedge to redenominate this one-year receivable into a Swiss franc-denominated receivable with a one-year maturity. Contract Size

Country

U.S. $ equiv. $ 1.9600

Currency per U.S. $ £ 0.5102

interest rates

£ 10,000

Britain (pound)

$ 2.0000

£ 0.5000

€ 10,000

12 months forward Euro

$ 1.5600

€ 0.6410

i$ = 1 %

12 months forward Swiss franc

$ 1.6000

€ 0.6250

i€ = 2 %

$ 0.9200

SFr. 1.0870

i£ = 3 %

12 months forward

$ 1.0000

SFr. 1.0000

iSFr. = 4 %

SFr. 10,000

APR

The following were computed without rounding. Select the answer closest to yours. A) B) C) D)

SFr. 1,728,900.26 SFr. 1,600,000 SFr. 1,544,705.88 SFr. 800,000

43) Your firm is a Swiss importer of bicycles. You have placed an order with an Italian firm for €1,000,000 worth of bicycles. Payment (in euro) is due in 12 months. Use a money market hedge to redenominate this one-year receivable into a Swiss franc-denominated receivable with a one-year maturity.

Version 1

Contract Size

Country

U.S. $ equiv. $ 1.9600

Currency per U.S. $ £ 0.5102

interest rates

£ 10,000

Britain (pound)

$ 2.0000

£ 0.5000

€ 10,000

12 months forward Euro

$ 1.5600

€ 0.6410

i$ = 1 %

12 months forward Swiss franc

$ 1.6000

€ 0.6250

i€ = 2 %

$ 0.9200

SFr. 1.0870

i£ = 3 %

12 months forward

$ 1.0000

SFr. 1.0000

iSFr. = 4 %

SFr. 10,000

APR

The following were computed without rounding. Select the answer closest to yours. A) B) C) D)

SFr. 1,728,900.26 SFr. 1,600,000 SFr. 1,544,705.88 SFr. 800,000

44) Your firm is an Italian exporter of bicycles. You have sold an order to a British firm for £1,000,000 worth of bicycles. Payment from the customer (in pounds sterling) is due in 12 months. Use a money market hedge to redenominate this one-year receivable into a eurodenominated receivable with a one-year maturity. Contract Size

Country

U.S. $ equiv. $ 1.9600

Currency per U.S. $ £ 0.5102

interest rates

£ 10,000

Britain (pound)

$ 2.0000

£ 0.5000

€ 10,000

12 months forward Euro

$ 1.5600

€ 0.6410

i$ = 1 %

12 months forward Swiss franc

$ 1.6000

€ 0.6250

i€ = 2 %

$ 0.9200

SFr. 1.0870

i£ = 3 %

12 months

$ 1.0000

SFr. 1.0000

iSFr. = 4 %

SFr. 10,000

Version 1

APR

forward

The following were computed without rounding. Select the answer closest to yours. A) B) C) D)

€1,225,490.20 €1,244,212.10 €1,250,000 €1,219,815.78

45) Your firm is an Italian importer of British bicycles. You have placed an order with a British firm for £1,000,000 worth of bicycles. Payment (in pounds sterling) is due in 12 months. Use a money market hedge to redenominate this one-year receivable into a euro-denominated receivable with a one-year maturity. Contract Size

Country

U.S. $ equiv. $ 1.9600

Currency per U.S. $ £ 0.5102

interest rates

£ 10,000

Britain (pound)

$ 2.0000

£ 0.5000

€ 10,000

12 months forward Euro

$ 1.5600

€ 0.6410

i$ = 1 %

12 months forward Swiss franc

$ 1.6000

€ 0.6250

i€ = 2 %

$ 0.9200

SFr. 1.0870

i£ = 3 %

12 months forward

$ 1.0000

SFr. 1.0000

iSFr. = 4 %

SFr. 10,000

The following were computed without rounding. Select the answer closest to yours. A) B) C) D)

Version 1

€1,225,490.20 €1,244,212.10 €1,250,000 €1,219,815.78

APR

46) Your firm is a U.K.-based exporter of bicycles. You have sold an order to a Swiss firm for SFr. 1,000,000 worth of bicycles. Payment from the Swiss firm (in Swiss francs) is due in 12 months. Use a money market hedge to redenominate this one-year receivable into a eurodenominated receivable with a one-year maturity. Contract Size

Country

U.S. $ equiv. $ 1.9600

Currency per U.S. $ £ 0.5102

interest rates

£ 10,000

Britain (pound)

$ 2.0000

£ 0.5000

€ 10,000

12 months forward Euro

$ 1.5600

€ 0.6410

i$ = 1 %

12 months forward Swiss franc

$ 1.6000

€ 0.6250

i€ = 2 %

$ 0.9200

SFr. 1.0870

i£ = 3 %

12 months forward

$ 1.0000

SFr. 1.0000

iSFr. = 4 %

SFr. 10,000

APR

The following were computed without rounding. Select the answer closest to yours. A) B) C) D)

£500,000 £464,874.41 £446,730.77 £509,900.99

47) Your firm is a U.K.-based importer of bicycles. You have placed an order with a Swiss firm for SFr. 1,000,000 worth of bicycles. Payment (in Swiss francs) is due in 12 months. Use a money market hedge to redenominate this one-year receivable into a euro-denominated receivable with a one-year maturity. Contract Size

Country

£ 10,000

Britain (pound)

€ 10,000

12 months forward Euro

Version 1

U.S. $ equiv. $ 1.9600

Currency per U.S. $ £ 0.5102

interest

$ 2.0000

£ 0.5000

rates

$ 1.5600

€ 0.6410

APR

i$ = 1 %

SFr. 10,000

12 months forward Swiss franc

$ 1.6000

€ 0.6250

i€ = 2 %

$ 0.9200

SFr. 1.0870

i£ = 3 %

12 months forward

$ 1.0000

SFr. 1.0000

iSFr. = 4 %

The following were computed without rounding. Select the answer closest to yours. A) B) C) D)

£500,000 £464,874.41 £446,730.77 £509,900.99

48) Your firm is a Swiss exporter of bicycles. You have sold an order to a British firm for £1,000,000 worth of bicycles. Payment from the British firm (in pounds sterling) is due in 12 months. Use a money market hedge to redenominate this one-year receivable into a eurodenominated receivable with a one-year maturity. Contract Size

Country

U.S. $ equiv. $ 1.9600

Currency per U.S. $ £ 0.5102

interest rates

£ 10,000

Britain (pound)

$ 2.0000

£ 0.5000

€ 10,000

12 months forward Euro

$ 1.5600

€ 0.6410

i$ = 1 %

12 months forward Swiss franc

$ 1.6000

€ 0.6250

i€ = 2 %

$ 0.9200

SFr. 1.0870

i£ = 3 %

12 months forward

$ 1.0000

SFr. 1.0000

iSFr. = 4 %

SFr. 10,000

The following were computed without rounding. Select the answer closest to yours.

Version 1

APR

A) B) C) D)

SFr. 2,000,000 SFr. 2,151,118.62 SFr. 2,068,383.28 SFr. 1,921,941.75

49) Your firm is a Swiss importer of bicycles. You have placed an order with a British firm for £1,000,000 worth of bicycles. Payment (in pounds sterling) is due in 12 months. Use a money market hedge to redenominate this one-year pound denominated payable into a Swiss franc-denominated payable with a one-year maturity. Contract Size

Country

U.S. $ equiv. $ 1.9600

Currency per U.S. $ £ 0.5102

interest rates

£ 10,000

Britain (pound)

$ 2.0000

£ 0.5000

€ 10,000

12 months forward Euro

$ 1.5600

€ 0.6410

i$ = 1 %

12 months forward Swiss franc

$ 1.6000

€ 0.6250

i€ = 2 %

$ 0.9200

SFr. 1.0870

i£ = 3 %

12 months forward

$ 1.0000

SFr. 1.0000

iSFr. = 4 %

SFr. 10,000

APR

The following were computed without rounding. Select the answer closest to yours. A) B) C) D)

SFr. 2,000,000 SFr. 2,151,118.62 SFr. 2,068,383.28 SFr. 1,921,941.75

50) Your firm is an Italian exporter of bicycles. You have sold an order to a Swiss firm for SFr. 2,000,000 worth of bicycles. Payment from the customer (in Swiss francs) is due in 12 months. Use a money market hedge to redenominate this one-year franc denominated receivable into a euro-denominated receivable with a one-year maturity.

Version 1

Contract Size £ 10,000

U.S. $ equiv. Britain (pound) $ 1.9600 $ 2.0000

£ 0.5000

€ 10,000

12 months forward Euro

$ 1.5600

€ 0.6410

i$ = 1 %

12 months forward Swiss franc

$ 1.6000

€ 0.6250

i€ = 2 %

$ 0.9200

SFr. 1.0870

i£ = 3 %

12 months forward

$ 1.0000

SFr. 1.0000

iSFr. = 4 %

SFr. 10,000

Country

Currency per U.S. $ £ 0.5102

interest rates

APR

The following were computed without rounding. Select the answer closest to yours. A) B) C) D)

€1,116,826.92 €1,250,000 €1,134,122.29 €1,156,804.73

51) Your firm is an Italian importer of bicycles. You have placed an order with a Swiss firm for SFr. 2,000,000 worth of bicycles. Payment (in francs) is due in 12 months. Use a money market hedge to redenominate this one-year franc denominated payable into a euro-denominated payable with a one-year maturity. Contract Size £ 10,000

U.S. $ equiv. Britain (pound) $ 1.9600 $ 2.0000

£ 0.5000

€ 10,000

12 months forward Euro

$ 1.5600

€ 0.6410

i$ = 1 %

12 months forward Swiss franc

$ 1.6000

€ 0.6250

i€ = 2 %

$ 0.9200

SFr. 1.0870

i£ = 3 %

SFr. 10,000

Version 1

Country

Currency per U.S. $ £ 0.5102

interest rates

APR

12 months forward

$ 1.0000

SFr. 1.0000

iSFr. = 4 %

The following were computed without rounding. Select the answer closest to yours. A) B) C) D)

52)

€1,116,826.92 €1,250,000 €1,134,122.29 €1,156,804.73

From the perspective of a corporate CFO, when hedging a payable versus a receivable A) credit risk considerations are more germane for a payable. B) credit risk considerations are more germane for a receivable. C) none of the options

53) Your firm is a U.K.-based exporter of British bicycles. You have sold an order to an Italian firm for €1,000,000 worth of bicycles. Payment from the Italian firm (in €) is due in twelve months. Your firm wants to hedge the receivable into pounds. Not dollars. Interest rates are 3 percent in €, 2 percent in $ and 4 percent in £. Country

Britain(pound)£62,500 1 Month Forward 3 Months Forward 6 Months Forward 12 Months Forward Euro €62,500 1 Month Forward 3 Months Forward 6 Months Forward 12 Months Forward

Version 1

U.S.$ equiv. Tuesday Monday 1.6000 1.6100 1.6300 1.6600 1.7200 1.2000 1.2100 1.2300 1.2600 1.2900

1.6100 1.6300 1.6600 1.7200 1.8000 1.2000 1.2100 1.2300 1.2600 1.3200

Currency per U.S.$ Tuesday Monday 0.625 0.6211 0.6173 0.6024 0.5814 0.833333 0.82645 0.813008 0.793651 0.775194

0.6211 0.6173 0.6024 0.5814 0.5556 0.833333 0.82645 0.813008 0.793651 0.7575758

Detail a strategy using spot exchange rates and borrowing or lending that will hedge your exchange rate risk. A) Borrow €970,873.79 in one year you owe €1m, which will be financed with the receivable. Convert €970,873.79 to dollars at spot, receive $1,165,048.54. Convert dollars to pounds at spot, receive £728,155.34. B) Sell €1m forward using 16 contracts at $1.20 per €1. Buy £750,000 forward using 12 contracts at $1.60 per £1. C) Sell €1m forward using 16 contracts at the forward rate of $1.29 per €1. Buy £750,000 forward using 12 contracts at the forward rate of $1.72 per £1. D) none of the options

54) A Japanese exporter has a €1,000,000 receivable due in one year. Detail a strategy using a money market hedge that will eliminate any exchange rate risk. 1-year rates of interest Borrowing

Lending

Dollar

4.5 %

4.00 %

Euro

6.00 %

5.25 %

Yen

1.00 %

0.75 %

Spot exchange rates

Version 1

1-year Forward Rates

$ 1.25 = € 1.00

$ 1.2262 = € 1.00

$ 1.00 = ¥ 100

1.03 = ¥ 100

A) Borrow €970,873.79 today. Convert the euro to dollars at the spot exchange rate, receive $1,165,048.54. Convert these dollars to yen at the spot rate, receive ¥. B) Borrow €943,396.22 today. Convert the euro to dollars at the spot exchange rate, convert these dollars to yen at the spot rate, receive ¥117,924,528.30. C) Lend €943,396.22 today. Convert the euro to dollars at the spot exchange rate, convert these dollars to yen at the spot rate. D) Convert ¥117,924,528.30 to dollars at the spot rate; convert dollars to euro at the spot rate; lend €943,396.22 at 5.25 percent.

55) A U.S. firm has sold an Italian firm €1,000,000 worth of product. In one year the U.S. firm gets paid. To hedge, the U.S. firm bought put options on the euro with a strike price of $1.65. They paid an option premium $0.01 per euro. If at maturity, the exchange rate is $1.60, A) B) C) D)

56)

Buying a currency option provides A) B) C) D)

57)

the firm will realize $1,145,000 on the sale net of the cost of hedging. the firm will realize $1,150,000 on the sale net of the cost of hedging. the firm will realize $1,140,000 on the sale net of the cost of hedging. none of the options

a flexible hedge against exchange exposure. limits the downside risk while preserving the upside potential. a right, but not an obligation, to buy or sell a currency. all of the options

Which of the following options strategies are internally consistent? A) B) C) D)

Version 1

Sell puts and buy calls. Buy puts and sell calls. Buy puts and buy calls. Sell puts and buy calls, as well as buy puts and sell calls.

58) A Japanese exporter has a €1,000,000 receivable due in one year. Detail a strategy using options that will eliminate exchange rate risk. Listed Options Strike

Puts

Calls

Euro€62,500

$ 1.25 = € 1.00

$ 0.0075 per€

$ 0.01 per€

Yen¥12,500,000

$ 1.00 = ¥

$ 0.0075 per¥100

A) B) C) D)

100

0.01 per¥100

Buy 16 put options on euro, sell 10 call options on yen. Buy 16 put options on euro, buy 10 call options on yen. Sell 16 call options on euro, buy 10 put options on yen. none of the options

59) A Japanese exporter has a €1,000,000 receivable due in one year. Estimate the cost today of an options strategy that will eliminate exchange rate risk. Listed Options Strike

Puts

Calls

Euro€62,500

$ 1.25 = € 1.00

$ 0.0075 per€

$ 0.01 per€

Yen¥12,500,000

$ 1.00 = ¥

$ 0.0075 per¥100

A) B) C) D)

60)

100

0.01 per¥100

$20,000 $5,000 $12,500 none of the options

A Japanese importer has a $1,250,000 payable due in one year. Spot exchange rates

Version 1

1-year Forward Rates

Contract size

$ 1.00 = ¥ 100

$ 1.00 = ¥ 120

¥ 12,500,000

Detail a strategy using forward contracts that will hedge his exchange rate risk. A) B) C) D)

61)

Go short in 12 yen forward contracts. Go long in 12 yen forward contracts. Go short in 16 yen forward contracts. none of the options

A Japanese importer has a €1,000,000 payable due in one year. Spot exchange rates

1-year Forward Rates

Contract size

$ 1.20 = € 1.00

$ 1.25 = € 1.00

€

$ 1.00 = ¥ 100

$ 1.00 = ¥ 120

¥ 12,500,000

62,500

The one-year risk free rates are i$ = 4.03%; i€ = 6.05%; and i¥ = 1%. Detail a strategy using forward contracts that will hedge his exchange rate risk. Have an estimate of how many contracts of what type. A) B) C) D)

Go short in 12 yen forward contracts. Go long in 16 euro contracts. Go long in 12 yen forward contracts. Go short in 16 euro contracts. Go short in 16 yen forward contracts. Go long in 12 euro contracts. none of the options

62) XYZ Corporation, located in the United States, has an accounts payable obligation of ¥750 million payable in one year to a bank in Tokyo. Which of the following is not part of a money market hedge?

Version 1

A) Buy the ¥750 million at the forward exchange rate. B) Find the present value of ¥750 million at the Japanese interest rate. C) Buy that much yen at the spot exchange rate. D) Invest in risk-free Japanese securities with the same maturity as the accounts payable obligation.

63) XYZ Corporation, located in the United States, has an accounts payable obligation of ¥750 million payable in one year to a bank in Tokyo. The current spot rate is ¥116/$1.00 and the one year forward rate is ¥109/$1.00. The annual interest rate is 3 percent in Japan and 6 percent in the United States. XYZ can also buy a one-year call option on yen at the strike price of $0.0086 per yen for a premium of 0.012 cent per yen. The future dollar cost of meeting this obligation using the money market hedge is A) B) C) D)

$6,450,000. $6,545,400. $6,653,833. $6,880,734.

64) XYZ Corporation, located in the United States, has an accounts payable obligation of ¥750 million payable in one year to a bank in Tokyo. The current spot rate is ¥116/$1.00 and the one year forward rate is ¥109/$1.00. The annual interest rate is 3 percent in Japan and 6 percent in the United States. XYZ can also buy a one-year call option on yen at the strike price of $0.0086 per yen for a premium of 0.012 cent per yen. The future dollar cost of meeting this obligation using the forward hedge is A) B) C) D)

65)

$6,450,000. $6,545,400. $6,653,833. $6,880,734.

To hedge a foreign currency payable,

Version 1

A) B) C) D)

66)

To hedge a foreign currency receivable, A) B) C) D)

67)

buy call options on the foreign currency. buy put options on the foreign currency. sell call options on the foreign currency. sell put options on the foreign currency.

buy call options on the foreign currency with a strike in the domestic currency. buy put options on the foreign currency with a strike in the domestic currency. sell call options on the foreign currency with a strike in the domestic currency. sell put options on the foreign currency with a strike in the domestic currency.

A call option on £1,000 with a strike price of €1,250 is equivalent to

A) a put option on €1,250 with an exercise price of €1,000. B) a portfolio of options: a put on €1,250 with a strike price in dollars plus a call on £1,000 with a strike price in dollars. C) a put option on £1,000 with an exercise price of €1,250. D) both a put option on €1,250 with an exercise price of €1,000 and a portfolio of options: a put on €1,250 with a strike price in dollars plus a call on £1,000 with a strike price in dollars.

68)

A call option to buy £10,000 at a strike price of $1.80 = £1.00 is equivalent to A) B) C) D)

69)

a put option to sell $18,000 at a strike price of $1.80 = £1.00. a call option on $18,000 at a strike price of $1.80 = £1.00. a put option on £10,000 at a strike price of $1.80 = £1.00. none of the options

A put option to sell $18,000 at a strike price of $1.80 = £1.00 is equivalent to

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A) B) C) D)

a call option to buy £10,000 at a strike price of $1.80 = £1.00. a call option on $18,000 at a strike price of $1.80 = £1.00. a put option on £10,000 at a strike price of $1.80 = £1.00. none of the options

70) XYZ Corporation, located in the United States, has an accounts payable obligation of ¥750 million payable in one year to a bank in Tokyo. The current spot rate is ¥116/$1.00 and the one year forward rate is ¥109/$1.00. The annual interest rate is 3 percent in Japan and 6 percent in the United States. XYZ can also buy a one-year call option on yen at the strike price of $0.0086 per yen for a premium of 0.012 cent per yen. Assume that the forward rate is the best predictor of the future spot rate. The future dollar cost of meeting this obligation using the option hedge is A) B) C) D)

$6,450,000. $6,545,400. $6,653,833. $6,880,734.

71) Your U.S. firm has a £100,000 payable with a 3-month maturity. Which of the following will hedge your liability? A) U.K. at i£. B) C) D)

Buy the present value of £100,000 today at the spot exchange rate, invest in the Buy a call option on £100,000 with a strike price in dollars. Take a long position in a forward contract on £100,000 with a 3-month maturity. all of the options

72) Your U.S. firm has a £100,000 payable with a 3-month maturity. Which of the following will hedge your liability?

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A) B) C) D)

Buy a call option on £100,000 with a strike price in euro. Buy a put option on £100,000 with a strike price in dollars. Buy a call option on £100,000 with a strike price in dollars. none of the options

73) Suppose that the exchange rate is €1.25 = £1.00.Options (calls and puts) are available on the London exchange in units of €10,000 with strike prices of £0.80 = €1.00.Options (calls and puts) are available on the Frankfurt exchange in units of £10,000 with strike prices of €1.25 = £1.00. For a U.K. firm to hedge a €100,000 payable, A) buy 10 call options on the euro with a strike in pounds sterling. B) buy 8 put options on the pound with a strike in euro. C) sell 10 call options on the euro with a strike in pounds sterling. D) buy 10 call options on the euro with a strike in pounds sterling and buy 8 put options on the pound with a strike in euro.

74) Suppose that the exchange rate is €1.25 = £1.00.Options (calls and puts) are available on the London exchange in units of €10,000 with strike prices of £0.80 = €1.00. Options (calls and puts) are available on the Frankfurt exchange in units of £10,000 with strike prices of €1.25 = £1.00. For a U.K. firm to hedge a €100,000 receivable, A) buy 10 call options on the euro with a strike in pounds sterling. B) buy 10 put options on the euro with a strike in pounds sterling. C) buy 8 call options on the pound with a strike in euro. D) buy 10 put options on the euro with a strike in pounds sterling and buy 8 call options on the pound with a strike in euro.

75) Suppose that the exchange rate is €1.25 = £1.00.Options (calls and puts) are available on the Philadelphia exchange in units of €10,000 with strike prices of $1.60/€1.00.Options (calls and puts) are available on the Philadelphia exchange in units of £10,000 with strike prices of $2.00/£1.00. For a U.S. firm to hedge a €100,000 payable,

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A) B) C) D)

buy 10 call options on the euro with a strike in dollars. buy 8 put options on the pound with a strike in dollars. sell 10 call options on the euro with a strike in dollars. sell 8 put options on the pound with a strike in dollars.

76) Suppose that the exchange rate is €1.25 = £1.00.Options (calls and puts) are available on the Philadelphia exchange in units of €10,000 with strike prices of $1.60/€1.00.Options (calls and puts) are available on the Philadelphia exchange in units of £10,000 with strike prices of $2.00/£1.00. For a U.S. firm to hedge a €100,000 receivable, A) B) C) D)

buy 10 call options on the euro with a strike in dollars. buy 10 put options on the pound with a strike in dollars. sell 10 call options on the euro with a strike in dollars. sell 8 put options on the pound with a strike in dollars.

77) Suppose that $2 = £1, $1.60 = €1, and the cross-exchange rate is €1.25 = £1.00. If you own a call option on £10,000 with a strike price of $1.50, you would exercise this option at maturity if A) B) C) D)

the $/£ exchange rate is at least $1.60/£. the $/€ exchange rate is at least $1.60/€. the €/£ exchange rate is at least €1.25/£. none of the options

78) Suppose that the exchange rate is €1.25 = £1.00.Options (calls and puts) are available on the London exchange in units of €10,000 with strike prices of £0.80 = €1.00.Options (calls and puts) are available on the Frankfurt exchange in units of £10,000 with strike prices of €1.25 = £1.00. For an Italian firm to hedge a £100,000 payable,

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A) buy 10 call options on the pound with a strike in euro. B) buy 8 put options on the euro with a strike in pounds. C) buying 10 call options on the pound with a strike in euro or buying 8 put options on the euro with a strike in pounds will both work. D) none of the options

79) Suppose that the exchange rate is €1.25 = £1.00.Options (calls and puts) are available on the London exchange in units of €10,000 with strike prices of £0.80 = €1.00. Options (calls and puts) are available on the Frankfurt exchange in units of £10,000 with strike prices of €1.25 = £1.00. For a French firm to hedge a £100,000 receivable, A) buy 10 call options on the pound with a strike in euro. B) buy 10 put options on the pound with a strike in euro. C) buy 8 call options on the euro with a strike in pounds. D) buy 10 put options on the pound with a strike in euro and buy 8 call options on the euro with a strike in pounds.

80)

A minor currency is

A) anything other than the "big six": U.S. dollar, British pound, Japanese yen, euro, Canadian dollar, and Swiss franc. B) any currency that trades at less than one U.S. dollar. C) any currency that is less than a $20 denomination. D) none of the options

81)

A U.S.-based MNC with exposure to the Swedish krona could best cross-hedge with A) B) C) D)

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forward contracts on the euro. forward contracts on the ruble. forward contracts on the pound. forward contracts on the yen.

82)

When cross-hedging,

A) try to find one asset that has a positive correlation with another asset. B) the main thing is to find one asset that covaries with another asset in some predictable way. C) try to find one asset that has a negative correlation with another asset. D) none of the options

83) Your firm is bidding on a large construction contract in a foreign country. This contingent exposure could best be hedged A) with put options on the foreign currency. B) with call options on the foreign currency. C) both with put and call options on the foreign currency, depending upon the specifics ("the rest of the story"). D) with futures contracts.

84) On a recent sale, Boeing allowed British Airways to pay either $18 million or £10 million. A) At the due date, British airways will be indifferent between paying dollars or pounds since they would of course have hedged their exposure either way. B) Boeing has provided British Airways with a free option to buy $18 million with an exercise price of £10 million. C) Boeing has provided British Airways with a free option to sell up to £10 million with an exercise price of $18 million. D) all of the options

85)

Contingent exposure can best be hedged with

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A) B) C) D)

options. money market hedging. futures. all of the options

86) A 5-year swap contract can be viewed as a portfolio of 5 forward contracts with maturities of 1, 2, 3, 4 and 5 years. One important exception is that A) B) C) D)

87)

To find the swap rate for a 3-year swap, you would A) B) C) D)

88)

the forward price is the same for the swap contract but not for the forward contracts. the swap contract will have daily resettlement. the forward contracts will have resettlement risk. none of the options

take the arithmetic average of the 1-, 2-, and 3-year forward rates. take the geometric average of the 1-, 2-, and 3-year forward rates. bootstrap the LIBOR yield curve. none of the options

Generally speaking, a firm with recurrent exposure can best hedge using which product? A) B) C) D)

Options Swaps Futures all of the options

89) The current exchange rate is €1.25 = £1.00 and a British firm offers a French customer the choice of paying a £10,000 bill due in 90 days with either £10,000 or €12,500.

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A) The seller has given the buyer an at-the-money put option. B) The seller has given the buyer an at-the-money call option. C) The seller has given the buyer both an at-the-money put option, as well as an at-themoney call option. D) none of the options

90) The current exchange rate is €1.25 = £1.00 and a British firm offers a French customer the choice of paying a £10,000 bill due in 90 days with either £10,000 or €12,500. A) pounds. B) euro. C) pounds. D)

91)

The seller has given the buyer an at-the-money put option on euro with a strike in The seller has given the buyer an at-the-money put option on pounds with a strike in The seller has given the buyer an at-the-money call option on euro with a strike in none of the options

An exporter can shift exchange rate risk to their customers by

A) invoicing in their home currency. B) invoicing in their customer's local currency. C) splitting the difference, and invoicing half of sales in local currency and half of sales in home currency. D) invoicing sales in a currency basket such as the SDR as the invoice currency.

92)

An exporter can share exchange rate risk with their customers by

A) invoicing in their customer's local currency. B) splitting the difference, and invoicing half of sales in local currency and half of sales in home currency. C) invoicing sales in a currency basket such as the SDR as the invoice currency. D) Both B and C are correct.

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93) An exporter faced with exposure to a depreciating currency can reduce transaction exposure with a strategy of A) B) C) D)

paying or collecting early. paying or collecting late. paying late, collecting early. paying early, collecting late.

94) An exporter faced with exposure to an appreciating currency can reduce transaction exposure with a strategy of A) B) C) D)

95)

paying or collecting early. paying or collecting late. paying late, collecting early. paying early, collecting late.

An MNC seeking to reduce transaction exposure with a strategy of leading and lagging

A) can probably employ the strategy more effectively with intra firm payables and receivables than with customers or outside suppliers. B) can employ the strategy most easily with customers, regardless of market structure. C) can employ the strategy most easily with suppliers, regardless of market structure. D) none of the options

96) A financial subsidiary used for centralizing exposure management functions is also referred to as a(an) A) B) C) D)

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invoice center reinvoice center affiliate none of the options

97) In evaluating the pros and cons of corporate risk management, one argument against hedging is A) if the corporate guys were good at forecasting exchange rates, they would make more money on Wall Street, so only incompetent managers are left at corporations to hedge. B) shareholders who are diversified have already managed their exchange rate risk. C) the hedging costs go into someone else's pocket. D) none of the options

98)

If a firm faces progressive tax rates, A) B) C) D)

they should spread income out across time and subsidiaries. they should focus on maximizing income in one division or subsidiary. they should manage their income recognition without regard to their taxes. none of the options

99) In evaluating the pros and cons of corporate risk management, "market imperfections" refer to A) information asymmetry, differential transaction costs, default costs, and progressive corporate taxes. B) leading and lagging, receivables and payables, and diversification costs. C) economic costs, noneconomic costs, arbitrage costs, and hedging costs. D) management costs, corporate costs, liquidity costs, and trading costs.

100) ABC Inc., an exporting firm, expects to earn $20 million if the dollar depreciates, but only $10 million if the dollar appreciates. Assume that the dollar has an equal chance of appreciating or depreciating. Calculate the expected tax of ABC if it is operating in a foreign country that has progressive corporate taxes as shown. Corporate income tax rate = 15% for the first $7,500,000. Corporate income tax rate = 30% for earnings exceeding $7,500,000.

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A) B) C) D)

$3,375,000 $6,000,000 $1,500,000 $4,500,000

101) ABC Inc., an exporting firm, expects to earn $20 million if the dollar depreciates, but only $10 million if the dollar appreciates. Assume that the dollar has an equal chance of appreciating or depreciating. Step one: calculate the expected tax of ABC if it is operating in a foreign country that has progressive corporate taxes as shown. Corporate income tax rate = 15% for the first $7,500,000.Corporate income tax rate = 30% for earnings exceeding $7,500,000. Step two: ABC is considering implementing a hedging program that will eliminate their exchange rate risk: they will make a certain $15 million whether or not the dollar appreciates or depreciates. How much will they save in taxes if they implement the program? A) B) C) D)

102)

A study of Fortune 500 firms hedging practices shows that A) B) C) D)

103)

$0 $3,375,000 $1,500,000 $4,500,000

over 90 percent of Fortune 500 firms use forward contracts. over 90 percent of Fortune 500 firms use options contracts. over 90 percent of Fortune 500 firms use both forward and options contracts. none of the options

If default costs are significant,

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A) corporate hedging would be justifiable because it will reduce the probability of default. B) corporate hedging would be unjustifiable because it will increase the probability of default. C) corporate hedging would be unjustifiable because it will increase the probability of default, resulting in a decreased credit rating and higher financing costs. D) none of the options

104)

With respect to information asymmetry,

A) management knows about the firm’s exposure position much better than stockholders, and therefore should be the ones to manage exchange exposure. B) stockholders know about the firm’s exposure position much better than management, and therefore should be the ones to manage exchange exposure. C) regulators know about the firm’s exposure position much better than management, and therefore should be the ones to oversee exchange exposure. D) none of the options

105)

Which of the following call and put option statement is not correct?

A) A currency call option gives the holder the right, but not the obligation, to buy a certain amount of foreign currency at a specific exchange rate up to or at the maturity date. B) A currency put option gives the holder the right, but not the obligation, to sell a certain amount of foreign currency at a specific exchange rate again up to or at the maturity date. C) The price of call or put options that option buyers have to pay is called premium. D) none of the options

106) Which of the following statements illustrates the discord between the stated internal risk management policies and the actual practices conducted in a recent study of 101 large nonfinancial corporations in South Korea (Kim & Chance, 2018)

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A) 53% of companies stated that they engage in internal risk management to control exchange rate risk. B) 86% reported in engaging in external risk management. C) 38% of companies practice their stated risk management when they state they engage in internal risk management. D) none of the options

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Answer Key Test name: Chap 08_9e 1) A 2) A 3) B 4) D 5) A 6) B 7) B 8) D 9) D 10) A 11) B 12) C 13) A 14) D 15) A 16) C 17) B 18) A 19) A 20) D 21) C 22) D 23) C 24) C 25) D 26) D Version 1

27) B 28) D 29) C 30) D 31) C 32) D 33) C 34) A 35) B 36) A 37) B 38) D 39) C 40) A 41) A 42) A 43) A 44) B 45) B 46) B 47) B 48) B 49) B 50) D 51) D 52) B 53) A 54) B 55) C 56) D Version 1

57) D 58) B 59) A 60) A 61) A 62) A 63) C 64) D 65) A 66) B 67) A 68) A 69) A 70) A 71) D 72) C 73) D 74) D 75) A 76) B 77) D 78) C 79) D 80) A 81) A 82) B 83) C 84) D 85) A 86) A Version 1

87) B 88) B 89) C 90) A 91) A 92) D 93) C 94) D 95) A 96) B 97) B 98) A 99) A 100) A 101) A 102) A 103) A 104) A 105) D 106) C

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CHAPTER 9 MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 1) Suppose the U.S. dollar substantially depreciates against the Japanese yen. The change in exchange rate A) B) C) D)

can have significant economic consequences for U.S. firmsonly. can have significant economic consequences for Japanese firmsonly. can have significant economic consequences for both U.S. and Japanese firms. none of the options

2) Suppose the U.S. dollar substantially depreciates against the Japanese yen. The change in exchange rate A) will tend to weaken the competitive position of import-competing U.S. car makers. B) will tend to strengthen the competitive position of import-competing U.S. car makers. C) will tend to strengthen the competitive position of Japanese car makers at the expense of U.S. makers. D) none of the options

The link between a firm's future operating cash flows and exchange rate fluctuations is A) B) C) D)

asset exposure. operating exposure. asset exposure and operating exposure. none of the options

When the Mexican peso collapsed in 1994, declining by 37 percent,

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A) U.S. firms that exported to Mexico and priced in pesos, but not dollars, were adversely affected. B) U.S. firms that exported to Mexico and priced in dollars, but not pesos were adversely affected. C) U.S. firms were unaffected by the peso collapse, since Mexico is such a small market. D) U.S. firms that exported to Mexico and priced in peso were adversely affected, and U.S. firms that exported to Mexico and priced in dollars were adversely affected.

When exchange rates change,

A) U.S. firms that produce domestically and sell only to domestic customers will be unaffected. B) U.S. firms that produce domestically and sell only to domestic customers can be affected if they compete against imports. C) U.S. firms that produce domestically and sell only to domestic customers will be affected, but only if they borrow in foreign currency to finance their domestic operations. D) U.S. firms that produce domestically and sell only to domestic customers will be unaffected, and U.S. firms that produce domestically and sell only to domestic customers can be affected if they compete against imports.

When exchange rates change,

A) B) C) liabilities. D)

this can alter the operating cash flow of a domestic firm. this can alter the competitive position of a domestic firm. this can alter the home currency values of a multinational firm's assets and all of the options

Two studies found a link between exchange rates and the stock prices of U.S. firms;

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A) this suggests that exchange rate changes can systematically affect the value of the firm by influencing its operating cash flows. B) this suggests that exchange rate changes can systematically affect the value of the firm by influencing the domestic currency values of its assets and liabilities. C) this suggests that exchange rate changes can systematically affect the value of the firm by influencing its operating cash flows, as well influencing the domestic currency values of its assets and liabilities. D) none of the options

It is conventional to classify foreign currency exposures into the following types: A) B) C) D)

economic exposure, transaction exposure, and translation exposure. economic exposure, noneconomic exposure, and political exposure. national exposure, international exposure, and trade exposure. conversion exposure, and exchange exposure.

Exposure to currency risk can be measured by the sensitivities of

A) the future home currency values of the firm's assets and liabilitiesonly. B) the firm's operating cash flows to random changes in exchange ratesonly. C) the future home currency values of the firm's assets and liabilities, as well as the firm's operating cash flows to random changes in exchange rates. D) none of the options

10)

Operating exposure measures

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A) the extent to which the foreign currency value of the firm's assets is affected by unanticipated changes in exchange rates. B) the extent to which the firm's operating cash flows will be affected by unexpected changes in exchange rates. C) the effect of changes in exchange rates will have on the consolidated financial reports of a MNC. D) the effect of unanticipated changes in exchange rates on the dollar value of contractual obligations denominated in a foreign currency.

11)

Economic exposure refers to

A) the sensitivity of realized domestic currency values of the firm's contractual cash flows denominated in foreign currencies to unexpected exchange rate changes. B) the extent to which the value of the firm would be affected by unanticipated changes in exchange rate. C) the potential that the firm's consolidated financial statement can be affected by changes in exchange rates. D) ex post and ex ante currency exposures.

12)

Currency risk A) B) C) D)

is the same as currency exposure. represents random changes in exchange rates. measure "what the firm has at risk." is the same as currency exposure and represents random changes in exchange rates.

13) Suppose a U.S.-based MNC maintains a vacation home for employees in the British countryside and the local price of this property is always moving together with the pound price of the U.S. dollar. As a result,

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A) whenever the pound depreciates against the dollar, the local currency price of this property goes up by the same proportion. B) the firm is not exposed to currency risk even if the pound–dollar exchange rate fluctuates randomly. C) whenever the pound depreciates against the dollar, the local currency price of this property goes up by the same proportion. Additionally, the firm is not exposed to currency risk even if the pound–dollar exchange rate fluctuates randomly. D) none of the options

14)

The exposure coefficient in the regression P = a + b × S + e is given by

A) B) P = a + b × S + e C) D) none of the options

15)

The exposure coefficient

in the regression P = a + b × S + e is

A) a measure of how a change in the exchange rate affects the dollar value of a firm's assets. B) a value of zero if the value of the firm's assets is perfectly correlated with changes in the exchange rate. C) a measure of how a change in the exchange rate affects the dollar value of a firm's assets, and has a value of zero if the value of the firm's assets is perfectly correlated with changes in the exchange rate. D) none of the options

16)

The exposure coefficient

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in the regression P = a + b × S + e informs

A) how much of a foreign currency to sell forward. B) the part of the variability of the dollar value of the asset that is related to random changes in the exchange rate. C) captures the residual part of the dollar value variability that is independent of exchange rate movements. D) how many call options to write.

17) Before you can use the hedging strategies such as a forward market hedge, options market hedge, and so on, you should consider running a regression of the form P = a + b × S + e . When reviewing the output, you should initially focus on A) B) C) D)

the intercept a. the slope coefficient b. mean square error, MSE. R2.

18) The link between the home currency value of a firm's assets and liabilities and exchange rate fluctuations is A) B) C) D)

19)

asset exposure. operating exposure. asset exposure and operating exposure. none of the options

A purely domestic firm that sources and sells only domestically,

A) faces exchange rate risk to the extent that it has international competitors in the domestic market. B) faces no exchange rate risk. C) should never hedge since this could actually increase its currency exposure. D) faces no exchange rate risk and should never hedge since this could actually increase its currency exposure.

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20) In recent years, the U.S. dollar has depreciated substantially against most major currencies of the world, especially against the euro. A) The stronger euro has made many European products more expensive in dollar terms, hurting sales of these products in the United States. B) The stronger euro has made many American products less expensive in euro terms, boosting sales of U.S. products in Europe. C) The stronger euro has made many European products more expensive in dollar terms, hurting sales of these products in the United States. Additionally, the stronger euro has made many American products less expensive in euro terms, boosting sales of U.S. products in Europe. D) none of the options

21)

In recent years,

A) the U.S. dollar has appreciated substantially against most major currencies of the world, especially against the euro. B) the U.S. dollar has depreciated substantially against most major currencies of the world, especially against the euro. C) the U.S. dollar has maintained its value against most major currencies of the world, especially against the euro. D) none of the options

22) From the perspective of the U.S. firm that owns an asset in Britain, the exposure that can be measured by the coefficient b in regressing the dollar value P of the British asset on the dollar–pound exchange rate S using regression equation P = a + b × S + e is A) B) C) D)

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asset exposure. operating exposure. accounting exposure. none of the options

23) On the basis of regression equation P = a + b × S + e, we can decompose the variability of the dollar value of the asset, Var(P), into two separate components: A) B) C) D)

Cov(P,S) = b2 × VAR(P) + VAR(S) VAR(P) = b2 × VAR(S) + VAR(e) Cov(P,S) = b2 × Cov(S,P) + Cov(S,e) VAR(P) = b2 × VAR(S)

24) On the basis of regression equation P = a + b × S + e, we can decompose the variability of the dollar value of the asset, Var(P), into two separate components: Var(P) = b2 × Var(S) + Var(e). The first term in the right-hand side of the equation, b2 × Var(S) represents A) the part of the variability of the dollar value of the asset that is related to random changes in the exchange rate. B) the residual part of the dollar value variability that is independent of exchange rate movements. C) the part of the variability of the dollar value of the asset that is related to random changes in the exchange rate, as well as the residual part of the dollar value variability that is independent of exchange rate movements. D) none of the options

25) On the basis of regression equation P = a + b × S + e, we can decompose the variability of the dollar value of the asset, VAR(P), into two separate components: VAR(P) = b2 × VAR(S) + VAR(e). The second term in the right-hand side of the equation, VAR(e) represents A) the part of the variability of the dollar value of the asset that is related to random changes in the exchange rate. B) the residual part of the dollar value variability that is independent of exchange rate movements. C) the part of the variability of the dollar value of the asset that is related to random changes in the exchange rate, as well as the residual part of the dollar value variability that is independent of exchange rate movements. D) none of the options

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26)

What does it mean to have redenominated an asset in terms of the dollar? A) B) C) D)

27)

You have undertaken a hedging strategy that gives the asset a constant dollar value. Multiply the foreign currency value of the asset by the spot exchange rate. You have undertaken accounting changes to eliminate translation exposure. none of the options

A firm with a highly elastic demand for its products

A) will be unable to pass increased costs following unfavorable changes in the exchange rate without significantly lowering the quantity sold. B) will be able to raise prices following unfavorable changes in the exchange rate without significantly lowering the quantity sold. C) can easily pass increased costs on to consumers. D) will sell about the same amount of product regardless of price.

28)

Operating exposure can be defined as

A) the link between the future home currency values of the firm's assets and liabilities and exchange rate fluctuations. B) the extent to which the firm's operating cash flows would be affected by random changes in exchange rates. C) the sensitivity of realized domestic currency values of the firm's contractual cash flows denominated in foreign currencies to unexpected exchange rate changes. D) the potential that the firm's consolidated financial statement can be affected by changes in exchange rates.

29) The extent to which the firm's operating cash flows would be affected by random changes in exchange rates is called

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A) B) C) D)

30)

asset exposure. operating exposure. asset exposure or operating exposure. none of the options

The variability of the dollar value of an asset (invested overseas) depends on

A) the variability of the dollar value of the asset that is related to random changes in the exchange rate. B) the dollar value variability that is independent of exchange rate movements. C) Both A and B are correct. D) none of the options

31) Consider a U.S. MNC who owns a foreign asset. If the foreign currency value of the asset is inversely related to changes in the dollar–foreign currency exchange rate, A) the company has no built-in hedge. B) the dollar value variability that is dependent on exchange rate movements. C) the company has a built-in hedge and the dollar value variability that is independent of exchange rate movements. D) none of the options

32)

With regard to operational hedging versus financial hedging,

A) operational hedging provides a more stable long-term approach than does financial hedging. B) financial hedging, when instituted on a rollover basis, is a superior long-term approach to operational hedging. C) since they both have the same goal, stabilizing the firm's cash flows in domestic currency, they are fungible in use. D) none of the options

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33) Which of the following are identified by your text as a strategy for managing operating exposure?(i) Selecting low-cost production sites(ii) Flexible sourcing policy(iii) Diversification of the market(iv) Product differentiation and R&D efforts(v) Financial Hedging A) B) C) D)

34)

(i), (iii), and (v) only (ii) and (iv) only (i), (iv), and (v) only all of the options

A U.S. firm holds an asset in Great Britain and faces the following scenario: State 1

State 2

State 3

25%

50%

25%

Probability Spot rate

2.20 /£

2.00 /£

1.80 /£

£ 2,000

£ 2,500

£ 3,000

$ 4,400

$ 5,000

$ 5,400

where,P* = Pound sterling price of the asset held by the U.S. firmP = Dollar price of the same assetThe expected value of the investment in U.S. dollars is A) B) C) D)

35)

$4,950. $3,700. $2,112.50. none of the options

A U.S. firm holds an asset in Great Britain and faces the following scenario:

Probability

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State 1

State 2

State 3

25%

50%

25%

Spot rate

2.20 /£

2.00 /£

1.80 /£

£ 2,000

£ 2,500

£ 3,000

$ 4,400

$ 5,000

$ 5,400

where,P* = Pound sterling price of the asset held by the U.S. firmP = Dollar price of the same assetThe variance of the exchange rate is: A) B) C) D)

36)

0.0200 0.10 0.002 none of the options

A U.S. firm holds an asset in Great Britain and faces the following scenario: State 1

State 2

State 3

25%

50%

25%

Probability Spot rate

2.20 /£

2.00 /£

1.80 /£

£ 2,000

£ 2,500

£ 3,000

$ 4,400

$ 5,000

$ 5,400

where,P* = Pound sterling price of the asset held by the U.S. firmP = Dollar price of the same assetThe "exposure" (i.e. the regression coefficient beta) isHint: Calculate the expression

A) B) C) D)

Version 1

−25,000 2,500 −2,500 none of the options

37)

A U.S. firm holds an asset in Great Britain and faces the following scenario: State 1

State 2

State 3

25%

50%

25%

Probability Spot rate

2.20 /£

2.00 /£

1.80 /£

£ 2,000

£ 2,500

£ 3,000

$ 4,400

$ 5,000

$ 5,400

where,P* = Pound sterling price of the asset held by the U.S. firmP = Dollar price of the same assetWhich of the following conclusions are correct? A) Most of the volatility of the dollar value of the British asset can be removed by hedging exchange risk because b2[Var(S)] and Var(e) are 236,717 ($)2 and 493,751 ($)2 respectively. B) Most of the volatility of the dollar value of the British asset cannot be removed by hedging exchange risk because b2[Var(S)] and Var(e) are 236,717 ($)2 and 493,751($)2 respectively. C) Most of the volatility of the dollar value of the British asset cannot be removed by hedging exchange risk because b2[Var(S)] and Var(e) are 125,000 ($)2 and −127,500 ($)2 respectively. D) Most of the volatility of the dollar value of the British asset can be removed by hedging exchange risk because b2[Var(S)] and Var(e) are 125,000 ($)2 and −127,500 ($)2 respectively.

38)

A U.S. firm holds an asset in Great Britain and faces the following scenario: State 1

State 2

State 3

25%

50%

25%

Probability Spot rate

£ 2,000

£ 2,500

£ 3,000

$ 4,400

$ 5,000

$ 5,400

Version 1

2.20 /£

2.00 /£

1.80 /£

where,P* = Pound sterling price of the asset held by the U.S. firmP = Dollar price of the same assetWhich of the following would be an effective hedge? A) B) C) D)

39)

Sell £2,500 forward at the 1-year forward rate, F1($/£), that prevails at time zero. Buy £2,500 forward at the 1-year forward rate, F1($/£), that prevails at time zero. Sell £25,000 forward at the 1-year forward rate, F1($/£), that prevails at time zero. none of the options

A U.S. firm holds an asset in Great Britain and faces the following scenario: State 1

State 2

State 3

25%

50%

25%

Probability Spot rate

2.20 /£

2.00 /£

1.80 /£

£ 3,000

£ 2,500

£ 2,000

$ 6,600

$ 5,000

$ 3,600

where,P* = Pound sterling price of the asset held by the U.S. firmP = Dollar price of the same assetThe expected value of the investment in U.S. dollars is A) B) C) D)

40)

$5,050 $3,700 $2,112.50 none of the options

A U.S. firm holds an asset in Great Britain and faces the following scenario:

Probability

Version 1

State 1

State 2

State 3

25%

50%

25%

Spot rate

2.20 /£

2.00 /£

1.80 /£

£ 3,000

£ 2,500

£ 2,000

$ 6,600

$ 5,000

$ 3,600

where,P* = Pound sterling price of the asset held by the U.S. firmP = Dollar price of the same assetThe variance of the exchange rate is A) B) C) D)

41)

0.0200 0.10 0.002 none of the options

A U.S. firm holds an asset in Great Britain and faces the following scenario: State 1

State 2

State 3

25%

50%

25%

Probability Spot rate

2.20 /£

2.00 /£

1.80 /£

£ 3,000

£ 2,500

£ 2,000

$ 6,600

$ 5,000

$ 3,600

where,P* = Pound sterling price of the asset held by the U.S. firmP = Dollar price of the same assetThe "exposure" (i.e. the regression coefficient beta) isHint: Calculate the expression

A) B) C) D)

Version 1

7,500 2,500 −2,500 none of the options

42)

A U.S. firm holds an asset in Great Britain and faces the following scenario: State 1

State 2

State 3

25%

50%

25%

Probability Spot rate

2.20 /£

2.00 /£

1.80 /£

£ 3,000

£ 2,500

£ 2,000

$ 6,600

$ 5,000

$ 3,600

where,P* = Pound sterling price of the asset held by the U.S. firmP = Dollar price of the same assetWhich of the following conclusions are correct? A) Most of the volatility of the dollar value of the British asset can be removed by hedging exchange risk because b2[Var(S)] and Var(e) are 1,125,000 ($)2 and 2,500 ($)2 respectively. B) Most of the volatility of the dollar value of the British asset cannot be removed by hedging exchange risk because b2[Var(S)] and Var(e) are 236,717 ($)2 and 493,751 ($)2 respectively. C) Most of the volatility of the dollar value of the British asset cannot be removed by hedging exchange risk because b2[Var(S)] and Var(e) are 125,000 ($)2 and −127,500 ($)2 respectively. D) Most of the volatility of the dollar value of the British asset can be removed by hedging exchange risk because b2[Var(S)] and Var(e) are 125,000 ($)2 and −127,500 ($)2 respectively.

43)

A U.S. firm holds an asset in Great Britain and faces the following scenario: State 1

State 2

State 3

25%

50%

25%

Probability Spot rate

£ 3,000

£ 2,500

£ 2,000

$ 6,600

$ 5,000

$ 3,600

Version 1

2.20 /£

2.00 /£

1.80 /£

where,P* = Pound sterling price of the asset held by the U.S. firmP = Dollar price of the same assetWhich of the following would be an effective hedge? A) B) C) D)

44)

Sell £7,500 forward at the 1-year forward rate, F1($/£), that prevails at time zero. Buy £2,500 forward at the 1-year forward rate, F1($/£), that prevails at time zero. Sell £25,000 forward at the 1-year forward rate, F1($/£), that prevails at time zero. none of the options

A U.S. firm holds an asset in Great Britain and faces the following scenario: State 1

State 2

State 3

25%

50%

25%

Probability Spot rate

2.50 /£

2.00 /£

1.60 /£

£ 1,800

£ 2,250

£ 2,812.50

$ 4,500

4,500

where,P* = Pound sterling price of the asset held by the U.S. firmP = Dollar price of the same assetThe expected value of the investment in U.S. dollars is: A) B) C) D)

45)

$5,050 $4,500 $2,112.50 none of the options

A U.S. firm holds an asset in Great Britain and faces the following scenario:

Probability

Version 1

State 1

State 2

State 3

25%

50%

25%

Spot rate

2.50 /£

2.00 /£

1.60 /£

£ 1,800

£ 2,250

£ 2,812.50

$ 4,500

4,500

where,P* = Pound sterling price of the asset held by the U.S. firmP = Dollar price of the same assetThe variance of the exchange rate is A) B) C) D)

46)

0.0200 0.1019 0.0020 none of the options

A U.S. firm holds an asset in Great Britain and faces the following scenario: State 1

State 2

State 3

25%

50%

25%

Probability Spot rate

2.50 /£

2.00 /£

1.60 /£

£ 1,800

£ 2,250

£ 2,812.50

$ 4,500

4,500

where,P* = Pound sterling price of the asset held by the U.S. firmP = Dollar price of the same assetThe "exposure" (i.e., the regression coefficient beta) isHint: Calculate the expression

A) B) C) D)

Version 1

7,500 2,500 −2,500 none of the options

47)

A U.S. firm holds an asset in Great Britain and faces the following scenario: State 1

State 2

State 3

25%

50%

25%

Probability Spot rate

2.50 /£

2.00 /£

1.60 /£

£ 1,800

£ 2,250

£ 2,812.50

$ 4,500

4,500

where,P* = Pound sterling price of the asset held by the U.S. firmP = Dollar price of the same assetWhich of the following conclusions are correct? A) Most of the volatility of the dollar value of the British asset can be removed by hedging exchange risk because b2[Var(S)] and Var(e) are 0 ($)2 and 0 ($)2 respectively. B) None of the volatility of the dollar value of the British asset can be removed by hedging exchange risk because b2[Var(S)] and Var(e) are 0 ($)2and 0 ($)2 respectively. C) Most of the volatility of the dollar value of the British asset cannot be removed by hedging exchange risk because b2[Var(S)] and Var(e) are 125,000 ($)2 and −127,500 ($)2 respectively. D) Most of the volatility of the dollar value of the British asset can be removed by hedging exchange risk because b2[Var(S)] and Var(e) are 125,000 ($)2 and −127,500 ($)2 respectively.

48)

A U.S. firm holds an asset in Great Britain and faces the following scenario: State 1

State 2

State 3

25%

50%

25%

Probability Spot rate

£ 1,800

£ 2,250

£ 2,812.50

$ 4,500

Version 1

2.50 /£

2.00 /£

1.60 /£

4,500

where,P* = Pound sterling price of the asset held by the U.S. firmP = Dollar price of the same assetWhich of the following would be an effective hedge? A) B) C) D)

49)

Sell £2,278.13 forward at the 1-year forward rate, F1($/£), that prevails at time zero. Buy £2,500 forward at the 1-year forward rate, F1($/£), that prevails at time zero. Sell £25,000 forward at the 1-year forward rate, F1($/£), that prevails at time zero. none of the options

A U.S. firm holds an asset in Israel and faces the following scenario: State 1

State 2

State 3

25%

50%

25%

Probability Spot rate

0.30 /IS

IS 2,000

IS 5,000

IS 3,000

$ 1,000

600

0.20 /IS

0.15 /IS

450

where,P* = Israeli shekel (IS) price of the asset held by the U.S. firmP = Dollar price of the same assetThe expected value of the investment in U.S. dollars is: A) B) C) D)

50)

$2,083.33 $762.50 $6,250.00 $6,562.50

A U.S. firm holds an asset in Israel and faces the following scenario: State 1

State 2

State 3

25%

50%

25%

Probability Spot rate

Version 1

0.30 /IS

0.20 /IS

0.15 /IS

IS 2,000

IS 5,000

IS 3,000

$ 1,000

600

4,50

where,P* = Israeli shekel (IS) price of the asset held by the U.S. firmP = Dollar price of the same assetThe variance of the exchange rate is: A) B) C) D)

51)

0.001901 0.002969 0.0039 0.0049

A U.S. firm holds an asset in Israel and faces the following scenario: State 1

State 2

State 3

25%

50%

25%

Probability Spot rate

0.30 /IS

IS 2,000

IS 5,000

IS 3,000

$ 1,000

600

0.20 /IS

0.15 /IS

4,50

where,P* = Israeli shekel (IS) price of the asset held by the U.S. firmP = Dollar price of the same assetThe "exposure" (i.e., the regression coefficient beta) is:Hint: Calculate the expression

A) B) C) D)

52)

−52.6316 1,289.80 12,898.00 none of the options

A U.S. firm holds an asset in Israel and faces the following scenario:

Version 1

State 1

State 2

State 3

25%

50%

25%

Probability Spot rate

0.30 /IS

IS 2,000

IS 5,000

IS 3,000

$ 1,000

600

0.20 /IS

0.15 /IS

4,50

where,P* = Israeli shekel (IS) price of the asset held by the U.S. firmP = Dollar price of the same assetBased on the information provided in Mc. Qu 48, which of the following conclusions are correct? A) Most of the volatility of the dollar value of the Israeli asset can be removed by hedging exchange risk because b2[Var(S)] and Var(e) are 236,717 ($)2 and 493,751 ($)2 respectively. B) Most of the volatility of the dollar value of the Israeli asset cannot be removed by hedging exchange risk because b2[Var(S)] and Var(e) are 236,717 ($)2 and 493,751 ($)2 respectively. C) Most of the volatility of the dollar value of the Israeli asset cannot be removed by hedging exchange risk because b2[Var(S)] and Var(e) are 8.22 ($)2 and 59,211 ($)2, respectively. D) Most of the volatility of the dollar value of the Israeli asset can be removed by hedging exchange risk because b2[Var(S)] and Var(e) are 8.22 ($)2 and 59,211 ($)2 respectively.

53)

A U.S. firm holds an asset in Israel and faces the following scenario: State 1

State 2

State 3

25%

50%

25%

Probability Spot rate

IS 2,000

IS 5,000

IS 3,000

$ 1,000

Version 1

0.30 /IS

600

0.20 /IS

0.15 /IS

4,50

where,P* = Israeli shekel (IS) price of the asset held by the U.S. firmP = Dollar price of the same assetWhich of the following would be an effective hedge? A) Sell 53 Israeli shekels forward at the 1-year forward rate, F1($/IS), that prevails at time zero. B) Buy 53 Israeli shekels forward at the 1-year forward rate, F1($/IS), that prevails at time zero. C) Sell 12,898 Israeli shekels forward at the 1-year forward rate, F1($/IS), that prevails at time zero. D) none of the options

54) Find an effective hedge financial hedge if a U.S. firm holds an asset in Great Britain and faces the following scenario: State 1

State 2

State 3

25%

50%

25%

Probability Spot rate

£ 3,000

£ 2,500

£ 2,000

$ 6,600

$ 5,000

$ 3,600

Version 1

2.20 /£

2.00 /£

1.80 /£

P* = Pound sterling price of the asset held by the U.S. firmP = Dollar price of the same assetThe CFO runs a regression of the form P = a + b × S + e The regression coefficient beta is calculated as b = Where Cov(P,S) = 0.25 × ($6,600 − $5,050) × ($2.20 − $2.00) + 0.50 × ($5,000 − $5,050) × ($2.00 − $2.00) + 0.25 × ($3,600 − $5,050) × ($1.80 − $2.00) Cov(P,S) = 77.50 + 0 + 72.50 Cov(P,S) = 150 b= = 7,500

The variance of the exchange rate is calculated as E(S) = 0.25 × $2.20 + 0.50 × $2.00 + 0.25 × $1.80 = $.55 + $1 + $.45 = $2.00 VAR(S) = 0.25($2.20 − $2.00)2 + 0.50($2.00 − $2.00)2 + 0.25($1.80 − $2.00)2 = 0.01 + 0 + 0.01 = 0.02 The expected value of the investment in U.S. dollars is: E[P] = 0.25 × $6,600 + 0.50 × $5,000 + 0.25 × $3,600 = $5,050Which of the following is the most effective hedge financial hedge? A) B) C) D)

Sell £7,500 forward at the 1-year forward rate, F1($/£), that prevails at time zero. Buy £7,500 forward at the 1-year forward rate, F1($/£), that prevails at time zero. Sell £2,500 forward at the 1-year forward rate, F1($/£), that prevails at time zero. 0.25 × £3,000 + 0.50 × £2,500 + 0.25 × £2,000 = £2,500

55) Find an effective hedge financial hedge if a U.S. firm holds an asset in Great Britain and faces the following scenario: State 1

Version 1

State 2

State 3

Probability

25% 2.20 /£

50% $

2.00 /£

25%

Spot rate

1.80 /£

£ 3,000

£ 2,500

£ 2,000

$ 6,600

$ 5,000

$ 3,600

= 7,500

The variance of the exchange rate is calculated as E(S) = 0.25 × $2.20 + 0.50 × $2.00 + 0.25 × $1.80 = $.55 + $1 + $.45 = $2.00 VAR(S) = 0.25($2.20 − $2.00)2 + 0.50($2.00 − $2.00)2 + 0.25($1.80 − $2.00)2 = 0.01 + 0 + 0.01 = 0.02 The expected value of the investment in U.S. dollars is: E[P] = 0.25 × $6,600 + 0.50 × $5,000 + 0.25 × $3,600 = $5,050Suppose that you implement your hedge at F1($/£) = $2/£. Your cash flows in state 1, 2, and 3 respectively will be

Version 1

A) B) C) D)

56)

$5,100, $5,000, $5,100. $5,100, $5,100, $5,100. $5,000, $5,000, $5,000. none of the options

A U.S. firm holds an asset in Great Britain and faces the following scenario: State 1

State 2

State 3

25%

50%

25%

Probability Spot rate

2.50 /£

£ 1,800

2.00 /£

£ 2,250

1.60 /£

£ 2,812.50

WhereP* = Pound sterling price of the asset held by the U.S. firmThe CFO decides to hedge his exposure by selling forward the expected value of the pound denominated cash flow at F1($/£) = $2/£. As a result, A) B) C) D)

57)

the firm's exposure to the exchange rate is made worse. he has a nearly perfect hedge. he has a perfect hedge. none of the options

A U.S. firm holds an asset in Italy and faces the following scenario:

Probability

State 1

State 2

State 3

30%

40%

30%

Spot rate

€ 1,350.00

Version 1

2.50

1.50

€ 2,250.00

0.90

€ 3,750.00

WhereP* = Euro price of the asset held by the U.S. firmThe CFO decides to hedge his exposure by selling forward the expected value of the euro denominated cash flow at F1($/£) = $1.50/€. As a result, A) B) C) D)

the firm's exposure to the exchange rate is made worse. he has a nearly perfect hedge. he has a perfect hedge. none of the options

58) Suppose a U.S. firm has an asset in Britain whose local currency price is random. For simplicity, suppose there are only three states of the world and each state is equally likely to occur. The future local currency price of this British asset (P*) as well as the future exchange rate (S) will be determined, depending on the realized state of the world. State

Probability

S× P*

980

$ 1.40 /£

$ 1,372

£ 1,000

$ 1.50 /£

$ 1,500

£ 1,070

$ 1.60 /£

$ 1,712

Which of the following statements is most correct? A) The firm faces no exchange rate risk since the local currency price of the asset and the exchange rate are negatively correlated. B) The firm faces substantial exchange rate risk since the local currency price of the asset and the exchange rate are positively correlated. C) The firm's exchange rate exposure can be completely hedged with derivatives written on the British pound. D) Since randomness is involved, no hedging is possible.

59) Suppose a U.S. firm has an asset in Britain whose local currency price is random. For simplicity, suppose there are only three states of the world and each state is equally likely to occur. The future local currency price of this British asset (P*) as well as the future exchange rate (S) will be determined, depending on the realized state of the world. Version 1

State

Probability

S× P*

£ 1,000

$ 1.40 /£

$ 1,400

£ 1,000

$ 1.50 /£

$ 1,500

£ 1,000

$ 1.60 /£

$ 1,600

60) Suppose a U.S. firm has an asset in Britain whose local currency price is random. For simplicity, suppose there are only three states of the world and each state is equally likely to occur. The future local currency price of this British asset (P*) as well as the future exchange rate (S) will be determined, depending on the realized state of the world. State

Probability

S× P*

£ 1,000

$ 1.40 /£

$ 1,400

933

$ 1.50 /£

$ 1,400

875

$ 1.60 /£

$ 1,400

Which of the following statements is most correct?

Version 1

A) The firm faces no exchange rate risk since the local currency price of the asset and the exchange rate are negatively correlated. B) The firm faces substantial exchange rate risk since the local currency price of the asset and the exchange rate are positively correlated. C) The firm's exchange rate exposure can be completely hedged with derivatives written on the British pound. D) Since randomness is involved, no hedging is possible.

61) Suppose a U.S. firm has an asset in Italy whose local currency price is random. For simplicity, suppose there are only three states of the world and each state is equally likely to occur. The future local currency price of this asset (P*) as well as the future exchange rate (S) will be determined, depending on the realized state of the world. State

Probability

S× P*

€ 1,000

$ 1.40 /£

$ 1,400

€

933

$ 1.50 /£

$ 1,400

€

875

$ 1.60 /£

$ 1,400

Assume that you choose to "hedge" this asset by selling forward the expected value of the euro denominated cash flow atF1($/£) = $1.50/€. Calculate your cash flows in each of the possible states. A) B) C) D)

$1,400, $1,400, $1,400 $1,496.6, $1,400, $1,306.40 $1,404, $1,404. $1,404 none of the options

62) Consider a U.S.-based MNC with a wholly-owned Italian subsidiary. Following a depreciation of the dollar against the euro, which of the following conclusions are correct?

Version 1

A) The cash flow in euro could be altered due an alteration in the firm's competitive position in the marketplace. B) A given operating cash flow in euro will be converted to a higher U.S. dollar cash flow. C) Both A and B are correct. D) none of the options

63) Consider a U.S.-based MNC with a wholly-owned Italian subsidiary. Following a depreciation of the dollar against the euro, which of the following describes the competitive effect of the depreciation? A) The cash flow in euro could be altered due an alteration in the firm's competitive position in the marketplace. B) A given operating cash flow in euro will be translated to a higher U.S. dollar cash flow. C) The cash flow in euro could be altered due an alteration in the firm's competitive position in the marketplace, and a given operating cash flow in euro will be translated to a higher U.S. dollar cash flow. D) none of the options

64) Consider a U.S. MNC with operations in Great Britain. Which of the following are potential risks following a strengthening of the dollar? A) A pound sterling depreciation may affect operating cash flow in pounds by altering the firm's competitive position in the marketplace. B) A given operating cash flow in pounds will be converted into a lower dollar amount after the pound depreciation. C) Both A and B are correct. D) none of the options

65)

Which of the following is false?

Version 1

A) The competitive effect is that a depreciation may affect operating cash flow in the foreign currency by altering the firm's competitive position in the marketplace. B) The conversion effect is defined as a given operating cash flow in a foreign currency will be converted into a lower dollar amount after a currency depreciation. C) The competitive effect is defined as a given operating cash flow in a foreign currency will be converted into a lower dollar amount after a currency depreciation. D) none of the options

66) Consider a U.S.-based MNC with a wholly-owned German subsidiary. Following a depreciation of the dollar against the euro, which of the following describes the conversion effect of the depreciation? A) The cash flow in euro could be altered due a change in the firm's competitive position in the marketplace. B) A given operating cash flow in euro will be translated to a higher U.S. dollar cash flow. C) Both A and B are correct. D) none of the options

67) Consider a U.S.-based MNC with a wholly-owned French subsidiary. Following a depreciation of the dollar against the euro, which of the following best describes the mechanism of any effect of the depreciation? A) The change in the cash flow in euro due an alteration in the firm's competitive position in the marketplace is in part a function of the elasticity of demand for the firm's product. B) A given operating cash flow in euro will be translated to a higher U.S. dollar cash flow regardless of the firm's hedging program. C) Both A and B are correct. D) none of the options

68)

Which of the following is true?

Version 1

A) The competitive effect is that a currency depreciation may affect operating cash flow in the foreign currency by altering the firm's competitive position in the marketplace. B) The conversion effect is defined as a given accounting cash value in a foreign currency will be converted into a lower dollar amount after currency depreciation. C) The competitive effect is defined as a given operating cash flow in a foreign currency will be converted into a lower dollar amount after a currency depreciation. D) none of the options

69) Consider a U.S.-based MNC with a wholly-owned European subsidiary selling a product sourced in euro and priced in euro with inelastic demand. Following a depreciation of the dollar against the euro, which of the following is the truest? A) Since they have inelastic demand, the U.S. firm can just pass through the impact of the exchange rate change. B) Since they have elastic demand, the U.S. firm cannot just pass through the impact of the exchange rate change. C) Since the exchange rate movement was favorable to the U.S. firm, there is no impact on the firm's position. D) none of the options.

70)

A firm's operating exposure is

A) defined as the extent to which the firm's operating cash flows would be affected by the random changes in exchange rates. B) determined by the structure of the markets in which the firm sources its inputs, such as labor and materials, and sells its products. C) determined by the firm's ability to mitigate the effect of exchange rate changes by adjusting its markets, product mix, and sourcing. D) all of the options

71)

Generally speaking, a firm is subject to high degrees of operating exposure

Version 1

A) B) C) D)

when its costs but not prices are sensitive to exchange rate changes. when its prices but not costs are sensitive to exchange rate changes. when either its cost or its price is sensitive to exchange rate changes. none of the options

72) Generally speaking, when both a firm's costs and its price are sensitive to exchange rate changes, A) B) C) D)

73)

the firm is not subject to high degrees of operating exposure. the firm is subject to high degrees of operating exposure. the firm should hedge. none of the options

The firm may not be subject to high degrees of operating exposure

A) when changes in real exchange rates are exactly offset by the inflation differential. B) when changes in nominal exchange rates are exactly matched by the inflation differential. C) when changes in nominal exchange rates are exactly offset by the inflation differential. D) none of the options

74)

The firm may not be able to pass through changes in the exchange rate A) B) C) D)

75)

in markets with high product differentiation. in markets with high price inelasticities. in markets with low product differentiation or in markets with high price elasticities. none of the options

The firm may not be able to pass through changes in the exchange rate

Version 1

A) in markets with mainly domestic (foreign to the firm) competitors. B) in markets with low price elasticities. C) in markets with mainly domestic (foreign to the firm) competitors or in markets with low price elasticities. D) none of the options

76)

Generally speaking, a firm is subject to high degrees of operating exposure when A) B) C) D)

77)

What is the objective of managing operating exposure? A) B) C) D)

78)

Stabilize cash flows in the face of fluctuating exchange rates. Selecting low cost production sites. Increase the variability of cash flows in the face of fluctuating exchange rates. Both A and C are correct.

What is the objective of managing operating exposure? A) B) C) D)

79)

either its cost or its price is sensitive to exchange rate changes. both the cost and the price are sensitive to exchange rate changes. both the cost and the price are insensitive to exchange rate changes. none of the options

Stabilize accounting results in the face of fluctuating exchange rates. Selecting low cost production sites. Increase the variability of cash flows in the face of fluctuating exchange rates. Both A and C are correct.

Managing operating exposure

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A) B) C) D)

80)

Which of the following can a company use to manage operating exposure? A) B) C) D)

81)

is a short-term tactical issue. is a long-term issue, like selecting a site for a factory. is relatively unimportant, since most MNCs have a built-in hedge. Both A and C are correct.

Selecting low-cost production sites, diversifying the market. Low cost production sites, but not financial hedging. Pursuing a flexible sourcing policy, product differentiation, R&D efforts. Both A and B are correct.

When the domestic currency is strong or expected to become strong,

A) this could erode the competitive position of the firm's exports. B) this could erode the competitive position of the firm's import competition. C) the firm should consider locating production facilities in a foreign country where costs are low. D) this could erode the competitive position of the firm's exports and the firm should consider locating production facilities in a foreign country where costs are low.

82)

A foreign country could provide low cost production sites

A) because the factors of production are underpriced. B) because the currency is undervalued. C) because the locals like to give away their land labor and capital to foreigners. D) because the factors of production are underpriced and because the currency is undervalued.

83)

While maintaining multiple production sites does provide a firm valuable options,

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A) a firm may miss out on economies of scope. B) a firm may miss out on economies of scale. C) a firm may find that exchange rate changes can fully offset the advantage of multiple manufacturing sites. D) a firm may miss out on economies of scope and economies of scale.

84) Goldman Sachs estimates that as much as __________ percent of the pretax profits that Porsche reported for a recent fiscal year came from skillfully executing currency options. A) B) C) D)

85)

Developing multiple production sites in a variety of countries, A) B) C) D)

86)

5 10 15 75

can create an excess capacity problem. can lead to underutilization of domestic plants. can lead to domestic job losses. all of the options

A flexible sourcing policy A) B) C) D)

is primarily concerned with low-cost (and often low-quality) vendors. need not be confined just to materials and parts. only works for manufacturing firms, not service firms. puts the focus on the exchange rate at the expense of shipping rates.

87) A firm that is committed to keeping manufacturing facilities in only the home country (and not developing multiple production sites in a variety of countries) can

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A) not mitigate the effects of exchange rate changes. B) lessen the effect of exchange rate changes by sourcing from where input costs are low. C) focus on selling commodity products with product differentiation. D) pursue a strategy of increasing its products price elasticity of demand.

88)

If the domestic currency is strong or expected to become strong,

A) a firm can choose to locate production facilities in a foreign country where costs are low due to either the undervalued currency or underpriced factors of production. B) a firm should curtail R&D efforts until the exchange rate situation improves. C) a firm should abandon international sales and focus on domestic market share. D) the firm should focus on profiting in the currency futures market based on its forecasts.

89)

Which of the following is a true statement?

A) As long as exchange rates do not always move in the same direction, the firm can stabilize its operating cash flows by diversifying its export market. B) The firm should not get into new lines of business solely to diversify exchange risk because conglomerate expansion can bring about inefficiency and losses. C) all of the options D) none of the options

90) A firm that is committed to keeping manufacturing facilities in only the home country (and not developing multiple production sites in a variety of countries) can

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A) lessen the effect of exchange rate changes by pursuing a strategy of diversifying the markets in which the firm's products are sold. B) not mitigate the effects of exchange rate changes. C) lessen the effect of exchange rate changes by pursuing a strategy of selling commodity products without product differentiation. D) pursue a strategy of increasing its products price elasticity of demand.

91)

It can be argued that, while financial hedging can be used to stabilize a firm's cash flows, A) B) C) D)

92)

it is not a substitute for long-term operational hedging. it is therefore a substitute for long-term operational hedging. it is inferior to money market hedging. none of the options.

Investments in R&D

A) are usually a waste of time and money. B) will likely weaken the firm's competitive position. C) can allow the firm to cut costs but decreases productivity. D) can allow the firm to maintain and strengthen its competitive position, as well as cut costs and enhance productivity.

93)

The price elasticity of demand for unique products tends to be A) B) C) D)

94)

highly elastic. highly inelastic. highly elastic and highly inelastic. none of the options

The price elasticity of demand for commodity products tends to be

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A) B) C) D)

95)

highly elastic. highly inelastic. highly elastic and highly inelastic. none of the options

In the figure below, label curves A and B are, respectively,{MISSING IMAGE} A) B) C) D)

unhedged and hedged. hedged and unhedged. normal and abnormal. none of the options

96) Investment in R&D activities can allow the firm to maintain and strengthen its competitive position in the face of adverse exchange rate movements. The mechanism for this includes A) successful R&D efforts allowing the firm to cut costs and enhance productivity. B) R&D efforts leading to the introduction of new and unique products for which competitors offer no close substitutes—since the demand for unique products tends to be highly inelastic the firm would be less exposed to exchange risk. C) successful R&D efforts creating a perception among consumers that its product is indeed different from those offered by competitors. Once the firm's product acquires a unique identity, its demand is less likely to be price-sensitive. D) all of the options

97) If the stock market of a foreign country is consistently up when the dollar value of the currency is down, A) B) C) D)

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there may not be a great deal of exchange rate risk for a U.S.-based investor. there will be a great deal of exchange rate risk for a U.S.-based investor. then investors can ignore diversification. none of the options

98) In the case application, “Exchange Risk Management at Merck”, Merck considered the alternative of financial hedging. Which of the following steps was not used by Merck for financial hedging? A) B) C) D)

Exchange forecasting and hedging rationale Assessing strategic plan impact and financial instruments Hedging program none of the options

99) Which of the following steps Merck used for financial hedging describes the process of reviewing the likelihood of adverse exchange movements, which includes polling outside forecasters for the dollar over the planning horizon? A) B) C) D)

Exchange forecasting Hedging rationale Assessing strategic plan impact Hedging program

100) Which of the following steps Merck used for financial hedging describes the process of projecting and comparing cash flows and earnings under the alternative exchange rate scenarios (i.e. strong and weak dollar scenarios). A) B) C) D)

Exchange forecasting Hedging rationale Assessing strategic plan impact Hedging program

101) Which of the following steps Merck used for financial hedging describes the process of focusing on the objective of maximizing long-term cash flows and on the potential effect of exchange rate movements on the firm’s ability to meet its strategic objectives.

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A) B) C) D)

Exchange forecasting Hedging rationale Assessing strategic plan impact Hedging program

102) Which of the following steps Merck used for financial hedging describes the process of formulating an implementation strategy regarding the term of the hedge, the strike price of the currency options, and the percentage of income to be covered? A) B) C) D)

Exchange forecasting Hedging rationale Assessing strategic plan impact Hedging program

SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question. 103) Suppose that you hold a piece of land in the city of London that you may want to sell in one year. As a U.S. resident, you are concerned with the dollar value of the land. Assume that if the British economy booms in the future, the land will be worth £2,000, and one British pound will be worth $1.80. If the British economy slows down, on the other hand, the land will be worth less, say, £1,500, but the pound will be stronger, say, $2.20/£. You feel that the British economy will experience a boom with a 60 percent probability and a slowdown with a 40 percent probability. Estimate your exposure (b) to the exchange risk.

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104) Suppose that you hold a piece of land in the city of London that you may want to sell in one year. As a U.S. resident, you are concerned with the dollar value of the land. Assume that if the British economy booms in the future, the land will be worth £2,000, and one British pound will be worth $1.80. If the British economy slows down, on the other hand, the land will be worth less, say, £1,500, but the pound will be stronger, say, $2.20/£. You feel that the British economy will experience a boom with a 60 percent probability and a slowdown with a 40 percent probability. Compute the variance of the dollar value of your property that is attributable to exchange rate uncertainty.

105) Suppose that you hold a piece of land in the city of London that you may want to sell in one year. As a U.S. resident, you are concerned with the dollar value of the land. Assume that if the British economy booms in the future, the land will be worth £2,000, and one British pound will be worth $1.80. If the British economy slows down, on the other hand, the land will be worth less, say, £1,500, but the pound will be stronger, say, $2.20/£. You feel that the British economy will experience a boom with a 60 percent probability and a slowdown with a 40 percent probability. Discuss how you can hedge your exchange risk exposure and also examine the consequences of hedging.

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Answer Key Test name: Chap 09_9e 1) C 2) B 3) B 4) D 5) B 6) D 7) C 8) A 9) C 10) B 11) B 12) B 13) C 14) A 15) A 16) A 17) B 18) A 19) A 20) C 21) B 22) A 23) B 24) A 25) B 26) A Version 1

27) A 28) B 29) B 30) C 31) C 32) A 33) D 34) A 35) A 36) C 37) D 38) B 39) A 40) A 41) A 42) A 43) A 44) B 45) B 46) D 47) B 48) D 49) B 50) B 51) A 52) C 53) B 54) A 55) A 56) A Version 1

57) A 58) B 59) C 60) A 61) A 62) C 63) A 64) C 65) C 66) B 67) A 68) A 69) D 70) D 71) C 72) A 73) C 74) C 75) A 76) A 77) A 78) D 79) B 80) D 81) D 82) D 83) B 84) D 85) D 86) B Version 1

87) B 88) A 89) C 90) A 91) A 92) D 93) B 94) A 95) A 96) D 97) A 98) D 99) A 100) C 101) B 102) D 103) b = %media:formula37.mml%E[P] = 0.60 × £2,000 × $1.80 + 0.40 × £1,500 × $2.20/£ = $3,480 E(S) = 0.60 × $1.80 + 0.40 × $ 2.20 = $1.96 The variance of the exchange rate is:VAR(S) = 0.60($1.80 − $1.96)2 + 0.40($2.20 − $1.96)2 = 0.0384COV(P,S) = 0.60 × ($3,600− $3,480) × ($2.20 − $1.96) + 0.40 × ($3,300 − $3,480) × ($1.80 − $1.96) = 17.28 + 11.52 = 28.80%media:formula38.mml%

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104) The expression "b2VAR(S)" represents the volatility of the dollar value of the asset that is related to random changes in the exchange rate. 21,600 = b2VAR(S)From the results to earlier questions we have the values:VAR(S) = .0384b = 750Therefore, using the Equation 9.2, we obtainV(P) = b2 VAR(S) + VAR(e)VAR(e) = V(P) − 21,600The expression "VAR(e)" is the volatility in the dollar value of the asset that is independent of exchange rate movements. 105) You could sell b = £750 forward. However, exchange rate movements only account for a small amount of the volatility in the dollar value of the asset. What we really have is a play on the state of the British economy, not on the exchange rate.

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CHAPTER 10 TRUE/FALSE - Write 'T' if the statement is true and 'F' if the statement is false. 1) Under the monetary/nonmonetary method, revenue and expense items associated with nonmonetary accounts, such as cost of goods sold and depreciation, are translated at the historical rate associated with the balance sheet account. ⊚ ⊚

true false

2) When using a derivatives hedge to control translation exposure, speculation about foreign exchange rate changes is involved. ⊚ ⊚

true false

MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 3) Translation exposure refers to A) accounting exposure. B) the effect that an unanticipated change in exchange rates will have on the consolidated financial reports of an MNC. C) the change in the value of a foreign subsidiaries assets and liabilities denominated in a foreign currency, as a result of exchange rate change fluctuations, when viewed from the perspective of the parent firm. D) all of the options

The recognized methods for consolidating the financial reports of an MNC are

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A) short/long term method, current/future method, flexible/inflexible method, and economic/noneconomic method. B) current/noncurrent method, monetary/nonmonetary method, short/long term method, and current/future method. C) current/noncurrent method, monetary/nonmonetary method, temporal method, and current rate method. D) temporal method, current rate method, flexible/inflexible method, and economic/noneconomic method.

5) How many methods of foreign currency translation have been used in recent years? (U.S. GAAP.) A) B) C) D)

One Two Three Four

6) Translation exposure, also frequently called accounting exposure, refers to the effect that an unanticipated change in exchange rates will have on the A) B) C) D)

choice of accounting methodology. consolidated financial reports of a MNC. firms competitive position. cash flows realized from foreign operations.

7) When exchange rates change, the value of a foreign subsidiary's assets and liabilities that are denominated in a foreign currency change

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A) when they are viewed from the perspective of the subsidiary firm. B) when they are viewed from the perspective of the parent firm. C) but this is only of material concern if the parent firm is liquidating the subsidiary in a bankruptcy and is forced to realize the value of the assets and liabilities at the current exchange rate. D) none of the options

8) The sensitivity of "realized" domestic currency values of the firm's contractual cash flows denominated in foreign currency to unexpected changes in the exchange rate is A) B) C) D)

transaction exposure. translation exposure. economic exposure. none of the options

The management of translation exposure is best described as

A) selecting a mechanical means for handling the consolidation process for MNCs that logically deals with exchange rate changes. B) selecting a mechanical means for handling the consolidation process for MNCs that makes this quarter's accounting numbers as attractive as possible. C) selecting a mechanical means for handling the consolidation process for MNCs that treats inventory valuation as LIFO on the income statement and FIFO on the balance sheet. D) selecting a mechanical means for handling the consolidation process for MNCs that treats inventory valuation as FIFO on the income statement and LIFO on the balance sheet.

10) The sensitivity of the firm's consolidated financial statements to unexpected changes in the exchange rate is

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A) B) C) D)

transaction exposure. translation exposure. economic exposure. none of the options

11) The extent to which the value of the firm would be affected by unexpected changes in the exchange rate is A) B) C) D)

12)

transaction exposure. translation exposure. economic exposure. none of the options

Which of the following is true?

A) The competitive effect is defined as the impact that a currency depreciation may have on the operating cash flow in the foreign currency by altering the firm's competitive position in the marketplace. B) The conversion effect is defined as a given accounting cash value in a foreign currency will be converted into a lower dollar amount after currency depreciation. C) The competitive effect is defined as a given operating cash flow in a foreign currency will be converted into a lower dollar amount after a currency depreciation. D) none of the options

13)

A mismatch between foreign currency denominated net assets and net liabilities

A) can be eliminated by constructing a balance sheet hedge. B) can be eliminated by multiplying the foreign currency value of the asset by the spot exchange rate. C) can be eliminated by undertaking accounting changes to eliminate translation exposure. D) none of the options

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14) The authoritative body in the United States that specifies accounting policy for U.S. business firms and certified public accounting firms. A) B) C) D)

15)

The difference between accounting exposure and translation exposure is that

A) numbers. B) C) D)

16)

The Federal Accounting Standards Board (FASB). The International Accounting Standards Board (IASB). The Financial Accounting Standards Board (FASB). The Securities and Exchange Commission (SEC).

translation is about going from one language to another, accounting is just about the accounting exposure and translation exposure are the same thing. hedging one always involves increasing the other. hedging one might involve increasing the other.

When exchange rates change

A) the value of a foreign subsidiary's foreign currency denominated assets and liabilities change to new numbers still denominated in the foreign currency. B) the value of a foreign subsidiary's foreign currency denominated assets and liabilities change when redenominated into the home currency. C) hedging should be done after the change. D) none of the options

17)

Translation exposure measures

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A) the effect that an anticipated change in exchange rates will have on the consolidated financial reports of an MNC. B) economic exposure. C) the change in the value of a foreign subsidiaries assets and liabilities denominated in a foreign currency, as a result of exchange rate change fluctuations, when viewed from the perspective of the parent firm. D) all of the options

18) The extent to which the value of the firm would be affected by expected changes in the exchange rate is A) B) C) D)

transaction exposure. translation exposure. economic exposure. none of the options

19) The current/noncurrent method of foreign currency translation was generally accepted in the United States from the 1930s until 1975, when A) B) C) D)

FASB 2 became effective. FASB 4 became effective. FASB 6 became effective. FASB 8 became effective.

20) The underlying principle of the current/noncurrent method is that assets and liabilities should be translated based on their maturity.

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A) Current assets and liabilities are converted at the current exchange rate in effect when the cash flow associated with the asset or liability actually occurred. Noncurrent assets and liabilities are translated at the historical exchange rate that prevailed when the asset was recognized. B) Current assets and liabilities, which by definition have a maturity of one year or less, are converted at the current exchange rate. Noncurrent assets and liabilities are translated at the historical exchange rate. C) All assets and liabilities are converted at the current exchange rate. D) none of the options

21) The generally accepted method for consolidating the financial reports of an MNC from the 1930s to 1975 was the A) B) C) D)

22)

current/noncurrent method. monetary/nonmonetary method. temporal method. current rate method.

Under the current/noncurrent method

A) a foreign subsidiary with current assets in excess of current liabilities will cause a translation gain (loss) if the local currency appreciates (depreciates). B) a foreign subsidiary with current assets in excess of current liabilities will cause a translation loss (gain) if the local currency appreciates (depreciates). C) a foreign subsidiary with current assets in excess of current liabilities will cause a translation gain (loss) if the local currency depreciates (appreciates). D) a foreign subsidiary with current assets in excess of current liabilities will cause a translation loss (gain) if the local currency appreciates (depreciates), and a foreign subsidiary with current assets in excess of current liabilities will cause a translation gain (loss) if the local currency depreciates (appreciates).

23)

When using the current/noncurrent method, current assets are defined as

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A) B) C) D)

24)

inventory that is currently salable. assets with a maturity of one year or less. assets with a maturity of 90 days or less. none of the options

When using the current/noncurrent method,

A) most income statement items are translated at the average exchange rate for the accounting period. B) revenue and expense items that are associated with noncurrent assets or liabilities are translated at the historical rate that applies to the applicable balance sheet items. C) depreciation expense is translated at the historical rate that applies to the applicable depreciable asset items. D) all of the options

25)

Which of the following statements is false?

A) Most income statement items under the current/noncurrent method are translated at the average exchange rate for the accounting period. B) Under the current/noncurrent method, revenue and expense items that are associated with current assets or liabilities, such as depreciation expense, are translated at the historical rate that applies to the applicable balance sheet item. C) Under the current/noncurrent method, revenue and expense items that are associated with noncurrent assets or liabilities, such as depreciation expense, are translated at the historical rate that applies to the applicable balance sheet item. D) Depreciation expense is translated at the historical rate that applies to the applicable depreciable asset items.

26)

The underlying principle of the current/noncurrent method is

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A) assets and liabilities should be translated based on their maturity. B) monetary balance sheet accounts should be translated at the spot rate; nonmonetary accounts are translated at the historical rate in effect when the account was first recorded. C) monetary accounts are translated at the current exchange rate; other accounts are translated at the current exchange rate if they are carried on the books at current value; items carried at historical cost are translated at historic exchange rates. D) all balance sheet accounts are translated at the current exchange rate, except stockholder equity.

27)

The underlying principle of the current/noncurrent method is

A) assets and liabilities should be translated based on their maturity. B) monetary accounts have a similarity because their value represents a sum of money whose currency equivalent after translation changes each time the exchange rate changes. C) monetary accounts are translated at the current exchange rate; other accounts are translated at the current exchange rate if they are carried on the books at current value; items carried at historical cost are translated at historic exchange rates. D) all balance sheet accounts are translated at the current exchange rate, except for stockholders' equity. A "plug" equity account, named cumulative translation adjustment (CTA), is used to make the balance sheet balance, since translation gains or losses do not go through the income statement according to this method.

28)

Under the monetary/nonmonetary method

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29) According to the monetary/nonmonetary method, monetary balance sheet accounts include A) for example, cash, marketable securities, accounts receivable, notes payable, accounts payable of a foreign subsidiary. B) for example, stockholders' equity and long term debt. C) for example, inventory paid for in cash, but not working capital. D) COGs, Sales, Net Income.

30)

The underlying philosophy of the monetary/nonmonetary method is that

A) monetary accounts have a similarity because their value represents a sum of money whose currency equivalent after translation is independent of exchange rate changes. B) monetary accounts have a similarity because their value represents a sum of money whose currency equivalent after translation changes each time the exchange rate changes. C) assets and liabilities should be translated based on their maturity. D) most income statement items are translated at the average exchange rate for the period. Depreciation and cost of goods sold, however, are translated at historical rates if the associated balance sheet accounts are carried at historical costs.

31)

In comparison to the current/noncurrent method, the monetary/nonmonetary method

A) B) maturities. C) D)

differs substantially with regard to the treatment of inventory. classifies accounts on the basis of similarity of attributes rather than the similarity of Both A & B are correct. none of the options

32) Under which accounting method are most income statement accounts translated at the average exchange rate for the period?

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A) B) C) D)

33)

Current/noncurrent method Monetary/nonmonetary method Temporal method All of the options

The underlying principle of the monetary/nonmonetary method is

34)

Using the temporal method, monetary accounts, such as cash, A) B) C) D)

35)

are not translated. are translated at the average exchange rate prevailing over the reporting period. are translated at the current forward exchange rate. are translated at the current spot exchange rate.

Under the temporal method

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36)

Since fixed assets and inventory are usually carried at historical costs,

A) the temporal method and the monetary/nonmonetary methods will typically provide the same translation. B) the current rate method and the monetary/nonmonetary methods will typically provide the same translation. C) the temporal method and the current/noncurrent methods will typically provide the same translation. D) none of the options

37)

Under the temporal method

38)

Under the current rate method

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39)

Under the current rate method,

A) income statement items are to be translated at the exchange rate at the dates the items are recognized. B) an appropriately weighted average exchange rate for the period may be used for translation. C) all balance sheet accounts are translated at the current exchange rate, except stockholder equity. D) all of the options

40) Which of the following is a translation method where the gain or loss due to translation adjustment does not affect reported cash flows? A) B) C) D)

41)

Current/noncurrent method Current rate method Current/future method Short/long term method

Under the current rate method

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42)

The simplest of all translation methods to apply is A) B) C) D)

current/noncurrent method. monetary/nonmonetary method. temporal method. current rate method.

43) Which of the following is a translation method where a "plug" equity account, called cumulative translation adjustment, is used? A) B) C) D)

44)

Current/noncurrent method Current rate method Current/future method Short/long term method

FASB 8 is essentially the A) B) C) D)

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current/noncurrent method. monetary/nonmonetary method. temporal method. current rate method.

45)

FASB 8 A) B) C) D)

required taking foreign exchange gains or losses through the income statement. caused reported earnings to fluctuate substantially from year to year. ran into acceptance problems from the accounting profession and MNCs. all of the options

46) Consider a U.S.-based MNC with manufacturing activities in Japan. The result of a change in the ¥–$ exchange rate on the assets and liabilities of the consolidated balance sheet is

Exposed assets

700,000,000

Exposed liabilities

500,000,000

Ignoring transaction exposure in the yen, the translation exposure will indicate a possible need for a "balance sheet hedge" of A) B) C) D)

¥200,000,000 more liabilities denominated in yen. ¥200,000,000 less assets denominated in yen. Both A & B are correct. none of the options

47) A U.S. parent firm, as result of its business activities in Germany, has a net exposure of €1,000,000. The consolidated reports were prepared at the year-end for the last two successive years. If the exchange rates on these reporting dates changed from $1.00 = €1.10 to $1.00 = €1.00, then the translation exposure report will indicate a "reporting currency imbalance" of A) B) C) D)

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$90,910. $0. −$90,910. none of the options

48) Financial Accounting Standards Board (FASB) Statements 8 and 52 relate to the translation methods. The following outlines the objectives and descriptions of the two statements.(i) Measure in dollars an enterprise's assets, liabilities, revenues, or expenses that are denominated in a foreign currency according to generally accepted accounting principles(ii) Is essentially the temporal method of translation (with some subtle differences)(iii) Provide information that is generally compatible with the expected economic effects of a rate change on an enterprise's cash flows and equity(iv) Reflect in consolidated statements the financial results and relationships of the individual consolidated entities as measured in their functional currencies in conformity with U.S. generally accepted accounting principlesWhich of the above statements pertain to FASB 8? A) B) C) D)

(i) (i) and (ii) (iii) and (iv) (i), (ii), and (iii)

49) Financial Accounting Standards Board (FASB) Statements 8 and 52 relate to the translation methods. The following outlines the objectives and descriptions of the two statements.(i) Measure in dollars an enterprise's assets, liabilities, revenues, or expenses that are denominated in a foreign currency according to generally accepted accounting principles(ii) Is essentially the temporal method of translation (with some subtle differences)(iii) Provide information that is generally compatible with the expected economic effects of a rate change on an enterprise's cash flows and equity(iv) Reflect in consolidated statements the financial results and relationships of the individual consolidated entities as measured in their functional currencies in conformity with U.S. generally accepted accounting principlesWhich of the above statements pertain to FASB 52? A) B) C) D)

50)

(i) (i) and (ii) (iii) and (iv) (i), (ii), and (iii)

FASB 52 requires

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A) the current rate method of translation in some circumstances and the temporal method in others. B) the current rate method of translation in some circumstances and the noncurrent method in others. C) the monetary rate method of translation in some circumstances and the temporal method in others. D) the current rate method of translation in some circumstances and the monetary method in others.

51)

The International Accounting Standards Committee A) B) C) D)

52)

In what year were U.S. MNCs mandated to implement FASB 52? A) B) C) D)

53)

is now known as The International Accounting Standards Board. is charged with accounting standards at the International House of Pancakes. includes many convicted felons among its members. all of the options

1952 1962 1972 1982

The "functional currency" is defined in FASB 52 as

A) the currency of the primary economic environment in which the entity operates. B) the currency in which the MNC prepares its consolidated financial statements. C) a currency that is not the parent firm's home country currency. D) the currency in which the MNC prepares its consolidated financial statements, as well as a currency that is not the parent firm's home country currency.

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54)

The "reporting currency" is defined in FASB 52 as

A) the currency of the primary economic environment in which the entity operates. B) the currency in which the MNC prepares its consolidated financial statements. C) a currency that is not the parent firm's home country currency. D) the currency of the primary economic environment in which the entity operates, as well as a currency that is not the parent firm's home country currency.

55)

The stated objectives of FASB 52 are

A) to provide information that is generally compatible with the expected economic effects of a rate change on an enterprise's cash flows and equity. B) to reflect in consolidated statements the financial results and relationships of the individual consolidated entities as measured in their functional currencies in conformity with U.S. generally accepted accounting principles. C) Both A & B are correct. D) none of the options

56) The currency of the primary economic environment in which the entity operates is defined in FASB 52 as A) B) C) D)

57)

the "reporting currency." the "functional currency." the "current currency." none of the options

The actual translation process prescribed by FASB 52 is A) B) C) D)

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a two-stage process. a twelve-step program. a five-step process. none of the options

58)

When determining the functional currency,

A) if the sales prices for the foreign entity's products are generally not responsive on a short-term basis to exchange rate changes, but are determined more by local competition and government regulation, the local currency should be the functional currency. B) if there is an active local market for the foreign entity's products the local currency should be the functional currency. C) if factor of production costs for the foreign entity are primarily, and on a continuing basis, costs for components obtained from the parent's country the function currency should be the home currency. D) all of the options

59) When determining the functional currency, which of the following are salient economic factors? A) B) C) D)

cash flow indicators sales price indicators sales market indicators. all of the options

60) When determining the functional currency, the statement, “financing of the foreign entity is primarily denominated in the foreign currency and the debt service obligations are normally handled by the foreign entity”, best describes which salient economic factor? A) B) C) D)

financing indicators sales price indicators sales market indicators. expense indicators

61) When determining the functional currency, the statement, “the factor of production costs of the foreign entity are primarily local costs”, best describes which salient economic factor?

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A) B) C) D)

62)

financing indicators sales price indicators sales market indicators. expense indicators

In implementing FASB 52,

A) the functional currency of the foreign entity must be translated into the reporting currency in which the consolidated statements are reported. B) the local currency of a foreign entity may not always be its functional currency. If it is not, the temporal method of translation is used to remeasure the foreign entity's books into the functional currency. C) the current rate method is used to translate from the functional currency to the reporting currency. D) in some cases, a foreign entity's functional currency may be the same as the reporting currency, in which case translation is not necessary.

63) A translation exposure report shows, for each account that is included in the consolidated balance sheet, A) the amount of foreign exchange exposure that exists for each foreign subsidiary in which the MNC has a material interest. B) the amount of foreign exchange exposure that exists on a net basis for the firm. C) the amount of foreign exchange exposure that exists for each foreign currency in which the MNC has exposure. D) none of the options

64)

Salient economic factors for determining the functional currency include

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A) B) C) D)

cash flow indicators. sales price indicators. sales market indicators. all of the options

65) XYZ Corporation, a U.S. parent firm, has a wholly owned sales affiliate, ABC Ltd., in the United Kingdom. The affiliate was established to service the local market.Assume thatthe functional currency of ABC is the pound.the reporting currency is the dollar.the initial exchange rate $1.00 = £0.67. ABC's nonconsolidated balance sheets and the footnotes to the financial statements indicate that ABC owes the parent firm £200,000. Assume that, XYZ had made an investment of $500,000 in the affiliate. Under FASB 52, the intercompany debt and investment will appear on the consolidated balance sheet as A) B) C) D)

66)

£200,000. $201,493. $298,507. $798,507

The impact of financing in determining the functional currency is that

A) financing does not impact the choice of functional currency due to the integrated nature of capital markets. B) if the financing of the foreign entity is primarily denominated in the foreign currency and the debt service obligations are normally handled by the foreign entity, the functional currency is the foreign currency. C) if the financing of the foreign entity is primarily from the parent, with debt service obligations are normally handled by the parent, the functional currency is the home currency. D) Both B & C are correct.

67) If a foreign entity is only a shell company for carrying accounts that could be carried on the parent's books,

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A) B) C) D)

68)

the functional currency would generally be the parent's currency. the functional currency would generally be the local currency. there is no reason to hedge transaction exposure. none of the options

A highly inflationary economy is defined in FASB 52 as

A) one that has cumulative inflation of approximately 100 percent or more over a 3year period. B) one that has current inflation of approximately 40 percent per year. C) one that has going-forward expected inflation of approximately 40 percent per year. D) none of the options

69) In highly inflationary economies, FASB 52 requires that the foreign entities financial statement be remeasured from the local currency "as if the functional currency were the reporting currency." The purpose of this requirement is A) to prevent large important balance sheet accounts, carried at historical values, from having insignificant values once translated into the reporting currency at the current rate. B) to prevent games playing in the accounting books. C) to prevent having to restate the books at a later date. D) none of the options

70)

Which of the following is true?

A) Some items that are a source of transaction exposure are also a source of translation exposure. B) Some items that are a source of transaction exposure are not also a source of translation exposure. C) Both A & B are correct. D) none of the options

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71)

Generally speaking,

A) it is not possible to hedge both translation exposure and transaction exposure simultaneously. B) if a firm can hedge translation exposure then transaction exposure will be simultaneously hedged. C) if a firm can hedge transaction exposure then translation exposure will be simultaneously hedged. D) none of the options

72)

Translation exposure, A) B) C) D)

73)

is not entity specific, rather it is currency specific. is not currency specific, rather it is entity specific. involves restatement from Italian to French. none of the options

The source of translation exposure

A) is a mismatch of net assets and net liabilities denominated in the same currency. B) is a mismatch of net assets and net liabilities denominated in the different currencies. C) is a mismatch of current assets and current liabilities denominated in different currencies. D) none of the options

74)

A balance sheet hedge seeks to

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A) currency. B) C) D)

75)

eliminate any mismatch of net assets and net liabilities denominated in the same transfer accounting exposure to transaction exposure. create cumulative translation adjustment. none of the options

A derivatives hedge that seeks to eliminate translation exposure

A) eliminates any mismatch of the rate of change in net assets and the rate of change in net liabilities denominated in the same currency. B) really involves speculation about foreign exchange rate changes. C) simultaneously goes long and short in currency futures contracts. D) none of the options

76) Consider a U.S.-based MNC with manufacturing activities in Japan. The result of a change in the ¥–$ exchange rate on the assets and liabilities of the consolidated balance sheet is:

Exposed assets

700,000,000

Exposed liabilities

500,000,000

Ignoring transaction exposure in the yen, the translation exposure will indicate a possible need for a "derivatives hedge" of A) short position in ¥200,000,000 currency futures. B) long position in ¥200,000,000 currency futures. C) either short position in ¥200,000,000 currency futures or long position in ¥200,000,000 currency futures. D) none of the options

77)

With regard to translation exposure versus operating exposure

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A) B) C) D)

upper management should be more concerned with translation exposure. any discussion really involves speculation about foreign exchange rate changes. upper management should be more concerned with operating exposure. none of the options

78) With regard to research on the stock price reaction to mandated accounting changes, such as FASB 52, A) the results suggest that market participants seem to think that changes in reported earnings do not change the actual cash flows in multinational firms. B) the results suggest that market agents react to "cosmetic" earning changes. C) the results suggest that market agents do not react to cosmetic earning changes that do not affect value. D) none of the options

79)

Which of the following are true statements?

A) Since translation exposure does not have an immediate direct effect on operating cash flows, its control is relatively unimportant in comparison to transaction exposure, which involves potential real cash flow losses. B) Since it is generally not possible to eliminate both translation exposure and transaction exposure, it is more logical to effectively manage transaction exposure. C) Two ways to control translation risk are: a balance sheet hedge and a derivatives hedge. D) all of the options

80) Under which method does the gain or loss due to translation adjustment not affect reported cash flows, as it does with the other three translation methods?

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A) B) C) D)

81)

Current/noncurrent method Monetary/nonmonetary method Temporal method Current rate method

Under FASB 52, when a net translation exposure exists,

A) a derivatives hedge is necessary to bring balance to the consolidated balance sheet after an exchange rate change. B) a money market hedge is necessary to bring balance to the consolidated balance sheet after an exchange rate change. C) a cumulative translation adjustment account is necessary to bring balance to the consolidated balance sheet after an exchange rate change. D) none of the options

82)

Under FASB 133, which of the following statements is true?

A) the statement establishes accounting and reporting standards for derivative instruments and hedging activities B) to qualify for FASB 133, a company must identify a clear link between exposure and a derivative instrument C) the statement clarifies which transactions qualify as an acceptable hedge and how to treat an unexpected gain or loss if the hedge is not effective. D) all of the options

83)

With regard to foreign currency translation methods used by foreign MNCs,

A) foreign currency translation methods are generally only used by U.S. based MNCs since foreign firms have a built-in hedge by being foreign. B) are generally the same methods used by U.S.-based firms. C) are exactly the same methods used by U.S.-based firms since GAAP is GAAP. D) none of the options

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SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question. 84) Find the foreign currency gain or loss for this U.S. MNC translating the balance sheet and income statement of a French subsidiary, which keeps its books in euro, then is translated into U.S. dollars using the current/noncurrent method—the reporting currency of the U.S. MNC.The subsidiary is at the end of its first year of operation. The historical exchange rate is $1.60/€1.00 and the most recent exchange rate is $1.50/€. Local Currency

Current/Non current

Balance Sheet Cash

€

2,100

3,150

Inventory (current Value = €1,800)

€

1,500

2,250

Net fixed assets

€

3,000

4,800

Total Assets

€

6,600

$ 10,200

Current liabilities

€

1,200

1,800

Long-term

€

1,800

2,880

Common stock

€

2,700

4,320

Retained earnings

€

900

€

6,600

$ 10,200

Sales Revenue

€ 10,000

$ 15,484

COGS

€

7,500

$ 11,613

Depreciation

€

1,000

1,600

NOI

€

1,500

2,271

Tax(40%)

€

600

908

CTA Total L&E Income Statement

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Profit after tax

€

900

Net income

€

900

Dividends

€

Addition to Retained Earnings

€

900

1,363

Foreign Exchange gain (loss)

85) Calculate the cumulative translation adjustment for this U.S. MNC translating the balance sheet and income statement of a French subsidiary, which keeps its books in euro, but that is translated into U.S. dollars using the current rate method, the reporting currency of the U.S. MNC. The subsidiary is at the end of its first year of operation.The historical exchange rate is $1.60/€1.00 and the most recent exchange rate is $1.50/€. Local Currency

Current Rate

Balance Sheet Cash

€

2,100

3,150

Inventory (Current Value = €1,800)

€

1,500

2,250

Net fixed assets

€

3,000

4,500

Total Assets

€

6,600

9,900

Current liabilities

€

1,200

1,800

Long-term debt

€

1,800

2,700

Common stock

€

2,700

4,320

Retained earnings

€

900

1,394

CTA

Version 1

Total L&E

€

6,600

9,900

Income Statement Sales Revenue

€ 10,000

$ 15,484

COGS

€

7,500

$ 11,613

Depreciation

€

1,000

1,548

NOI

€

1,500

2,323

Tax(40%)

€

600

929

Profit after tax

€

900

1,394

Net income

€

900

1,394

Dividends

€

Addition to Retained Earnings

€

900

1,394

Foreign Exchange gain (loss)

86) Assume that the balance sheet and income statement of a French subsidiary, which keeps its books in euro, is translated into U.S. dollars, the reporting currency of the U.S. MNC.The table presents the balance sheet and income statement in euro.The subsidiary is at the end of its first year of operation.The historical exchange rate is $1.60/€1.00 and the most recent exchange rate is $2.00/€.Fill out the 20 missing entries that translate the balance sheet and income statement for this French subsidiary using the Current/Noncurrent Method, the Monetary/Nonmonetary Method, the Temporal Method, and the Current Rate Method. Local Current/Non Monetary/Non Temporal Current Currency current monetary Rate Balance Sheet 1

Cash

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€ 2,100

Inventory € 1,500 (current Value = €1,800) Net fixed assets € 3,000

Total Assets

€ 6,600

€ 1,200

Current liabilities Long-term debt

Common stock

€ 2,700

€

Retained earnings CTA

Total L&E

€ 6,600

€ 1,800

900

Income Statement 11

Sales Revenue

€ 10,000

COGS

€ 7,500

Depreciation

€ 1,000

NOI

€ 1,500

Tax(40%)

€

600

Profit after tax €

900

17 18

Foreign Exchange gain (loss) Net income €

900

Dividends

€

Addition to Retained Earnings

€

900

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Answer Key Test name: Chap 10_9e 1) TRUE 2) TRUE 3) D 4) C 5) D 6) B 7) B 8) A 9) A 10) B 11) C 12) A 13) A 14) C 15) B 16) B 17) C 18) D 19) D 20) B 21) A 22) A 23) B 24) D 25) B 26) A Version 1

27) A 28) B 29) A 30) B 31) C 32) D 33) B 34) D 35) C 36) A 37) C 38) D 39) D 40) B 41) D 42) D 43) B 44) C 45) D 46) C 47) A 48) B 49) C 50) A 51) A 52) D 53) A 54) B 55) C 56) B Version 1

57) A 58) D 59) D 60) A 61) D 62) A 63) C 64) D 65) D 66) D 67) A 68) A 69) A 70) C 71) A 72) A 73) A 74) A 75) B 76) D 77) C 78) C 79) D 80) D 81) C 82) C 83) D 84) Correct answer is −$163.$10,200 − $1,800 − $2,880 − $4,320 = $1,200 = Net income.Foreign exchange gain (loss) = $1,200 − $1,363 = −$163. Version 1

85) Correct answer is −$314 = $9,900 − $1,800 − $2,700 − $4,320 − $1,394. 86) Local Current/Non Monetary/Non Temporal Current Currency current monetary Rate Balance Sheet 1

Cash

€ 2,100

4,200

$ 4,200 $ 4,200

Inventory (current Value = €1,800) Net fixed assets

€ 1,500

3,000

2,400

$ 3,600 $ 3,000

€ 3,000

4,800

$ 4,800 $ 6,000

Total Assets

€ 6,600

$ 12,000

$ 11,400

$ 12,600 $ 13,200

€ 1,200

2,400

$ 2,400 $ 2,400

Current liabilities Long-term debt

€ 1,800

2,880

3,600

$ 3,600 $ 3,600

Common stock

€ 2,700

4,320

$ 4,320 $ 4,320

€

2,400

1,080

$ 2,280 $ 1,600

Retained earnings CTA

Total L&E

€ 6,600

$ 12,000

$ 11,400

$ 12,600 $ 13,200

Income Statement Sales Revenue

€ 10,000

$ 17,778

$ 17,778 $ 17,778

COGS

€ 7,500

$ 13,333

$ 12,000

$ 13,333 $ 13,333

Depreciation

€ 1,000

1,600

$ 1,600 $ 1,778

NOI

€ 1,500

2,844

4,178

$ 2,844 $ 2,667

Tax(40%)

€

600

1,138

1,671

$ 1,138 $ 1,067

Profit after tax Foreign

€

900

1,707

2,507

$ 1,707 $ 1,600

693

−$

1,427

Version 1

900

1,280

573

Exchange gain (loss) Net income

€

900

2,400

1,080

Dividends

€

Addition to Retained Earnings

€

900

2,400

1,080

Version 1

$ 2,280 $ 1,600 $

0 $

$ 2,280 $ 1,600

CHAPTER 11 TRUE/FALSE - Write 'T' if the statement is true and 'F' if the statement is false. 1) Edge Act banks are not prohibited from owning equity in business corporations, unlike domestic commercial banks. ⊚ ⊚

true false

2) An Edge Act bank is typically located in a state different from that of its parent in order to get around the prohibition on interstate branch banking. ⊚ ⊚

true false

MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 3) International banks are different from domestic banks in what way(s)? A) B) C) D)

Major distinguishing features between domestic banks and international banks are A) B) C) D)

International banks can arrange trade financing. International banks can arrange for foreign exchange transactions. International banks can assist their clients in hedging exchange rate risk. all of the options

the types of deposits they accept. the types of loans and investments they make. membership in loan syndicates. all of the options

Since international banks have the facilities to trade foreign exchange,

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A) B) C) D)

they generally also make a market as a dealer in foreign exchange. they generally also make a market as a dealer in foreign exchange derivatives. they generally also trade foreign exchange products for their own account. none of the options

6) Banks that both perform traditional commercial banking functions and engage in investment banking activities are often called A) B) C) D)

Universal banks A) B) C) D)

may engage in investment banking activities. may arrange for foreign exchange transactions. may assist their clients in hedging exchange rate risk. all of the options

By far the most important international finance centers are A) B) C) D)

international service banks. investment banks. commercial banks. merchant banks.

Zurich and Moscow. Paris, London, and Tokyo. New York, London, Tokyo, Paris, and Zurich. New York, London, Tokyo, Paris, Zurich, and Frankfurt.

Multinational banks are often not subject to the same regulations as domestic banks.

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A) B) C) D)

There may be increased need to publish adequate financial information. There may be reduced need to publish adequate financial information. The requirements to publish adequate financial information are the same. none of the options

10) A domestic bank that follows a multinational client abroad to preserve that banking relationship A) B) C) D)

is playing the role of the desperate housewife in this relationship. is pursuing a wholesale defensive strategy. is pursuing a retail defensive strategy. none of the options

11) A domestic bank that becomes a multinational bank to prevent erosion by foreign banks of the traveler's checks, touring, and foreign business market A) B) C) D)

is playing the role of the desperate housewife in this relationship. is pursuing a wholesale defensive strategy. is pursuing a retail defensive strategy. none of the options

12) Managerial and marketing knowledge developed at home can be used abroad with low managerial costs describes which reason for international banking? A) B) C) D)

low marginal costs knowledge advantage growth risk reduction

13) Greater stability of earnings is possible with international diversification describes which reason for international banking? Version 1

A) B) C) D)

low marginal costs knowledge advantage growth risk reduction

14) Growth prospects in a home nation may be limited by a market largely saturated with the services offered by domestic banks describes which reason for international banking? A) B) C) D)

low marginal costs knowledge advantage growth risk reduction

15) The foreign bank subsidiary can draw on the parent bank’s knowledge of personal contacts and credit investigations for use in that foreign market describes which reason for international banking? A) B) C) D)

16)

Banking tends to be A) B) C) D)

17)

low marginal costs knowledge advantage growth risk reduction

a low average cost industry. a high marginal cost industry. a constant average cost industry. none of the options

A U.S.-based multinational bank

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A) would not have to provide deposit insurance and meet reserve requirements on foreign currency deposits. B) would have to provide deposit insurance and meet reserve requirements on foreign currency deposits. C) would not have to provide deposit insurance but would have to meet reserve requirements on foreign currency deposits. D) would have to provide deposit insurance but not meet reserve requirements on foreign currency deposits.

18) A bank may establish a multinational operation for the reason of low marginal costs. The underlying rationale being that A) banks follow their multinational customers abroad to prevent the erosion of their clientele to foreign banks seeking to service the multinational's foreign subsidiaries. B) multinational banking operations help a bank prevent the erosion of its traveler's check, tourist, and foreign business markets from foreign bank competition. C) managerial and marketing knowledge developed at home can be used abroad with low marginal costs. D) the foreign bank subsidiary can draw on the parent bank's knowledge of personal contacts and credit investigations for use in that foreign market.

19) A bank may establish a multinational operation for the reason of knowledge advantage. The underlying rationale being that

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A) local firms may be able to obtain from a foreign subsidiary bank operating in their country more complete trade and financial market information about the subsidiary's home country than they can obtain from their own domestic banks. B) by maintaining foreign branches and foreign currency balances, banks may reduce transaction costs and foreign exchange risk on currency conversion if government controls can be circumvented. C) greater stability of earnings is possible with international diversification. Offsetting business and monetary policy cycles across nations reduces the country-specific risk of any one nation. D) the foreign bank subsidiary can draw on the parent bank's knowledge of personal contacts and credit investigations for use in that foreign market.

20) A bank may establish a multinational operation for the reason of prestige. The underlying rationale being that A) local firms may be able to obtain from a foreign subsidiary bank operating in their country more complete trade and financial market information about the subsidiary's home country than they can obtain from their own domestic banks. B) the foreign bank subsidiary can draw on the parent bank's knowledge of personal contacts and credit investigations for use in that foreign market. C) very large multinational banks have high perceived prestige, liquidity, and deposit safety that can be used to attract clients abroad. D) multinational banks are often not subject to the same regulations as domestic banks. There may be reduced need to publish adequate financial information, lack of required deposit insurance and reserve requirements on foreign currency deposits, and the absence of territorial restrictions.

21) A bank may establish a multinational operation for the reason of risk reduction. The underlying rationale being that

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A) by maintaining foreign branches and foreign currency balances, banks may reduce transaction costs and foreign exchange risk on currency conversion if government controls can be circumvented. B) greater stability of earnings is possible with international diversification. Offsetting business and monetary policy cycles across nations reduces the country-specific risk of any one nation. C) multinational banks are often not subject to the same regulations as domestic banks. There may be reduced need to publish adequate financial information, lack of required deposit insurance and reserve requirements on foreign currency deposits, and the absence of territorial restrictions. D) multinational banking operations help a bank prevent the erosion of its traveler's check, tourist, and foreign business markets from foreign bank competition.

22) A bank may establish a multinational operation for the reason of regulatory advantage. The underlying rationale being that A) banks follow their multinational customers abroad to prevent the erosion of their clientele to foreign banks seeking to service the multinational's foreign subsidiaries. B) multinational banking operations help a bank prevent the erosion of its traveler's check, tourist, and foreign business markets from foreign bank competition. C) by maintaining foreign branches and foreign currency balances, banks may reduce transaction costs and foreign exchange risk on currency conversion if government controls can be circumvented. D) multinational banks are often not subject to the same regulations as domestic banks. There may be reduced need to publish adequate financial information, lack of required deposit insurance and reserve requirements on foreign currency deposits, and the absence of territorial restrictions.

23)

Currently, the biggest bank in the world is A) B) C) D)

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ICBC. Bank of America. UBS. The World Bank.

24) A bank may establish a multinational operation for the reason of retail defensive strategy. The underlying rationale being that A) banks follow their multinational customers abroad to prevent the erosion of their clientele to foreign banks seeking to service the multinational's foreign subsidiaries. B) multinational banking operations help a bank prevent the erosion of its traveler's check, tourist, and foreign business markets from foreign bank competition. C) by maintaining foreign branches and foreign currency balances, banks may reduce transaction costs and foreign exchange risk on currency conversion if government controls can be circumvented. D) multinational banks are often not subject to the same regulations as domestic banks. There may be reduced need to publish adequate financial information, lack of required deposit insurance and reserve requirements on foreign currency deposits, and the absence of territorial restrictions.

25) A bank may establish a multinational operation for the reason of wholesale defensive strategy. The underlying rationale being that A) banks follow their multinational customers abroad to prevent the erosion of their clientele to foreign banks seeking to service the multinational's foreign subsidiaries. B) multinational banking operations help a bank prevent the erosion of its traveler's check, tourist, and foreign business markets from foreign bank competition. C) by maintaining foreign branches and foreign currency balances, banks may reduce transaction costs and foreign exchange risk on currency conversion if government controls can be circumvented. D) multinational banks are often not subject to the same regulations as domestic banks. There may be reduced need to publish adequate financial information, lack of required deposit insurance and reserve requirements on foreign currency deposits, and the absence of territorial restrictions.

26)

Which of the following are reasons why a bank may establish a multinational operation?

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A) B) C) D)

Low marginal and transaction costs Home nation information services, and prestige Growth and risk reduction all of the options

27) A bank may establish a multinational operation for the reason of transaction costs. The underlying rationale being that A) banks follow their multinational customers abroad to prevent the erosion of their clientele to foreign banks seeking to service the multinational's foreign subsidiaries. B) multinational banking operations help a bank prevent the erosion of its traveler's check, tourist, and foreign business markets from foreign bank competition. C) by maintaining foreign branches and foreign currency balances, banks may reduce transaction costs and foreign exchange risk on currency conversion if government controls can be circumvented. D) multinational banks are often not subject to the same regulations as domestic banks. There may be reduced need to publish adequate financial information, lack of required deposit insurance and reserve requirements on foreign currency deposits, and the absence of territorial restrictions.

28) A bank may establish a multinational operation for the reason of growth. The rationale being that

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A) growth prospects in a home nation may be limited by a market largely saturated with the services offered by domestic banks. B) multinational banks are often not subject to the same regulations as domestic banks. There may be reduced need to publish adequate financial information, lack of required deposit insurance and reserve requirements on foreign currency deposits, and the absence of territorial restrictions. C) greater stability of earnings is possible with international diversification. Offsetting business and monetary policy cycles across nations reduces the country-specific risk of any one nation. D) by maintaining foreign branches and foreign currency balances, banks may reduce transaction costs and foreign exchange risk on currency conversion if government controls can be circumvented.

29) A bank may establish a multinational operation for the reason of home country information services. The underlying rationale being that A) by maintaining foreign branches and foreign currency balances, banks may reduce transaction costs and foreign exchange risk on currency conversion if government controls can be circumvented. B) local firms may be able to obtain from a foreign subsidiary bank operating in their country more complete trade and financial market information about the subsidiary's home country than they can obtain from their own domestic banks. C) the foreign bank subsidiary can draw on the parent bank's knowledge of personal contacts and credit investigations for use in that foreign market. D) greater stability of earnings is possible with international diversification. Offsetting business and monetary policy cycles across nations reduces the country-specific risk of any one nation.

30)

A correspondent bank relationship is established when

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A) B) C) offering. D)

31)

two banks maintain deposits with one another. two banks write to each other about the credit conditions of their countries. a group of banks form a syndicate to spread out the risk and cost of a large bond all of the options

Correspondent bank relationships can be beneficial

A) because a bank can service its MNC clients at a very low cost. B) because a bank can service its MNC clients without the need to have personnel in many different countries. C) because a bank can service its MNC clients without developing its own foreign facilities to service its clients. D) all of the options

32) Consider a U.S. importer desiring to purchase merchandise from a Dutch exporter invoiced in euros, at a cost of €160,000. The U.S. importer will contact his U.S. bank (where, of course, he has an account denominated in U.S. dollars) and inquire about the exchange rate, which the bank quotes as €0.6250/$1.00. The importer accepts this price, so his bank will proceed to __________ the importer's account in the amount of __________. A) B) C) D)

debit; $256,000 credit; €512,100 credit; $500,000 debit; €100,000

33) The current exchange rate is £1.00 = $2.00. Compute the correct balances in Bank A's correspondent account(s) with bank B if a currency trader employed at Bank A buys £45,000 from a currency trader at bank B for $90,000 using its correspondent relationship with Bank B.

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A) B) C) D)

34)

Correspondent bank services include A) B) C) D)

prepaid postage and packing materials. letters of introduction. foreign exchange conversions. Both B and C are correct

35) The current exchange rate is £1.00 = $2.00. Compute the correct balances in Bank A's correspondent account(s) with bank B if a currency trader employed at Bank A buys £45,000 from a currency trader at bank B for $90,000 using its correspondent relationship with Bank B. A) B) C) D) E)

36) The current exchange rate is €1.00 = $1.50. Compute the correct balances in Bank A's correspondent account(s) with bank B if a currency trader employed at Bank A buys €100,000 from a currency trader at bank B for $150,000 using its correspondent relationship with Bank B. A) B) C) D)

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37)

A representative office

A) is what lawyers' offices are called in Mexico. B) is a small service facility staffed by parent bank personnel that is designed to assist MNC clients of the parent bank in dealings with the bank's correspondents. C) is a small service facility staffed by correspondent bank personnel that is designed to assist MNC clients of the parent bank in dealings with the bank's correspondents. D) none of the options

38)

A representative office

A) is a way for the parent bank to provide its MNC clients with a level of service greater than that provided through merely a correspondent relationship. B) is a small service facility staffed by parent bank personnel that is designed to assist MNC clients of the parent bank in dealings with the bank's correspondents. C) is a step up from a correspondent relationship, but below a foreign branch. D) all of the options

39)

A foreign branch bank

A) is a small service facility staffed by parent bank personnel that is designed to assist MNC clients of the parent bank in dealings with the bank's correspondents. B) operates like a local bank, but legally is a part of the parent bank. C) is subject to domestic regulation only. D) all of the options

40)

What is the primary reason a U.S. bank would open a foreign branch bank?

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A) Because this form of bank organization can allow a U.S. bank to provide a fuller range of services for its MNC customers than it can through a representative office. B) To avoid U.S. banking regulation on transactions routed through that foreign country. C) Because this form of organization allows the bank to service MNC clients at low cost and without the need of having bank personnel located in the country. D) Because this form of bank organization can allow a U.S. bank to provide a fuller range of services for its MNC customers than it can through a representative office, and to avoid U.S. banking regulation on transactions routed through that foreign country.

41) Why would a U.S. bank open a foreign branch bank instead of a foreign chartered subsidiary? A) This form of bank organization allows the bank to be able to extend a larger loan to a customer than a locally chartered subsidiary bank of the parent. B) To slow down check clearing and maximize the bank's float. C) To avoid U.S. banking regulation. D) This form of bank organization allows the bank to be able to extend a larger loan to a customer than a locally chartered subsidiary bank of the parent, as well as avoid U.S. banking regulation.

42)

The most popular way for a U.S. bank to expand overseas is A) B) C) D)

43)

branch banks. representative offices. subsidiary banks. affiliate banks.

A foreign branch bank operates like a local bank, but legally

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A) it is not a part of the parent bank. B) a branch bank is subject to neither the banking regulations of its home country nor the country in which it operates. C) a branch bank is subject to only the banking regulations of its home country and not the country in which it operates. D) it is a part of the parent bank, and a branch bank is subject to both the banking regulations of its home country and the country in which it operates.

44)

The major legislation controlling the operation of foreign banks in the U.S.

A) specifies that foreign branch banks operating in the U.S. must comply with U.S. banking regulations just like U.S. banks. B) specifies that foreign branch banks operating in the U.S. must comply with their country-of-origin banking regulations just like U.S. banks operating abroad. C) specifies that the "shell" branches are illegal for U.S. and foreign banks. D) specifies that foreign branch banks operating in the U.S. must comply with U.S. banking regulations just like U.S. banks, and also specifies that the "shell" branches are illegal for U.S. and foreign banks.

45)

A subsidiary bank is A) a locally incorporated bank that is wholly owned by a foreign parent. B) a locally incorporated bank that is majority owned by a foreign parent. C) a locally incorporated bank that is partially owned (but not controlled) by a foreign

parent. D) a locally incorporated bank that is wholly (or majority) owned by a foreign parent.

46)

An affiliate bank is

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A) a locally incorporated bank that is wholly owned by a foreign parent. B) a locally incorporated bank that is majority owned by a foreign parent. C) a locally incorporated bank that is partially owned (but not controlled) by a foreign parent. D) a locally incorporated bank that is wholly (or majority) owned by a foreign parent.

47)

Both subsidiary and affiliate banks

A) operate under the banking laws of the country in which they are incorporated. B) operate under the banking laws of the U.S. C) can underwrite securities, but not accept dollar-denominated deposits. D) operate under the banking laws of the country in which they are incorporated, as well as the banking laws of the U.S.

48)

U.S. banks that establish subsidiary and affiliate banks

A) are allowed to underwrite securities. B) must provide FDIC insurance on their foreign-currency denominated demand deposits. C) can underwrite securities, but not accept dollar-denominated deposits. D) are allowed to underwrite securities and must provide FDIC insurance on their foreign-currency denominated demand deposits.

49)

Foreign banks that establish subsidiary and affiliate banks in the U.S.

A) tend to avoid states that are major centers of financial activity. B) tend to avoid the highly populous states of New York, California, Illinois, Florida, Georgia, and Texas. C) can underwrite securities, but not accept dollar-denominated deposits. D) tend to locate in states that are major centers of financial activity, as well as the highly populous states of New York, California, Illinois, Florida, Georgia, and Texas.

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50)

Edge Act banks are so-called because

A) they are federally chartered subsidiaries of U.S. banks that are physically located in the United States and are allowed to engage in a full range of international banking activities. B) Senator Walter E. Edge of New Jersey sponsored the 1919 amendment to Section 25 of the Federal Reserve Act to allow U.S. banks to be competitive with the services foreign banks could supply their customers. C) they can only be chartered in states that are on the borders of the United States—on the "edge" of the map. D) none of the options

51)

Edge Act banks

A) can accept foreign deposits, extend trade credit, finance foreign projects abroad, trade foreign currencies, and engage in investment banking activities with U.S. citizens involving foreign securities. B) are federally chartered subsidiaries of U.S. banks that are physically located in the United States and are allowed to engage in a full range of international banking activities. C) can underwrite securities, but can only be located in states on the edge of the U.S. D) Both A and B are correct.

52)

Edge Act banks A) B) C) D)

53)

are not prohibited from owning equity in business corporations. are prohibited from owning equity in business corporations. could be prohibited (or not) from owning equity in business corporations. none of the options

An offshore banking center is

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A) a country whose banking system is organized to permit external accounts beyond the normal economic activity of the country. B) is external to any government, frequently located on old oil drilling platforms located in international waters. C) a country like North Korea. D) none of the options

54)

Offshore banks A) B) C) D)

55)

are frequently located on old oil drilling platforms located in international waters. are often located in "pariah" countries like North Korea and Iran. operate as branches or subsidiaries of the parent bank. none of the options

The primary activities of offshore banks

A) include money laundering where banking secrecy laws are strict. B) is to seek deposits and grant loans in currencies other than the currency of the host government. C) involve check clearing of large bags of checks. D) none of the options

56)

Which banks cannot accept foreign deposits? A) B) C) D)

57)

Domestic banks located in the U.S. Edge Act banks located in the U.S. Subsidiary banks located overseas Foreign branches located overseas

In reference to capital requirements,

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A) bank capital adequacy refers to the amount of equity capital a bank holds as reserves against impaired loans. B) bank capital adequacy refers to the amount of debt capital a bank holds as reserves against risky assets to reduce the probability of bank failure. C) most bank regulators agree with the doctrine of "less is more." D) none of the options

58)

Examples of operational risk include A) B) C) D)

computer failure poor documentation fraud all of the options

59) In reference to Basel Accord minimum bank capital adequacy requirements, riskweighted assets A) refers to traditional bank loans. B) refers to a "risk-focused" approach to determining adequate bank capital. C) provides a level of confidence measure of the probability of the maximum loss that can occur during a period of time. D) none of the options.

60)

The core of the international money market is A) B) C) D)

61)

the Eurocurrency market. the market for foreign exchange. the futures forwards and options markets on foreign exchange. none of the options

Eurocurrency

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A) is the euro, the common currency of Europe. B) is a time deposit of money in an international bank located in a country different from the country that issued the currency. C) is a demand deposit of money in an international bank located in a country different from the country that issued the currency. D) is either a time deposit of money in an international bank located in a country different from the country that issued the currency or a demand deposit of money in an international bank located in a country different from the country that issued the currency.

62)

The Eurocurrency market

A) is only in Europe. B) is an external banking system that runs parallel to the domestic banking system of the country that issued the currency. C) has languished following monetary union in Europe. D) none of the options

63)

LIBOR

A) market. B) C) D)

64)

is the rate at which prime banks in London will offer Eurocurrency in the interbank is a government set rate, like the discount rate. is the rate at which prime banks in London will accept interbank deposits. none of the options

LIBOR

A) is the London Interbank Offered Rate. B) is the reference rate in London for Eurodollar deposits. C) one of several reference rates in London: there is a LIBOR for Eurodollars, Euro yen, Euro—Canadian dollars, and even euro. D) all of the options

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65) The rate charged by banks with excess funds is referred to as the interbank offered rate; they will accept interbank deposits at the interbank bid rate. A) B) C) D)

66)

The spread is generally 10 – 12 basis points for most major Euro currencies. The spread is generally referred to as "the TED spread." The spread is generally referred to as the bid-ask commission. none of the options

The LIBOR rate for euro

A) is EURIBOR. B) is a government set rate. C) is the rate at which Interbank deposits of euro are offered by one prime bank to another in the euro zone. D) is the rate at which Interbank deposits of euro are offered by one prime bank to another in the London Eurocurrency market.

67)

In the wholesale money market, denominations A) B) C) D)

are at least $10,000, but sizes of $100,000 or larger are more typical. are at least $100,000, but sizes of $500,000 or larger are more typical. are at least $500,000, but sizes of $1,000,000 or larger are more typical. none of the options

68) Approximately __________ of wholesale Euro bank external liabilities come from fixed time deposits, the remainder from Negotiable Certificates of Deposit. A) B) C) D)

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50 percent 75 percent 90 percent none of the options

69)

Eurodollars refers to dollar deposits when the depository bank is located A) B) C) D)

70)

in Europe. in Europe, and the Caribbean. outside the United States. in the United States.

Euro credits A) are credit cards that work in the euro zone. B) are denominated in currencies that are the same as the home currency of the Euro

bank. C) short- to medium-term loans of Euro currency extended by Euro banks to corporations, sovereign governments, non prime banks, or international organizations. D) none of the options

71)

Euro credits

A) are often so large that individual banks cannot handle them. B) short- to medium-term loans of Euro currency extended by Euro banks to corporations, sovereign governments, non prime banks, or international organizations. C) frequently require the use of a banking syndicate. D) all of the options

72)

Euro credits feature rollover pricing.

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A) Rollover pricing was created on Euro credits so that Euro banks do not end up paying more on Euro currency time deposits than they earn from the loans. B) Because of the rollover pricing feature, a Euro credit may be viewed as a series of shorter-term loans, where at the end of each time period (generally three or six months), the loan is rolled over and the base lending rate is repriced to current LIBOR over the next time interval of the loan. C) The lending rate on these Euro credits is stated as LIBOR + X percent, where X is the lending margin charged depending upon the credit worthiness of the borrower. LIBOR is reset according to a set schedule. D) all of the options

73) Teltrex International can borrow $3,000,000 at LIBOR plus a lending margin of 0.75 percent per annum on a three-month rollover basis from Barclays in London. Suppose that threemonth LIBOR is currently 5 17⁄32 percent. Further suppose that over the second three-month interval LIBOR falls to 5 1⁄8 percent. How much will Teltrex pay in interest to Barclays over the six-month period for the Eurodollar loan? A) B) C) D)

$79,921.875 $91,171.88 $96,174.39 $364,687.52

74) A bank agrees to buy from a customer a "three against six" FRA at the market rate for such instruments. How can the bank hedge this obligation? A) Go long a 6-month Eurodollar deposit in the amount of the FRA at the current 6month rate financed by going short a 3-month Eurodollar deposit in the amount of the FRA at the current 3-month rate. B) Go short a 6-month Eurodollar deposit in the amount of the FRA at the current 6month rate; go long a 3-month Eurodollar deposit in the amount of the FRA at the current 3month rate. C) Borrow a 3-month Eurodollar deposit in the amount of the FRA at the current 3month rate. D) none of the options

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75)

In a forward rate agreement (FRA)

A) the buyer agrees to pay the seller the increased interest costs on a notational amount if interest rates rise above the agreement rate B) the seller agrees to pay the buyer the increased cost if interest rates increase above the agreement rate. C) the seller agrees to pay the buyer the increased cost if interest rates decrease below the agreement rate. D) none of the options

76)

A forward rate agreement (FRA) is a contract between two banks A) that allows the Euro bank to hedge the interest rate risk in mismatched deposits and

credits. B) in which the buyer agrees to pay the seller the increased interest cost on a notional amount if interest rates fall below an agreed rate, and the seller agrees to pay the buyer the increased interest cost if interest rates increase above the agreed rate. C) that is structured to capture the maturity mismatch in standard-length Euro deposits and credits. D) all of the options

77)

A bank bought a "three against six" FRA. Payment is made when? A) B) C) D)

78)

At the end of 3 months At the end of 6 months At the end of 9 months none of the options

In an FRA, the buyer agrees to pay the seller

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A) the increased interest cost on a notional amount if interest rates fall below an agreement rate. B) the increased interest cost if interest rates increase above the agreement rate. C) the increased interest cost on a notional amount if interest rates rise above an agreement rate. D) none of the options

79)

In an FRA, the seller agrees to pay the buyer

A) the increased interest cost if interest rates fall below the agreement rate. B) the increased interest cost if interest rates increase above the agreement rate. C) the increased interest cost on a notional amount if interest rates fall below an agreement rate. D) none of the options

80) ABC International has borrowed $4,000,000 at LIBOR plus a lending margin of .65 percent per annum on a three-month rollover basis from Barclays in London. Three month LIBOR is currently 5.5 percent, but ABC is worried about an increase in three-month LIBOR 3 months from now. What could they do to hedge? A) B) C) D)

Buy a 3 × 6 FRA in the amount of $4 million. Sell a 3 × 6 FRA in the amount of $4 million. Buy a 3 × 3 FRA in the amount of $4 million. Buy a 3 × 9 FRA in the amount of $4 million.

81) ABC International can borrow $4,000,000 at LIBOR plus a lending margin of 0.65 percent per annum on a three-month rollover basis from Barclays in London. Three month LIBOR is currently 5.5 percent. Suppose that over the second three-month interval LIBOR falls to 5.0 percent. How much will ABC pay in interest to Barclays over the six-month period for the Eurodollar loan?

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A) B) C) D)

$50,000 $100,000 $118,000 $120,000

82) You entered into a long 3 × 6 forward rate agreement on a notional amount of $10,000,000 at an agreement rate of 3 percent. Suppose at the settlement date of the FRA, the settlement rate is 3.5 percent. What is the cash settlement of the FRA? A) B) C) D)

Net payment of $12,391.57 to you Net payment of $12,500 to you Net payment of $50,000 to you Net payment of $48,309.18 to you

83) A bank bought a "three against six" $5,000,000 FRA for a three-month period beginning three months from today and ending six months from today. The reason that the bank bought the FRA was to hedge: the bank accepted a 3-month deposit and made a six-month loan. The agreement rate with the seller is 5 percent. Assume that three months from today the settlement rate is 5.25 percent. Who pays whom? How much? When? The actual number of days in the FRA is 90. A) B) C) D)

84)

The bank pays $3,084.52 at the end of 3 months The bank pays $3,084.52 at the end of 6 months The counterparty pays $3,084.52 at the end of 3 months The counterparty pays $3,084.52 at the end of 6 months

A bank sold a 3 × 9 FRA. Payment is made when? A) B) C) D)

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At the end of 3 months At the end of 6 months At the end of 9 months none of the options

85)

Since SR < AR, then

ABC Bank (seller) has made a "three against six" Forward Rate Agreement (FRA), with XYZ Bank (buyer). Assume that the: Notional Amount = $4,000,000 Settlement Rate (SR) (i.e., three-month market LIBRO) = 5% Agreement Rage (AR) = 6% Actual number of days in the three-month agreement period = 91 A) ABC Bank will pay XYZ Bank a cash settlement at the beginning of the 91-day FRA period. B) XYZ Bank will pay ABC Bank a cash settlement at the beginning of the 91-day FRA period. C) ABC Bank will pay XYZ Bank a cash settlement at the end of the 91-day FRA period. D) XYZ Bank will pay ABC Bank a cash settlement at the end of the 91-day FRA period.

86)

The payment amount under this FRA is

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$9,985. $10,111. $60,667. $120,000.

87)

A "three against nine" forward rate agreement

A) could call for a buyer to sell a six-month Eurobond in three months at prices agreed upon today. B) could call for a buyer to pay the seller the increased interest cost on a notational amount if six-month interest rates fall below an agreed rate beginning three months from now and ending nine months from now. C) is a forward contract on a three-month Eurobond with a nine-month maturity. D) is a forward contract on a nine-month Eurobond with a three-month maturity.

88) Forward rate agreements can be used for speculative purposes. If one believes rates will be less than the agreement rate, A) B) C) D)

89) is

take a short position in a forward rate agreement. the purchase of a FRA is the suitable position. the sale of a FRA is the suitable position. take a long position in the spot market.

The most widely used futures contract for hedging short-term U.S. dollar interest rate risk

A) B) C) D)

the Eurodollar contract. theEuroyen contract. the EURIBOR contract. none of the options

90) Consider the position of a treasurer of a MNC, who will receive $20,000,000 that his firm will not need for the next 90 days. To hedge against an interest rate decline

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A) B) C) D)

91)

A decrease in the implied three-month LIBOR yield causes Eurodollar futures price A) B) C) D)

92)

Avoid an undue concentration of loans to single activities. Control mismatches between assets and liabilities. Expand cautiously into unfamiliar activities. all of the options

Who benefits from debt-for-equity swaps? A) B) C) D)

94)

to increase. to decrease. there is no direct or indirect relationship. none of the options

Which of the following are principles of sound banking behavior? A) B) C) D)

93)

He could borrow the $20,000,000 in the money market. He could take a long position in Eurodollar futures contracts. He could take a short position in Eurodollar futures contracts. none of the options

The creditor bank The LDC The market maker all of the options

The Brady Bond is named after

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A) B) C) D)

95)

U.S. Treasury Secretary, Nicholas F. Brady. U.S. Treasury Secretary, Brady F. Nichols. U.S. bank robber, Nicholas F. Brady. none of the options

The Asian crisis

A) followed a period of economic recession in the region coupled with record private capital outflows. B) followed a period of economic expansion in the region financed by record private capital inflows. C) began in the fall of 2001 when Japan devalued the yen. D) none of the options

96)

Proceeding the Asian crisis,

A) bankers from industrialized countries actively sought to finance the growth opportunities in the region. B) the risk exposure of the lending banks in East Asia was primarily to local banks and commercial firms, and not to sovereignties, as in the LDC debt crisis. C) bankers failed to correctly assess the political and economic risks. D) all of the options

97)

Proceeding the Asian crisis,

A) domestic price bubbles in East Asia, particularly in real estate, were fostered by capital inflows from bankers from the G-10 countries. B) the liberalization of financial markets coupled with capital inflows from bankers from the G-10 countries contributed to bubbles in financial asset prices. C) the close interrelationships common among commercial firms and financial institutions in Asia resulted in poor investment decision making. D) all of the options

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98)

Proceeding the Asian crisis,

A) it may have been implicitly assumed that the governments would come to the rescue of their private banks should financial problems develop. B) the history of managed growth in the East Asian region at least suggested that the economic and financial system, as an integral unit, could be managed in an economic downturn. C) it may have been implicitly assumed that the governments would come to the rescue of their private banks should financial problems develop, and the history of managed growth in the East Asian region at least suggested that the economic and financial system, as an integral unit, could be managed in an economic downturn. D) none of the options

99)

So-called subprime mortgages were typically

A) mortgages granted to borrowers with less-than-perfect credit. B) backed by the full faith and credit of the U.S. government. C) held to maturity by the originating lender, thereby assuring that default risk was priced into the rate of return. D) none of the options

100)

One lesson from the credit crunch is that

A) in the aggregate, credit scores tend to understate the probability of default—thereby a pool of subprime mortgages is actually quite a safe investment since not every borrower defaults. B) moral hazard, while an issue in the market for used cars, does not seem to affect the U.S. financial system due to the effective regulatory environment. C) bankers seem not to scrutinize credit risk as closely when they serve only as mortgage originators and then pass it on to MBS investors rather than hold the paper themselves. D) none of the options

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101) The models that the credit rating firms (e.g., Moody's, S&P, and Fitch) used to evaluate the risk of the various tranches of MBS debt and thereby assign a credit rating (e.g. AAA, AABB, or unrated) were A) right on target, but only in the aggregate. B) poorly specified. C) superfluous, since the CDOs turned out to be backed by the full faith and credit of the U.S. Treasury. D) super models, and while as a group they were not so good at evaluating credit risk, they made up for it with their good looks and impeccable fashion sense.

102)

Many lessons should be learned from the credit crunch.

A) One lesson is that credit rating agencies need to refine their models for evaluating esoteric credit risk created in MBS and CDOs. B) One lesson is that lenders must be more wary of putting complete faith in credit ratings. C) One lesson is that bankers seem not to scrutinize credit risk as closely when they serve only as mortgage originators and then pass it on to MBS investors rather than hold the paper themselves. D) all of the options

103)

So-called subprime mortgages were typically

A) not held by the originating bank, but instead were resold for packaging into mortgage-backed securities. B) aggregated and then sliced into tranches each representing a different risk class: AAA, AA-BB, or unrated. C) not held by the originating bank, but instead were resold for packaging into mortgage-backed securities. Additionally, they were aggregated and then sliced into tranches each representing a different risk class: AAA, AA-BB, or unrated. D) all of the options

104)

One enduring truth of banking is that

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A) bankers always seem willing to lend huge amounts to borrowers with a limited potential to repay. B) credit ratings work, but only in the aggregate. C) when liquidity dries up, bankers are typically able to ride out the storm by buying up other investors debt at pennies on the dollar, holding it until the crisis is over, and then selling at a huge profit. D) none of the options

105)

With regard to creating money,

A) only central banks such as the Federal Reserve can create money. B) money is created when a bank customer invests in a time deposit. C) commercial banks can create money when a bank lends out funds borrowed from another customer who invested in a time deposit. D) none of the options

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Answer Key Test name: Chap 11_9e 1) TRUE 2) TRUE 3) D 4) D 5) C 6) D 7) D 8) B 9) B 10) B 11) C 12) A 13) D 14) C 15) B 16) D 17) A 18) C 19) D 20) C 21) B 22) D 23) A 24) B 25) A 26) D Version 1

27) C 28) A 29) B 30) A 31) D 32) A 33) C 34) D 35) E 36) A 37) B 38) D 39) B 40) A 41) A 42) A 43) D 44) A 45) D 46) C 47) A 48) A 49) D 50) B 51) D 52) A 53) A 54) C 55) B 56) A Version 1

57) A 58) D 59) B 60) A 61) B 62) B 63) A 64) D 65) A 66) D 67) C 68) C 69) C 70) C 71) D 72) D 73) B 74) A 75) C 76) D 77) A 78) A 79) B 80) A 81) C 82) A 83) C 84) A 85) B 86) A Version 1

87) B 88) C 89) A 90) B 91) A 92) D 93) D 94) A 95) B 96) D 97) D 98) C 99) A 100) C 101) B 102) D 103) C 104) A 105) C

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CHAPTER 12 TRUE/FALSE - Write 'T' if the statement is true and 'F' if the statement is false. 1) Eurobonds sold in the United States may not be sold to U.S. citizens. ⊚ ⊚

true false

MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 2) Domestic bonds account for the largest share of outstanding bonds, equaling approximately what percent of the total? A) B) C) D)

78 percent 45 percent 25 percent 15 percent

A "foreign bond" issue is

A) one denominated in a particular currency but sold to investors in national capital markets other than the country that issued the denominating currency. B) one offered by a foreign borrower to investors in a national market and denominated in another nation's currency. C) for example, a German MNC issuing euro-denominated bonds to U.S. investors. D) one offered by a foreign borrower to investors in a national market and denominated in that nation's currency (e.g., a German MNC issuing dollar-denominated bonds to U.S. investors).

4) The four currencies in which the majority of domestic and international bonds are denominated are

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A) B) C) D)

U.S. dollar, the euro, the Indian rupee, and the Chinese yuan. U.S. dollar, the euro, the pound sterling, and the Swiss franc. U.S. dollar, the euro, the Swiss franc, and the yen. U.S. dollar, the euro, the pound sterling, and the yen.

A "Eurobond" issue is

A) denominated in a particular currency but sold to investors in national capital markets other than the country that issued the denominating currency. B) usually a bearer bond. C) for example, a Dutch borrower issuing dollar-denominated bonds to investors in the U.K., Switzerland, and the Netherlands. D) all of the options

In any given year, 80 percent of new international bonds are likely to be A) B) C) D)

"Yankee" bonds are A) B) C) D)

Eurobonds. foreign currency bonds. domestic bonds. none of the options

dollar-denominated foreign bonds originally sold to U.S. investors. yen-denominated foreign bonds originally sold in Japan. pound sterling-denominated foreign bonds originally sold in the U.K. none of the options

"Samurai" bonds are

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A) B) C) D)

"Dragon" bonds are A) B) C) D)

10)

dollar-denominated foreign bonds originally sold to U.S. investors. dollar-denominated bonds originally sold in Asia with non-Japanese issuers. pound sterling-denominated foreign bonds originally sold in the U.K. none of the options

"Bulldog" bonds are A) B) C) D)

11)

A "bearer bond" is one that A) B) C) D)

shows the owner's name on the bond. the owner's name is recorded by the issuer. possession is evidence of ownership. shows the owner's name on the bond, and the owner's name is recorded by the

issuer.

12)

A "registered bond" is one that

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A) B) C) D)

shows the owner's name on the bond. the owner's name is recorded by the issuer. the owner's name is assigned to a bond serial number recorded by the issuer. all of the options

13) U.S. security regulations require Yankee bonds and U.S. corporate bonds sold to U.S. citizens to be A) B) C) D)

14)

municipal bonds. registered bonds. bearer bonds. none of the options

Eurobonds are usually A) B) C) D)

bearer bonds. registered bonds. bulldog bonds. foreign currency bonds.

15) Investors will generally accept a lower yield on __________ than on __________ of comparable terms, making them a less costly source of funds for the issuer to service. A) B) C) D)

16)

bearer bonds; registered bonds registered bonds; bearer bonds Eurobonds; domestic bonds domestic bonds; Eurobonds

With a bearer bond,

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A) B) C) D)

possession is evidence of ownership. the issuer keeps records indicating only who the current owner of a bond is. the owner's name is on the bond. the owner's name is assigned to the bond serial number, but not indicated on the

bond.

17)

Publicly traded Yankee bonds must A) B) C) D)

meet the same regulations as U.S. domestic bonds. meet the same regulations as Eurobonds if sold to Europeans. meet the same regulations as Samurai bonds if sold to Japanese. none of the options

18) Securities sold in the United States to public investors must be registered with the SEC, and a prospectus disclosing detailed financial information about the issuer must be provided and made available to prospective investors. This encourages foreign borrowers wishing to raise U.S. dollars to use A) B) C) D)

the Eurobond market. their domestic market. bearer bonds. none of the options

19) Because __________ do not have to meet national security regulations, name recognition of the issuer is an extremely important factor in being able to source funds in the international capital market. A) B) C) D)

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Eurobonds Foreign bonds Bearer bonds Registered bonds

20) The shorter length of time in bringing a Eurodollar bond issue to market, coupled with the lower rate of interest that borrowers pay for Eurodollar bond financing in comparison to Yankee bond financing, are two major reasons why the Eurobond segment of the international bond market is roughly __________ the size of the foreign bond segment. A) B) C) D)

21)

four times two times ten times one hundred times

The Eurobond segment of the international bond market

A) is roughly four times the size of the foreign bond segment. B) has considerably less regulatory hurdles than the foreign bond segment. C) typically has a lower rate of interest that borrowers pay in comparison to Yankee bond financing. D) all of the options

22)

U.S. corporations A) B) C) D)

23)

are allowed to issue bearer bonds to non-U.S. citizens. are not allowed to issue bearer bonds. are allowed to issue treasury bonds but not T-bills. none of the options

Shelf registration

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A) accounts for outstanding shares repurchased and "shelved" by the company. B) allows an issuer to preregister a securities issue, and then "shelve" the securities for later sale. C) allows an investment bank to increase the fees they charge by charging for storage of the "shelved" securities. D) eliminates the information disclosure that many foreign firms found objectionable in the foreign bond market.

24)

Which of the following statements regarding shelf registration is not true?

A) has eliminated the time delay in bringing a foreign bond issue to market in the United States. B) allows an issuer to preregister a securities issue, and then "shelve" the securities for later sale. C) has not eliminated the information disclosure that many foreign borrowers find too expensive. D) eliminates the information disclosure that many foreign firms found objectionable in the foreign bond market.

25)

Private placement bond issues A) do not have to meet the strict information disclosure requirements of publicly traded

issues. B) have auditing requirements that do not adhere to publicly traded issues. C) meet the strict information disclosure requirements of publicly traded issues, but have larger minimum denominations. D) none of the options

26)

In 1990, the SEC instituted Rule 144A which

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A) allows qualified institutional buyers in the U.S. to trade in private placement issues that do not have to meet the strict information disclosure requirements of publicly traded issues. B) was designed to make the U.S. capital markets more competitive with the Eurobond market. C) issues are non-registered and make only trade among qualified institutional buyers. D) all of the above.

27)

Global bond issues were first offered in A) B) C) D)

28)

Purchasers of global bonds are A) B) C) D)

29)

1889. 1989. 1999. 2007.

mainly institutional investors to date. desirous of the increased liquidity of the issues. have been willing to accept lower yields. all of the options

A "global bond" issue

A) is a very large international bond offering by several borrowers pooled together. B) is a very large international bond offering by a single borrower that is simultaneously sold in several national bond markets. C) has higher yields for the purchasers. D) has a lower liquidity.

30)

A global bond issue denominated in U.S. dollars and issued by U.S. corporations

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A) B) C) market. D)

31)

none of the options

Global bond issues A) B) C) D)

32)

trade as Eurobonds overseas. trade as domestic bonds in the U.S. domestic market. trade as Eurobonds overseas and trade as domestic bonds in the U.S. domestic

tend to be larger bond issues with worldwide marketability tend to have increased liquidity relative to Eurobonds or domestic bonds. have been partially facilitated by rule 144A. all of the options

In terms of the types of instruments offered,

A) market. B) C) D)

the Yankee bond market has been more innovative than the international bond the international bond market has been much more innovative than the U.S. market. the most innovations have come from Milan. none of the options

33) Find the present value of a 2-year Treasury bond that pays a semi-annual coupon, has a coupon rate of 6 percent, a yield to maturity of 5 percent, and a par value of $1,000. A) B) C) D)

$1,018.81 $1,231.15 $699.07 none of the options

34) Find the present value of a 3-year bond that pays an annual coupon, has a coupon rate of 6 percent, a yield to maturity of 5 percent, and a par value of €1,000. Version 1

A) B) C) D)

€1,018.81 €1,027.23 €1,099.96 none of the options

35) Find the present value of a 30-year bond that pays an annual coupon, has a coupon rate of 6 percent, a yield to maturity of 5 percent, and a par value of €1,000. A) B) C) D)

36)

The vast majority of new international bond offerings A) B) C) D)

37)

€1,018.81 €1,027.23 €1,153.72 none of the options

are straight fixed-rate notes. are callable and convertible. are convertible adjustable rate. are adjustable rate, with interest rate caps and collars.

The vast majority of new international bond offerings A) B) C) D)

make annual coupon payments. have fixed coupon payments. have a fixed maturity. all of the options

38) In contrast to many domestic bonds, which make __________ coupon payments, coupon interest on Eurobonds is typically paid __________.

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A) B) C) D)

39)

semiannual; annually annual; semiannually quarterly; semiannually quarterly; annually

Straight fixed-rate bond issues have

A) a designated maturity date at which the principal of the bond issue is promised to be repaid. During the life of the bond, fixed coupon payments, which are a percentage of the face value, are paid as interest to the bondholders. B) a designated maturity date at which the principal of the bond issue is promised to be repaid. During the life of the bond, coupon payments, which are indexed to some reference rate like LIBOR, are paid as interest to bondholders. C) a fixed payment, which amortizes the debt, like a house payment or car payment. D) none of the options

40)

The coupon interest on Eurobonds A) B) C) D)

41)

is paid annually. is paid in cash. is paid in arrears. all of the options

Eurobonds are usually A) B) C) D)

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registered bonds. bearer bonds. floating-rate, callable and convertible. denominated in the currency of the country that they are sold in.

42) Unlike a bond issue, in which the entire issue is brought to market at once, __________ is partially sold on a continuous basis through an issuance facility that allows the borrower to obtain funds only as needed on a flexible basis. A) B) C) D)

43)

a Euro-medium term note issue bearer bond a Euro-long term note issue a Euro-short term note issue

Euro-medium term notes

A) are typically fixed-rate corporate notes issued with maturities ranging from less than a year to about ten years. B) are typically fixed-rate corporate notes issued with maturities ranging from three years to about ten years. C) are sold just like bonds in the primary market. D) none of the options

44) Six-month U.S. dollar LIBOR is currently 4.25 percent; your firm issued floating-rate notes indexed to six-month U.S. dollar LIBOR plus 50 basis points. What is the amount of the next semi-annual coupon payment per U.S. $1,000 of face value? A) B) C) D)

45)

$43.75 $47.50 $23.75 $46.875

Floating-rate notes (FRN)

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A) experience very volatile price changes between reset dates. B) are typically medium-term bonds with coupon payments indexed to inflation only. C) appeal to investors with strong need to preserve the principal value of the investment;they have an appetite for interest rate risk. D) are typically medium-term bonds with coupon payments indexed to some reference rate (e.g., LIBOR), and appeal to investors with strong need to preserve the principal value of the investment should they need to liquidate prior to the maturity of the bonds.

46)

The first floating-rate notes (FRN) were introduced in A) B) C) D)

47)

On a reset date, floating-rate notes

A) B) C) declined. D)

48)

1970 1980 1985 1975

experience very volatile price changes. market price will always gravitate toward par. market price will usually gravitate toward par, unless the borrowers’ credit rating has none of the options

Floating-rate notes A) B) C) D)

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are a form of adjustable rate bond. have contractually specified coupon payments; therefore they are fixed-rate bonds. always trade at par value. are a form of adjustable rate bond and always trade at par value.

49) A five-year floating-rate note has coupons referenced to six-month dollar LIBOR, and pays coupon interest semiannually. Assume that the current six-month LIBOR is 6 percent. If the risk premium above LIBOR that the issuer must pay is 1/8 percent, the next period's coupon rate on a $1,000 face value FRN will be A) B) C) D)

$29.375 $30,000 $30.625 $61.250

50) Floating rate notes behave differently in response to interest rate risk than straight fixedrate bonds. A) True since FRNs experience only mild price changes between reset dates, over which time the next period's coupon payment is fixed (assuming, of course, that the reference rate corresponds to the market rate applicable to the issuer). B) False since all bonds experience an inverse price change of equal amount when the market rate of interest changes. C) all of the options D) none of the options

51) A ten-year floating-rate note (FRN) has coupons referenced to 3-month pound LIBOR, and pays coupon interest quarterly. Assume that the current 3-month LIBOR is 4 percent. If the risk premium above LIBOR that the issuer must pay is 1/8 percent, the next period's coupon payment on a £1,000 face value FRN will be A) B) C) D)

52)

£31.25. £82.50. £165.00. £41.25.

The floor value of a convertible bond

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A) B) C) D)

53)

There are two types of equity related bonds: A) B) C) D)

54)

is the "straight bond" value. is the conversion value. is the minimum of the "straight bond" value and the conversion value. is the maximum of the "straight bond" value and the conversion value.

convertible bonds and dual currency bonds. convertible bonds and kitchen sink bonds. convertible bonds and bonds with equity warrants. callable bonds and exchangeable bonds.

Bonds with equity warrants

A) are really the same as convertible bonds if the stated price of exercising the warrant is the par value of the bond. B) can be viewed as straight debt with a call option (technically a warrant) attached. C) can only be exercised on coupon dates. D) typically are convertible as well.

55) A convertible bond pays interest annually at a coupon rate of 5 percent on a par value of $1,000. The bond has 10 years maturity remaining and the discount rate on otherwise identical non-convertible debt is 6.5 percent. The bond is convertible into shares of common stock at a conversion price of $25 per share (i.e. the bond is exchangeable for 40 shares). Today's closing stock price was $20. What is the floor value of this bond? A) B) C) D)

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$800.00 $892.17 $1,250 none of the options

56) A convertible bond pays interest annually at a coupon rate of 5 percent on a par value of $1,000. The bond has 10 years maturity remaining and the discount rate on other-wise identical non-convertible debt is 5 percent. The bond is convertible into shares of common stock at a conversion price of $25 per share (i.e., the bond is exchangeable for 40 shares). Today's closing stock price was $31.25. What is the floor value of this bond? A) B) C) D)

$800.00 $1,000 $1,250 none of the options

57) Consider a bond with an equity warrant. The warrant entitles the bondholder to buy 25 shares of the issuer at €50 per share for the lifetime of the bond. The bond is a 30-year zero coupon bond with a €1,000 par value that has a yield to maturity of i€ = 5 percent. The price of the bond is €500. What is the value of the warrant? A) B) C) D)

€231.38 €268.62 €500 none of the options

58) A __________-__________ bond is a straight fixed-rate bond issued in one currency that pays coupon interest in that same currency, then at maturity, the principal is repaid in another currency. A) B) C) D)

dual-currency bonds with equity warrants warrant-convertible exchange-convertible

59) Find the price of a 30-year zero coupon bond with a €1,000 par value that has a yield to maturity of i€ = 5 percent.

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A) B) C) D)

€231.38 €432.20 €4,321.94 none of the options

60) Zero-coupon bonds issued in 2016 are due in 2026. If they were originally sold at 55 percent of face value, the implied yield to maturity at issuance is A) B) C) D)

61)

1.062 percent. 6.16 percent. 8.31 percent. cannot be determined, need more information.

Zero coupon bonds A) pay interest at zero percent. B) are sold at a discount from par value. C) are attractive to Japanese investors who are not required to pay taxes on capital

gains. D) pay interest at zero percent and are sold at a discount from par value.

62)

Zero coupon bonds A) B) C) D)

have no interest income. are sold at a premium to par value. give only capital gains income. have no interest income and give only capital gains income.

63) When the bond sells at par, the implicit €/$ exchange rate at maturity of a Euro/U.S. dollar dual currency bond that pays $651.25 at maturity per €1,000, is

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A) B) C) D)

€1.54/$1.00. €1.22/$1.00. €1.79/$1.00. €1/$1.00.

64) When the bond sells at par, the implicit SF/$ exchange rate at maturity of a Swiss franc/U.S. dollar dual currency bond that pays $581.40 at maturity per SF1,000, is A) B) C) D)

SF0.58/$1.00. SF1.58/$1.00. SF1.72/$1.00. SF1.95/$1.00.

65) Consider a British pound—U.S. dollar dual currency bonds that pay £581.40 at maturity per $1,000 of par value. If at maturity, the exchange rate is $1.80 = £1.00, A) you should insist on getting paid in dollars. B) it is an advantageous situation for investors holding this bond. C) it is a disadvantageous situation for the issuer of the bond. D) investors holding this bond are better off for the exchange rate and the issuer of the bond is worse off for the exchange rate.

66) Assuming that the bond sells at par, the implicit $/€ exchange rate at maturity of a Euro— U.S. dollar dual currency bond that pays €651.25 at maturity per $1,000 of par value is A) B) C) D)

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$1.72/€1.00. $1.54/€1.00. $1.27/€1.00. $1.62/€1.00.

67) Assuming that the bond sells at par, the implicit $/£ exchange rate at maturity of a British pound—U.S. dollar dual currency bond that pays £581.40 at maturity per $1,000 of par value is A) B) C) D)

$1.95/£1.00. $1.72/£1.00. $1.58/£1.00. $0.5814/£1.00.

68) Your firm has just issued five-year floating-rate notes indexed to six-month U.S. dollar LIBOR plus 1/4 percent. What is the amount of the first semi-annual coupon payment your firm will pay per U.S. $1,000 of face value, if six-month LIBOR is currently 7.2 percent? A) B) C) D)

69)

$36.00 $37.25 $74.50 none of the options

Which of the following is not one of the five main sovereign rating factors? A) B) C) D)

Religiosity assessment Institutional assessment Economic assessment Monetary assessment

70) Which of the following best reflects a country’s ability to obtain funds from abroad necessary to meet its public- and private-sector obligations to nonresidents? A) B) C) D)

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Fiscal assessment External assessment Monetary assessment Institutional assessment

71)

The fiscal assessment considers A) B) C) D)

72)

fiscal flexibility. long-term fiscal trends and vulnerabilities. debt structure. all of the options

Which of the following factors is not considered in the fiscal assessment? A) B) C) D)

Equity structure Fiscal flexibility Debt structure Funding access

73) The extent to which a sovereign’s monetary authority can fulfill its mandate while supporting sustainable economic growth and attenuating major economic or financial shocks is best described as the A) B) C) D)

external assessment. monetary assessment. institutional assessment. fiscal assessment.

74) A potentially significant factor in slowing or preventing a deterioration of sovereign creditworthiness in times of stress is (are) A) B) C) D)

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stringent monetary policy. flexible monetary policy. large credit lines. liquid assets.

75) What type of economies tend to produce higher wealth levels because they enable more efficient allocation of resources to promote sustainable, long-term economic growth? A) B) C) D)

Centrally planned Command Market-oriented none of the options

76) Which of the following reflects the sustainability of a sovereign’s deficits and debt burden? A) B) C) D)

77)

"Investment grade" ratings are in these categories. A) B) C) D)

78)

Institutional assessment External assessment Fiscal assessment Monetary assessment

Moody's: AAA to BBB and S&P Global Ratings: Aaa to Baa Moody's: Aaa to Baa and S&P Global Ratings: AAA to BBB Moody's: AAA to A and S&P Global Ratings: Aaa to A Moody's: Aaa to A and S&P Global Ratings: AAA to A

S&P Global Ratings has, for years, provided credit ratings on international bonds.

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A) The ratings reflect the safety of principal for a U.S. investor. B) Their ratings reflect the creditworthiness of the borrower and not exchange rate uncertainty. C) Their ratings reflect creditworthiness of the lender and predict the exchange rate expected to prevail at maturity. D) The ratings are biased since 40 percent of Eurobond issues are rated AAA and 30 percent are AA.

79) A disproportionate share of Eurobonds have high credit ratings in comparison to domestic and foreign bonds. (Approximately 40 percent of Eurobond issues are rated AAA and 30 percent are AA). Explanations for this include A) the issuers receiving low credit ratings invoke their publication rights and have had them withdrawn prior to dissemination. B) the Eurobond market is accessible only to firms that have good credit ratings and name recognition to begin with; hence, they are rated highly. C) there is "grade inflation" on the part of the bond rating agencies which are paid by the issuers and have to compete for business. D) Both A and B

80)

The credit rating of an international borrower

A) depends on the volatility of the exchange rate. B) depends on the volatility, but not absolute level, of the exchange rate. C) is usually never higher than the rating assigned to the sovereign government of the country in which it resides. D) is unrelated to the rating assigned to the sovereign government of the country in which it resides.

81)

Investors in corporate bonds would still be interested in sovereign credit ratings

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A) because the sovereign credit rating usually represents a ceiling on corporate credit ratings within that country. B) because they might play the TED spread. C) because they are the rating assigned by the country's regulators. D) none of the options

82) One of the five main sovereign rating factors, institutional assessment, comprises an analysis of how a government’s institutions and policymaking affect a sovereign’s credit fundamentals by A) B) C) D)

83)

delivering sustainable public finances. promoting balanced economic growth. responding to economic or political shocks. all of the options

The key driver of a sovereign’s economic assessment is A) B) C) D)

income levels. growth prospects. economic diversity and volatility. all of the options

84) In any year, the Eurobond segment of the international bond market accounts for approximately what percent of new bond offering? A) B) C) D)

85)

10 percent 25 percent 50 percent 80 percent

The underwriting syndicate of a bond offering is

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A) a group of investment banks, merchant banks, and the merchant banking arms of commercial banks that agree to buy the bond from the issuer and then resell it. B) a group of investment fund managers, brokers, and dealers who specialize in the secondary bond market. C) a group of investment banks, merchant banks, and the merchant banking arms of commercial banks that specialize in some phase of a public issuance. D) none of the options

86)

The lead manager will sometimes invite co-managers to form a managing group to: A) B) C) D)

help negotiate terms with the borrower ascertain market conditions manage the issuance all of the options

87) Underwriters for an international bond issue will commit their own capital to buy the issue from the borrower at a discount from the issue price. The discount, or underwriting spread, is typically A) B) C) D)

in the 1 to 1.5 percent range. in the 2 to 2.5 percent range. in the 3 to 3.5 percent range. in the 4 to 4.5 percent range.

88) Underwriters for a domestic bond issue will commit their own capital to buy the issue from the borrower at a discount from the issue price. The discount, or underwriting spread, is typically A) B) C) D)

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in the 1 to 1.5 percent range. in the 2 to 2.5 percent range. in the 3 to 3.5 percent range. in the 4 to 4.5 percent range.

89)

The role of an underwriter is to A) B) C) D)

90)

help negotiate terms with the borrower. ascertain market conditions. manage the issuance. all of the options

The secondary market for Eurobonds A) B) C) D)

is an over-the-counter market. is an organized exchange. has never developed—there is only a primary market for Eurobonds. none of the options

91) Eurobond market makers and dealers are members of the __________, a self-regulatory body based in Zurich. A) B) C) D)

92) true?

International Currency Market Association (ICMA) International Bond Marketers Association (IBMA) International Bond Regulators Association (IBRA) International Capital Market Association (ICMA)

In the bond market, there are brokers and market makers. Which of the following are

A) Brokers accept buy or sell orders from market makers and then attempt to find a matching party for the other side of the trade; they may also trade for their own account. B) Brokers charge a small commission for their services to the market maker that engaged them. C) Brokers do not deal directly with retail clients. D) all of the options

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93)

Market makers in the secondary bond market A) B) C) D)

94)

stand ready to buy or sell for their own account. quote bid and ask spreads. trade directly with one another, through a broker or with retail customers. all of the options

With regard to clearing procedures for bond transactions A) B) C) D)

it is a system for transferring ownership of bonds. it is a system for ensuring payment from buyers to sellers. most Eurobond trades clear through two major clearing systems. all of the options

95) With regard to clearing procedures for bond transactions, when a transaction is conducted, electronic book entries are made that transfer book ownership of the bond certificates from the seller to the buyer and transfer funds from the purchaser's cash account to the seller's. However, A) physical transfer of the bonds seldom takes place. B) the physical transfer of the bonds takes place as much as 3 days later. C) the physical transfer of the bonds takes place as much as 6 weeks later. D) the physical transfer of bonds only occurs if the depository banks that physically store bond certificates are different for the buyer and seller.

96)

Two major clearing systems for international bond transactions are A) B) C) D)

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Euroclear and Clearstream International. Euroclear and Clearasil. Deutsche Börse Clearing and Cedel International. none of the options

97)

A bond market index A) is a reference rate, like LIBOR, that adjustable rate bonds use to set the coupon. B) is analogous to a stock market index, but with bond price data instead of stock price

data. C) represents a price-weighted average of all bonds that exist. D) none of the options

98) The J. P. Morgan and Company Global Government Bond Index is __________ representation of the individual country government bond indexes. A) B) C) D)

a value weighted a price weighted an unweighted none of the options

99) The Wall Street Journal publishes daily values of yields to maturity for Japanese, German, British, and Canadian Government bonds. A) Bond market participants can thereby compare the yield curve of the various countries. B) Bond market participants can thereby compare the term structure of interest rates of the various countries. C) Both A and B are correct. D) none of the options

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Answer Key Test name: Chap 12_9e 1) TRUE 2) A 3) D 4) D 5) D 6) A 7) A 8) B 9) B 10) C 11) C 12) D 13) B 14) A 15) A 16) A 17) A 18) A 19) A 20) A 21) D 22) A 23) B 24) D 25) A 26) A Version 1

27) B 28) D 29) B 30) C 31) D 32) B 33) A 34) B 35) C 36) A 37) D 38) A 39) A 40) A 41) B 42) A 43) A 44) C 45) D 46) A 47) C 48) A 49) C 50) A 51) D 52) D 53) C 54) B 55) B 56) C Version 1

57) A 58) A 59) A 60) B 61) D 62) D 63) A 64) C 65) D 66) B 67) B 68) B 69) A 70) B 71) D 72) A 73) B 74) B 75) C 76) C 77) B 78) B 79) D 80) C 81) A 82) D 83) D 84) D 85) C 86) D Version 1

87) B 88) A 89) D 90) A 91) D 92) D 93) D 94) D 95) A 96) A 97) B 98) A 99) C

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CHAPTER 13 TRUE/FALSE - Write 'T' if the statement is true and 'F' if the statement is false. 1) In a dealer market, the broker takes the trade through the dealer, who participates in trades as a principal by buying and selling the security for his own account. ⊚ ⊚

true false

Public traders do not trade directly with one another in a dealer market. ⊚ ⊚

true false

MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 3) The sale of new common stock by corporations to initial investors occurs in A) B) C) D)

The sale of previously issued common stock traded between investors occurs in A) B) C) D)

the primary market. the secondary market. the OTC market. the dealer market.

the primary market. the secondary market. the on-the-run market. the dealer market.

A "primary" stock market is

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A) B) C) D)

a big internationally-important market like the NYSE. a market where corporations issue new shares to investors. where brokers and market makers trade. none of the options

6) During the 1980s, cross-border equity investment was largely confined to the equity markets of A) B) C) D)

developing countries. developed countries. both developing and developed countries. none of the options

Investment in foreign equity markets became common practice in the A) B) C) D)

1960s. 1970s. 1980s. none of the options

8) Only in the ________ did world investors start to invest sizable amounts in the emerging equity markets. A) B) C) D)

1970s 1980s 1990s none of the options

9) Investment in foreign equity markets became common practice in the 1980s as investors became aware of the benefits of

Version 1

A) B) C) D)

international portfolio diversification. debt forgiveness. international portfolio diversification and debt forgiveness. none of the options

10) Only in the 1990s did world investors start to invest sizable amounts in the emerging equity markets, as A) B) C) D)

the economic growth and prospects of the developing countries improved. the economic growth and prospects of the developing countries declined. the economic growth and prospects of the developed countries stagnated. none of the options

11) At year-end 2018, total market capitalization of 80 organized stock exchanges tracked by the World Federation of Exchanges stood at A) B) C) D)

$74,667 billion. $74,667 trillion. $67,125 billion. $67,125 trillion.

12) Total market capitalization for exchanges increased by about ________ percent over 2014 to 2018. A) B) C) D)

13)

10 20 30 40

Which investment is likely to be the most liquid?

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A) B) C) D)

14)

Which investment is likely to be the least liquid? A) B) C) D)

15)

A share of a publicly traded company trading on the NYSE. A bond issued by a Fortune 500 company. A house in a expensive part of town. A painting by Picasso.

A share of publicly traded company trading on the NYSE. A bond issued by a Fortune 500 company. A house in an expensive part of town. An exchange-traded fund that invests in commodities such as precious metals.

A liquid stock market

A) is one in which prices reflect all relevant information quickly. B) is one in which prices reflect all publicly available information quickly. C) is one in which prices reflect price and volume information quickly. D) is one in which investors can buy and sell stocks quickly at close to the current quoted prices.

16)

A measure of liquidity for a stock market is the turnover ratio; defined as

A) the ratio of stock market transactions over a period of time divided by the size, or market capitalization, of the stock market. B) the ratio the size, or market capitalization, of the stock market divided by the value of the stock market transactions over a period of time. C) the ratio of aggregate company sales over a period of time divided by the size, or market capitalization, of the stock market. D) none of the options

17)

Generally, the higher the turnover ratio,

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A) B) C) D)

the less liquid the secondary stock market, indicating ease in trading. the more liquid the secondary stock market, indicating ease in trading. the more liquid the primary stock market, indicating ease in trading. the more efficient the stock market is.

18) The turnover velocity percentages for 74 of the stock exchanges for 2018 were measured. Over 40 percent of the exchanges, in most years, had in excess of A) B) C) D)

19)

Relatively low turnover ratios indicate A) B) C) D)

20)

15 percent turnover per month. 25 percent turnover per month. 30 percent turnover per month. 75 percent turnover per month.

poor liquidity. good liquidity. strong investment performance. low market concentration.

A measure of "liquidity" for a stock market is

A) the times interest earned ratio. B) the ratio of stock market transactions over a period of time divided by the size, or market capitalization, of the stock market. C) the LIBOR rate. D) the ratio of the market capitalization of the largest ten companies divided by the total market capitalization.

21)

As a measure of liquidity,

Version 1

A) market. B) market. C) D)

22)

the less liquid the secondary stock market, indicating difficulty in trading. the more liquid the secondary stock market, indicating difficulty in trading. the more liquid the primary stock market, indicating difficulty in trading. the more efficient the stock market is.

have poor liquidity at present. are very liquid stock markets. have fairly high turnover ratios indicating strong liquidity. none of the options

In general, if an investment A) B) C) D)

25)

the more a financial asset gurgles when shook the greater the liquidity. none of the options

Many of the small foreign equity markets (e.g., Argentina, Sri Lanka) A) B) C) D)

24)

generally, the higher the turnover, the greater the liquidity of a secondary stock

Generally, the lower the turnover ratio, A) B) C) D)

23)

generally, the lower the turnover, the greater the liquidity of a secondary stock

has poor liquidity, it should offer investors a liquidity premium. can be sold fairly quickly at a fair price, it has good liquidity. both of the options none of the options

Many of the larger emerging equity markets (e.g., China, India)

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A) B) C) D)

26)

In which type of market can liquidity "dry up"? A) B) C) D)

27)

A bull market A bear market A speculative bubble A financial panic

In which type of policy actions by the Fed can liquidity "dry up"? A) B) C) D)

28)

have poor liquidity at present. are more liquid stock markets than the developed world. have high turnover ratios. none of the options

Easy money Tight money Decrease in the reserve requirement Decrease in the discount rate

Fair prices for existing issues is established in the secondary market due to A) B) C) D)

competitive trading between buyers and sellers. decreased trading activity between buyers and sellers. destructive competition between buyers and sellers. none of the options

29) A limit order is an order away from the market price that is held in a ________ until it can be executed at the desired price.

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A) B) C) D)

30)

Over-the-counter stocks are generally A) B) C) D)

31)

agency markets only. auction markets only. both agency/auction markets. none of the options

The first automated national stock market was the A) B) C) D)

33)

unlisted stocks. listed stocks. traded at a discount due to their high risk. none of the options

The exchange markets in the U.S. are A) B) C) D)

32)

continuous order book limit order book dealer book none of the options

NASDAQ. TMX. AMEX. none of the options

The secondary stock markets

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A) B) C) D)

34)

Price discovery in the secondary stock markets A) B) C) D)

35)

are the markets for "pre-owned" or "used" shares of stock. provide marketability to shares. provide price discovery or share valuation. all of the options

occurs due to the competitive trading between buyers and sellers, just like on eBay. is set once a day at the close. is set by the investment bankers at the IPO. all of the options

A market order

A) is an instruction from a customer to a broker to buy or sell at the best price available when the order is received (immediately). B) is an instruction from a customer to a broker to buy or sell in a particular market (e.g., NYSE). C) is always and everywhere "fill-or-kill." D) is always and everywhere "good-till-cancelled."

36)

A limit order A) is an instruction from a customer to a broker to buy or sell in at a particular price (or

better). B) can be a "day order"—that is the order is cancelled if not executed during that day's trading. C) can be "good-till-cancelled." D) all of the options

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37) A stop-limit order is an order to buy or sell a stock that combines the features of a stop order and a limit order. Once the stop price is touched in the market, the stop-limit order becomes a limit order to buy or to sell at the limit price. Which of the following are true? A) The benefit of a stop-limit order is that the investor can control the price at which the trade will get executed. B) A stop-limit order may never get filled if the stock's price never reaches the specified limit price. C) The use of stop limit orders is much more frequent for stocks that trade on an exchange than in the over-the-counter (OTC) market. D) all of the options

38)

Which of the following are true?

A) Unless you give your broker specific instructions to the contrary, orders to buy or sell a stock are day orders. B) Orders that have been placed but not executed during regular trading hours will automatically carry over into after-hours trading but not the next regular trading day. C) Day orders placed during after-hours trading will automatically carry over into the next regular trading day. D) If your order is not executed during a trading session, you are not allowed to place a new order in the next trading session.

39) A stop order is an order to buy or sell a stock once the price of the stock reaches a specified price, known as the stop price. When the specified price is reached, your stop order becomes A) B) C) D)

a market order. a good-till-cancelled (GTC) order. a day order. none of the options

40) To avoid buying a stock at a price higher than you intend, you need to place ________ rather than a market order. Version 1

A) B) C) D)

a stop-loss order a day order a good-till-cancelled order a limit order

41) A stop order is an order to buy or sell a stock once the price of the stock reaches a specified price, known as A) B) C) D)

42)

the stop price. the limit price. the last price. the sell price

The advantages of a market order include the fact that

A) since you are not guaranteed the order will be fulfilled, the price is typically discounted. B) since there is a high probability that the market order will not be executed. C) market orders increase your liquidity. D) you are pretty much guaranteed that your order will be executed, and a market order typically has lower commissions than a limit order.

43)

Dealers in an OTC market A) B) C) D)

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stand ready to buy at the bid and sell at the ask price. set their own bid and ask prices. do not charge commissions. all of the options

44) A stop order is an order to buy or sell a stock once the price of the stock reaches a specified price, known as the stop price. When the specified price is reached, your stop order becomes a market order. The advantage of a stop order is that A) you don't have to monitor how a stock is performing on a daily basis. B) the stop price can be activated by a short-term fluctuation in a stock's price. C) once your stop price is reached, your stop order becomes a market order and the price you receive may be much different from the stop price, especially in a fast-moving market where stock prices can change rapidly. D) all of the options

45)

The OTC market A) B) C) D)

46)

A "specialist" A) B) C) D)

47)

does not accept credit—the dealers "only take cash." is a dealer market. includes the NASDAQ in the U.S. is a dealer market and includes the NASDAQ in the U.S.

makes a market by holding an inventory of a particular security, like IBM or Intel. is a participant on the floor of the exchange, like the NYSE. has a designated station on the floor of the exchange. all of the options

A crowd of floor traders on the NYSE

A) may arrive at a more favorable price for their clients "inside" the specialist's bid and ask quotes. B) are obliged to execute their trades through a specialist. C) are allowed to "front run" their own trades ahead of customer trades. D) all of the options

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48)

A specialist on the NYSE

A) is obliged to fill limit orders if they are more favorable than the specialist's posted bid and ask quotes. B) is obliged to fill limit orders at the specialist's posted bid and ask quotes. C) is actually a computer program, not a human. D) is obliged to fill limit orders if they are more favorable than the specialist's posted bid and ask quotes, and is actually a computer program, not a human.

49)

A "call market"

A) is OTC and over-the-phone. B) features an agent of the exchange that accumulates a batch of orders that are periodically executed by written or verbal auction throughout the day. C) provides traders with execution at certain prices. D) features an agent of the exchange that accumulates a batch of orders that are periodically executed by written or verbal auction throughout the day and provides traders with execution at certain prices.

50)

The Toronto Stock exchange A) B) C) D)

is a fully automated. features electronic matching of public orders. has continuous order flow. all of the options

51) In an agency market, the broker takes the client's order through the agent, who matches it with another public order. The agent can be viewed as

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A) B) C) D)

a dealer. a specialist. a broker's broker. none of the options

52) In an agency market, the broker takes the client's order through the agent, who matches it with another public order. Names for the agent are A) B) C) D)

official broker. central broker. a broker's broker. all of the options

53) The Paris Bourse was traditionally a call market. In a call market, an agent of the exchange accumulates, over a period of time, a batch of orders that are periodically executed by written or verbal auction throughout the trading day. Both market and limit orders are handled in this way. The major disadvantage of a call market is that A) traders are not certain about the price at which their orders will transact because bid and ask quotations are not available prior to the call. B) traders are not certain about how many shares will be able to sell or buy at the price they quote because order volume is not available prior to the call. C) there is a lack of liquidity inter call. D) none of the options

54)

A type of non-continuous exchange trading system is crowd trading.

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A) Unlike a call market in which there is a common price for all trades, several bilateral trades may take place at different prices in crowd trading. B) Unlike a continuous market in which there is a common price for all trades, several bilateral trades may take place at different prices. C) Unlike a call market in which several bilateral trades may take place at different prices there is a common price for all trades in a call market. D) none of the options

55)

Which type of trading system is desirable for actively traded issues? A) B) C) D)

Continuous trading systems Call trading systems Crowd trading systems none of the options

56) Call markets and crowd trading offer advantages for ________ because they mitigate the possibility of sparse order flow over short time periods. A) B) C) D)

thinly traded issues actively traded issues stocks but not bonds none of the options

57) The over-the-counter (OTC) market is a dealer market. Almost all OTC stocks trade on the National Association of Security Dealers Automated Quotation System (NASDAQ), which is a computer-linked system that shows A) B) C) D)

Version 1

the limit orders of all available counterparties. the last price at which a security was sold. the bid (buy) and ask (sell) prices of all dealers in a security. the bid (sell) and ask (buy) prices of all dealers in a security.

58) On the NYSE, limit order prices receive preference in establishing the posted bid and ask prices if they are more favorable than the specialist's. Therefore, A) a specialist must fill a limit order, if possible, from his own account before trading the flow of public orders. B) specialists must fill a limit order, if possible, from the flow of public orders before trading for his own account. C) a specialist must change his posted bid and ask prices to reflect the available limit orders. D) none of the options

59)

The large exchange markets in the United States are A) B) C) D)

60)

"Call market" and "crowd trading" take place on A) B) C) D)

61)

agency markets. call markets. auction markets. agency/auction markets.

a non-continuous exchange trading system. a continuous trading exchange system. non-continuous markets and continuous markets, respectively. continuous markets and non-continuous markets, respectively.

On September 22, 2000, Euronext was formed as a result of a merger of the A) B) C) D)

Version 1

Amsterdam Exchanges Brussels Exchanges Paris Bourse All of the options

62) In June 2001, the ________ merged with Euronext, and Dublin followed suit acquiring the ________ in March 2018 A) B) C) D)

63)

Amsterdam Exchanges; Brussels Exchanges Brussels Exchanges; Paris Bourse Lisbon Stock Exchange; Irish Stock Exchange none of the options

A market-value index

A) is calculated such that the proportion of the index a stock represents is determined by its proportion of the total market capitalization of all stocks in the index. B) is calculated as the average price of all the stocks in the index that trade that day, one example is the NASDAQ. C) is calculated like the DJIA. D) none of the options

64) Transactions in shares of the iShares Funds will typically generate tax consequences. This is because A) B) C) D)

65)

iShares Funds are obliged to distribute portfolio gains to shareholders. iShares Funds are not allowed to be held in tax-qualified accounts such as IRAs. iShares Funds feature daily resettlement. none of the options

iShares MSCI are

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A) exchange traded funds that are subject to U.S. SEC and IRS diversification requirements. B) open-end mutual funds sold OTC. C) exchange traded funds that are NOT subject to U.S. SEC and IRS diversification requirements. D) none of the options

66)

A firm may cross-list its share to

A) establish a broader investor base for its stock. B) establish name recognition in foreign capital markets, thus paving the way for the firm to source new equity and debt capital from investors in different markets. C) expose the firm's name to a broader investor and consumer groups. D) all of the options

67)

Which of the following statements regarding cross-listing is not true?

A) Cross-listing provides a means for expanding the firms base for an investor’s stock. B) Cross-listing establishes name recognition of the company in a new capital market C) Cross-listing mitigates the possibility of a hostile takeover of the firm through the broader investor base created for the firm’s shares. D) none of the options

68) Stock in Daimler AG, the famous German automobile manufacturer trades on both the Frankfurt Stock Exchange in Germany and on the New York Stock Exchange. On the Frankfurt bourse, Daimler closed at a price of €54.34 on Wednesday, March 5, 2008. On the same day, Daimler closed in New York at $83.55 per share. To prevent arbitrage trading between the two exchanges, the shares should trade at the same price when adjusted for the exchange rate. The $/€ exchange rate on March 5 was $1.5203/€1.00. Thus, €54.34 × $1.5203/€ = $82.61, while the closing price in New York was $83.55. The difference is easily explainable by the fact that

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A) transactions costs exceeded the price difference, so no arbitrage was possible even for market makers. B) no one noticed the arbitrage that day, but in a day or so the opening price will adjust. C) the New York market closes several hours after the Frankfurt exchange, and thus market prices or exchange rates had changed slightly. D) none of the options

69) Companies domiciled in countries with weak investor protection can reduce agency costs between shareholders and management A) B) C) D)

70)

by moving to a better country. by listing their stocks in countries with strong investor protection. by voluntarily complying with the provisions of the U.S. Sarbanes-Oxley Act. by having a press conference and promising to be nice to their investors.

Advantages of cross-listing include

A) providing their shareholders with a higher degree of protection than may be available in the home country. B) a possible signal of the company's commitment to shareholder rights. C) possibly making investors, both at home and abroad, more willing to provide capital and to increase the value of the pre-existing shares. D) all of the options

71)

"Yankee" stock offerings are A) B) C) D)

shares in foreign companies originally sold to U.S. investors. dollar-denominated shares in foreign companies originally sold to U.S. investors. U.S. stocks held abroad. none of the options

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72)

Following the monetary union and the advent of the euro:

A) The countries of the European Union have enacted common securities regulation. B) A pan-European stock exchange has developed in London, similar to the NYSE in scope and trading practices. C) Development of a common securities regulations, even among the countries of the European Union, has not yet occurred. D) none of the options

73)

The European Stock Exchange, comparable in volume to the NYSE A) B) C) D)

is located in Milan. is located in London. is located in Frankfurt. none of the options

74) The first ADRs began trading ________ as a means of eliminating some of the risks, delays, inconveniences, and expenses of trading the actual shares. A) B) C) D)

75)

in 1997 in 1987 in 2017 in 1927

American Depository Receipt (ADRs) represent foreign stocks A) B) C) D)

Version 1

denominated in U.S. dollars that trade on European stock exchanges. denominated in U.S. dollars that trade on a U.S. stock exchange. denominated in a foreign currency that trade on a U.S. stock exchange. non-registered (bearer) securities.

76) At the end of 2018, there were how many DR programs representing issuers from around the world trading on the world’s exchanges according to the DR market review by BNY Mellon? A) B) C) D)

77)

3,049 40,390 34,090 4,309,000

Yankee stocks

A) never trade as ADRs and have higher risks than trading the actual shares. B) often trade as ADRs and have lower risks than trading the actual shares. C) are bank receipts representing a multiple of foreign shares deposited in a U.S. bank. D) often trade as ADRs, have lower risks than trading the actual shares, and are bank receipts representing a multiple of domestic shares deposited in a foreign bank.

78)

ADRs A) B) C) D)

79)

are American Depository Receipts. are denominated in U.S. dollars and may trade on a U.S. stock exchange. are depository receipts for foreign stocks held by the U.S. depository's custodian. all of the options

Sponsored ADRs

A) are created by a bank at the request of the foreign company that issued the underlying security. B) can trade on the NASDAQ. C) can trade on the NYSE. D) all of the options

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80)

ADR trades

A) clear in three days, just like trades in U.S. shares. B) settle only after the trade in the underlying stocks clear, which can take time depending on the clearing practices of the national market. C) are priced in the currency of the underlying security. D) all of the options

81) On the Paris bourse, shares of Avionelle trade at €45. The spot exchange rate is $1.40 = €1.00. What is the no-arbitrage U.S. dollar price of an Avionelle ADR? Assume that transactions costs are negligible and that one ADR represent one underlying share. A) B) C) D)

$63.00 $32.14 $45.00 $45.50

82) In the London market, Rolls-Royce stock closed at £0.875 per share. On the same day, the British Pound sterling to the U.S. dollar spot exchange rate was £0.6366/$1.00. Rolls Royce trades as an ADR in the OTC market in the United States. Five underlying Rolls-Royce shares are packaged into one ADR. The no-arbitrage U.S. price of one ADR is A) B) C) D)

83)

$4.87. $5.87. $6.87. $7.87.

ADRs

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A) B) C) D)

frequently represent a multiple of the underlying shares. can trade on the NYSE. can trade on the NASDAQ. all of the options

84) In the London market, Rolls-Royce stock closed at £0.875 per share. On the same day, the British Pound sterling to the U.S. dollar spot exchange rate was £0.6366/$1.00. Rolls Royce trades as an ADR in the OTC market in the United States. Five underlying Rolls-Royce shares are packaged into one ADR. If the Rolls Royce ADRs were trading at $5.75 when the underlying shares were trading in London at £0.875, ignoring transaction costs, the arbitrage trading profit would be A) B) C) D)

$0.00. $1.12. $2.12. $3.12.

85) In the Frankfurt market, Aldi stock closed at €5 per share. On the same day, the euro-U.S. dollar spot exchange rate was €.625/$1.00. Aldi trades as an ADR in the OTC market in the United States. Five underlying Aldi shares are packaged into one ADR. The no-arbitrage U.S. price of one ADR is A) B) C) D)

86)

€25.00. $15.63. $40.00. none of the options

Global Registered Shares

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A) are created when a MNC issues shares globally. B) purchased on one exchange (say NYSE) is fully fungible with shares purchased on another exchange (e.g., Frankfurt Stock Exchange). C) can trade in multiple currencies. D) all of the options

87)

Factors affecting international equity returns are A) B) C) D)

88)

Cross-correlations among major stock markets are A) B) C) D)

89)

relatively high. relatively low. essentially perfect. practically zero.

Macroeconomic factors affecting international equity returns include A) B) C) D)

90)

macroeconomic variables that influence the overall economy. exchange rate changes. the industrial structure of the country. all of the options

exchange rate changes. interest rate differentials. changes in inflationary expectations. all of the options

Changes in exchange rates

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A) indexes. B) C) D)

91)

explain a larger portion of the variability foreign bond indexes than foreign equity do not affect all foreign equity markets equally. affect dollar-denominated foreign equity returns, but this risk can be hedged. all of the options

A common set of factors that affect equity returns include

A) macroeconomic variables that influence the overall economic environment in which the firm issuing the security conducts its business. B) exchange rate changes between the currency of the country issuing the stock and the currency of other countries where suppliers, customers, and investors of the firm reside. C) the industrial structure of the country in which the firm operates. D) all of the options

92) Solnik (1984) examined the effect of exchange rate changes, interest rate differentials, the level of the domestic interest rate, and changes in domestic inflation expectations. He found that A) international monetary variables had only weak influence on equity returns in comparison to domestic variables. B) international monetary variables had a stronger influence on equity returns in comparison to domestic variables. C) international monetary variables had no influence at all on equity returns. D) none of the options

93) Adler and Simon (1986) examined the exposure of a sample of foreign equity and bond index returns to exchange rate changes. They found that

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A) changes in exchange rates generally explained a smaller portion of the variability of foreign bond indexes than foreign equity indexes. B) changes in exchange rates generally explained none of the variability of foreign bond indexes but completely explained the variability in foreign equity indexes. C) changes in exchange rates generally explained a larger portion of the variability of foreign equity indexes than foreign bond indexes. D) changes in exchange rates generally explained a larger portion of the variability of foreign bond indexes than foreign equity indexes.

94)

Studies examining the influence of industrial structure on foreign equity returns A) B) C) D)

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conclusively show a connection. have been inconclusive. show that industrialized economies outperform lesser developed economies. none of the options

Answer Key Test name: Chap 13_9e 1) TRUE 2) TRUE 3) A 4) B 5) B 6) B 7) C 8) C 9) A 10) A 11) A 12) A 13) A 14) C 15) D 16) A 17) B 18) C 19) A 20) B 21) B 22) A 23) A 24) C 25) C 26) D Version 1

27) B 28) A 29) B 30) A 31) C 32) B 33) D 34) A 35) A 36) D 37) D 38) A 39) A 40) D 41) A 42) D 43) D 44) A 45) D 46) D 47) A 48) A 49) B 50) D 51) C 52) D 53) A 54) A 55) A 56) A Version 1

57) C 58) B 59) D 60) A 61) D 62) C 63) A 64) A 65) A 66) D 67) A 68) C 69) B 70) D 71) B 72) C 73) D 74) D 75) B 76) A 77) D 78) D 79) D 80) A 81) A 82) C 83) D 84) B 85) C 86) D Version 1

87) D 88) B 89) D 90) D 91) D 92) A 93) D 94) B

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CHAPTER 14 TRUE/FALSE - Write 'T' if the statement is true and 'F' if the statement is false. 1) The size of the swap market is measured by notational principal, a reference amount of principal for determining interest payments. ⊚ ⊚

true false

MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 2) The term interest rate swap A) refers to a "single-currency interest rate swap" shortened to "interest rate swap." B) involves "counterparties" who make a contractual agreement to exchange cash flows at periodic intervals. C) can be "fixed-for-floating rate" or "floating-for-floating rate." D) all of the options

3) are:

Examples of "single-currency interest rate swap" and "cross-currency interest rate swap"

A) fixed-for-floating rate interest rate swap, where one counterparty exchanges the interest payments of a floating-rate debt obligations for fixed-rate interest payments of the other counter party. B) fixed-for-fixed rate debt service (currency swap), where one counterparty exchanges the debt service obligations of a bond denominated in one currency for the debt service obligations of the other counterparty denominated in another currency. C) Both A and B D) none of the options

The primary reasons for a counterparty to use a currency swap are

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A) to hedge and to speculate. B) to play in the futures and forward markets. C) to obtain debt financing in the swapped currency at an interest cost reduction brought about through comparative advantages each counterparty has in its national capital market, and the benefit of hedging long-run exchange rate exposure. D) to hedge and to speculate, as well as to play in the futures and forward markets.

The size of the currency swap market (at year-end 2018) is A) B) C) D)

immeasurable. over 24 billion dollars. measured by notational principal and over 24 trillion dollars. none of the options

6) Which combination of the following statements is true about a swap bank?(i) it is a generic term to describe a financial institution that facilitates swaps between counterparties(ii) it can be an international commercial bank(iii) it can be an investment bank(iv) it can be a merchant bank(v) it can be an independent operator A) B) C) D)

(i) and (ii) (i), (ii) and (iii) (i), (ii), (iii) and (iv) (i), (ii), (iii), (iv) and (v)

A swap bank

A) can act as a broker, standing ready to buy and sell swaps. B) can act as a dealer, bringing together counterparties to a swap. C) can act as a broker, bringing together counterparties to a swap, and/or as a dealer, standing ready to buy and sell swaps. D) only sometimes acts as a broker, bringing together counterparties to a swap, but never ever acts as a dealer, standing ready to buy and sell swaps.

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In the swap market, which position potentially carries greater risks, broker or dealer? A) B) C) D)

Broker Dealer They are the same swaps, therefore the same risks. none of the options

Which of the following statements regarding the swap bank are not true?

A) As a broker, the swap bank matches counterparties but does not assume any risk of the swap. B) Today’s swap banks serve as dealers or market makers. C) A swap bank can be an international commercial bank, an investment bank, a merchant bank, or an independent operator. D) none of the options

10) Suppose the quote for a five-year swap with semiannual payments is 8.50–8.60 percent. This means A) the swap bank will pay semiannual fixed-rate dollar payments of 8.60 percent against receiving six-month dollar LIBOR. B) the swap bank will receive semiannual fixed-rate dollar payments of 8.50 percent against paying six-month dollar LIBOR. C) the swap bank will pay semiannual fixed-rate dollar payments of 8.50 percent against receiving six-month dollar LIBOR, and the swap bank will receive semiannual fixed-rate dollar payments of 8.60 percent against paying six-month dollar LIBOR. D) none of the options

11) Suppose the quote for a five-year swap with semiannual payments is 8.50–8.60 percent. This means

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A) the swap bank will pay semiannual fixed-rate dollar payments of 8.60 percent against receiving six-month dollar LIBOR B) the swap bank will receive semiannual fixed-rate dollar payments of 8.50 percent against paying six-month dollar LIBOR. C) if the swap bank is successful in getting counterparties to both legs of the swap at these prices, he will have an annual profit of ten basis points. D) none of the options

12)

A swap bank makes the following quotes for 5-year swaps and AAA-rated firms: USD

Euro

Bid

Ask

Bid

Ask

5.2 %

7.2 %

A) The bank stands ready to pay $5.2 percent against receiving dollar LIBOR on 5-year loans. B) The bank stands ready to receive €7 percent against receiving dollar LIBOR on 5year loans. C) The bank stands ready to pay €7 percent against receiving dollar LIBOR on 5-year loans. D) none of the options

13) Suppose the quote for a five-year swap with semiannual payments is 8.50−8.60 percent in dollars and 6.60−6.80 percent in euro against six-month dollar LIBOR. This means

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A) the swap bank will enter into a currency swap in which it would pay semiannual fixed-rate dollar payments of 8.60 percent against receiving semiannual fixed-rate euro payments of 6.80. B) the swap bank will enter into a currency swap in which it would pay semiannual fixed-rate euro payments of 6.60 percent against receiving semiannual fixed-rate dollar payments of 8.50. C) the swap bank will enter into a currency swap in which it would pay semiannual fixed-rate dollar payments of 8.50 percent against receiving semiannual fixed-rate euro payments of 6.80, and the swap bank will enter into a currency swap in which it would pay semiannual fixed-rate euro payments of 6.60 percent against receiving semiannual fixed-rate dollar payments of 8.60. D) none of the options

14)

An interest-only single currency interest rate swap A) B) C) D)

is also known as a plain vanilla swap. is also known as an interest rate swap. is about as simple as swaps can get. all of the options

15) Company X and company Y have mirror-image financing needs (they both want to borrow equivalent amounts for the same amount of time. Company X has a AAA credit rating, but company Y's credit standing is considerably lower. A) Company X should demand most of the QSD in any swap with Y as compensation for default risk. B) Since Y has a poor credit rating, it would not be a participant in the swap market. C) Company X should more readily agree to a swap involving Y if there is also a swap bank providing credit risk intermediation. D) Company X should demand most of the QSD in any swap with Y as compensation for default risk, and Company X should more readily agree to a swap involving Y if there is also a swap bank providing credit risk intermediation.

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16) A swap bank has identified two companies with mirror-image financing needs (they both want to borrow equivalent amounts for the same amount of time. Company X has agreed to one leg of the swap but company Y is "playing hard to get." A) If the swap bank has already contracted one leg of the swap, they should be hesitant to offer better terms to company Y. B) The swap bank could just buy the company X side of the swap. C) Company X should lobby Y to "get on board." D) If the swap bank has already contracted one leg of the swap, they should be eager to offer better terms to company Y to just get the deal done, and the swap bank could just sell the company X side of the swap.

17) A swap bank has identified two companies with mirror-image financing needs—they both want to borrow equivalent amounts for the same amount of time. Company X has agreed to one leg of the swap but company Y is "playing hard to get." A) B) C) D)

The swap bank could just sell the company X side of the swap. Company X should lobby Y to "get on board." Company Y should calculate the QSD and subtract that from their best outside offer. none of the options

18) Company X wants to borrow $10,000,000 floating for 5 years; company Y wants to borrow $10,000,000 fixed for 5 years. Their external borrowing opportunities are shown here: Fixed-Rate

Floating-Rate

Borrowing Cost

Company X

10%

LIBOR

Company Y

12%

LIBOR + 1.5%

A swap bank proposes the following interest only swap: X will pay the swap bank annual payments on $10,000,000 at a rate of LIBOR − 0.15 percent; in exchange the swap bank will pay to company X interest payments on $10,000,000 at a fixed rate of 9.90 percent. What is the value of this swap to company X? Version 1

A) B) C) D)

Company X will lose money on the deal. Company X will save 25 basis points per year on $10,000,000 = $25,000 per year. Company X will only break even on the deal. Company X will save 5 basis points per year on $10,000,000 = $5,000 per year.

19) Company X wants to borrow $10,000,000 floating for 5 years; company Y wants to borrow $10,000,000 fixed for 5 years. Their external borrowing opportunities are shown here: Fixed-Rate

Floating-Rate

Borrowing Cost

Company X

10%

LIBOR

Company Y

12%

LIBOR + 1.5%

A swap bank proposes the following interest only swap: Y will pay the swap bank annual payments on $10,000,000 at a fixed rate of 9.90 percent. In exchange the swap bank will pay to company Y interest payments on $10,000,000 at LIBOR − 0.15 percent; What is the value of this swap to company Y? A) B) C) D)

Company Y will save 15 basis points per year on $10,000,000 = $15,000 per year. Company Y will save 45 basis points per year on $10,000,000 = $45,000 per year. Company Y will save 5 basis points per year on $10,000,000 = $5,000 per year. Company Y will only break even on the deal.

20) Company X wants to borrow $10,000,000 floating for 5 years; company Y wants to borrow $10,000,000 fixed for 5 years. Their external borrowing opportunities are shown here: Fixed-Rate

Floating-Rate

Borrowing Cost

Company X

10%

LIBOR

Company Y

12%

LIBOR + 1.5%

Version 1

A swap bank proposes the following interest only swap: X will pay the swap bank annual payments on $10,000,000 with the coupon rate of LIBOR− 0.15 percent; in exchange the swap bank will pay to company X interest payments on $10,000,000 at a fixed rate of 9.90 percent. Y will pay the swap bank interest payments on $10,000,000 at a fixed rate of 10.30 percent and the swap bank will pay Y annual payments on $10,000,000 with the coupon rate of LIBOR − 0.15 percent.{MISSING IMAGE}What is the value of this swap to the swap bank? A) The swap bank will lose money on the deal. B) The swap bank will earn 40 basis points per year on $10,000,000 = $40,000 per year. C) The swap bank will break even. D) none of the options

21) Company X wants to borrow $10,000,000 floating for 5 years; company Y wants to borrow $10,000,000 fixed for 5 years. Their external borrowing opportunities are shown here: Fixed-Rate

Floating-Rate

Borrowing Cost

Company X

10%

LIBOR

Company Y

12%

LIBOR + 1.5%

A swap bank proposes the following interest only swap: X will pay the swap bank annual payments on $10,000,000 with the coupon rate of LIBOR; in exchange the swap bank will pay to company X interest payments on $10,000,000 at a fixed rate of 10.05 percent. Y will pay the swap bank interest payments on $10,000,000 at a fixed rate of 10.30 percent and the swap bank will pay Y annual payments on $10,000,000 with the coupon rate of LIBOR − 0.15 percent.{MISSING IMAGE}What is the value of this swap to the swap bank?

Version 1

A) The swap bank will earn 40 basis points per year on $10,000,000 = $40,000 per year. B) The swap bank will earn 10 basis points per year on $10,000,000 = $10,000 per year. C) The swap bank will lose money. D) none of the options

22) Company X wants to borrow $10,000,000 floating for 5 years; company Y wants to borrow $10,000,000 fixed for 5 years. Their external borrowing opportunities are shown here: Fixed-Rate

Floating-Rate

Borrowing Cost

Company X

10%

LIBOR

Company Y

12%

LIBOR + 1.5%

A swap bank is involved and quotes the following for five-year dollar interest rate swaps: 10.05 percent−10.45 percent against LIBOR flat.{MISSING IMAGE}Assume both X and Y agree to the swap bank's terms. Fill in the values for A, B, C, D, E, & F on the diagram. A) B) C) D)

A = LIBOR; B = 10.45%; C = 10.05%; D = LIBOR; E = LIBOR; F = 12% A = 10%; B = 10.45%; C = 10.05%; D = LIBOR; E = LIBOR; F = LIBOR + 1½% A = 10%; B = 10.45%; C = LIBOR; D = LIBOR; E = 10.05%; F = LIBOR + 1½% A = 10%; B = LIBOR; C = LIBOR; D = 10.45%; E = 10.05%; F = LIBOR + 1½%

23) Company X wants to borrow $10,000,000 floating for 5 years; company Y wants to borrow $10,000,000 fixed for 5 years. Their external borrowing opportunities are shown here:

Company X

Version 1

Fixed-Rate

Floating-Rate

Borrowing Cost

10%

LIBOR

Company Y

12%

LIBOR + 1.5%

Design a mutually beneficial interest only swap for X and Y with a notational principal of $10 million by having appropriate values for;A = Company X's external borrowing rateB = Company Y's payment to X (rate)C = Company X's payment to Y (rate)D = Company Y's external borrowing rate{MISSING IMAGE}a) A = 10%; B = 11.75%; C = LIBOR - .25%; D = LIBOR + 1.5%b) A = 10%; B = 10%; C = LIBOR - .25%; D = LIBOR + 1.5%c) A = LIBOR; B = 10%; C = LIBOR - .25%; D = 12%d) A = LIBOR; B = LIBOR; C = LIBOR - .25%; D = 12% A) B) C) D)

Option a Option b Option c Option d

24) Suppose ABC Investment Banker Ltd., is quoting swap rates as follows: 7.50 − 7.85 annually against six-month dollar LIBOR for dollars, and 11.00 percent−11.30 percent annually against six-month dollar LIBOR for British pound sterling. ABC would enter into a $/£ currency swap in which: A) it would pay annual fixed-rate dollar payments of 7.5 percent in return for receiving annual fixed-rate £ payments at 11.0 percent. B) it will receive annual fixed-rate dollar payments at 7.50 percent against paying annual fixed-rate £ payments at 11 percent. C) it would pay annual fixed-rate dollar payments of 7.5 percent in return for receiving annual fixed-rate £ payments at 11.3 percent, and it will receive annual fixed-rate dollar payments at 7.85 percent against paying annual fixed-rate £ payments at 11 percent. D) none of the options

25)

Which of the following statements regarding a quality spread differential are true?

Version 1

A) It is the difference between the default-risk premium differential on the fixe-rate debt and the default-risk premium differential on the floating rate debt. B) It is the sum of the default-risk premium differential and the fixed-rate debt divided by the default-risk premium differential on the floating rate debt. C) It is not possible for all parties to have a positive quality spread differential. D) none of the options

26)

An all-in cost consists of A) B) C) D)

27)

interest expense transaction costs service charges all of the options

Use the following information to calculate the quality spread differential (QSD).

Company X Company Y

A) B) C) D)

Fixed-Rate Borrowing Cost 10 % 12 %

Floating-Rate Borrowing Cost LIBOR LIBOR + 1.5 %

0.50 percent 1.00 percent 1.50 percent 2.00 percent

28) Company X wants to borrow $10,000,000 floating for 5 years; company Y wants to borrow $10,000,000 fixed for 5 years. Their external borrowing opportunities are shown below. Fixed-Rate Borrowing Cost

Version 1

Floating-Rate Borrowing Cost

Company X

10 %

Company Y

12 %

LIBOR LIBOR + 1.5 %

A swap bank is involved and quotes the following rates five-year dollar interest rate swaps at 10.05 percent –10.45 percent against LIBOR flat.Assume company Y has agreed, but company X will only agree to the swap if the bank offers better terms.What are the absolute best terms the bank can offer X, given that it already booked Y?{MISSING IMAGE} A) B) C) D)

10.45% −10.45% against LIBOR flat. 10.45%−10.05% against LIBOR flat. 10.50%−10.50% against LIBOR flat. none of the options

29) Company X wants to borrow $10,000,000 for 5 years; company Y wants to borrow £5,000,000 for 5 years. The exchange rate is $2 = £1 and is not expected to change over the next 5 years. Their external borrowing opportunities are shown here: $ Borrowing

£Borrowing

Cost

Company X

$ 10 %

£ 10.5 %

Company Y

$ 12 %

13 %

A swap bank proposes the following interest only swap: X will pay the swap bank annual payments on $10,000,000 with the coupon rate of 9.80 percent; in exchange the swap bank will pay to company X interest payments on £5,000,000 at a fixed rate of 10.5 percent. Y will pay the swap bank interest payments on £5,000,000 at a fixed rate of 12.80 percent and the swap bank will pay Y annual payments on $10,000,000 with the coupon rate of 12 percent.{MISSING IMAGE}What is the value of this swap to the swap bank?

Version 1

A) The swap bank will earn 10 basis points per year; the only risk is default risk. B) The swap bank will earn 10 basis points per year but has exchange rate risk: dollardenominated income and pound-denominated costs and default risk. C) The swap bank will earn 10 basis points per year but has exchange rate risk: pounddenominated income and dollar-denominated costs and default risk. D) The swap bank will earn 20 basis points per year in dollars but has exchange rate risk: pound-denominated income and dollar-denominated costs and default risk.

30)

Swaps are said to offer market completeness.

A) This means that all types of debt instruments are not regularly available for all borrowers. Thus interest rate swap markets assist in tailoring financing to the type desired by a particular borrower. B) In that the swap market offers price discovery to the market C) Because you can trade across both currencies and fixed and floating market segments D) none of the options

31)

Consider the dollar- and euro-based borrowing opportunities of companies A and B. € borrowing

$ borrowing

€ 7%

$ 8%

€ 6%

$ 9%

A is a U.S.-based MNC with AAA credit; B is an Italian firm with AAA credit. Firm A wants to borrow €1,000,000 for one year and B wants to borrow $2,000,000 for one year. The spot exchange rate is $2.00 = €1.00 and the one-year forward rate is given by IRP as Suppose they agree to the swap shown here. Is this mutually beneficial swap equally fair to both parties?{MISSING IMAGE}

Version 1

A) Yes, QSD = [€7%− €6% × $2.00/€1.00] − ($8% − $9%) = $2% + $1% = $3%. B) No, company A borrows at 6 percent in euro but company B borrows at 8 percent in dollars. C) Yes, A will be better off by €1 percent on €1m; B by 1 percent on $2m and $2.00 = €1.00. D) No, company A saves 1 percent in euro but company B saves only 1 percent in dollars when the spot exchange rate is $2.00 = €1.00—A is twice as better off as B.

32) A is a U.S.-based MNC with AAA credit; B is an Italian firm with AAA credit. Firm A wants to borrow €1,000,000 for one year and B wants to borrow $2,000,000 for one year. The spot exchange rate is $2.00 = €1.00, a swap bank makes the following quotes for 1-year swaps and AAA-rated firms against USD LIBOR. USD

Euro

Bid

Ask

Bid

Ask

8.1 %

6.1 %

The firms external borrowing opportunities are € borrowing

$ borrowing

€ 7%

$ 8%

€ 6%

$ 9%

Is there a mutually beneficial swap?

Version 1

A) Yes, Firm A swaps with the swap bank, $ at bid and € at ask. Firm B swaps with the swap bank, $ at ask and € at bid. Firms A and B would each save 90bp and the swap bank would earn 20bp. B) There is no mutually beneficial swap at these prices. C) Yes, Firm A swaps with the swap bank, $ at ask and € at bid. Firm B swaps with the swap bank, $ at bid and € at ask. Firms A and B would each save 90bp and the swap bank would earn 20bp. D) none of the options

33)

Consider the dollar- and euro-based borrowing opportunities of companies A and B. € borrowing

$ borrowing

€ 7%

$ 8%

€ 6%

$ 9%

A is a U.S.-based MNC with AAA credit; B is an Italian firm with AAA credit. Firm A wants to borrow €1,000,000 for one year and B wants to borrow $2,000,000 for one year. The spot exchange rate is $2.00 = €1.00 and the one-year forward rate is given by IRP as $2.00 × (1.08)/€1.00 × (1.06) = $2.0377/€1.Is there a mutually beneficial swap? A) B) C) D)

34)

No, Savings = 0 Yes, Savings = 2% = (7% − 6%) − (8% − 9%) = 1% − (−1%) Yes, Savings = [€7% − €6%] × $2.00/€1.00 − ($8% − $9%) = $2% + $1% = $3% Yes, Savings = [€7% − €6%] − ($8% − $9%) × €1.00/$2.00 = €1½%

Pricing an interest-only single currency swap after inception involves

Version 1

A) sending a market order to a swap dealer. B) finding the difference between the present values of the payments streams the party will receive and pay. C) finding the sum of the present values of the payments streams that each party will receive in one currency and pay in the other currency, converted to a common currency. D) none of the options

35) Company X wants to borrow $10,000,000 floating for 5 years; Company Y wants to borrow £5,000,000 fixed for 5 years. The exchange rate is $2 = £1. Their external borrowing opportunities are: $ Borrowing

£Borrowing

Cost

Company X

$ 10 %

£ 10.5 %

Company Y

$ 12 %

13 %

A swap bank proposes the following swap: Company X will pay the swap bank annual payments on $10,000,000 at an interest rate of $9.80 percent; in exchange the swap bank will pay to company X interest payments on £5,000,000 at a fixed rate of ₤10.5 percent. Y will pay the swap bank interest payments on £5,000,000 at a fixed rate of ₤12.80 percent and the swap bank will pay Y annual payments on $10,000,000 with the coupon rate of $12 percent. Principal amounts will be exchanged and re-exchanged, respectively, at inception and maturity.{MISSING IMAGE}If company X takes on the swap, what external action should it engage in? A) It should borrow $10,000,000 at $10 percent. B) It should borrow £5,000,000 at ₤10.50 percent for five years; translate pounds to dollars at the spot rate. C) It should borrow £5,000,000 at £12.80 percent for five years. D) none of the options

Version 1

36) Company X wants to borrow $10,000,000 fixed for 5 years; company Y wants to borrow £5,000,000 fixed for 5 years. The exchange rate is $2 = £1. Their external borrowing opportunities are $ Borrowing

£Borrowing

Cost

Company X

$ 10 %

£ 10.5 %

Company Y

$ 12 %

13 %

A swap bank wants to design a profitable fixed-for-fixed currency swap. In order for X and Y to be interested, they can face no exchange rate risk.{MISSING IMAGE}What must the values of A and B in the graph shown above be in order for the swap to be of interest to firms X and Y? A) B) C) D)

37)

A = $10.50%; B = £12%. A = $10%; B = £13%. A = $12%; B = £13%. A = £10.50%; B = $12%.

Pricing a currency swap after inception involves

A) finding the difference between the present values of the payments streams the party will receive in one currency and pay in the other currency, converted to a common currency. B) sending a market order to a swap dealer. C) finding the sum of the present values of the payments streams that each party will receive in one currency and pay in the other currency, converted to a common currency. D) none of the options

38) Company X wants to borrow $10,000,000 floating for 1 year; company Y wants to borrow £5,000,000 fixed for 1 year. The spot exchange rate is $2 = £1 and IRP calculates the one-year forward rate as $2.00 × (1.08)/£1.00 × (1.06) = $2.0377/£1. Their external borrowing opportunities are:

Version 1

$ Borrowing

£Borrowing

Cost

Company X

$ 8%

£ 7%

Company Y

$ 9%

£ 6%

A swap bank wants to design a profitable fixed-for-fixed currency swap. In order for X and Y to be interested, they can face no exchange rate risk.What must the values of A and B in the graph shown above be in order for the swap to be of interest to firms X and Y? A) B) C) D)

A = £7%; B = $9%. A = $8%; B = £6%. A = $7%; B = £7%. A = $8%; B = £8%.

39) Company X wants to borrow $10,000,000 floating for 1 year; company Y wants to borrow £5,000,000 fixed for 1 year. The spot exchange rate is $2 = £1 and IRP calculates the one-year forward rate as $2.00 × (1.08)/£1.00 × (1.06) = $2.0377/£1. Their external borrowing opportunities are: $ Borrowing

£Borrowing

Cost

Company X

$ 8%

£ 7%

Company Y

$ 9%

£ 6%

A swap bank wants to design a profitable fixed-for-fixed currency swap. In order for X and Y to be interested, they can face no exchange rate risk.Company X

Version 1

A) B) C) D)

40)

is probably British. is probably American. has a comparative advantage in borrowing pounds. is probably British, and has a comparative advantage in borrowing pounds.

In a currency swap,

A) it may be the case that two counterparties have equivalent credit ratings. B) it may be the case that firms have a comparative advantage in borrowing in their domestic markets. C) Both A and B D) none of the options

41)

When an interest rate swap is established on an amortizing basis,

A) the debt service exchanges decrease periodically through time as the hypothetical notational principal is amortized. B) the debt service exchanges are the same each year, but the level of interest and principal changes as the loans amortize. C) there is no such thing as an amortizing swap. D) none of the options

42)

Floating-for-floating currency swaps

A) have different reference rates for the different currencies: e.g. dollar LIBOR versus euro LIBOR. B) do not exist. C) offer the swap bank a built-in hedge. D) none of the options

Version 1

43) Compute the payments due in the first year on a three-year amortizing swap from company B to company A. Company A and company B both want to borrow £1,000,000 for three years. A wants to borrow floating and B wants to borrow fixed. A and B agree to split the QSD.

Company A

Fixed-Rate Borrowing Cost 10 %

Company B

A) B) C) D)

44)

12 %

Floating-Rate Borrowing Cost LIBOR LIBOR + 1.5 %

B pays £402,114.80 to A B pays £100,000 to A B pays £69,788.52 to A none of the options

In an interest-only currency swap

A) the counterparties must raise the actual notational principal in their home markets; then exchange it for the foreign currency they desire. They must also hedge with forward contracts on the currency. B) the counterparties periodically exchange the amortized portions of the notational principals. C) the counterparties must raise the actual notational principal in their home markets; then exchange it for the foreign currency they desire. They must also hedge with forward contracts on the currency. Additionally, the counterparties periodically exchange the amortized portions of the notational principals. D) none of the options

45)

Amortizing currency swaps

Version 1

A) decrease the debt service exchanges periodically through time as the hypothetical notational principal is amortized. B) incorporate an amortization feature in which periodically the amortized portions of the notational principals are re-exchanged. C) Both A and B D) none of the options

46)

Nominal differences in currency swap rates A) B) C) D)

47)

can be explained by the set of international parity relationships. can be explained by the credit risk differentials. can be explained by the quality spread differential. disappear when controlling for volatility.

Floating-for-floating currency swaps

A) have reference rates that are different for the different currencies (e.g., dollar LIBOR versus euro LIBOR). B) have reference rates that can be the same but have different frequencies. C) Both A and B D) none of the options

48) XYZ Corporation enters into a 6-year interest rate swap with a swap bank in which it agrees to pay the swap bank a fixed-rate of 9 percent annually on a notional amount of SFr10,000,000 and receive LIBOR−½ percent. As of the third reset date (i.e., midway through the 6-year agreement), calculate the price of the swap, assuming that the fixed-rate at which XYZ can borrow has increased to 10 percent. A) B) C) D)

Version 1

SFr248,685 SFr900,000 SFr2,700,000 SFr7,300,000

49) Which combination of the following represent the risks that a swap dealer confronts.(i) interest rate risk(ii) basis risk(iii) exchange rate risk(iv) political risk(v) sovereign risk A) B) C) D)

50)

A major risk faced by a swap dealer is credit risk. This is A) B) C) D)

51)

(i), (ii), (iii), and (v) (i), (iii), and (iv) (iii), (iv), and (iv) (i), (ii), (iii), (iv), and (v)

the probability that a counterparty will default. the probability that both counterparties default. the probability floating rates will move against the dealer. none of the options

A major risk that can be eliminated through a swap is exchange rate risk.

A) But only to the extent that the foreign counterparty, or swap bank, will not default in the currency swap. B) But only if the bid-ask spreads are wide. C) But swaps can be less efficient in this than just trading at the expected spot exchange rates each year. D) none of the options

52)

A major risk faced by a swap dealer is exchange rate risk. This is A) B) C) D)

Version 1

the probability that a foreign counterparty will default in a currency swap. the probability that either counterparty defaults in a currency swap. the probability exchange rates will move against the dealer. none of the options

53)

A major risk faced by a swap dealer is mismatch risk. This is

A) the probability floating rates and exchange rates will not move together. B) the difficulty in finding a second counterparty with an exact opposite match for a swap that the bank has agreed to take with another counterparty. C) the probability that both counterparties default. D) none of the options

54) Some of the risks that a swap dealer confronts are "basis risk" and "sovereign risk." Select the definitions that best describe each. A) "Basis risk" refers to the probability that a country will impose exchange restrictions on a currency involved in a swap, and "sovereign risk" refers to a situation in which the floating rates of the two counterparties are not pegged to the same index. B) "Basis risk" refers to a situation in which the floating rates of the two counterparties are not pegged to the same index and "sovereign risk" refers to the probability that a country will impose exchange restrictions on a currency involved in a swap. C) "Basis risk" refers to interest rate changing unfavorably before the swap bank can lay off to an opposing counterparty the other side of an interest rate swap entered into with a counter party, and "sovereign risk" refers to the probability that a country will impose exchange restrictions on a currency involved in a swap. D) "Basis risk" refers to the risk of fluctuating exchange rates, and "sovereign risk" refers to a situation in which the floating rates of the two counterparties are not pegged to the same index.

55)

A major risk faced by a swap dealer is sovereign risk. This is

A) the probability that a sovereign counterparty will default. B) the probability that a country will impose exchange restrictions on a currency involved in an existing swap. C) the probability governments will intervene to support an exchange rate. D) none of the options

Version 1

56) In an efficient market without barriers to capital flows, the cost-savings argument of the QSD is difficult to accept, because A) it implies that an arbitrage opportunity exists because of some mispricing of the default risk premiums on different types of debt instruments. B) it implies that an arbitrage opportunity exists because of some mispricing of the exchange rates on different maturities of forward contracts. C) it implies that an arbitrage opportunity exists because of some mispricing of the default risk premiums on different types of debt instruments, and it implies that an arbitrage opportunity exists because of some mispricing of the exchange rates on different maturities of forward contracts. D) none of the options

57)

When a swap bank serves as a dealer, A) B) C) D)

58)

the swap bank stands willing to accept either side of a swap. the swap bank matches counterparties but does not assume any risk of the swap. the swap bank receives a commission for matching buyers and sellers. none of the options

When a swap bank serves as a broker, A) B) C) D)

59) Consider a plain vanilla interest rate swap. Firm A can borrow at 8 percent fixed or can borrow floating at LIBOR. Firm B is somewhat less creditworthy and can borrow at 10 percent fixed or can borrow floating at LIBOR + 1 percent. Firm A wants to borrow floating and Firm B prefers to borrow fixed. Both corporations wish to borrow $10 million for 5 years. Which of the following swaps is mutually beneficial to each party and meets their financing needs?

Version 1

A) Firm A borrows $10 million externally for 5 years at LIBOR; agrees to swap LIBOR to firm B for 8 ½ percent fixed for 5 years on a notational principal of $5 million; B borrows $10 million externally at 10 percent. B) A borrows $10 million externally for 5 years at LIBOR; agrees to pay 8½ percent to B for LIBOR fixed for 5 years on a notational principal of $5 million; B borrows $10 million externally at 10 percent. C) Since the QSD = 0 there is no mutually beneficial swap. D) A borrows $10 million externally at 8 percent fixed for 5 years; agrees to swap LIBOR to B for 8½ percent fixed for 5 years on a notational principal of $5 million; B borrows $10 million externally at LIBOR + 1 percent.

60) Consider fixed-for-fixed currency swap. Firm A is a U.S.-based multinational. Firm B is a U.K.-based multinational. Firm A wants to finance a £2 million expansion in Great Britain. Firm B wants to finance a $4 million expansion in the U.S. The spot exchange rate is £1.00 = $2.00. Firm A can borrow dollars at 10 percent and pounds sterling at 12 percent. Firm B can borrow dollars at 9 percent and pounds sterling at 11 percent. Which of the following swaps is mutually beneficial to each party and meets their financing needs? Neither party should face exchange rate risk. A) There is no mutually beneficial swap that has neither party facing exchange rate risk. B) Firm A should borrow $4 million in dollars, pay 11 percent in pounds to Firm B, who in turn borrows ₤2 million and pays 8 percent in dollars to A. C) Firm A should borrow $2 million in dollars, pay 11 percent in pounds to Firm B, who in turn borrows ₤4 million and pays 8 percent in dollars to A. D) Firm A should borrow $4 million in dollars, pay 11 percent in pounds to Firm B, who in turn borrows ₤2 million and pays 10 percent in dollars to A.

61) Consider a bank that has entered into a five-year swap on a notational balance of $10,000,000 with a corporate customer who has agreed to pay a fixed payment of 10 percent in exchange for LIBOR. As of the fourth reset date, determine the price of the swap from the bank's point of view assuming that the fixed-rate side of the swap has increased to 11 percent. LIBOR is at 5 percent.

Version 1

A) B) C) D)

$909,090.91. −$90,090.09. No loss or no gain since maturity has not arrived. $90,090.09.

62) Find the all-in-cost of a swap to a party that has agreed to borrow $5 million at 5 percent externally and pays LIBOR + ½ percent on a notational principal of $5 million in exchange for fixed rate payments of 6 percent. A) B) C) D)

LIBOR + ½ percent LIBOR LIBOR − ½ percent none of the options

63) Consider a fixed for fixed currency swap. The Dow Corporation is a U.S.-based multinational. The Jones Corporation is a U.K.-based multinational. Dow wants to finance a £2 million expansion in Great Britain. Jones wants to finance a $4 million expansion in the U.S. The spot exchange rate is £1.00 = $2.00. Dow can borrow dollars at $10 percent and pounds sterling at 12 percent. Jones can borrow dollars at 9 percent and pounds sterling at 10 percent. Assuming that the swap bank is willing to take on exchange rate risk, but the other counterparties are not, which of the following swaps is mutually beneficial to each party and meets their financing needs?

Version 1

A) Dow should borrow $4 million in dollars externally at $10 percent; pay £11¾ percent in pounds to the swap bank on a notational principal of £2 million; receive $10 percent from the swap bank on a notational principal of $4 million. Jones, borrows £2 million pounds externally at £10 percent; pays $8¾ percent to the swap bank on a notational principal of $4 million and receives £10 percent in pounds from the swap bank on a notational principal of £2 million. B) Dow should borrow $4 million in dollars externally at $10 percent; pay £11½ percent in pounds to the swap bank on a notational principal of £2 million; receive $10 percent from the swap bank on a notational principal of $4 million. Jones, borrows £2 million pounds externally at £10 percent; pays $8½ percent to the swap bank on a notational principal of $4 million and receives £10 percent in pounds from the swap bank on a notational principal of £2 million. C) Dow should borrow $4 million in dollars externally at $10 percent; pay £11 percent in pounds to the swap bank on a notational principal of £2 million; receive $8 percent from the swap bank on a notational principal of $4 million. Jones, borrows £2 million pounds externally at £10 percent; pays $10 percent to the swap bank on a notational principal of $4 million and receives £11 percent in pounds from the swap bank on a notational principal of £2 million. D) There is no swap that is possible.

64) With regard to a swap bank acting as a dealer in swap transactions, interest rate risk refers to A) the risk that arises from the situation in which the floating-rates of the two counterparties are not pegged to the same index. B) the risk that interest rates changing unfavorably before the swap bank can lay off to an opposing counterparty on the other side of an interest rate swap entered into with the first counterparty. C) the risk the swap bank faces from fluctuating exchange rates during the time it takes for the bank to lay off a swap it undertakes with one counterparty with an opposing transaction. D) the risk that a counterparty will default.

65) to

With regard to a swap bank acting as a dealer in swap transactions, mismatch risk refers

Version 1

A) the risk that arises from the situation in which the floating-rates of the two counterparties are not pegged to the same index. B) the risk that interest rates changing unfavorably before the swap bank can lay off to an opposing counterparty on the other side of an interest rate swap entered into with the first counterparty. C) the risk the swap bank faces from fluctuating exchange rates during the time it takes for the bank to lay off a swap it undertakes with one counterparty with an opposing transaction. D) the risk that it may be difficult or impossible to find an exact opposite match for a swap the bank has agreed take.

66) You are the debt manager for a U.S.-based multinational. You need to borrow €100,000,000 for five years. You can either borrow the €100,000,000 directly in Germany or borrow dollars in the U.S. and enter into a currency swap with a swap bank. One risk that you face by using the swap that you do not face by borrowing euros directly is A) B) C) D)

exchange rate risk. sovereign risk. credit risk. interest rate risk.

67) Suppose that you are a swap bank and you notice that interest rates on coupon bonds are as shown. Develop the 3-year bid price of a euro swap quoted against flat USD LIBOR. The current spot exchange rate is $1.50 per €1.00. The size of the swap is €40 million versus $60 million. Rates

3-year

USD

$ 7%

Euro

€ 5%

In other words, what will you be willing to pay in euro against receiving USD LIBOR?

Version 1

A) B) C) D)

68)

7 percent 6 percent 5 percent none of the options

The two primary reasons for an interest rate swap are

A) to better match maturities of assets and liabilities; to obtain low cost debt B) to better match maturities of assets and liabilities; to obtain cost savings via the quality spread differential C) to obtain low cost debt; to achieve cost savings via the quality spread D) none of the options

69) Suppose that the swap that you proposed is now 4 years old (i.e., there is exactly one year to go on the swap). The fourth payment has already been made. If the spot exchange rate prevailing in year 4 is $1.8778 = €1 and the 1-year forward exchange rate prevailing in year 4 is $1.95 = €1, what is the value of the swap to the party paying dollars? If the swap were initiated today the correct rates would be as shown. A) B) C) D)

$184,909 $186,760 $200,000 $183,057

70) Suppose that the swap that you proposed is now 4 years old (i.e., there is exactly one year to go on the swap). If the spot exchange rate prevailing in year 4 is $1.8778 = €1 and the 1-year forward exchange rate prevailing in year 4 is $1.95 = €1, what is the value of the swap to the party paying dollars? If the swap were initiated today the correct rates would be as shown.

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A) B) C) D)

$185,000 $180,000 $173,625 $625,000

SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question. 71) Come up with a swap (exchange of interest and principal) for parties A and B who have the following borrowing opportunities. €

€5%

$LIBOR%

€6%

$LIBOR + ½%

The current exchange rate is $1.60 = €1.00. Company "A" is in Milan, Italy and wishes to borrow $1,000,000 at a floating rate for 5 years and company "B" is a U.S. firm that wants to borrow €625,000 for 5 years at a fixed rate of interest. You are a swap dealer. Quote A and B a swap that makes money for all parties and eliminates exchange rate risk for both A and B.

72) Come up with a swap (principal + interest) for two parties A and B who have the following borrowing opportunities. € A B

Version 1

€LIBOR% €LIBOR + ½%

$ $ 8% $ 8.20 %

The current exchange rate is $1.60 = €1.00. Company "A" wishes to borrow $1,000,000 for 5 years and "B" wants to borrow €625,000 for 5 years. You are a swap dealer. Quote A and B a swap that makes money for all parties and eliminates exchange rate risk for both A and B. Firms A and B are more concerned with what currency that they borrow in than whether the debt is fixed or floating.

73) Consider the situation of firm A and firm B. The current exchange rate is $1.50/€. Firm A is a U.S. MNC and wants to borrow €40 million for 2 years. Firm B is a French MNC and wants to borrow $60 million for 2 years. Their borrowing opportunities are as shown; both firms have AAA credit ratings. $

€

$ 7%

€ 6%

$ 8%

€ 5%

What are the IRP 1-year and 2-year forward exchange rates?

74) Consider the situation of firm A and firm B. The current exchange rate is $1.50/€. Firm A is a U.S. MNC and wants to borrow €40 million for 2 years. Firm B is a French MNC and wants to borrow $60 million for 2 years. Their borrowing opportunities are as shown; both firms have AAA credit ratings. $

€

$ 7%

€ 6%

$ 8%

€ 5%

Version 1

Explain how firm A could use the forward exchange markets to redenominate a 2-year $60m 7 percent USD loan into a 2-year euro denominated loan.

75) Consider the situation of firm A and firm B. The current exchange rate is $1.50/€. Firm A is a U.S. MNC and wants to borrow €40 million for 2 years. Firm B is a French MNC and wants to borrow $60 million for 2 years. Their borrowing opportunities are as shown; both firms have AAA credit ratings. $

€

$ 7%

€ 6%

$ 8%

€ 5%

If firm A could use the forward exchange markets to redenominate a 2-year $60m 7 percent USD loan into a 2-year euro denominated loan, what would be the interest rate?

76) Consider the situation of firm A and firm B. The current exchange rate is $1.50/€. Firm A is a U.S. MNC and wants to borrow €40 million for 2 years. Firm B is a French MNC and wants to borrow $60 million for 2 years. Their borrowing opportunities are as shown; both firms have AAA credit ratings. $

€

$ 7%

€ 6%

$ 8%

€ 5%

Explain how this opportunity affects which swap firm A will be willing to participate in.

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77) Consider the situation of firm A and firm B. The current exchange rate is $1.50/€. Firm A is a U.S. MNC and wants to borrow €40 million for 2 years. Firm B is a French MNC and wants to borrow $60 million for 2 years. Their borrowing opportunities are as shown; both firms have AAA credit ratings. $

€

$ 7%

€ 6%

$ 8%

€ 5%

Explain how firm B could use the forward exchange markets to redenominate a 2-year €40m 5 percent euro loan into a 2-year USD-denominated loan.

78) Consider the situation of firm A and firm B. The current exchange rate is $1.50/€. Firm A is a U.S. MNC and wants to borrow €40 million for 2 years. Firm B is a French MNC and wants to borrow $60 million for 2 years. Their borrowing opportunities are as shown; both firms have AAA credit ratings. $

€

$ 7%

€ 6%

$ 8%

€ 5%

If firm B could use the forward exchange markets to redenominate a 2-year €40m 5 percent euro loan into a 2-year USD-denominated loan, what would be the interest rate?

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79) Consider the situation of firm A and firm B. The current exchange rate is $1.50/€. Firm A is a U.S. MNC and wants to borrow €40 million for 2 years. Firm B is a French MNC and wants to borrow $60 million for 2 years. Their borrowing opportunities are as shown; both firms have AAA credit ratings. $

€

$ 7%

€ 6%

$ 8%

€ 5%

Explain how this opportunity affects which swap firm B will be willing to participate in.

80) Consider the situation of firm A and firm B. The current exchange rate is $1.50/€. Firm A is a U.S. MNC and wants to borrow €40 million for 2 years. Firm B is a French MNC and wants to borrow $60 million for 2 years. Their borrowing opportunities are as shown; both firms have AAA credit ratings. $

€

$ 7%

€ 6%

$ 8%

€ 5%

Devise a direct swap for A and B that has no swap bank. Show their external borrowing.{MISSING IMAGE}

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81) Consider the situation of firm A and firm B. The current exchange rate is $1.50/€. Firm A is a U.S. MNC and wants to borrow €40 million for 2 years. Firm B is a French MNC and wants to borrow $60 million for 2 years. Their borrowing opportunities are as shown; both firms have AAA credit ratings. $

€

$ 7%

€ 6%

$ 8%

€ 5%

Act as a swap bank and quote bid and ask prices to A and B that are attractive to A and B and promise to make at least 20bp for your firm. USD

Euro

Bid

Ask

Bid

Ask

82) Consider the situation of firm A and firm B. The current exchange rate is $1.50/€. Firm A is a U.S. MNC and wants to borrow €40 million for 2 years. Firm B is a French MNC and wants to borrow $60 million for 2 years. Their borrowing opportunities are as shown; both firms have AAA credit ratings. $

€

$ 7%

€ 6%

$ 8%

€ 5%

Show how your proposed swap would work for firm A. (e.g., if you were acting as an agent for the swap bank, try to "sell" firm A on your swap)

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83) Consider the situation of firm A and firm B. The current exchange rate is $2.00/£ Firm A is a U.S. MNC and wants to borrow £30 million for 2 years. Firm B is a British MNC and wants to borrow $60 million for 2 years. Their borrowing opportunities are as shown, both firms have AAA credit ratings. $

$ 6%

£ 5%

$ 7%

£ 4%

What are the IRP 1-year and 2-year forward exchange rates?

84) Consider the situation of firm A and firm B. The current exchange rate is $2.00/£ Firm A is a U.S. MNC and wants to borrow £30 million for 2 years. Firm B is a British MNC and wants to borrow $60 million for 2 years. Their borrowing opportunities are as shown, both firms have AAA credit ratings. $

$ 6%

£ 5%

$ 7%

£ 4%

Explain how firm A could use the forward exchange markets to redenominate a 2-year $60m 6 percent USD loan into a 2-year pound denominated loan.

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85) Consider the situation of firm A and firm B. The current exchange rate is $2.00/£ Firm A is a U.S. MNC and wants to borrow £30 million for 2 years. Firm B is a British MNC and wants to borrow $60 million for 2 years. Their borrowing opportunities are as shown, both firms have AAA credit ratings. $

$ 6%

£ 5%

$ 7%

£ 4%

If firm A could use the forward exchange markets to redenominate a 2-year $60m 6 percent USD loan into a 2-year pound denominated loan, what would be the interest rate?

86) Consider the situation of firm A and firm B. The current exchange rate is $2.00/£ Firm A is a U.S. MNC and wants to borrow £30 million for 2 years. Firm B is a British MNC and wants to borrow $60 million for 2 years. Their borrowing opportunities are as shown, both firms have AAA credit ratings. $

$ 6%

£ 5%

$ 7%

£ 4%

Explain how this opportunity affects which swap firm A will be willing to participate in.

Version 1

87) Consider the situation of firm A and firm B. The current exchange rate is $2.00/£ Firm A is a U.S. MNC and wants to borrow £30 million for 2 years. Firm B is a British MNC and wants to borrow $60 million for 2 years. Their borrowing opportunities are as shown, both firms have AAA credit ratings. $

$ 6%

£ 5%

$ 7%

£ 4%

Explain how firm B could use the forward exchange markets to redenominate a 2-year £30m 4 percent pound sterling loan into a 2-year USD-denominated loan.

88) Consider the situation of firm A and firm B. The current exchange rate is $2.00/£ Firm A is a U.S. MNC and wants to borrow £30 million for 2 years. Firm B is a British MNC and wants to borrow $60 million for 2 years. Their borrowing opportunities are as shown, both firms have AAA credit ratings. $

$ 6%

£ 5%

$ 7%

£ 4%

If firm B could use the forward exchange markets to redenominate a 2-year £30m 4 percent pound sterling loan into a 2-year USD-denominated loan, what would be the interest rate?

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89) Consider the situation of firm A and firm B. The current exchange rate is $2.00/£ Firm A is a U.S. MNC and wants to borrow £30 million for 2 years. Firm B is a British MNC and wants to borrow $60 million for 2 years. Their borrowing opportunities are as shown, both firms have AAA credit ratings. $

$ 6%

£ 5%

$ 7%

£ 4%

Explain how this opportunity affects which swap firm B will be willing to participate in.

90) Consider the situation of firm A and firm B. The current exchange rate is $2.00/£ Firm A is a U.S. MNC and wants to borrow £30 million for 2 years. Firm B is a British MNC and wants to borrow $60 million for 2 years. Their borrowing opportunities are as shown, both firms have AAA credit ratings. $

$ 6%

£ 5%

$ 7%

£ 4%

Devise a direct swap for A and B that has no swap bank. Show their external borrowing.{MISSING IMAGE}

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91) Consider the situation of firm A and firm B. The current exchange rate is $2.00/£ Firm A is a U.S. MNC and wants to borrow £30 million for 2 years. Firm B is a British MNC and wants to borrow $60 million for 2 years. Their borrowing opportunities are as shown, both firms have AAA credit ratings. $

$ 6%

£ 5%

$ 7%

£ 4%

Act as a swap bank and quote bid and ask prices to A and B that are attractive to A and B and promise to make at least 20bp for your firm. USD Bid

pounds Ask

Bid

Ask

92) Consider the situation of firm A and firm B. The current exchange rate is $2.00/£ Firm A is a U.S. MNC and wants to borrow £30 million for 2 years. Firm B is a British MNC and wants to borrow $60 million for 2 years. Their borrowing opportunities are as shown, both firms have AAA credit ratings. $

$ 6%

£ 5%

$ 7%

£ 4%

Show how your proposed swap would work for firm A. (e.g., if you were acting as an agent for the swap bank, try to "sell" firm A on your swap)

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93) Consider the borrowing rates for Parties A and B. A wants to finance a $100,000,000 project at a fixed rate. B wants to finance a $100,000,000 project at a floating rate. Both firms want the same maturity, 5 years. Firm

Fixed Rate

$ 10.3 %

Prime + 1%

Prime + 1/2%

8.9 %

Floating

Construct a mutually beneficial interest rate swap that makes money for A, B, and the swap bank in equal measure.

94) Consider the borrowing rates for Parties A and B. A wants to finance a $100,000,000 project at a fixed rate. B wants to finance a $100,000,000 project at a floating rate. Both firms want the same maturity, 5 years. Firm

Fixed Rate

$ 10.3 %

Prime + 1%

Prime + 1/2%

8.9 %

Floating

For your swap (the one you have shown above) how would the swap bank quote the swap against prime? (Hint: they are quoting a bid-ask spread against "flat" prime.)

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95) An interest-only currency swap has a remaining life of 18 months. It involves exchanging interest at ₤14 percent on £20 million for interest at $10 percent on $14 million once a year. The term structure of interest rates is currently flat in both the U.S. and in the U.K. If the swap were negotiated today the interest rates exchanged would be $8 percent and £11 percent. All rates were quoted with annual compounding. The current exchange rate is $1.95 = £1. What is the value of the swap to the party paying dollars?

96) Consider the situation of firm A and firm B. The current exchange rate is $2.00/£ Firm A is a U.S. MNC and wants to borrow £30 million for 2 years. Firm B is a British MNC and wants to borrow $60 million for 2 years. Their borrowing opportunities are as shown, both firms have AAA credit ratings. $

$ 6%

£5%

$ 7%

£4%

The IRP 1-year and 2-year forward exchange rates are

USD

pounds

Bid

Ask

Bid

Ask

6.1 %

4.1 %

Explain how firm A could use two of the swaps offered above to hedge its exchange rate risk.

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97) Consider the situation of firm A and firm B. The current exchange rate is $2.00/£ Firm A is a U.S. MNC and wants to borrow £30 million for 2 years. Firm B is a British MNC and wants to borrow $60 million for 2 years. Their borrowing opportunities are as shown, both firms have AAA credit ratings. $

$ 6%

£5%

$ 7%

£4%

The IRP 1-year and 2-year forward exchange rates are

USD

pounds

Bid

Ask

Bid

Ask

6.1 %

4.1 %

Explain how firm B could use two of the swaps offered above to hedge its exchange rate risk.

98) Consider the situation of firm A and firm B. The current exchange rate is $2.00/£ Firm A is a U.S. MNC and wants to borrow £30 million for 2 years. Firm B is a British MNC and wants to borrow $60 million for 2 years. Their borrowing opportunities are as shown, both firms have AAA credit ratings.

Version 1

$ 6%

£5%

$ 7%

£4%

The IRP 1-year and 2-year forward exchange rates are

USD

pounds

Bid

Ask

Bid

Ask

6.1 %

4.1 %

Explain how firm A could use the forward exchange markets to redenominate a 2-year $60m 6 percent USD loan into a 2-year pound denominated loan.

99) Consider the situation of firm A and firm B. The current exchange rate is $2.00/£ Firm A is a U.S. MNC and wants to borrow £30 million for 2 years. Firm B is a British MNC and wants to borrow $60 million for 2 years. Their borrowing opportunities are as shown, both firms have AAA credit ratings. $

$ 6%

£5%

$ 7%

£4%

Version 1

The IRP 1-year and 2-year forward exchange rates are

USD

pounds

Bid

Ask

Bid

Ask

6.1 %

4.1 %

Explain how this opportunity affects which swap firm A will be willing to participate in.

100) Consider the situation of firm A and firm B. The current exchange rate is $2.00/£ Firm A is a U.S. MNC and wants to borrow £30 million for 2 years. Firm B is a British MNC and wants to borrow $60 million for 2 years. Their borrowing opportunities are as shown, both firms have AAA credit ratings. $

$ 6%

£5%

$ 7%

£4%

The IRP 1-year and 2-year forward exchange rates are

USD Bid

Version 1

pounds Ask

Bid

Ask

6.1 %

4.1 %

Explain how firm B could use the forward exchange markets to redenominate a 2-year £30m 4 percent-pound sterling loan into a 2-year USD-denominated loan.

101) Consider the situation of firm A and firm B. The current exchange rate is $2.00/£ Firm A is a U.S. MNC and wants to borrow £30 million for 2 years. Firm B is a British MNC and wants to borrow $60 million for 2 years. Their borrowing opportunities are as shown, both firms have AAA credit ratings. $

$ 6%

£5%

$ 7%

£4%

The IRP 1-year and 2-year forward exchange rates are

USD

pounds

Bid

Ask

Bid

Ask

6.1 %

4.1 %

Explain how this opportunity affects which swap firm B will be willing to participate in.

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Answer Key Test name: Chap 14_9e 1) TRUE 2) D 3) C 4) C 5) C 6) D 7) C 8) B 9) D 10) C 11) C 12) C 13) C 14) D 15) D 16) D 17) A 18) D 19) B 20) B 21) A 22) D 23) B 24) C 25) A 26) D Version 1

27) A 28) A 29) C 30) A 31) C 32) A 33) B 34) B 35) B 36) D 37) A 38) B 39) D 40) C 41) A 42) A 43) B 44) A 45) C 46) A 47) C 48) A 49) D 50) A 51) A 52) C 53) B 54) B 55) B 56) A Version 1

57) A 58) B 59) D 60) A 61) B 62) C 63) A 64) B 65) D 66) C 67) C 68) B 69) B 70) C 71) [MISSING IMAGE: , ] 72) [MISSING IMAGE: , ] 73) %media:7formula2.mml%%media:formula3.mml% 74) Firm A could borrow $60m today and exchange for €40m at today's spot rate. Then they could enter a 1-year forward contract on euro agreeing to buy enough dollars with euro to service their loan. At the 1year forward rate of $1.5268 this will cost 0.07 × $60m × €1.00/$1.5268 = €2,747,663.55 in one year. They also enter into a 2-year forward contract on euro agreeing to buy enough dollars with euro to service their loan. At the 2-year forward rate of $1.5577 this will cost 1.07 × $60m × €1.00/$1.5577 = €41,214,953.27 at the end of the second year. 75) The IRR on a €40m loan with payments of €2,747,663.55 and €41,214,953.27 is 5 percent.

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76) Since A can redenominate a $60m 7 percent loan into a €40m 5 percent loan, it won't be very interested in swaps with an all-in-cost very much higher than €5 percent. 77) Firm B could borrow €40m today and exchange for at $60m today's spot rate. Then they could enter a 1-year forward contract on euro agreeing to buy enough euro with dollars to service their loan. At the 1year forward rate of $1.5268 this will cost 0.05 × €40m × $1.5268/€1.00 = $3,057,142.86 in one year. They also enter into a 2-year forward contract on euro agreeing to buy enough dollars with euro to service their loan. At the 2-year forward rate of $1.5577 this will cost 1.05 × €40m × $1.5577/€1.00 = $65,422,857 at the end of the second year. 78) The IRR on a $60m loan with payments of $3,057,142.86 and $65,422,857 is 7 percent. 79) Since B can redenominate a €40m 5 percent loan into a $60m 7 percent loan, they won't be very interested in swaps with an all-in-cost very much higher than $7 percent. 80) <img alt="" src="/extMedia/bne/Eun_9e/Chapter_14/SA14_78e.png" style="width: 494px; height: 281px;"> 81) USD

Euro

Bid

Ask

Bid

Ask

7.1 %

5.1 %

82) I would point out that his contracting costs might be less with just having 1 swap instead of 2 forward contracts. Also, he might be able to get a better rate through the swap if he can't find forward contracts at his desired maturity and amounts.

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83) %media:4formula4.mml% %media:4formula5.mml% 84) Firm A could borrow $60m today and exchange for £30m at today's spot rate. Then they could enter a 1-year forward contract on euro agreeing to buy enough dollars with pounds to service their loan. At the 1-year forward rate of $2.0385/£ this will cost 0.06 × $60m × £1.00/$2.0385 = £1,766,037.74 in one year. They also enter into a 2year forward contract on euro agreeing to buy enough dollars with euro to service their loan. At the 2-year forward rate of $2.0777 this will cost 1.06 × $60m × £1.00/$2.0777 = £30,610,772 at the end of the second year. 85) The IRR on a £30m loan with payments of £1,766,037.74 and £30,610,772.75 is 4 percent. 86) Since A can redenominate a $60m 6 percent loan into a £30m 4 percent loan, it won't be very interested in swaps with an all-in-cost very much higher than 4 percent. 87) Firm B could borrow £30m today and exchange for at $60m today's spot rate. Then they could enter a 1-year forward contract on euro agreeing to buy enough pounds with dollars to service their loan. At the 1-year forward rate of $2.0385/£ this will cost 0.04 × £30m × $2.0385/£1.00 = $2,446,153.85 in one year. They also enter into a 2year forward contract on euro agreeing to buy enough dollars with euro to service their loan. At the 2-year forward rate of $2.0777 this will cost 1.04 × £30m × 2.0777/£1.00 = $64,823,076.93 at the end of the second year. 88) The IRR on a $60m loan with payments of $2,446,153.85 and $64,823,076.93 is 6 percent. 89) Since B can redenominate a £30m 4 percent loan into a $60m 6 percent loan, it won't be very interested in swaps with an all-in-cost very much higher than $6 percent. Version 1

90) <img alt="" src="/extMedia/bne/Eun_9e/Chapter_14/SA14_88e.png" style="width: 480px; height: 271px;"> 91) USD

pounds

Bid

Ask

Bid

Ask

6.1 %

4.1 %

92) I would point out that his contracting costs might be less with just having 1 swap instead of 2 forward contracts. Also, he might be able to get a better rate through the swap if he can't find forward contracts at his desired maturity and amounts. 93) <img alt="" src="/extMedia/bne/Eun_9e/Chapter_14/SA14_91e.png" style="width: 503px; height: 280px;"> 94) 8.7 − 9.0(By the way, 8.7 − 9.0 means that the swap bank will pay fixed-rate dollar payments at 8.7% against receiving dollar prime or it will receive fixed-rate dollar payments of 9.0% against receiving dollar prime). 95) [MISSING IMAGE: , ] Value of the swap to the party paying dollars: %media:4formula6.mml% %media:4formula7.mml%$7,256,721.56 96) Firm A could agree to a swap at the pound ask price, agreeing to pay 4.1 percent to the swap bank in exchange for receiving USD LIBOR while at the same time agreeing to a USD swap at the bid price, agreeing to pay USD LIBOR in exchange for receiving $6 percent. [MISSING IMAGE: , ]

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97) Firm B could agree to a swap at the pound BID price, agreeing to RECEIVE 4.0 percent to the swap bank in exchange for paying USD LIBOR while at the same time agreeing to a USD swap at the ask price, agreeing to receive USD LIBOR in exchange for paying $6.1 percent. [MISSING IMAGE: , ]

98) Firm A could borrow $60m today and exchange for £30m at today's spot rate. Then they could enter a 1-year forward contract on euro agreeing to buy enough dollars with pounds to service their loan. At the 1-year forward rate of $2.0385/£ this will cost 0.06 × $60m × £1.00/$2.0385 = £1,766,037.74 in one year. They also enter into a 2-year forward contract on euro agreeing to buy enough dollars with euro to service their loan. At the 2-year forward rate of $2.0777 this will cost 1.06 × $60m × £1.00/$2.0777 = £30,611,320.75 at the end of the second year. The IRR on a £30m loan with payments of £1,766,037.74 and £30,610,772.75 is 4 percent. 99) Since A can redenominate a $60m, 6 percent loan into a £30m, 4 percent loan, it won't be very interested in swaps with an all-in-cost very much higher than 4 percent. 100) Firm B could borrow £30m today and exchange for at $60m today's spot rate. Then they could enter a 1-year forward contract on euro agreeing to buy enough pounds with dollars to service their loan. At the 1-year forward rate of $2.0385/£ this will cost 0.04 × £30m × $2.0385/£1.00 = $2,446,153.85 in one year. They also enter into a 2-year forward contract on euro agreeing to buy enough dollars with euro to service their loan. At the 2-year forward rate of $2.0777 this will cost 1.04 × £30m × 2.0777/£1.00 = $60,823,076.92 at the end of the second year. The IRR on a $60m loan with payments of $2,446,153.85 and $64,823,076.93 is 6 percent.

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101) Since B can redenominate a £30m, 4 percent loan into a $60m, 6 percent loan, it won't be very interested in swaps with an all-in-cost very much higher than $6 percent.

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CHAPTER 15 MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 1) Under the investment dollar premium system, A) U.K. residents received a premium over the prevailing commercial exchange rate when they sold foreign securities and repatriated the funds to the U.K. B) U.K. residents had to pay a premium over the prevailing commercial exchange rate when they bought foreign currencies to invest in foreign securities. C) none of the options

2) Foreign equities as a proportion of U.S. investors' portfolio wealth rose from about 1 percent in the early 1980s to about _______ by 2018. A) B) C) D)

10 percent 25 percent 35 percent 67 percent

3) In the context of investments in securities (stocks and bonds), portfolio risk diversification refers to A) the time-honored adage "Don't put all your eggs in one basket." B) investors' ability to reduce portfolio risk by holding securities that are less than perfectly correlated. C) the fact that the less correlated the securities in a portfolio, the lower the portfolio risk. D) all of the options

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In the graph at shown, X and Y represent

A) B) C) D)

U.S. stocks and global stocks, respectively. global stocks and U.S. stocks, respectively. systematic risk and unsystematic risk. none of the options

Systematic risk is

A) diversifiable risk. B) the risk that remains until investors fully diversify their portfolio holdings. C) non-diversifiable risk and the risk that remains even after investors fully diversify their portfolio holdings. D) none of the options

Investors can reduce portfolio risk by

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A) B) C) D)

Investors can enhance benefits from international diversification by using A) B) C) D)

unsystematic risk. sensitivity of returns on a security to world market movements. risk-adjusted performance. risk of default and bankruptcy.

The less correlated the securities in a portfolio, A) B) C) D)

10) true?

industry funds. factor funds. style funds. all of the options.

The "world beta" measures the A) B) C) D)

holding securities that are less than perfectly correlated. diversifying portfolio holdings internationally. both A and B. neither A or B.

the lower the portfolio risk. the higher the portfolio risk. the lower the unsystematic risk. the higher the diversifiable risk.

Regarding the mechanics of international portfolio diversification, which statement is

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A) Security returns are much less correlated across countries than within a county. B) Security returns are more correlated across countries than within a county. C) Security returns are about as equally correlated across countries as they are within a county. D) none of the options

11)

Systematic risk

A) B) C) holdings. D)

12)

is also known as non-diversifiable risk. is market risk. refers to the risk that remains even after investors fully diversify their portfolio all of the options

A fully diversified U.S. portfolio is about A) B) C) D)

75 percent as risky as a typical individual stock. 27 percent as risky as a typical individual stock. 12 percent as risky as a typical individual stock. half as risky as a fully diversified international portfolio.

13) Studies show that international stock markets tend to move more closely together when the volatility is higher. This finding suggests that A) investors should liquidate their portfolio holdings during turbulent periods. B) since investors need risk diversification most precisely when markets are turbulent, there may be less benefit to international diversification for investors who liquidate their portfolio holdings during turbulent periods. C) this kind of correlation is why international portfolio diversification is smart for today's investor. D) none of the options

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14)

The "Sharpe performance measure" (SHP) is

A) a "risk-adjusted" performance measure. B) the excess return (above and beyond the risk-free interest rate) per standard deviation risk. C) the sensitivity level of a national market to world market movements. D) a "risk-adjusted" performance measure, as well as the excess return (above and beyond the risk-free interest rate) per standard deviation risk.

15)

The optimal international portfolio can be solved by maximizing the Sharpe ratio A) B) C) D)

16)

SHP = [E(Rp) − Rf]/σp, SHP = [R(Ep) − Rf]/σp, SHP = [E(Rp) − σp,/Rf] none of the options

The "Sharpe performance measure" (SHP) is

A) B) C) D) none of the options

17) The mean and standard deviation (SD) of monthly returns, over a given period of time, for the stock markets of two countries, X and Y, are: Country

Mean(%)

SD(%)

1.57

4.87

1.92

7.64

Assuming that the monthly risk-free interest rate is 0.25 percent, the Sharpe performance measures, SHP(X) and SHP(Y), and the performance ranks, respectively, for X and Y are:

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A) B) C) D)

18)

SHP(X) = 0.271, rank = 1, and SHP(Y) = 0.219, rank = 2. SHP(X) = 0.271, rank = 2, and SHP(Y) = 0.219, rank = 1. SHP(X) = 18.84, rank = 1, and SHP(Y) = 23.04, rank = 2. SHP(X) = 23.04, rank = 2, and SHP(Y) = 18.84, rank = 1.

With regard to the OIP,

A) the composition of the optimal international portfolio is identical for all investors, regardless of home country. B) the composition of the optimal international portfolio are varies depending upon the numeraire currency used to measure returns. C) the composition of the optimal international portfolio is identical for all investors, regardless of home country, if they hedge their risk with currency futures contracts. D) the composition of the optimal international portfolio are varies depending upon the numeraire currency used to measure returns, and the composition of the optimal international portfolio is identical for all investors (regardless of home country) if they hedge their risk with currency futures contracts.

19)

With regard to the OIP,

A) the composition of the optimal international portfolio is identical for all investors, regardless of home country. B) the OIP has more return and less risk for all investors, regardless of home country. C) the composition of the optimal international portfolio is identical for all investors, regardless of home country, if they hedge their risk with currency futures contracts. D) none of the options

20)

With regard to the OIP,

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A) the composition of the optimal international portfolio is identical for all investors, regardless of home country. B) the OIP has more return and less risk for all investors, regardless of home country. C) the composition of the optimal international portfolio is identical for all investors of a particular country, whether or not they hedge their risk with currency futures contracts. D) none of the options

21)

With regard to the OIP, A) B) C) D)

the optimal international portfolio contains investments from every country. the OIP has more return and less risk for all investors. the composition of the optimal international portfolio changes according to IRP. none of the options

22) Emerald Energy is an oil exploration and production company that trades on the London Stock Exchange. Assume that when purchased by an international investor the stock's price and the exchange rate were £5 and £0.64/$1.00 respectively. At selling time, one year after the purchase date, they were £6 and £0.60/$1.00. Calculate the investor's annual percentage rate of return in terms of the U.S. dollars. A) B) C) D)

0.20 percent 20.00 percent 1.28 percent 28.00 percent

23) Emerald Energy is an oil exploration and production company that trades on the London Stock Exchange. Over the past year, the stock has enjoyed a 20 percent return in pound terms, but over the same period, the exchange rate has fallen from $2.00 = £1 to $1.80 = £1. Calculate the investor's annual percentage rate of return in terms of the U.S. dollars.

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A) 3.5 percent B) 9.25 percent C) 8 percent D) There is not enough information to compute the investor's annual percentage rate of return in terms of the U.S. dollars.

24) Emerald Energy is an oil exploration and production company that trades on the London Stock Exchange. Over the past year, the stock has gone from £50 per share to £55, but over the same period, the dollar has appreciated from $1.21 = £1 to $1.10 = £1. Calculate the U.S. investor's annual percentage rate of return in terms of the U.S. dollars. A) 3.5 percent B) −1 percent C) 0 percent D) There is not enough information to compute the investor's annual percentage rate of return in terms of the U.S. dollars.

25) Bema Gold is an exploration and production company that trades on the Toronto Stock Exchange. Assume that when purchased by an international investor the stock's price and the exchange rate were CAD5 and CAD1.0/USD0.72 respectively. At selling time, one year after the purchase date, they were CAD6 and CAD1.0/USD1.0. Calculate the U.S. investor's annual percentage rate of return in terms of the U.S. dollars. A) B) C) D)

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−13.60 percent 66.67 percent 38.89 percent 28.00 percent

26) The realized dollar returns for a U.S. resident investing in a foreign market will depend on the return in the foreign market as well as on the exchange rate fluctuations between the dollar and the foreign currency.Calculate the variance of the monthly rate of return in dollar terms, if the variance of the foreign market's return (in terms of its own currency) is 1.14, the variance between the U.S. dollar and the foreign currency is 17.64, the covariance is 2.34, and the contribution of the cross-product term is 0.04. A) B) C) D)

21.16 23.50 26.89 28.65

27) Emerald Energy is an oil exploration and production company that trades on the London Stock Exchange. Assume that when purchased by an international investor the stock's price and the exchange rate were £5 and £0.64/$1.00 respectively. At selling time, one year after purchase, they were £6 and £0.60/$1.00. Suppose the investor had sold £5, the principal investment amount, forward at the forward exchange rate of £0.60/$1.00 at the same time that the stock was purchased. The dollar rate of return would be A) B) C) D)

0.20 percent. 20.00 percent. 28.00 percent. 30.00 percent.

28) Assume that you have invested $100,000 in British equities. When purchased, the stock's price and the exchange rate were £50 and £0.50/$1.00 respectively. At selling time, one year after purchase, they were £60 and £0.60/$1.00. If the investor had sold £50,000 forward at the forward exchange rate of £0.55/$1.00, the dollar rate of return would be A) B) C) D)

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10.90 percent. 7.58 percent. 28.00 percent. 9.09 percent.

29) Assume that you have invested $100,000 in Japanese equities. When purchased, the stock's price and the exchange rate were ¥100 and ¥100/$1.00 respectively. At selling time, one year after purchase, they were ¥110 and ¥110/$1.00. If the investor had sold ¥10,000,000 forward at the forward exchange rate of ¥105/$1.00 the dollar rate of return would be A) B) C) D)

−27.27 percent. 4.33 percent. 28.00 percent. −9.09 percent.

30) Assume that you have invested $100,000 in Japanese equities. When purchased the stock's price and the exchange rate were ¥100 and ¥100/$1.00 respectively. At selling time, one year after purchase, they were ¥110 and ¥110/$1.00. The dollar rate of return would be A) B) C) D)

0 percent. 4.32 percent. 28 percent. −9.09 percent.

31) Suppose you are a euro-based investor who just sold Microsoft shares that you had bought six months ago. You had invested €10,000 to buy Microsoft shares for $120 per share; the exchange rate was $1.55 per euro. You sold the stock for $135 per share and converted the dollar proceeds into euro at the exchange rate of $1.50 per euro. Compute the rate of return on your investment in euro terms. A) B) C) D)

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12.50 percent 16.25 percent 28.00 percent −9.09 percent

32) Suppose you are a euro-based investor who just sold Microsoft shares that you had bought six months ago. You had invested €10,000 to buy Microsoft shares for $120 per share; the exchange rate was $1.55 per euro. You sold the stock for $135 per share and converted the dollar proceeds into euro at the exchange rate of $1.50 per euro. How much of the return is due to the exchange rate movement? A) B) C) D)

33)

3.76 percent 3.33 percent 12.50 percent 16.25 percent

Which of the following is a true statement?

A) Generally, exchange rate volatility is greater than bond market volatility. B) When investing in international bonds, it is essential to control exchange risk to enhance the efficiency of international bond portfolios. C) The real-world evidence suggests that investing in Swiss bonds largely amounts to investing in Swiss currency. D) all of the options

34)

Compared with bond markets

A) the risk of investing in foreign stock markets is, to a lesser degree, attributable to exchange rate uncertainty. B) the risk of investing in foreign stock markets is, to a much greater degree, attributable to exchange rate uncertainty. C) exchange risk is lower than default risk and interest rate risk. D) all of the options

35) Exchange rate fluctuations contribute to the risk of foreign investment through three possible channels(i) the volatility of the investment due to the volatility of the exchange rate(ii) the contribution of the cross-product term(iii) its covariance with the local market returnsWhich of the following contributes and accounts for most of the volatility?

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A) B) C) D)

(i) and (ii) (ii) and (iii) (i) and (iii) only (ii)

36) In May 1995 when the exchange rate was 80 yen per dollar, Japan Life Insurance Company invested ¥800,000,000 (i.e., $10,000,000) in pure-discount U.S. bonds. The investment was liquidated one year later when the exchange rate was 110 yen per dollar. If the rate of return earned on this investment was 46 percent in terms of yen, calculate the dollar amount that the bonds were sold at. A) B) C) D)

$10,618,182 $10,720,000 $14,600,000 none of the options

37) Recent studies show that when investors control exchange risk by using currency forward contracts, A) B) C) D) portfolios.

they can substantially enhance the efficiency of international bond portfolios. they can substantially enhance the efficiency of international stock portfolios. the risk of investing in foreign stock markets can be completely hedged. they can substantially enhance the efficiency of international bond and stock

38) Recent studies show that when investors control exchange risk by using currency forward contracts to hedge,

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A) international bond portfolios outperform domestic bond portfolios. B) international bond portfolios dominate domestic stock portfolios in terms of riskreturn efficiency. C) international bond portfolios outperform domestic bond portfolios, and also dominate domestic stock portfolios in terms of risk-return efficiency. D) none of the options

39)

Advantages of investing in U.S.-based international mutual funds include

A) lower transactions costs relative to direct investing. B) circumvention of many legal and institution barriers to direct portfolio investment in many foreign markets. C) professional management, potentially expertise in security selection, definitely record-keeping. D) all of the options

40) By investing in international mutual funds, investors cani) save any extra transaction and/or information costs they may have to incur when they attempt to invest directly in foreign marketsii) circumvent many legal and institutional barriers to direct portfolio investments in foreign marketsiii) potentially benefit from the expertise of professional fund managers A) B) C) D)

41)

i). i) and ii) ii) and iii). i), ii), and iii)

The record of investing in U.S.-based MNCs

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A) shows that the share prices of U.S.-based MNCs behave much like those of domestic firms, without providing effective international diversification. B) shows that the share prices of U.S.-based MNCs behave much differently than those of domestic firms, providing effective international diversification. C) shows that the share prices of U.S.-based MNCs behave much like the currency returns of their foreign markets. D) none of the options

42)

U.S.-based mutual funds known as country funds:

A) Invest in the government securities of different sovereign governments, giving riskfree portfolios effective exchange rate diversification. B) Invests exclusively in stocks of a single country. C) Invests exclusively in government securities of a single country. D) none of the options

43)

Advantages of investing in mutual funds known as country funds include A) B) C) D)

44)

A closed-end mutual fund A) B) C) D)

45)

speculation in a single foreign market at minimum cost. using them as building blocks of a personal international portfolio. diversification into emerging markets that are otherwise practically inaccessible. all of the options

invests in bonds of a particular maturity, and when they mature, the fund closes. trades on a stock exchange just like a publicly traded corporation. always trades at Net Asset Value. all of the options

With regard to the past price performance of closed-end mutual funds

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A) most funds have traded at both a premium and a discount to NAV. B) most funds trade on a stock exchange just like a publicly traded corporation. C) suggests the risk-return characteristics can be quite different from those of the securities underlying the fund. D) all of the options

46)

With regard to the past price performance of U.S.-based closed-end country funds, A) B) C) D)

47)

The majority of ADRS A) B) C) D)

48)

most CECFs behave more like U.S. securities than their corresponding NAVs. most CECFs have track records nearly identical to their currency returns. most CECFs have stock betas of around zero when measured against the S&P 500. none of the options

are from such developed countries as Australia and Japan. are from developing nations. are from emerging markets. are from both developing nations and emerging markets.

American Depository Receipt (ADRs) represent foreign stocks A) B) C) D)

49) Hedge fund advisors typically receive a management fee, often ________ of the fund asset value as compensation, plus performance fee that can be 20-25 percent of capital appreciation.

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A) B) C) D)

50)

1 to 2 percent 10 to 20 basis points 10 percent none of the options

Hedge fund advisors typically receive a "2-plus-twenty" management fee

A) meaning 2 percent per year of the assets under management, plus performance fee of 20 percent of any capital appreciation. B) meaning 2 percent per year of the assets under management, plus performance fee of 20 basis points. C) meaning 2 percent per year of the assets under management, plus performance fee of 20 percent of the excess return. D) meaning 2 percent per year of the assets under management, plus performance fee 20 percent of gross return net of the risk-free rate.

51)

Hedge funds

A) do not register as an investment company and are not subject to reporting or disclosure requirements. B) have experienced phenomenal growth in recent years. C) tend to have relatively low correlations with various stock market benchmarks. D) all of the options

52)

Explanations for Home Bias include

A) domestic securities may provide investors with certain extra services, such as hedging against domestic inflation that foreign securities do not. B) there may be barriers, formal or informal, to investing in foreign securities. C) investors may face country-specific inflation in violation of PPP. D) all of the options

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53)

When a country is more remote, with an uncommon language A) B) C) D)

54)

domestic investors tend to invest more in the country's market and less abroad. foreign investors tend to invest less in the country's market. domestic investors tend to invest more in the country's market. Both A and B are correct.

The degree of home bias varies across investors.

A) Wealthier, more experienced, and sophisticated investors are less likely to exhibit home bias. B) Wealthier, more experienced, and sophisticated investors are more likely to exhibit home bias. C) Wealthier, more experienced, and sophisticated investors are less likely to invest in foreign securities. D) None of the options

55)

Current research suggests that A) B) C) D)

investors can get more diversification with shares of domestic, large-cap stocks. investors can get more diversification with shares of domestic, small-cap stocks. investors can get more diversification with shares of foreign, large-cap stocks. investors can get more diversification with shares of foreign, small-cap stocks.

56) The return and variance of return to a U.S. dollar based investor from investing in individual foreign security i are given by: A) B) C) D)

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Ri$ = (1 + Ri)(1 + ei) − 1 and Var(Ri$) = Var(Ri) Ri$ = Ri + ei and Var(Ri$) = Var(Ri) + Var(ei) Ri$ = (1 + Ri)(1 + ei) – 1 and Var(Ri$) = Var(Ri) + Var(ei) + 2Cov(Ri, ei) none of the options

57) Consider a simple exchange risk hedging strategy in which the U.S. dollar based investor sells the expected foreign currency proceeds of a risky investment forward. Although the expected foreign investment proceeds will be converted into U.S. dollars at the known forward exchange rate under this strategy, the unexpected portion of the foreign investment proceeds A) will have to be converted into U.S. dollars at the uncertain forward spot exchange rate. B) will have to be converted into U.S. dollars at the uncertain future spot exchange rate. C) will have to be converted into U.S. dollars at the uncertain swap exchange rate. D) none of the options

SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question. 58) Calculate the euro-based return an Italian investor would have realized by investing €10,000 into a £50 British stock. One year after investment, the stock pays a £1 dividend, and sells for £55 the exchange rate has changed from €1.25 per pound to €1.30 per pound.

59) Calculate the euro-based return an Italian investor would have realized by investing €10,000 into a £50 British stock using 50 percent margin. One year after investment, the stock pays a £1 dividend, and sells for £54. In the meantime, the exchange rate has changed from €1.25 per pound to €1.30 per pound. The interest on the margin loan is 1 percent per year. The margin loan was denominated in pounds.

60) Calculate the euro-based return an Italian investor would have realized by investing €10,000 into a £50 British stock. The stock pays a £0.30 quarterly dividend, and after one year the investment sells for £55.20. The exchange rate has changed from €1.25 per pound to €1.30 per pound.

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61) Calculate the euro-based return an Italian investor would have realized by investing €10,000 into a £50 British stock on margin with only 40 percent down and 60 percent borrowed. The stock pays a £0.30 quarterly dividend, and after one year the investment sells for £54. The exchange rate has changed from €1.25 per pound to €1.30 per pound. The interest on the margin loan is 1 percent per year. The margin loan is denominated in pounds.

62) Calculate the euro-based return an Italian investor would have realized by investing €10,000 into a £50 British stock. One year after investment, the stock has no value since the firm is bankrupt. Meanwhile the exchange rate has changed from €1.25 per pound to €1.30 per pound, and he sold £8,000 forward at the forward rate of €1.28 per pound.

63) Calculate the euro-based return an Italian investor would have realized by investing €10,000 into a $50 American stock. One year after investment, the stock pays a $1 dividend, and sells for $54. The exchange rate has changed from €0.625 per dollar to €0.6875 per dollar.

64) Calculate the euro-based return an Italian investor would have realized by investing €10,000 into a $50 American stock using 50 percent margin. One year after investment, the stock pays a $1 dividend and sells for $54. The exchange rate has changed from €0.625 per dollar to €0.6875 per dollar. The interest on the margin loan is 1 percent per year. The margin loan was denominated in dollars.

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65) Calculate the euro-based return an Italian investor would have realized by investing €10,000 into a $50 American stock. The stock pays a $0.30 quarterly dividend, and after one year the investment sells for $54. The exchange rate has changed from €0.625 per dollar to €0.6875 per dollar.

66) Calculate the euro-based return an Italian investor would have realized by investing €10,000 into a $50 American stock on margin with only 40 percent down and 60 percent borrowed. The stock pays a $0.30 quarterly dividend, and after one year the investment sells for $54. The exchange rate has changed from €0.625 per dollar to €0.6875 per dollar. The interest on the margin loan is 1 percent per year. The margin loan is denominated in dollars.

67) Calculate the euro-based return an Italian investor would have realized by investing €10,000 into a $50 American stock. One year after investment, the stock pays a $1 dividend, and sells for $54. The exchange rate has changed from €0.625 per dollar to €0.6875 per dollar.

68) Calculate the euro-based return an Italian investor would have realized by investing €10,000 into a $50 American stock. One year after investment, the stock pays a $1 dividend and sells for $54. The exchange rate has changed from €0.625 per dollar to €0.6875 per dollar, although he sold $16,000 forward at the forward rate of €0.65 per dollar.

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69) Calculate the euro-based return an Italian investor would have realized by investing €10,000 into a $50 American stock. One year after investment, the stock has no value since the firm is bankrupt. Meanwhile the exchange rate has changed from €0.625 per dollar to €0.6875 per dollar, and he sold $16,000 forward at the forward rate of €0.65 per dollar.

70) Calculate the euro-based return an Italian investor would have realized by investing €10,000 into a £50 British stock. One year after investment, the stock pays a £1 dividend, and sells for £54. Spot exchange rates at the start and end of the year are shown in the table. T = 0

T = 1

Euro

1.60

Pound

2.00

2.08

71) Calculate the euro-based return an Italian investor would have realized by investing €10,000 into a £50 British stock using 50 percent margin. One year after investment, the stock pays a £1 dividend, and sells for £54. The interest on the margin loan is 1 percent per year. The margin loan was denominated in pounds. T = 0

T = 1

Euro

1.60

Pound

2.00

2.08

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72) Calculate the euro-based return an Italian investor would have realized by investing €10,000 into a £50 British stock. The stock pays a £0.30 quarterly dividend, and after one year the investment sells for £54. T = 0

T = 1

Euro

1.60

Pound

2.00

2.08

73) Calculate the euro-based return an Italian investor would have realized by investing €10,000 into a £50 British stock on margin with only 40 percent down and 60 percent borrowed. The stock pays a £0.30 quarterly dividend, and after one year the investment sells for £54. The interest on the margin loan is 1 percent per year. The margin loan is denominated in pounds.Spot dollar exchange rates at the start and end of the year are shown in the table. T = 0

T = 1

Euro

1.60

Pound

2.00

2.08

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74) The stock market of country A has an expected return of 5 percent, and standard deviation of expected return of 8 percent. The stock market of country B has an expected return of 15 percent and standard deviation of expected return of 10 percent.Find the expected return of a portfolio with half invested in A and half invested in B.

75) The stock market of country A has an expected return of 5 percent, and standard deviation of expected return of 8 percent. The stock market of country B has an expected return of 15 percent and standard deviation of expected return of 10 percent.Assume that the correlation of expected return between A and B is negative 1. Calculate the standard deviation of expected return of a portfolio with half invested in A and half invested in B.

76) The stock market of country A has an expected return of 5 percent, and standard deviation of expected return of 8 percent. The stock market of country B has an expected return of 15 percent and standard deviation of expected return of 10 percent.Find the Global Minimum Variance Portfolio.

77) The stock market of country A has an expected return of 8 percent, and standard deviation of expected return of 5 percent. The stock market of country B has an expected return of 16 percent and standard deviation of expected return of 10 percent.Find the expected return of a portfolio with half invested in A and half invested in B.

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78) The stock market of country A has an expected return of 8 percent, and standard deviation of expected return of 5 percent. The stock market of country B has an expected return of 16 percent and standard deviation of expected return of 10 percent.Assume that the correlation of expected return between A and B is negative 1. Calculate the standard deviation of expected return of a portfolio with half invested in A and half invested in B.

79) The stock market of country A has an expected return of 8 percent, and standard deviation of expected return of 5 percent. The stock market of country B has an expected return of 16 percent and standard deviation of expected return of 10 percent.Assume that the correlation of expected returns between A and B is negative 1.Is it reasonable to conclude that your portfolio is on the efficient frontier? If not, then prove your point by finding just one portfolio weighting between A and B that offers more return with less risk. If you think it is on the efficient frontier, why do you think this?

80) The stock market of country A has an expected return of 8 percent, and standard deviation of expected return of 5 percent. The stock market of country B has an expected return of 16 percent and standard deviation of expected return of 10 percent.Find the Global Minimum Variance Portfolio.

81) The stock market of country A has an expected return of 5 percent, and a standard deviation of expected return of 8 percent. The stock market of country B has an expected return of 15 percent and a standard deviation of expected return of 10 percent.Calculate the expected return of a portfolio that is half invested in A and half in B.

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82) The stock market of country A has an expected return of 5 percent, and a standard deviation of expected return of 8 percent. The stock market of country B has an expected return of 15 percent and a standard deviation of expected return of 10 percent.Assume that the correlation of expected return between security A and B is 0.2. Calculate the standard deviation of expected return of a portfolio that has half of its money invested in A and half in B.

83) The stock market of country A has an expected return of 5 percent, and a standard deviation of expected return of 8 percent. The stock market of country B has an expected return of 15 percent and a standard deviation of expected return of 10 percent.Is it reasonable to conclude that your portfolio is on the efficient frontier? If not, then prove your point by finding just one portfolio weighting between A and B that offers more return with less risk. If you think it is on the efficient frontier, why do you think this? Either way, your answer should include verification.

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Answer Key Test name: Chap 15_9e 1) B 2) B 3) D 4) A 5) C 6) C 7) D 8) B 9) A 10) A 11) D 12) B 13) B 14) D 15) A 16) A 17) A 18) B 19) D 20) C 21) D 22) D 23) C 24) C 25) B 26) B Version 1

27) B 28) B 29) B 30) A 31) B 32) A 33) D 34) A 35) C 36) A 37) A 38) B 39) D 40) D 41) A 42) B 43) D 44) B 45) D 46) A 47) A 48) B 49) A 50) A 51) D 52) D 53) D 54) A 55) D 56) C Version 1

57) B 58) %media:4formula7.mml%%media:formula11.mml% 59) %media:formula14.mml%%media:formula15.mml% 60) %media:formula19.mml%%media:formula20.mml% 61) Our investor's initial endowment is £8,000. If that represents 40 percent of his investment, then he borrows £12,000 and has a total investment of £20,000. At £50/share £20,000 buys 400 shares. At the end of the year he must repay a £12,000 loan. %media:5formula27.mml%%media:5formula28.mml% 62) Our investor lost all of his money on the stock and then some more on the forward contract. %media:formula41.mml% %media:formula42.mml% 63) %media:4formula52.mml% %media:formula46.mml% %media: formula47.mml% 64) Our investor's initial endowment is $16,000. If that represents 50 percent of his investment, then he borrows $16,000 and has a total investment of $32,000. At $50/share, $32,000 buys 640 shares. At the end of the year, he must repay his loan. %media:formula51.mml% %media:formula55.mml% 65) %media:4formula61.mml% %media:4formula62.mml% %medi a:4formula63.mml%

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66) Our investor's initial endowment is $16,000. If that represents 40 percent of his investment, then he borrows $24,000 and has a total investment of $40,000. At $50/share $40,000 buys 800 shares. At the end of the year he must repay his loan. %media:formula67.mml% %media:formula68.mml% 67) %media:formula71.mml% %media:formula72.mml% 68) %media:formula76.mml% %media:formula77.mml% 69) Our investor lost all of his money on the stock and then some more on the forward contract. %media:formula80.mml% %media:formula81.mml% 70) The key is to calculate the cross-exchange rates of €1.25/£ and €1.30/£. %media:formula84.mml% %media:formula85.mml% 71) The key is to calculate the cross-exchange rates of €1.25/£ and €1.30/£. %media:formula88.mml% %media:formula89.mml% 72) The key is to calculate the cross-exchange rates of €1.25/£ and €1.30/£. %media:formula92.mml% %media:formula93.mml%

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73) The key is to calculate the cross-exchange rates of €1.25/£ and €1.30/£. Our investor's initial endowment is £8,000. If that represents 40 percent of his investment, then he borrows £12,000 and has a total investment of £20,000. At £50/share, £20,000 buys 400 shares. At the end of the year he must repay a £12,000 loan with interest. %media:formula98.mml% %media:formula99.mml% 74) E (rp) = 10% = 1/2 × 5% + 1/2 × 15% 75) σ2p = (WAσA)2 + (WBσB)2 + 2WAσAWBσBPAB σ2p =(1/2 × 8%)2 + (1/2 × 10%)2 + 2 × 1/2 × 8% × 1/2 × 10% × (–1) σ2p = 16 + 25 – 40 = 1 σp =1% 76) [MISSING IMAGE: , ]With a correlation coefficient of negative one we know that the efficient frontier will intersect the vertical axis. Finding the minimum variance portfolio is just about solving this equation for WA σ2P = (WA8%)2 + (WB10%)2 – 2WA8%WB10% = 0 substituting (1 – WA) for WB we have (WA8%) + ((1 – WA)10%)2 – 2WA8% (1 – WA)10% = 0 A bit of algebra reveals that WA = 5/9 Thus the minimum variance portfolio has 55.56% (= 5/9) invested in country A and 44.44% (= 4/9) invested in country B. 77) E(rp) = 12% = 1/2 × 8% + 1/2 × 16% 78) σ2p = (WAσA)2 + (WBσB)2 + 2WAσAWBσBPAB σ2p =(1/2 × 5%)2 + (1/2 × 10%)2 + 2 × 1/2 × 5% × 1/2 × 10% × (–1) σ2p = 6.25 + 25 – 25 σp = 2.50% 79) With a 60-40 portfolio (both ways) you get higher return with higher risk or lower risk with lower return. Since we do not easily find dominant portfolios, we're probably on the efficient frontier.

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80) [MISSING IMAGE: , ]With a correlation coefficient of negative one we know that the efficient frontier will intersect the vertical axis. Finding the minimum variance portfolio is just about solving this equation for WA σ2P = (WA5%)2 + (WB10%)2 – 2WA5%WB10% = 0 substituting (1 – WA) for WB we have (WA5%) + ((1 – WA)10%)2 – 2WA5% (1 – WA)10% = 0 A bit of algebra reveals that WA = 2/3. Thus the minimum variance portfolio has 2/3 invested in country A and 1/3 invested in country B. 81) E(rp) = 10% = 1/2 × 5% + 1/2 × 15% 82) σ2p = (WAσA)2 + (WBσB)2 + 2WAσAWBσBPAB σ2p =(1/2 × 8%)2 + (1/2 × 10%)2 + 2 × 1/2 × 8% × 1/2 × 10% × 0.2 σ2p = 16 + 25 + 8 = 49 σp =7% 83) With a 60-40 portfolio (both ways) you get higher return with higher risk or lower risk and lower return. If you try portfolio weights adjacent to 50-50, you do not get dominant portfolios. Therefore, we're on the efficient frontier.

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CHAPTER 16 TRUE/FALSE - Write 'T' if the statement is true and 'F' if the statement is false. 1) In the early 1980s, Honda, the Japanese automobile company, built an assembly plant in Marysville, Ohio, and began to produce cars for the North American market. As the production capacity at the Ohio plant expanded, Honda began to export its U.S.-manufactured cars to Japan. ⊚ ⊚

true false

2) Shareholders of U.S. bidders (acquiring firms in M&A) experience significant positive abnormal returns when firms expand into new industries and geographic markets. ⊚ ⊚

true false

3) Shareholders of U.S. targets experience higher wealth gains when they are acquired by foreign firms than when acquired by U.S. firms. ⊚ ⊚

true false

4) Cross-border acquisitions are generally found to be synergy-generating corporate activities. ⊚ ⊚

true false

MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 5) Under a 1981 Voluntary Restraint Agreement Japanese automobile manufacturers were not allowed to increase their exports to the U.S. market. As a result

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A) they exited the market. B) Honda was motivated to circumvent the trade barriers. C) Honda's FDI may have been part of an overall corporate strategy designed to bolster their competitive position vis-à-vis their domestic rivals such as Toyota. D) Honda was motivated to circumvent the trade barriers, and Honda's FDI may have been part of an overall corporate strategy designed to bolster their competitive position vis-à-vis their domestic rivals such as Toyota.

Following Honda's FDI in the U.S.,

A) the U.S. government imposed a Voluntary Restraint Agreement under which Japanese automobile manufacturers were not allowed to increase their exports to the U.S. market. B) Toyota and Nissan made direct investments in America. C) sales of Hondas declined. D) none of the options

Honda's decision to build a plant in Ohio

A) was welcomed by the United Auto Workers. B) was encouraged by assistance from the state of Ohio, including improved infrastructure around the plant and abatement of property taxes. C) involved setting up a special foreign trade zone that allowed Honda to import auto parts from Japan at a reduced tariff rate. D) all of the options

When firms undertake FDI,

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A) they become MNCs. B) they reduce their tax rate since they can tell each country that they do business in that they paid their taxes in other countries. C) they can exploit workers by paying them below-market wages in depreciating currencies. D) all of the options

Prior to Honda's decision to build a plant in Ohio,

A) the Japanese government had been urging the automobile companies to begin production in the United States. B) the Japanese government had been urging the automobile companies to keep production in Japan. C) the Japanese government imposed import quotas on U.S.-made automobiles. D) none of the options

10)

FDI can take the form of A) B) C) D)

Greenfield investment. cross-border M &A. establishing new production facilities in a foreign country. all of the options

11) The Ford Motor Company recently acquired Mazda, a Japanese auto maker, and Jaguar, a British auto maker. A) B) C) D)

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This is an example of cross-border M&A. This was a Greenfield investment. This is an example of cross-border M&A, and was also a Greenfield investment. none of the options

12)

Firms become multinational

A) when they undertake foreign direct investments (FDI). B) with the establishment of new production facilities in foreign countries such as Honda's Ohio plant. C) when they become involved in mergers with and acquisitions of existing foreign businesses. D) all of the options

13)

The United States is the largest initiator, of FDI. The largest recipient of FDI is A) B) C) D)

14)

According to a recent UN survey, the world FDI stock grew to what amount in 2017? A) B) C) D)

15)

$31 billion $28 billion $10 billion none of the options

During the six-year period 2012-2017, total annual worldwide FDI outflows amounted to A) B) C) D)

16)

also the United States. France. Germany. China.

about $1,979 million on average. about $1,423 billion on average. about $1,150 trillion on average. none of the options

During the six-year period 2012-2017,

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A) B) C) D)

17)

China received the largest amount of FDI inflows. India received the largest amount of FDI inflows. Mexico received the largest amount of FDI inflows. the United States received the largest amount of FDI inflows.

Japan plays a major role as an exporter of FDI. As a recipient of FDI,

A) Japan receives as much FDI as it exports, making it a major player on both fronts. B) Japan plays a relatively minor role, reflecting a variety of legal, economic, and cultural barriers to FDI. C) Japan's receipts of FDI are third in the world. D) none of the options

18)

MNCs might have been lured to invest in China A) B) C) D)

19)

The third most important source of FDI outflows is A) B) C) D)

20)

by China's lower labor and material costs. by the desire to preempt the entry of rivals into China's potentially huge market. Both A & B are correct. Neither A nor B are correct.

the United States. Japan. China. Mexico.

MNCs have invested in China

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A) B) C) D)

21)

FDI stocks A) B) C) D)

22)

several developed countries. a few underdeveloped countries next to wealthy neighbors, like Mexico. Africa and China. none of the options

Alternatives to firms locating production overseas include A) B) C) D)

24)

are the common shares of multinational companies that invest abroad. are mutual funds that invest in FDI. represent the accumulation of previous years' FDI flows. are the sum total of current year FDI flows.

The dominant source of FDI outflows is A) B) C) D)

23)

by lower material costs. by lower labor costs. by a desire to preempt the entry of rivals into China's potentially huge market. all of the options

exporting from the home country. licensing production to a local firm in the host country. ignoring the foreign market. all of the options

The key factors that are important in a firm's decision to invest overseas are

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A) B) C) D)

25)

trade barriers, imperfect labor market, and intangible assets. vertical integration, product life cycle, and shareholder diversification services. profit maximization, global prestige, and competition. Both A & B are correct.

Why do firms locate production overseas rather than exporting finished goods? A) B) C) D)

Shipping costs Firms seek to extend corporate control overseas Imperfect factor markets all of the options

26) Unlike the theory of international trade or the theory of international portfolio investment, A) B) C) D)

27)

we do not have a well-developed, comprehensive theory of FDI. the comprehensive theory of FDI focuses on mean-variance efficiency. the comprehensive theory of FDI is an arbitrage argument, like interest rate parity. none of the options

While there is no comprehensive theory of FDI, many existing theories emphasize A) B) C) D)

imperfections in product markets. imperfections in capital markets. imperfections in labor markets. all of the options

28) International markets for goods and services are often imperfect. Which is the most common and most important?

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A) B) C) D)

29)

Why do governments regulate international trade? A) B) C) D)

30)

To raise revenue Protect domestic industries Pursue other economic objectives all of the options

Governments regulate international trade A) B) C) D)

31)

Acts of governments Natural barriers like distance Cultural barriers Lack of knowledge

to raise revenue (e.g., through tariffs). to protect domestic industries. to pursue other economic policy objectives (e.g., North Korea forgoing trade). all of the options

A classic example for trade barrier-motivated FDI is A) B) C) D)

Honda's investment in Ohio. Bridgestone's investment in Japan. NAFTA. none of the options

32) Such products as mineral ore and cement that are heavy or bulky relative to their economic values

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A) may be suitable for exporting because high transportation costs will be overcome by high profit margins in oligopolistic industries. B) have high "value-to-weight ratios" that protect profit margins. C) may not be suitable for exporting because high transportation costs will substantially reduce profit margins. D) none of the options

33)

Trade barriers can arise naturally. Which of the following are natural barriers to trade? A) B) C) D)

Transportation costs Quotas Tariffs Transactions costs

34) In a push to serve the North American market Samsung, a Korean firm, chose to locate production facilities in Mexico, mainly because A) B) C) D)

35)

of lower labor costs in Mexico. to circumvent trade barriers imposed by NAFTA. because of colder weather in Canada. none of the options

Labor services in a country might be underpriced relative to productivity because A) workers are not allowed to freely move across national boundaries to seek higher

wages. B) some countries do a bad job of educating their work force, consequently they are not very productive. C) in some countries there is a shortage of capital investment. D) all of the options are equally important

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36)

Labor services in a country can be severely underpriced relative to its productivity

A) because workers are not allowed to freely move across national boundaries to seek higher wages. B) because among all factor markets, the labor market is the most imperfect. C) because workers may choose to not move across national boundaries to seek higher wages due to the cultural differences. D) all of the options

37) Severe imperfections in the labor market lead to persistent wage differentials among countries A) because workers are not allowed to freely move across national boundaries to seek higher wages. B) because workers may choose to not move across national boundaries to seek higher wages due to the cultural differences. C) but these differences are offset by low productivity in low labor cost countries. D) Both A & B are correct.

38) Factors of production include land, labor, capital, and entrepreneurial ability. Of all the factor markets, the most imperfect is the A) B) C) D)

39)

labor market. capital market. real estate market. market for entrepreneurial ability.

Severe imperfections in the labor market lead to

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A) B) C) D)

persistent wage differentials among countries. persistent exchange rate volatility among countries. persistent interest rate differentials among countries. none of the options

40) Severe imperfections in the labor market arise from immobility of workers due to immigration barriers. As a response, firms should consider A) B) C) D)

moving to the workers. moving to countries where labor services are the lowest in absolute terms. moving to countries where labor services are underpriced relative to productivity. hiring illegal immigrants.

41) Coca-Cola has invested in bottling plants all over the world rather than licensing local firms A) because the foreigners can't be trusted to follow the secret recipe. B) because Coca-Cola wanted to protect the formula for its famous soft drink. C) because of the internalization theory of FDI. D) because Coca-Cola wanted to protect the formula for its famous soft drink and because of the internalization theory of FDI.

42)

The boomerang effect is defined as

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A) the possibility that if the secret formula of Coca-Cola were leaked, that other firms would come up with similar products and hurt Coca-Cola's sales. B) the possibility that FDI in an undeveloped nation will lead to a group of workers who have enough money to afford the firm's products, leading to an increase of sales and increase of workers and so on. C) the possibility that FDI in an undeveloped nation will lead to a group of domestic workers no longer have enough money to afford the firm's products, leading to an decrease of sales. D) none of the options

43)

Examples of intangible assets include A) B) C) D)

technological, managerial, and marketing know-how. superior R&D capabilities. brand names. all of the options

44) In the 1960s, Coca-Cola, which had bottling plants in India, faced strong pressure from the Indian government to reveal the Coke formula as a condition for continued operations in India. As a result, A) Coke agreed to reveal the formula to the Indian government, which has maintained it as a state secret to this day. B) instead of revealing the formula, Coke withdrew from the Indian market. C) Coke was able to successfully lobby the government to withdraw this demand. D) none of the options

45) MNCs may undertake overseas investment projects in a foreign country, despite the fact that local firms may enjoy inherent advantages. This implies that

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A) MNCs are making a mistake in this case and will have to eventually withdraw. B) MNCs should have significant advantages over local firms such as comparative advantages due to intangible assets. C) the local firms will not have to compete due to their inherent advantages over the foreigners. D) none of the options

46)

Intangible assets are often hard to package and sell to foreigners

A) because they usually default on the contracts that they sign. B) and as a result, there is more FDI than there might otherwise be. C) because property rights in intangible assets are difficult to establish and protect, especially in foreign countries where legal recourse may not be readily available. D) Both B & C are correct.

47)

According to the internalization theory of FDI,

A) firms that have intangible assets with a public good property tend to invest directly in foreign countries. B) property rights in intangible assets are difficult to establish and protect, especially in foreign countries where legal recourse may not be readily available. C) firms that have intangible assets with a public good property tend to invest directly in foreign countries. Additionally, property rights in intangible assets are difficult to establish and protect, especially in foreign countries where legal recourse may not be readily available. D) All of the above are correct.

48) Firms that have intangible assets with a public good property tend to invest directly in foreign countries. This is

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A) in order to use these assets on a larger scale. B) to avoid the misappropriation that may occur while transacting in foreign countries through the market mechanism. C) in order to use these assets on a larger scale, and to avoid the misappropriation that may occur while transacting in foreign countries through the market mechanism. D) none of the options

49)

What kind of integration is vertical integration?

A) When the government outlaws discrimination against both short and tall people. B) When two firms join together in a conglomerate merger. C) When two firms related in the production process are owned by the same firm, as in a plywood manufacturer owning a logging company. D) all of the options

50)

The conflicts between the upstream and downstream firms can be resolved, A) B) C) D)

51)

Many MNCs involved in extractive/natural resources industries A) B) C) D)

52)

if the two firms form a horizontally integrated firm. if the two firms form a vertically integrated firm. if the two firms form a linearly integrated firm. none of the options

tend to directly own oil fields, mine deposits, and forests. tend to lease their oil fields, mine deposits, and forests. tend to partner with local firms, leveraging their intangible assets. none of the options

Also, MNCs often find it profitable to locate manufacturing/processing facilities near

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A) the home office to exploit their assets in place. B) the natural resources in order to save transportation costs. C) their competitor's manufacturing plant to even out the playing field with regard to shipping costs. D) none of the options

53)

FDI vertical integration is backward

A) when FDI involves an industry abroad that produces inputs for MNCs. B) when FDI involves an industry abroad that sells the MNC's outputs. C) none of the options D) when FDI involves an industry abroad that produces inputs for MNCs, as well as when FDI involves an industry abroad that sells the MNC's outputs.

54)

The majority of foreign vertical integration is A) B) C) D)

55)

backward. forward. sideways. none of the options

An example of forward vertical FDI is when A) U.S. car makers built their own network of dealerships in Japan to help sell their

cars. B) U.S. car makers began to source parts in Japan to lower the cost of their cars. C) U.S. car makers entered into joint partnerships with car makers in Japan to help sell their cars. D) none of the options

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56) U.S. car makers were forced to build their own network of dealerships to enter the Japanese market. A) B) C) D)

57)

This is an example of backward vertical integration. This is an example of forward vertical integration. This is an example of sideways vertical integration. none of the options

Which of the following statements is true about product life cycle theory?

A) In the early stages of the product life cycle, the demand for the new product is relatively insensitive to the price and thus a pioneering firm can charge a relatively high price. B) It predicts that over time the U.S. switches from an exporting country of new products to an importing country. C) It has an "S"-shaped curve when plotting "quantity sold" versus "time." D) all of the options

58)

According to Raymond Vernon (1966),

A) U.S. firms undertake FDI at a particular stage in the life cycle of the products that they initially introduced. B) the majority of new products, such as computers, televisions, and mass-produced cars, were developed by U.S. firms and first marketed in the United States. C) in the early stage of the product life cycle, the demand for the new product is relatively insensitive to the price and thus the pioneering firm can charge a relatively high price. D) all of the options

59)

The product life-cycle theory predicts that

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A) over time the United States switches from an exporting country of new products to an importing country. B) over time the United States switches from a comparative advantage in R&D to a service economy. C) over time the United States education system maintains the country's dominant position in the world economy. D) none of the options

60)

Which of the following statements is true about product life cycle theory?

A) The theory was developed in the 1960s when the U.S. was the leader in R&D. B) The international system of production is becoming too complicated to be explained by a simple version of the product life cycle theory. C) It predicts that over time the U.S. switches from an exporting country of new products to an importing country. D) all of the options

61) Since shareholders of MNCs may indirectly benefit from corporate international diversification, A) firms are motivated to undertake FDI for the purpose of providing shareholders with diversification services. B) firms are motivated to undertake FDI for the purpose of being part of the global minimum variance portfolio. C) firms are motivated to undertake FDI for the purpose of staying on the efficient frontier. D) none of the options

62) Considering the fact that many barriers to international portfolio investments have been dismantled in recent years,

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A) capital market imperfections as a motivating factor for FDI are likely to become more important going forward. B) capital market imperfections as a motivating factor for FDI are likely to become less relevant. C) labor market imperfections as a motivating factor for FDI are likely to become less relevant. D) none of the options

63)

When a firm holds assets in many countries,

A) the firm's cash flows are internationally hedged. B) shareholders of the firm can indirectly benefit from international diversification even if they are not directly holding foreign shares. C) shareholders of the firm can directly benefit from international diversification even if they are not directly holding foreign shares. D) none of the options

64)

Which of the following is the most disingenuous argument in favor of FDI? A) B) C) D)

65)

Shareholder diversification The internalization theory of FDI The promise of synergistic gains Vertical integration

A "greenfield" investment A) involves soybeans in the spring, corn in the summer. B) is generally less politically sensitive than the acquisition of an existing foreign firm. C) is generally more politically sensitive than the acquisition of an existing foreign

firm. D) none of the options

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66)

As a mode of entry into a foreign market, cross-border acquisition

A) involves building new production facilities in a foreign country. B) offer faster speed over greenfield investment. C) can offer access to proprietary assets. D) offer faster speed over greenfield investment, and can also offer access to proprietary assets.

67)

Cross-border acquisition involves

A) building new production facilities in a foreign country. B) buying an existing foreign business. C) building new production facilities in a foreign country and buying an existing foreign business. D) none of the options

68)

The rapid increase in cross-border M&A deals can be attributed to

A) B) C) economy. D)

the end of the greenfield era—we are running out of land. the lack of domestic investment opportunity. the ongoing liberalization of capital markets and the integration of the world none of the options

69) As a mode of FDI entry, cross-border M&A offers two key advantages over greenfield investments:

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A) speed and access to proprietary assets. B) firms bolster their competitive positions in the world market by acquiring special assets from other firms or using their own assets on a larger scale. C) firms can better leverage their intangible assets and on a larger scale. D) none of the options

70) Mergers and acquisitions are a popular mode of investment for firms wishing to protect, consolidate and advance their global competitive positions. Examples include A) B) C) licensing. D)

71)

selling off divisions that fall outside the scope of their core competence. acquiring strategic assets that reduce their competitiveness. firms can better leverage their intangible assets and on a larger scale through none of the options

Synergistic gains refers to

A) gains from hedging. B) gains obtained when the value of the acquiring and target firms, combined, is less than the stand-alone valuations of the individual firms. C) gains arising if the combined companies can save on the costs of production, marketing, distribution, but not R&D. D) gains obtained when the value of the acquiring and target firms, combined, is greater than the stand-alone valuations of the individual firms. It also refers to gains arising if the combined companies can save on the costs of production, marketing, distribution, and R&D.

72) Whether or not cross-border acquisitions produce synergistic gains and how such gains are divided between acquiring and target firms

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A) B) C) D)

are important issues from the perspective of shareholder welfare. are important issues from the perspective of public policy. are important issues from the perspective of stakeholders in the target firms. all of the options

73) Imperfections in the market for intangible assets can also play a major role in motivating firms to undertake cross-border acquisitions. According to the internalization theory, A) cross-border acquisitions may also be motivated by the acquirer's desire to acquire and internalize the target firm's intangible assets. B) a firm with intangible assets that have a public good property such as technical and managerial know-how may acquire foreign firms as a platform for using its special assets on a larger scale and, at the same time, avoid the misappropriation that may occur while transacting in foreign markets through a market mechanism. C) the internalization, thus, may proceed forward to internalize the acquirer's assets, or backward to internalize the target's assets. D) all of the options

74) In a study of the effect of international acquisitions on the stock prices of U.S. firms, U.S. acquiring firms with information-based intangible assets experience a significantly positive stock price reaction upon foreign acquisition. A) This is consistent with the finding that the market value of the firm is positively related to its multinationality because of the firm's intangible assets, such as R&D capabilities, with public good nature. B) It is not the multinationality per se that contributes to the firm's value. C) Their empirical findings support the (forward-) internalization theory of FDI. D) all of the options

75)

Synergistic gains

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A) are obtained when the acquiring firm is greater in value than the stand-alone valuations of the target firm(s). B) can only be obtained by increases in market power. C) are obtained when the value of the combined firm is greater than the stand-alone valuations of the individual (acquiring and target) firms. D) none of the options

76)

If cross-border acquisitions generate synergistic gains,

A) then both the acquiring and target shareholders gain wealth at the same time. B) then one can argue that cross-border acquisitions are mutually beneficial and thus should not be thwarted both from a national and global perspective. C) then the value of the combined firm is greater than the stand-alone valuations of the individual (acquiring and target) firms. D) all of the options.

77)

OPIC is the A) B) C) D)

78)

Cross-border acquisitions of businesses are a politically sensitive issue, A) B) C) D)

79)

Overseas Pirate Investment Corporation. Overseas Private Investment Corporation. Organization Petroleum Importing Countries. none of the options

as most countries prefer to retain foreign control of domestic firms. as most countries prefer to retain local control of domestic firms. as most countries prefer to retain local control of foreign firms. none of the options

Political risk refers to

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A) the potential losses to the parent firm of an MNC resulting from adverse political developments in the host country. B) macroeconomic risks. C) microeconomic risks. D) bankruptcy or high inflation rates.

80) Depending on the manner in which firms are affected, political risk can be classified into which of the following types of risk? A) B) C) D)

81)

Control risk refers to the risk which arises from the uncertainty about A) B) C) D)

82)

the host's country's policies affecting the local operations of an MNC. the host's country's policy regarding ownership and control of local operations. cross-border flows of capital, payment, know-how, and the like. none of the options

Transfer risk refers to the risk which arises from the uncertainty about A) B) C) D)

83)

transfer and operational risk only operational and control risk only operational and transfer risk only. transfer, operational, and control risk

Operational risk refers to the risk which arises from the uncertainty about

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A) B) C) D)

84)

Countries may welcome greenfield investments, A) B) C) D)

85)

political risk. credit risk, and other economic performances. every risk except political risk. political risk, credit risk, and other economic performances.

More than fifty percent of FDI in dollar terms A) B) C) D)

87)

as they are viewed as representing new investment and employment opportunities. as they are viewed as substitutes for foreign firms' bids to acquire domestic firms. but they are also often resisted and sometimes even resented by the local firms. none of the options

Country risk refers to A) B) C) D)

86)

takes the form of cross-border mergers and acquisitions. takes the form of greenfield investment. is initiated by governments. none of the options

An increase in political risk can be managed by

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A) adjusting a foreign investment project's NPV by either reducing its expected cash flows, or by increasing the cost of capital. B) forming joint venture with a local company. C) purchasing insurance against the hazard of political risk. D) all of the options

88) Some of the risks that a U.S.-based MNC can encounter in its foreign investments are(i) an increase in the cost of borrowing due to a rise in interest rates.(ii) increase in inflation rates.(iii) dumping.(iv) unfair competition by local companies.(v) inconvertibility of foreign currencies.(vi) expropriation.(vii) destruction of properties due to war, revolution, and other violent political events in foreign countries.(viii) loss of business income due to political violence. A) B) C) D)

89)

The communist victory in China in 1949 is an example of A) B) C) D)

90)

(i), (ii), (iii), and (iv) (v), (vi), (vii), and (viii) (i), (ii), (iii), (iv), (v), (vi), (vii), and (viii) none of the options

micro risk. macro risk. both micro and macro risk. none of the options

Examples of transfer risk include

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A) the unexpected imposition of capital controls, inbound or outbound, and withholding taxes on dividend and interest payments. B) unexpected changes in environmental policies, sourcing/local content requirements, minimum wage law, and restriction on access to local credit facilities. C) restrictions imposed on the maximum ownership share by foreigners, mandatory transfer of ownership to local firms over a certain period of time (fade-out requirements), and the nationalization of local operations of MNCs. D) none of the options

91)

Examples of operational risk include

92)

Examples of control risk include

93) Once a MNC decides to undertake a foreign project, it can take various measures to minimize its exposure to political risk. These include

Version 1

A) the MNC can form a joint venture with a local company. B) the MNC may also consider forming a consortium of international companies to undertake the foreign project. C) the MNC can use local debt to finance the foreign project. D) the MNC may purchase insurance against the hazard of political risk. E) all of the options

94) One particular type of political risk that MNCs and investors may face is corruption associated with the abuse of public office for private benefits. A) Investors may often encounter demands for bribes from politicians and government officials for contracts and smooth bureaucratic processes. B) If companies refuse to make grease payments, they may lose business opportunities or face difficult bureaucratic red tape. C) They may risk violating laws or being embarrassed when the payments are discovered and reported in the media. D) all of the options

95) Severe inequality in income distribution and deteriorating living standards are examples of which type of political risk key factor? A) B) C) D)

Integration into the world system Economic indicators Regional security Host country’s ethnic and religious stability

96) In the United States the Overseas Private investment Corporation offers insurance against i) the inconvertibility of foreign currencies. ii) expropriation of U.S.-owned assets overseas iii) destruction of U.S.-owned physical properties due to war, revolution, and other violent political event sin foreign countries iv) loss of business income due to political violence

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A) B) C) D)

i) i), ii) i), ii), iii) i), ii), iii), iv)

97) Which of the following statements regarding political risk that MNCs and investors may face regarding corruption is not true? A) Investors may often encounter demands for bribes from politicians and government officials for contracts and smooth bureaucratic processes. B) Refusing to make grease payments may result in companies losing business opportunities or facing difficult bureaucratic red tape. C) If companies pay a bribe, they may risk violating laws or being embarrassed when the payments are discovered and reported in the media D) none of the options.

98)

In evaluating political risk, experts focus their attention on a set of key factors such as A) B) C) D)

integration of the host country into the world political/economic system. the host country's ethnic and religious stability. the host country's regional security, and key economic indicators. all of the options

99) When evaluating a foreign investment project, it is important for the MNC to consider the effect of political risk, as a sovereign country can change "the rules of the game." To account for this A) B) C) D)

the MNC may adjust the cost of capital upward. the MNC may lower the expected cash flows from the foreign project. the MNC may purchase insurance policies against the hazard of political risks. all of the options

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100)

In evaluating political risk, experts focus their attention on a set of key factors such as A) B) C) D)

101)

Country risk A) B) C) D)

102)

the host country's political/government system. historical records of political parties and their relative strengths. integration of the host country into the world political/economic system. all of the options

is a broader measure of risk than political risk. encompasses political risk, credit risk, and other economic performances. all of the options none of the options

North Korea, Iran, and Cuba are examples of A) B) C) D)

countries with low levels of political risk. countries with zero levels of political risk. countries that are politically and economically isolated from the rest of the world. countries with high and low levels of political risk.

103) In 1992, the Enron Development Corporation, a subsidiary of the Houston-based energy company, signed a contract to build the largest-ever power plant in India, requiring a total investment of $2.8 billion. After Enron had spent nearly $300 million, the project was canceled by Hindu nationalist politicians in the Maharashtra state where the plant was to be built. Which of the following is(are) true?

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A) Upon the news release of the project cancellation, Enron's share price fell immediately by about 10 percent. B) In the process of structuring the deal, Enron made a profound political miscalculation: Instead of waiting for the next election results, Enron rushed to close the deal and began construction, apparently believing that a new government would find it difficult to unwind the deal when construction was already under way. C) Enron had the last laugh, however when they went bankrupt and left the power plant unfinished. D) all of the options

104) In 1992, the Enron Development Corporation, a subsidiary of the Houston-based energy company, signed a contract to build the largest-ever power plant in India, requiring a total investment of $2.8 billion. After Enron had spent nearly $300 million, the project was canceled by Hindu nationalist politicians in the Maharashtra state where the plant was to be built. Which of the following is(are) true? A) This move by the government played well with Indian voters with visceral distrust of foreign companies since the British colonial era. B) This move by the government was widely criticized in India on the grounds that it would deter future foreign investment. C) This move by the government was widely criticized in India on the grounds that severe power shortages have been one of the bottlenecks hindering India's economic growth. D) none of the options

105) In 1992, the Enron Development Corporation, a subsidiary of the Houston-based energy company, signed a contract to build the largest-ever power plant in India, requiring a total investment of $2.8 billion. After Enron had spent nearly $300 million, the project was canceled by Hindu nationalist politicians in the Maharashtra state where the plant was to be built. Which of the following are true?

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A) Subsequently, Maharashtra invited Enron to renegotiate its contract. B) The lack of an effective means of enforcing contracts in a foreign country is clearly a major source of political risk associated with FDI. C) In an effort to pressure Maharashtra to reverse its decision, Enron "pushed like hell" the U.S. Energy Department to make a statement in June 1995 to the effect that canceling the Enron deal could adversely affect other power projects. The statement only compounded the situation. The BJP politicians immediately criticized the statement as an attempt by Washington to bully India. D) all of the options

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Answer Key Test name: Chap 16_9e 1) TRUE 2) TRUE 3) TRUE 4) TRUE 5) D 6) B 7) D 8) A 9) A 10) D 11) A 12) D 13) A 14) A 15) B 16) D 17) B 18) C 19) C 20) D 21) C 22) A 23) D 24) D 25) D 26) A Version 1

27) D 28) A 29) D 30) D 31) A 32) C 33) A 34) A 35) A 36) D 37) D 38) A 39) A 40) C 41) B 42) A 43) D 44) B 45) B 46) D 47) A 48) C 49) C 50) B 51) A 52) B 53) A 54) A 55) A 56) B Version 1

57) D 58) D 59) A 60) D 61) D 62) B 63) B 64) A 65) B 66) D 67) B 68) C 69) A 70) A 71) D 72) D 73) D 74) D 75) C 76) D 77) B 78) B 79) A 80) D 81) B 82) C 83) A 84) A 85) C 86) A Version 1

87) D 88) B 89) B 90) A 91) B 92) C 93) D 94) D 95) B 96) D 97) D 98) D 99) D 100) D 101) C 102) C 103) D 104) A 105) D

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CHAPTER 17 MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 1) The cost of capital is A) the minimum rate of return an investment project must generate in order to pay its financing costs. B) the minimum rate of return an investment project must generate in order to pay its financing costs plus a reasonable profit. C) the maximum rate of return an investment project must generate in order to pay its financing costs. D) the maximum rate of return an investment project must generate in order to pay its financing costs plus a reasonable profit.

2) For a firm that has both debt and equity in its capital structure, its financing cost can be represented by the weighted average cost of capital that is computed by A) weighing the pre-tax borrowing cost of the firm and the cost of equity capital, using the debt as the weight. B) weighing the after-tax borrowing cost of the firm and the cost of equity capital, using the debt as the weight. C) K = (1 − λ)Kl + λ (1 − τ)iwhere: K = weighted average cost of capital Kl = cost of equity capital for a leveraged firm i = before-tax borrowing cost τ = marginal corporate income tax rate λ = debt-to-total-market-value ratio D) Both B & C are correct.

In the notation of the book, K = (1 − λ)Kl + λ(1 − τ)iWhich of these is correct?

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A) B) C) D)

The debt-to-equity ratio is λ The cost of equity capital for a levered firm is The pre-tax cost of debt capital is i all of the options

In the notation of the book, K = (1 − λ)Kl + λ(1 − τ)i ; which of the following is correct? A) B) C) D)

The debt-to-total market value ratio is λ The tax rate is i The after-tax cost of debt capital is i all of the options

In the notation of the book, K = (1 − λ)Kl + λ(1 − τ)i ; which of the following is correct? A) B) C) D)

The debt-to-equity ratio is λ The tax rate is τ The after-tax cost of debt capital is all of the options

The debt-to-equity ratio is λ The cost of equity capital for a levered firm is The after-tax cost of debt capital is i all of the options

In the notation of the book, K = (1 − λ)Kl + λ(1 − τ)i ; which of the following is correct?

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A) B) C) D)

The weighted average cost of capital for a levered firm is The tax rate is τ The after-tax cost of debt capital is i all of the options

At the optimal capital structure, A) B) C) D)

K = (1 − λ)Kl + λ(1 − τ)i will be minimized. The debt-equity ratio will be equal to the debt-to-value ratio. K = (1 − λ)Kl + λ(1 − τ)i will be maximized. none of the options

Solve for the weighted average cost of capital.

10.60 % = 1/3 =

K1 λ

= cost of equity capital for a leveraged firm = debt-to-total-market-value ratio

8.0 % = 40.0 % =

i τ

= before-tax borrowing cost = marginal corporate income tax rate

A) B) C) D)

10)

8.67 percent 8.00 percent 7.60 percent 7.33 percent

Solve for the weighted average cost of capital.

11.20 % =

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= cost of equity capital for a leveraged firm

1/2

= debt-to-total-market-value ratio

8.0 % = 40.0 % =

i τ

= before-tax borrowing cost = marginal corporate income tax rate

A) B) C) D)

11)

8.67 percent 8.00 percent 7.60 percent 7.33 percent

Solve for the weighted average cost of capital.

11.80 % = 3/5 =

K1 λ

= cost of equity capital for a leveraged firm = debt-to-total-market-value ratio

8.0 % = 40.0 % =

i τ

= before-tax borrowing cost = marginal corporate income tax rate

A) B) C) D)

12)

8.67 percent 8.00 percent 7.60 percent 7.33 percent

Solve for the weighted average cost of capital.

12.40 % = 2/3 =

K1 λ

= cost of equity capital for a leveraged firm = debt-to-total-market-value ratio

8.0 % = 40.0 % =

i τ

= before-tax borrowing cost = marginal corporate income tax rate

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A) B) C) D)

13)

8.67 percent 8.00 percent 7.60 percent 7.33 percent

Solve for the weighted average cost of capital.

13.00 % = 5/7 =

K1 λ

= cost of equity capital for a leveraged firm = debt-to-total-market-value ratio

8.0 % = 40.0 % =

i τ

= before-tax borrowing cost = marginal corporate income tax rate

A) B) C) D)

14)

8.67 percent 7.60 percent 7.33 percent 7.14 percent

Solve for the weighted average cost of capital.

13.60 % = 3/4 =

K1 λ

= cost of equity capital for a leveraged firm = debt-to-total-market-value ratio

8.0 % = 40.0 % =

i τ

= before-tax borrowing cost = marginal corporate income tax rate

A) B) C) D)

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7.00 percent 6.89 percent 6.73 percent 6.67 percent

15)

Solve for the weighted average cost of capital.

14.20 % = 7/9 =

K1 λ

= cost of equity capital for a leveraged firm = debt-to-total-market-value ratio

8.0 % = 40.0 % =

i τ

= before-tax borrowing cost = marginal corporate income tax rate

A) B) C) D)

16)

7.00 percent 6.89 percent 6.73 percent 6.67 percent

Solve for the weighted average cost of capital.

15.40 % = 9/11 =

K1 λ

= cost of equity capital for a leveraged firm = debt-to-total-market-value ratio

8.0 % = 40.0 % =

i τ

= before-tax borrowing cost = marginal corporate income tax rate

A) B) C) D)

17)

7.00 percent 6.89 percent 6.73 percent 6.67 percent

Solve for the weighted average cost of capital.

16.00 % =

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= cost of equity capital for a leveraged firm

5/6

= debt-to-total-market-value ratio

8.0 % = 40.0 % =

i τ

= before-tax borrowing cost = marginal corporate income tax rate

A) B) C) D)

18)

7.00 percent 6.89 percent 6.73 percent 6.67 percent

Solve for the weighted average cost of capital.

17.20 % = 6/7 =

K1 λ

= cost of equity capital for a leveraged firm = debt-to-total-market-value ratio

8.0 % = 40.0 % =

i τ

= before-tax borrowing cost = marginal corporate income tax rate

A) B) C) D)

19)

7.00 percent 6.89 percent 6.73 percent 6.57 percent

Solve for the weighted average cost of capital.

10.60 % 1/3

= =

K1 λ

8.0 % 40.0 %

= =

i τ

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A) B) C) D)

20)

Solve for the weighted average cost of capital.

11.20 % 1/2

= =

K1 λ

8.0 % 40.0 %

= =

i τ

A) B) C) D)

21)

8.67 percent 8.00 percent 7.60 percent 7.33 percent

Solve for the weighted average cost of capital.

11.80 % 3/5

= =

K1 λ

8.0 % 40.0 %

= =

i τ

A) B) C) D)

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8.67 percent 8.00 percent 7.60 percent 7.33 percent

22)

Solve for the weighted average cost of capital.

12.40 % 2/3

= =

K1 λ

8.0 % 40.0 %

= =

i τ

A) B) C) D)

23)

Solve for the weighted average cost of capital.

13.00 % 5/7

= =

K1 λ

8.0 % 40.0 %

= =

i τ

A) B) C) D)

24)

8.67 percent 8.00 percent 7.60 percent 7.33 percent

8.67 percent 8.00 percent 7.60 percent 7.14 percent

Solve for the weighted average cost of capital.

13.60 %

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3/4

8.0 % 40.0 %

= =

i τ

A) B) C) D)

25)

Solve for the weighted average cost of capital.

14.20 % 7/9

= =

K1 λ

8.0 % 40.0 %

= =

i τ

A) B) C) D)

26)

7.00 percent 6.89 percent 6.73 percent 6.67 percent

Solve for the weighted average cost of capital.

15.40 % 9/11

= =

K1 λ

8.0 % 40.0 %

= =

i τ

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A) B) C) D)

27)

Solve for the weighted average cost of capital.

16.00 % 5/6

= =

K1 λ

8.0 % 40.0 %

= =

i τ

A) B) C) D)

28)

7.00 percent 6.89 percent 6.73 percent 6.67 percent

Solve for the weighted average cost of capital.

17.20 % 6/7

= =

K1 λ

8.0 % 40.0 %

= =

i τ

A) B) C) D)

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7.00 percent 6.89 percent 6.73 percent 6.57 percent

29)

Find the debt-to-value ratio for a firm with a debt-to-equity ratio of 1/2. A) B) C) D)

30)

Find the debt-to-value ratio for a firm with a debt-to-equity ratio of 1. A) B) C) D)

31)

1/3 1/2 3/5 2/3

Find the debt-to-value ratio for a firm with a debt-to-equity ratio of 2. A) B) C) D)

33)

1/3 1/2 3/5 2/3

Find the debt-to-value ratio for a firm with a debt-to-equity ratio of 1½. A) B) C) D)

32)

1/3 1/2 3/5 2/3

Find the debt-to-value ratio for a firm with a debt-to-equity ratio of 2½.

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A) B) C) D)

34)

Find the debt-to-value ratio for a firm with a debt-to-equity ratio of 2½. A) B) C) D)

35)

3/4 7/9 4/5 9/11

Find the debt-to-value ratio for a firm with a debt-to-equity ratio of 3½. A) B) C) D)

37)

1/3 1/2 3/5 5/7

Find the debt-to-value ratio for a firm with a debt-to-equity ratio of 3. A) B) C) D)

36)

1/3 1/2 3/5 5/7

3/4 7/9 4/5 9/11

Find the debt-to-value ratio for a firm with a debt-to-equity ratio of 4.

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A) B) C) D)

38)

Find the debt-to-value ratio for a firm with a debt-to-equity ratio of 4½. A) B) C) D)

39)

3/4 7/9 4/5 5/6

Find the debt-to-equity ratio for a firm with a debt-to-total-value ratio of 1/2. A) B) C) D)

41)

3/4 7/9 4/5 9/11

Find the debt-to-value ratio for a firm with a debt-to-equity ratio of 5. A) B) C) D)

40)

3/4 7/9 4/5 9/11

1 2 3 4

Find the debt-to-equity ratio for a firm with a debt-to-total-value ratio of 2/3.

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A) B) C) D)

42)

Find the debt-to-equity ratio for a firm with a debt-to-total-value ratio of 3/4 A) B) C) D)

43)

1 2 3 4

Find the debt-to-equity ratio for a firm with a debt-to-total-value ratio of 4/5. A) B) C) D)

44)

1 2 3 4

Find the debt-to-equity ratio for a firm with a debt-to-total-value ratio of 5/6. A) B) C) D)

2 3 4 5

45) Corporations are becoming multinational not only in the scope of their business activities but also in their capital structure

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A) by raising funds from domestic as well as government sources. B) by raising funds from foreign as well as domestic sources. C) This trend reflects not only a conscious effort on the part of firms to raise the cost of capital by international sourcing of funds but also the ongoing liberalization and deregulation of international financial markets that make them accessible for many firms. D) by raising funds from foreign as well as domestic sources. This trend reflects not only a conscious effort on the part of firms to raise the cost of capital by international sourcing of funds, but also the ongoing liberalization and deregulation of international financial markets that make them accessible for many firms.

46) Find the weighted average cost of capital for a firm that has a debt-to-equity ratio of 1½, a tax rate of 34 percent, a levered cost of equity of 12 percent and an after-tax cost of debt of 8 percent. A) B) C) D)

9.6 percent 7.968 percent 14 percent none of the options

47) Find the weighted average cost of capital for a firm that has a debt-to-equity ratio of 1½, a tax rate of 34 percent, a levered cost of equity of 12 percent and a pre-tax cost of debt of 10 percent. A) B) C) D)

9.6 percent 7.968 percent 8.76 percent none of the options

48) Find the weighted average cost of capital for a firm that has a debt-to-equity ratio of 2, a tax rate of 40 percent, a levered cost of equity of 12 percent and an after-tax cost of debt of 9 percent.

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A) B) C) D)

7.6 percent 7.968 percent 10 percent none of the options

49) Find the weighted average cost of capital for a firm that has a debt-to-equity ratio of 2, a tax rate of 40 percent, a levered cost of equity of 12 percent and a pre-tax cost of debt of 9 percent. A) B) C) D)

50)

The cost of equity capital is

A) B) C) security. D)

51)

the expected return on the firm's stock that investors require. frequently estimated by using the Capital Asset Pricing Model (CAPM). generally considered to be a linear function of the systematic risk inherent in the all of the options

A reduced cost of equity capital increases the firm's value A) B) C) D)

52)

7.6 percent 7.968 percent 10 percent none of the options

through revaluation of the firm's existing cash flows from existing projects. through increased investment as more projects become positive NPVs. both of the options none of the options

A value-maximizing firm would

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A) B) C) D)

53)

undertake an investment project as long as the IRR exceeds the NPV. undertake an investment project as long as the IRR is less than the cost of capital. undertake an investment project as long as the IRR exceeds the cost of capital. none of the options

Using the notation of the text, the CAPM states

A) B) C) D) none of the options

54) The common stock of Kansas City Power and Light has a beta of 0.80. The Treasury bill rate is 4 percent and the market risk premium is 8 percent. What is their cost of equity capital? A) B) C) D)

55)

The market risk premium

A) free rate. B) C) D)

56)

12.0 percent 10.4 percent 7.20 percent 6.4 percent

can be defined by the difference between the expected market return and the riskis the reward for bearing nondiversifiable risk. is the slope of the security market line. can be expressed as

Compute the debt-to-equity ratio for a firm that has a debt-to-value ratio of 60 percent.

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A) B) C) D)

57)

1/3 2/5 3/2 none of the options

Compute the debt-to-total-value ratio for a firm that has a debt-to-equity ratio of 2. A) B) C) D)

1/3 2/5 3/2 2/3

58) Micro Spinoffs, Inc., issued 20-year debt one year ago today at par value with a coupon rate of 9 percent, paid annually. Today, the debt is selling at $1,050. If the firm's tax rate is 34 percent, what is its after-tax cost of debt? A) B) C) D)

9 percent 8.46 percent 5.94 percent 5.58 percent

59) The firm's tax rate is 34 percent. The firm's pre-tax cost of debt is 8 percent; the firm's debt-to-equity ratio is 4; the risk-free rate is 3 percent; the beta of the firm's common stock is 1.5; the market risk premium is 9 percent. What is the firm's cost of equity capital? A) B) C) D)

60)

33.33 percent 10.85 percent 13.12 percent 16.50 percent

Systematic risk refers to

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A) B) C) D)

the diversifiable (company specific) risk of an asset. the nondiversifiable (market) risk of an asset. economic and political risk. the risk that can be hedged.

61) The firm's tax rate is 34 percent. The firm's pre-tax cost of debt is 8 percent; the firm's debt-to-equity ratio is 4; the risk-free rate is 3 percent; the beta of the firm's common stock is 1.5; the market risk premium is 9 percent. Calculate the weighted average cost of capital. A) B) C) D)

62)

33.33 percent 8.09 percent 9.02 percent 16.5 percent

The formula for beta is

A) B) C) D)

63)

In the Capital Asset Pricing Model (CAPM), the term Beta, β, is

A) a measure of systematic risk inherent in a security. B) calculated as the "covariance of future returns between a specific security and the market portfolio" divided by the "variance of returns of the market portfolio." C) Both A & B are correct. D) none of the options

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64) Assume that XYZ Corporation is a levered company with the following information: Kl = cost of levered equity capital for XYZ = 13 percent i = before-tax borrowing cost = 8 percent t = marginal corporate income tax rate = 30 percent If XYZ's debt-to-total-market-value ratio is 40 percent, then its weighted average cost of capital, K, is A) B) C) D)

65)

8 percent. 9 percent. 10 percent. 12 percent.

In the graph,

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A) Kl and Kg represent, respectively, the cost of capital under international and local capital structures; IRR represents the internal rate of return on investment projects; Il and Ig represent, respectively, the optimal investment outlays under the alternative capital structures. B) Kl and Kg represent, respectively, the cost of capital under local and international capital structures; IRR represents the internal rate of return on investment projects; Il and Ig represent the optimal investment outlays under the alternative capital structures. C) both of the options D) none of the options

66) Suppose that the firm's cost of capital can be reduced from Kl under the local capital structure to Kg under an internationalized capital structure. The take-away lesson from the graph

is that

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A) the firm can then increase its profitable investment outlay from Il to Ig, contributing to the firm's value. B) a reduced cost of capital increases the firm's value not only through increased investments in new projects but also through revaluation of the cash flows from existing projects. C) Kl and Kg represent, respectively, the cost of capital under local and international capital structures; IRR represents the internal rate of return on investment projects; Il and Ig represent the optimal investment outlays under the alternative capital structures. D) all of the options

67) For a firm confronted with a fixed schedule of possible new investments, any policy that lowers the firm's cost of capital will increase the profitable capital expenditures the firm takes on and increase the wealth of the firm's shareholders. One such policy is A) B) C) D)

68)

internationalizing the firm's capital budgeting opportunities. internationalizing the firm's cost of capital. investing in riskier projects financed with debt. none of the options

For most countries and most firms, the domestic country beta A) B) C) D)

can be no lower than its world beta. is normally much smaller than the world beta. is normally much higher than the world beta. is exactly equal to the world beta.

69) Suppose the domestic U.S. beta of IBM is 1.0, that is , and that the expected return on the U.S. market portfolio is percent, and that the U.S. T-bill rate is 6 percent. If the world beta measure of IBM is then we can say

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A) that if the U.S. markets are fully integrated with the rest of the world, IBM's cost of equity capital would be 20 percent lower than if U.S. markets were segmented. B) that if the U.S. markets are fully integrated with the rest of the world, IBM's cost of equity capital would be 10 percent lower than if U.S. markets were segmented. C) that if the U.S. markets are fully integrated with the rest of the world, IBM's cost of equity capital would be one-third lower than if U.S. markets were segmented. D) none of the options

70)

Studies suggest that international capital markets are not segmented anymore A) B) C) D)

71)

and are therefore fully integrated. but are not as yet fully integrated. so cross-listing of shares will not lower a firm's cost of capital. none of the options

Compute the domestic country beta of Stansfield Bicycles as well as its world beta. Correlation Coefficients Stansfield

A) B) C) D)

England

World

SD(%)

1.00 and 0.80 respectively 0.80 and 0.00 respectively 4.50 and 4.00 respectively none of the options

72) Suppose that the British stock market is segmented from the rest of the world. Using the CAPM and a risk-free rate of 5 percent, estimate the equity cost of capital for Stansfield. Correlation Coefficients Stansfield

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England

World

SD(%)

A) B) C) D)

14 percent 12 percent 9 percent none of the options

73) Suppose that the British stock market is integrated with the rest of the world and Stansfield Company has made its shares tradable internationally via cross-listing on the NYSE. Using the CAPM and a risk-free rate of 5 percent, estimate the equity cost of capital for Stansfield. Correlation Coefficients Stansfield

A) B) C) D)

England

World

SD(%)

12 percent 10.60 percent 6.60 percent None of the options

74) Assume that XYZ Corporation is a leveraged company with the following information: Kl = cost of equity capital for XYZ = 13 percent i = before-tax borrowing cost = 8 percent t = marginal corporate income tax rate = 30 percent If XYZ's debt-to-total-market-value ratio is 40 percent, then its weighted average cost of capital, K, is: A) B) C) D)

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8 percent 9 percent 10 percent 12 percent

75) Assume that XYZ Corporation is a leveraged company with the following information: Kl = cost of equity capital for XYZ = 13 percent i = before-tax borrowing cost = 8 percent t = marginal corporate income tax rate = 30 percent Calculate the debt-to-total-market-value ratio that would result in XYZ having a weighted average cost of capital of 9.3 percent. A) B) C) D)

35 percent 40 percent 45 percent 50 percent

76) Assume that the risk-free rate of return is 4 percent, and the expected return on the market portfolio is 10 percent. If the systematic risk inherent in the stock of ABC Corporation is 1.80, using the Capital Asset Pricing Model (CAPM) calculate the expected return of ABC. A) B) C) D)

77)

14.0 percent 14.8 percent 16.0 percent 16.8 percent

In the real world, does the cost of capital differ among countries? A) Yes B) No

78) Recent studies suggest that agency costs of managerial discretion are lower in Japan than in the United States. This suggests that

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A) the cost of capital can be lower in Japan than the United States, but only if international financial markets are not fully integrated. B) the cost of capital can be lower in Japan than the United States, even if international financial markets are fully integrated. C) the cost of capital will be higher in Japan than the United States, even if international financial markets are fully integrated. D) none of the options

79)

Which of the following statements regarding cross-border listings of shares is not true?

A) Cross-listing shares may not be used as the “acquisition currency” for taking over foreign companies. B) Cross-listing may improve the company’s corporate governance and transparency. C) Cross-listing can enhance the liquidity of the company’s stock. D) Cross-listing enhances the visibility of the company’s name and its products in foreign marketplaces.

80) The following is an outline of certain potential benefits as well as costs associated with the cross-border listings of stocks:(i) the company can expand its potential investor base(ii) issues involving the disclosure and listing requirements(iii) creates a secondary market for the company's shares(iv) volatility spillover from the overseas markets(v) liquidity(vi) control of the company by foreigners(vii) enhances the visibility of the company's name and its products in foreign marketplacesWhich of the following represent all the potential benefits of the crossborder listings of stocks? A) B) C) D)

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(i), (ii), and (iii) (ii), (iv), and (vi) (i), (iii), (v), and (vii) (iv), (v), (vi), and (vii)

81) The following is an outline of certain potential benefits as well as costs associated with the cross-border listings of stocks:(i) the company can expand its potential investor base(ii) issues involving the disclosure and listing requirements(iii) creates a secondary market for the company's shares(iv) volatility spillover from the overseas markets(v) liquidity(vi) control of the company by foreigners(vii) enhances the visibility of the company's name and its products in foreign marketplacesWhich of the following represent all the potential costs of the cross-border listings of stocks? A) B) C) D)

82)

(i), (ii), and (iii) (ii), (iv), and (vi) (i), (iii), (v), and (vii) (iv), (v), (vi), and (vii)

Which of the following statement is not a downside to overseas listings?

A) It can be costly to meet the disclosure and listing requirements imposed by the foreign exchange and regulatory authorities. B) Controlling insiders may find it difficult to continue to derive private benefits once the company is cross-listed on domestic exchanges C) Once a company’s stock is traded in overseas markets, there can be volatility spillover from those markets. D) Once a company’s stock is made available to foreigners, they might acquire a controlling interest and challenge the domestic control of the company.

83) An extensive study by Karolyi (1996) reports i) the share price reacts favorably to cross-border listings.ii) the total postlisting trading volume increases on average, and, for many issues, home-market trading volume also increasesiii) liquidity of trading in shares improves overall iv) the stock’s exposure to domestic market risk is significantly reduced and is associated with only a small increase in global market risk v) cross-border listings resulted in a net reduction in the cost of equity capital of 114 basis points on average vi) stringent disclosure requirements are the greatest impediment to cross-border listings Version 1

A) B) C) D)

84)

i), ii), and iii). iii), iv), and v) iv), v), and vi) i), ii), iii), iv), v), and vi)

A firm may cross-list its share to

85) Companies domiciled in countries with weak investor protection can reduce agency costs between shareholders and management A) B) C) D)

86)

by moving to a better county. by listing their stocks in countries with strong investor protection. by voluntarily complying with the provisions of the U.S. Sarbanes-Oxley Act. having a press conference and promising to be nice to their investors.

Benetton, an Italian clothier, is listed on the New York Stock Exchange.

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87) In the real world, many firms that have cross-listed their shares on the U.S. markets have experienced a reduction in the cost of capital. This effect was greater for A) B) C) D)

88)

Australian firms than for Canadian firms. United States firms than for Mexican firms. bonds than for stocks. none of the options

To maximize the benefits of partial integration of capital markets

A) a country should choose to internationally cross-list those assets that are least correlated with the domestic market portfolio. B) a country should choose to internationally cross-list those assets that are most highly correlated with the domestic market portfolio. C) a country should choose to internationally cross-list those assets that are uncorrelated with the domestic market portfolio. D) none of the options

89)

One explanation for foreign equity ownership restrictions

A) company. B) C) D)

is to make it difficult or impossible for foreigners to gain control of a domestic is to expropriate wealth from domestic shareholders. is the arguments in favor of free trade. none of the options

90) One likely effect of a company or government instituting foreign equity ownership restrictions is

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A) B) C) D)

91)

a decrease in domestic stock prices. an increase in domestic stock prices. a transfer of wealth from international shareholders to domestic shareholders. none of the options

The pricing-to-market phenomenon

A) describes the potential effect of foreign equity ownership restrictions. B) describes the premium or discount faced by foreign shareholders relative to domestic investors in the price of a stock due to legal restrictions imposed on foreign equity ownership. C) was evidenced in the relative prices of Nestlé shares prior to November 17, 1988. D) all of the options

92)

The Nestlé episode shows

A) that political risk can exist in a country like Switzerland, long considered a haven from such risk. B) the pricing to market phenomenon exists. C) it is possible to expropriate wealth from one group of shareholders and transfer it to another group. D) all of the options

93) Shares can exhibit a dual pricing or __________ phenomenon because of the constraint in limiting desired foreign ownership, resulting in foreign and domestic investors facing different market share prices. A) B) C) D)

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cost-to-foreign pricing-to-market cost-to-market currency-to-market

94) The majority of publicly traded Swiss corporations have up to three classes of common stock:Registered stockVoting bearer stockNonvoting bearer stock Until 1989, foreigners were not allowed to buy registered stocks. In the case of Nestlé this had the effect of A) B) C) D)

95)

distorting the prices of registered stock downward. distorting the prices of registered stock upward. this had no effect on prices. none of the options

With regard to the financial structure of a foreign subsidiary,

A) using local financing can reduce political risk. B) a MNC that finances a foreign investment with home-country equity faces greater risk of expropriation than if it had financed the investment with at least some local debt or equity. C) there may be advantages other than a reduction in political risk that encourage MNCs to finance foreign subsidiaries with local money. D) all of the options

96) According to Lessard and Shapiro (1984) which of the following is not an approach to determining the subsidiary’s financial structure. A) Conform to the parent company’s norm. B) Conform to the local norm of the country where the subsidiary operates. C) Vary judiciously to capitalize on opportunities to lower taxes, reduce financing costs and risks, and take advantage of various market imperfections. D) none of the options

97)

With regard to the financial structure of a foreign subsidiary

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A) one option is to conform to the parent company's capital structure. B) one option is to conform to the local norm of the country where the subsidiary operates. C) one option is to vary judiciously to capitalize on opportunities to lower taxes, reduce financing costs and risks, and take advantage of market imperfections. D) all of the options

98)

When the parent company is fully responsible for the subsidiary's obligations,

A) the independent financial structure of the subsidiary is irrelevant. B) potential creditors will examine the parent's overall financial condition, not the subsidiary's. C) the independent financial subsidiary can have the same capital structure as the parent. D) all of the options

99) A recent study of MNCs suggests that when a foreign subsidiary's obligations cannot be met with locally generated revenues, A) B) C) D)

parent firms bail out their subsidiaries regardless of circumstances. that parent firms routinely allow subsidiaries to default. most subsidiaries are financed almost entirely with banker's acceptances. none of the options

100) When the choice of financing a foreign subsidiary is between external debt and equity financing A) political risk considerations tend to favor the latter. B) political risk considerations tend to favor the former. C) political risk is separate from financial risk and so does not enter into a discussion of debt equity ratios. D) none of the options

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101) When the choice of financing a foreign subsidiary is between external debt and equity financing A) many host governments tolerate the repatriation of funds in the form of interest much better than dividends. B) debt financing is generally secured from the World Bank, but only in developed countries. C) many host governments tolerate the repatriation of funds in the form of dividends much better than interest. D) none of the options

102)

The parent company should decide the financing method for its own subsidiaries A) B) C) D)

with a view toward minimizing the parent's overall cost of capital. by copying the norms of the host country. with a view toward gaming the bankruptcy system of the host country. none of the options

103) The required return on equity for a levered firm is 10.60 percent. The debt to equity ratio is 1/2, the tax rate is 40 percent, the pre-tax cost of debt is 8 percent. Find the cost of capital if this firm were financed entirely with equity. A) B) C) D)

10 percent 12 percent 8.67 percent none of the options

104) The required return on equity for an all-equity firm is 10.0 percent. They are considering a change in capital structure to a debt-to-equity ratio of 1/2, the tax rate is 40 percent, the pre-tax cost of debt is 8 percent. Find the new cost of capital if this firm changes capital structure.

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A) B) C) D)

14.93 percent 8.67 percent 7.40 percent none of the options

105) The required return on equity for an all-equity firm is 10.0 percent. They currently have a beta of one and the risk-free rate is 5 percent and the market risk premium is 5 percent. They are considering a change in capital structure to a debt-to-equity ratio of 1/2, the tax rate is 40 percent, the pre-tax cost of debt is 8 percent. Find the beta if this firm changes capital structure. A) B) C) D)

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1.12 percent 10 percent 7.4 percent none of the options

Answer Key Test name: Chap 17_9e 1) A 2) D 3) B 4) A 5) C 6) B 7) A 8) A 9) A 10) B 11) C 12) D 13) D 14) A 15) B 16) C 17) D 18) D 19) A 20) B 21) C 22) D 23) D 24) A 25) B 26) C Version 1

27) D 28) D 29) A 30) B 31) C 32) D 33) D 34) D 35) A 36) B 37) C 38) D 39) D 40) A 41) B 42) C 43) D 44) D 45) B 46) A 47) C 48) C 49) A 50) D 51) C 52) C 53) C 54) B 55) A 56) C Version 1

57) D 58) D 59) D 60) B 61) B 62) C 63) C 64) C 65) B 66) A 67) B 68) A 69) B 70) B 71) A 72) A 73) A 74) C 75) D 76) B 77) A 78) B 79) A 80) C 81) B 82) B 83) D 84) D 85) B 86) D Version 1

87) A 88) B 89) A 90) A 91) D 92) D 93) B 94) A 95) D 96) D 97) D 98) D 99) A 100) B 101) A 102) A 103) A 104) B 105) D

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CHAPTER 18 MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 1) Capital budgeting analysis is very important, because it A) B) C) D)

involves, usually expensive, investments in capital assets. has to do with the productive capacity of a firm. will determine how competitive and profitable a firm will be. all of the options

2) Tiger Towers, Inc. is considering an expansion of their existing business, student apartments. The new project will be built on some vacant land that the firm has just contracted to buy. The land cost $1,000,000 and the payment is due today. Construction of a 20-unit office building will cost $3 million; this expense will be depreciated straight-line over 30 years to zero salvage value; the pretax value of the land and building in year 30 will be $18,000,000. The $3,000,000 construction cost is to be paid today. The project will not change the risk level of the firm. The firm will lease 20 office suites at $20,000 per suite per year; payment is due at the start of the year; occupancy will begin in one year. Variable cost is $3,500 per suite. Fixed costs, excluding depreciation, are $75,000 per year. The project will require a $10,000 investment in net working capital. rdebt = 10.0%

rWACC = 11.20%

What is the unlevered after-tax incremental cash flow for year 0? A) B) C) D)

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−$3,660,000 −$5,100,000 −$4,000,000 −$4,010,000

3) Tiger Towers, Inc. is considering an expansion of their existing business, student apartments. The new project will be built on some vacant land that the firm has just contracted to buy. The land cost $1,000,000 and the payment is due today. Construction of a 20-unit office building will cost $3 million; this expense will be depreciated straight-line over 30 years to zero salvage value; the pretax value of the land and building in year 30 will be $18,000,000. The $3,000,000 construction cost is to be paid today. The project will not change the risk level of the firm. The firm will lease 20 office suites at $20,000 per suite per year; payment is due at the start of the year; occupancy will begin in one year. Variable cost is $3,500 per suite. Fixed costs, excluding depreciation, are $75,000 per year. The project will require a $10,000 investment in net working capital. rdebt = 10.0%

rWACC = 11.20%

What is the unlevered after-tax incremental cash flow for year 2? A) B) C) D)

−$4,610 $102,300 $202,300 $255,000

4) Tiger Towers, Inc. is considering an expansion of their existing business, student apartments. The new project will be built on some vacant land that the firm has just contracted to buy. The land cost $1,000,000 and the payment is due today. Construction of a 20-unit office building will cost $3 million; this expense will be depreciated straight-line over 30 years to zero salvage value; the pretax value of the land and building in year 30 will be $18,000,000. The $3,000,000 construction cost is to be paid today. The project will not change the risk level of the firm. The firm will lease 20 office suites at $20,000 per suite per year; payment is due at the start of the year; occupancy will begin in one year. Variable cost is $3,500 per suite. Fixed costs, excluding depreciation, are $75,000 per year. The project will require a $10,000 investment in net working capital. rdebt = 10.0%

rWACC = 11.20%

What is the unlevered after-tax incremental cash flow for year 30?

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A) B) C) D)

$12,432,300 $12,225,390 $12,332,300 $12,485,000

5) Tiger Towers, Inc. is considering an expansion of their existing business, student apartments. The new project will be built on some vacant land that the firm has just contracted to buy. The land cost $1,000,000 and the payment is due today. Construction of a 20-unit office building will cost $3 million; this expense will be depreciated straight-line over 30 years to zero salvage value; the pretax value of the land and building in year 30 will be $18,000,000. The $3,000,000 construction cost is to be paid today. The project will not change the risk level of the firm. The firm will lease 20 office suites at $20,000 per suite per year; payment is due at the start of the year; occupancy will begin in one year. Variable cost is $3,500 per suite. Fixed costs, excluding depreciation, are $75,000 per year. The project will require a $10,000 investment in net working capital. rdebt = 10.0%

rWACC = 11.20%

Assume that the firm will partially finance the project with a $3,000,000 interest-only 30-year loan at 10.0 percent APR with annual payments. What is the levered after-tax incremental cash flow for year 0? A) B) C) D)

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−$1,010,000 −$1,000,000 −$660,000 −$2,100,000

6) Tiger Towers, Inc. is considering an expansion of their existing business, student apartments. The new project will be built on some vacant land that the firm has just contracted to buy. The land cost $1,000,000 and the payment is due today. Construction of a 20-unit office building will cost $3 million; this expense will be depreciated straight-line over 30 years to zero salvage value; the pretax value of the land and building in year 30 will be $18,000,000. The $3,000,000 construction cost is to be paid today. The project will not change the risk level of the firm. The firm will lease 20 office suites at $20,000 per suite per year; payment is due at the start of the year; occupancy will begin in one year. Variable cost is $3,500 per suite. Fixed costs, excluding depreciation, are $75,000 per year. The project will require a $10,000 investment in net working capital. rdebt = 10.0%

rWACC = 11.20%

$4,300 −$202,610 −$95,700 $57,000

7) Tiger Towers, Inc. is considering an expansion of their existing business, student apartments. The new project will be built on some vacant land that the firm has just contracted to buy. The land cost $1,000,000 and the payment is due today. Construction of a 20-unit office building will cost $3 million; this expense will be depreciated straight-line over 30 years to zero salvage value; the pretax value of the land and building in year 30 will be $18,000,000. The $3,000,000 construction cost is to be paid today. The project will not change the risk level of the firm. The firm will lease 20 office suites at $20,000 per suite per year; payment is due at the start of the year; occupancy will begin in one year. Variable cost is $3,500 per suite. Fixed costs, excluding depreciation, are $75,000 per year. The project will require a $10,000 investment in net working capital. rdebt = 10.0%

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rWACC = 11.20%

$9,027,390 $9,234,300 $9,134,300 $9,287,000

8) Tiger Towers, Inc. is considering an expansion of their existing business, student apartments. The new project will be built on some vacant land that the firm has just contracted to buy. The land cost $1,000,000 and the payment is due today. Construction of a 20-unit office building will cost $3 million; this expense will be depreciated straight-line over 30 years to zero salvage value; the pretax value of the land and building in year 30 will be $18,000,000. The $3,000,000 construction cost is to be paid today. The project will not change the risk level of the firm. The firm will lease 20 office suites at $20,000 per suite per year; payment is due at the start of the year; occupancy will begin in one year. Variable cost is $3,500 per suite. Fixed costs, excluding depreciation, are $75,000 per year. The project will require a $10,000 investment in net working capital. rdebt = 10.0%

rWACC = 11.20%

Assume that the firm will partially finance the project with a subsidized $3,000,000 interest only 30-year loan at 8.0 percent APR with annual payments. Note that eight percent is less than the 10 percent that they normally borrow at. What is the NPV of the loan? A) B) C) D)

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$198,469 $53,979.83 $102,727.55 $1,334,851.09

9) Tiger Towers, Inc. is considering an expansion of their existing business, student apartments. The new project will be built on some vacant land that the firm has just contracted to buy. The land cost $1,000,000 and the payment is due today. Construction of a 20-unit office building will cost $3 million; this expense will be depreciated straight-line over 30 years to zero salvage value; the pretax value of the land and building in year 30 will be $18,000,000. The $3,000,000 construction cost is to be paid today. The project will not change the risk level of the firm. The firm will lease 20 office suites at $20,000 per suite per year; payment is due at the start of the year; occupancy will begin in one year. Variable cost is $3,500 per suite. Fixed costs, excluding depreciation, are $75,000 per year. The project will require a $10,000 investment in net working capital. rdebt = 10.0%

rWACC = 11.20%

The firm's tax rate is 34 percent. The firm's pre-tax cost of debt is 8 percent; the firm's debt-toequity ratio is 3; the risk-free rate is 3 percent; the beta of the firm's common stock is 1.5; the market risk premium is 9 percent. What is the firm's cost of equity capital? A) B) C) D)

33.33 percent 10.85 percent 13.12 percent 16.5 percent

10) Tiger Towers, Inc. is considering an expansion of their existing business, student apartments. The new project will be built on some vacant land that the firm has just contracted to buy. The land cost $1,000,000 and the payment is due today. Construction of a 20-unit office building will cost $3 million; this expense will be depreciated straight-line over 30 years to zero salvage value; the pretax value of the land and building in year 30 will be $18,000,000. The $3,000,000 construction cost is to be paid today. The project will not change the risk level of the firm. The firm will lease 20 office suites at $20,000 per suite per year; payment is due at the start of the year; occupancy will begin in one year. Variable cost is $3,500 per suite. Fixed costs, excluding depreciation, are $75,000 per year. The project will require a $10,000 investment in net working capital. rdebt = 10.0%

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rWACC = 11.20%

33.33 percent 10.85 percent 13.12 percent 16.5 percent

11) Today is January 1, 2009. The state of Iowa has offered your firm a subsidized loan. It will be in the amount of $10,000,000 at an interest rate of 5 percent and have ANNUAL (amortizing) payments over 3 years. The first payment is due today and your taxes are due January 1 of each year on the previous year's income. The yield to maturity on your firm's existing debt is 8 percent. What is the APV of this subsidized loan? If you rounded in your intermediate steps, the answer may be slightly different from what you got. Choose the closest. A) B) C) D)

−$3,497,224.43 $417,201.05 $840,797 none of the options

12) Today is January 1, 2009. The state of Iowa has offered your firm a subsidized loan. It will be in the amount of $10,000,000 at an interest rate of 5 percent and have ANNUAL (amortizing) payments over 3 years. The first payment is due December 31, 2009 and your taxes are due January 1 of each year on the previous year's income. The yield to maturity on your firm's existing debt is 8 percent. What is the APV of this subsidized loan? Note that I did not round my intermediate steps. If you did, your answer may be off by a bit. Select the answer closest to yours.

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A) B) C) D)

−$3,497,224.43 $417,201.05 $840,797 none of the options

13) The required return on assets is 18 percent. The firm can borrow at 12.5 percent; firm's target debt to value ratio is 3/5. The corporate tax rate is 34 percent, and the risk-free rate is 4 percent and the market risk premium is 9.2 percent. What is the weighted average cost of capital? The firm has a beta of 2.11. A) B) C) D)

12.15 percent 13.02 percent 14.33 percent 23.45 percent

14) Your firm is in the 34 percent tax bracket. The yield to maturity on your existing bonds is 8 percent. The state of Georgia offers to loan your firm $1,000,000 with a two year amortizing loan at a 5 percent rate of interest and annual payments due at the end of the year. The interest will be deductible at the time that you pay. What is the APV of this below-market loan to your firm? I did not round any of my intermediate steps. You might be a little bit off. Pick the answer closest to yours. A) B) C) D)

$64,157.38 $417,201.05 $840,797 none of the options

15) The firm's tax rate is 34 percent. The firm's pre-tax cost of debt is 8 percent; the firm's debt-to-equity ratio is 3; the risk-free rate is 3 percent; the beta of the firm's common stock is 1.5; the market risk premium is 9 percent. Calculate the weighted average cost of capital.

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A) B) C) D)

33.33 percent 8.09 percent 9.02 percent 16.5 percent

16) Consider a project of the Cornell Haul Moving Company, the timing and size of the incremental after-tax cash flows (for an all-equity firm) are shown below in millions:{MISSING IMAGE}The firm's tax rate is 34 percent; the firm's bonds trade with a yield to maturity of 8 percent; the current and target debt-equity ratio is 2; if the firm were financed entirely with equity, the required return would be 10 percent. Using the weighted average cost of capital methodology, what is the NPV? I didn't round my intermediate steps. If you do, you're not going to get the right answer. A) B) C) D)

−$1,406,301.25 $12,494,643.75 $36,580,767.55 $108,994.618.20

17) Consider a project of the Cornell Haul Moving Company, the timing and size of the incremental after-tax cash flows (for an all-equity firm) are shown below in millions:{MISSING IMAGE}The firm's tax rate is 34 percent; the firm's bonds trade with a yield to maturity of 8 percent; the current and target debt-equity ratio is 2; if the firm were financed entirely with equity, the required return would be 10 percent. What is the levered after-tax incremental cash flow for year 2? A) B) C) D)

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$185,796,000 $215,152,000 $267,952,000 $284,848,000

18) Consider a project of the Cornell Haul Moving Company, the timing and size of the incremental after-tax cash flows (for an all-equity firm) are shown below in millions:{MISSING IMAGE}The firm's tax rate is 34 percent; the firm's bonds trade with a yield to maturity of 8 percent; the current and target debt-equity ratio is 2; if the firm were financed entirely with equity, the required return would be 10 percent. What is the levered after-tax incremental cash flow for year 4? A) B) C) D)

$281,704,000 $465,152,000 −$194,848,000 $460,796,000

19) Consider a project of the Cornell Haul Moving Company, the timing and size of the incremental after-tax cash flows (for an all-equity firm) are shown below in millions:{MISSING IMAGE}The firm's tax rate is 34 percent; the firm's bonds trade with a yield to maturity of 8 percent; the current and target debt-equity ratio is 2; if the firm were financed entirely with equity, the required return would be 10 percent. Using the flow to equity methodology, what is the value of the equity claim? A) B) C) D)

−$1,540,000 $446,570,866.00 $36,580,767.55 $470,953,393.70

20) Consider a project of the Cornell Haul Moving Company, the timing and size of the incremental after-tax cash flows (for an all-equity firm) are shown below in millions:{MISSING IMAGE}The firm's tax rate is 34 percent; the firm's bonds trade with a yield to maturity of 8 percent; the current and target debt-equity ratio is 2; if the firm were financed entirely with equity, the required return would be 10 percent. Using the APV method, what is the value of this project to an all-equity firm?

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A) B) C) D)

−$46,502,288.10 $12,494,643.75 $36,580,767.55 −$67,163,445.12

21) Consider a project of the Cornell Haul Moving Company, the timing and size of the incremental after-tax cash flows (for an all-equity firm) are shown below in millions:{MISSING IMAGE}The firm's tax rate is 34 percent; the firm's bonds trade with a yield to maturity of 8 percent; the current and target debt-equity ratio is 2; if the firm were financed entirely with equity, the required return would be 10 percent. Using the APV method, what is the value of the debt side effects? A) B) C) D)

$239,072,652.70 $66,891,713.66 $59,459,301.03 $660,000,000

22) Consider a project of the Cornell Haul Moving Company, the timing and size of the incremental after-tax cash flows (for an all-equity firm) are shown below in millions:{MISSING IMAGE}The firm's tax rate is 34 percent; the firm's bonds trade with a yield to maturity of 8 percent; the current and target debt-equity ratio is 3; if the firm were financed entirely with equity, the required return would be 10 percent. Using the weighted average cost of capital methodology, what is the NPV? I didn't round my intermediate steps. If you do, you're not going to get the right answer. A) B) C) D)

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−$1,406,301.25 $12,494,643.75 $36,580,767.55 $108,994.618.20

23) Consider a project of the Cornell Haul Moving Company, the timing and size of the incremental after-tax cash flows (for an all-equity firm) are shown below in millions:{MISSING IMAGE}The firm's tax rate is 34 percent; the firm's bonds trade with a yield to maturity of 8 percent; the current and target debt-equity ratio is 3; if the firm were financed entirely with equity, the required return would be 10 percent. What is the levered after-tax incremental cash flow for year 2? A) B) C) D)

$185,796,000 $215,152,000 $267,952,000 $284,848,000

24) Consider a project of the Cornell Haul Moving Company, the timing and size of the incremental after-tax cash flows (for an all-equity firm) are shown below in millions:{MISSING IMAGE}The firm's tax rate is 34 percent; the firm's bonds trade with a yield to maturity of 8 percent; the current and target debt-equity ratio is 3; if the firm were financed entirely with equity, the required return would be 10 percent. What is the levered after-tax incremental cash flow for year 4? A) B) C) D)

−$281,704,000 $465,152,000 −$194,848,000 $460,796,000

25) Consider a project of the Cornell Haul Moving Company, the timing and size of the incremental after-tax cash flows (for an all-equity firm) are shown below in millions:{MISSING IMAGE}The firm's tax rate is 34 percent; the firm's bonds trade with a yield to maturity of 8 percent; the current and target debt-equity ratio is 3; if the firm were financed entirely with equity, the required return would be 10 percent. Using the flow to equity methodology, what is the value of the equity claim?

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A) B) C) D)

−$1,540,000 $446,570,866.00 $36,580,767.55 $30,716,236.13

26) Consider a project of the Cornell Haul Moving Company, the timing and size of the incremental after-tax cash flows (for an all-equity firm) are shown below in millions:{MISSING IMAGE}The firm's tax rate is 34 percent; the firm's bonds trade with a yield to maturity of 8 percent; the current and target debt-equity ratio is 3; if the firm were financed entirely with equity, the required return would be 10 percent. Using the APV method, what is the value of this project to an all-equity firm? A) B) C) D)

−$46,502,288.10 $12,494,643.75 $36,580,767.55 −$67,163,445.12

27) Consider a project of the Cornell Haul Moving Company, the timing and size of the incremental after-tax cash flows (for an all-equity firm) are shown below in millions:{MISSING IMAGE}The firm's tax rate is 34 percent; the firm's bonds trade with a yield to maturity of 8 percent; the current and target debt-equity ratio is 3; if the firm were financed entirely with equity, the required return would be 10 percent. Using the APV method, what is the value of the debt side effects? A) B) C) D)

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$239,072,652.70 $66,891,713.66 $59,459,301.03 $660,000,000

28) Your firm's existing bonds trade with a yield to maturity of eight percent. The state of Missouri has offered to loan your firm $10,000,000 at zero percent for five years. Repayment will be of the form of $2,000,000 per year for five years; the first payment is due in one year. What is the value of this offer? A) B) C) D)

$4,729,622.75 $2,014,579.93 $0 $196,929.88

29) What proportion of the firm is financed by debt for a firm that expects a 15 percent return on equity, a 12 percent return on assets, and a 10 percent return on debt? The tax rate is 25 percent. A) B) C) D)

20 percent 1/3 60 percent 2/3

30) The required return on equity for an all-equity firm is 10.0 percent. They are considering a change in capital structure to a debt-to-equity ratio of ½ the tax rate is 40 percent, the pre-tax cost of debt is 8 percent. Find the new cost of capital if this firm changes capital structure. A) B) C) D)

14.93 percent 8.67 percent 7.40 percent none of the options

31) The required return on equity for an all-equity firm is 10.0 percent. They currently have a beta of one and the risk-free rate is 5 percent and the market risk premium is 5 percent. They are considering a change in capital structure to a debt-to-equity ratio of ½ the tax rate is 40 percent, the pre-tax cost of debt is 8 percent. Find the beta if this firm changes capital structure. Version 1

A) B) C) D)

1.12 1 7.4 percent none of the options

32) What is the expected return on equity for firm in the 40 percent tax bracket with a 15 percent expected return on assets that pays 12 percent on its debt, which totals 25 percent of assets? A) B) C) D)

33)

24 percent 15.60 percent 16 percent 20 percent

Assume that XYZ Corporation is a leveraged company with the following information:

Kl = cost of equity capital for XYZ = 13% i = before-tax borrowing cost = 8% t = marginal corporate income tax rate = 30% Calculate the debt-to-total-market-value ratio that would result in XYZ having a weighted average cost of capital of 9.3 percent. A) B) C) D)

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35 percent 40 percent 45 percent 50 percent

34) Today is January 1, 2009. The state of Iowa has offered your firm a subsidized loan. It will be in the amount of $10,000,000 at an interest rate of 5 percent and have ANNUAL (amortizing) payments over 3 years. The first payment is due today and your taxes are due January 1 of each year on the previous year's income. The yield to maturity on your firm's existing debt is 8 percent. What is the NPV of this subsidized loan? Note that I did not round my intermediate steps. If you did, your answer may be off by a bit. Select the answer closest to yours. A) B) C) D)

$406,023.10 $840,797 $64,157.38 $20,659.77

35) Today is January 1, 2009. The state of Iowa has offered your firm a subsidized loan. It will be in the amount of $10,000,000 at an interest rate of 5 percent and have ANNUAL (amortizing) payments over 3 years. The first payment is due today and your taxes are due January 1 of each year on the previous year's income. The yield to maturity on your firm's existing debt is 8 percent.What is the €-denominated NPV of this project? I did not round my intermediate steps, if you did, select the answer closest to yours. A) B) C) D)

€5,563.23 €2,270.79 €7,223.14 €3,554.29

36) The spot exchange rate is ¥125 = $1. The U.S. discount rate is 10 percent; inflation over the next three years is 3 percent per year in the U.S. and 2 percent per year in Japan. Calculate the dollar NPV of this project.{MISSING IMAGE}I did not round my intermediate steps, if you did, select the answer closest to yours. A) B) C) D)

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$267,181.87 $14,176.67 $2,536.49 $2,137.46

37) In the context of the capital budgeting analysis of an MNC that has strong foreign competitors, "lost sales" refers to A) the cannibalization of existing projects by new projects. B) the entire sales revenue of a new foreign manufacturing facility representing the incremental sales revenue of the new project. C) Both A & B are correct. D) none of the options

38)

Which of the following statements is false about "borrowing capacity"?

A) It is an especially important point in international capital budgeting analysis because of the frequency of large concessionary loans. B) It creates tax shields for APV analysis regardless of how the project is actually financed. C) It is synonymous to the "project debt." D) It is based on the firm's optimal capital structure.

39) The adjusted present value (APV) model that is suitable for an MNC is the basic net present value (NPV) model expanded to A) distinguish between the market value of a levered firm and the market value of an unlevered firm. B) discern the blocking of certain cash flows by the host country from being legally remitted to the parent. C) consider foreign currency fluctuations or extra taxes imposed by the host country on foreign exchange remittances. D) all of the options

40) Given the following information for a levered and unlevered firm, calculate the difference in the cash flow available to investors. Assume the corporate tax rate is 40 percent. (Hint: Calculate the tax savings arising from the tax deductibility of interest payments).

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Levered

Unlevered

Revenue

$ 250

Operating cost

−$ 100

Interest expense

−$

A) B) C) D)

$8 $18 $78 $90

41) As of today, the spot exchange rate is €1.00 = $1.25 and the rates of inflation expected to prevail for the next year in the U.S. is 2 percent and 3 percent in the euro zone. What is the oneyear forward rate that should prevail? A) B) C) D)

€1.00 = $1.2379 €1.00 = $1.2139 €1.00 = $0.9903 $1.00 = €1.2623

42) As of today, the spot exchange rate is €1.00 = $1.25 and the rates of inflation expected to prevail for the next three years in the U.S. is 2 percent and 3 percent in the euro zone. What spot exchange rate should prevail three years from now? A) B) C) D)

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€1.00 = $1.2379 €1.00 = $1.2139 €1.00 = $0.9903 $1.00 = €1.2623

SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question. 43) Your firm is based in southern Ireland (and thereby operates in euro, not pounds) and is considering an investment in the United States.

The project involves selling widgets: you project a sales volume of 50,000 widgets per year, sales price of $20 per widget with a contribution margin of $15 per widget. The project will last for 5 years, require an investment of $1,000,000 at time zero (which will be depreciated straight-line to $10,000 over the 5 years). Salvage value for the equipment is projected to be $10,000. The project will operate in rented quarters: $300,000 rent is due at the start of each year.The corporate tax rate is 12½ percent in Ireland and 40 percent in the U.S. For simplicity, assume that taxes are paid like sales taxes: immediately. The spot exchange rate is $1.50 = €1.00. The cost of capital to the Irish firm for a domestic project of this risk is 8 percent. The U.S. risk-free rate is 3 percent; the Irish risk-free rate is 2 percent. What is CF0 in dollars?

44) Your firm is based in southern Ireland (and thereby operates in euro, not pounds) and is considering an investment in the United States.

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45) Your firm is based in southern Ireland (and thereby operates in euro, not pounds) and is considering an investment in the United States.

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46) Your firm is based in southern Ireland (and thereby operates in euro, not pounds) and is considering an investment in the United States.

47) Your firm is based in southern Ireland (and thereby operates in euro, not pounds) and is considering an investment in the United States.

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48) Your firm is based in southern Ireland (and thereby operates in euro, not pounds) and is considering an investment in the United States.

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49) Your firm is based in southern Ireland (and thereby operates in euro, not pounds) and is considering an investment in the United States.

50) Your firm is based in southern Ireland (and thereby operates in euro, not pounds) and is considering an investment in the United States.

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51) Consider the following international investment opportunity. It involves a gold mine that can be opened at a cost, then produces a positive cash flow, but then requires environmental clean-up. {MISSING IMAGE} The current exchange rate is $1.60 = €1.00. The inflation rate in the U.S. is 6 percent and in the euro zone 2 percent. The appropriate cost of capital to a U.S.-based firm for a domestic project of this risk is 8 percent. Find the euro-zone cost of capital to compute is the dollar-denominated NPV of this project.

52) Consider the following international investment opportunity. It involves a gold mine that can be opened at a cost, then produces a positive cash flow, but then requires environmental clean-up. {MISSING IMAGE} The current exchange rate is $1.60 = €1.00. The inflation rate in the U.S. is 6 percent and in the euro zone 2 percent. The appropriate cost of capital to a U.S.-based firm for a domestic project of this risk is 8 percent. Find the dollar cash flows to compute the dollar-denominated NPV of this project.

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53) Consider the following international investment opportunity. It involves a gold mine that can be opened at a cost, then produces a positive cash flow, but then requires environmental clean-up. {MISSING IMAGE} The current exchange rate is $1.60 = €1.00. The inflation rate in the U.S. is 6 percent and in the euro zone 2 percent. The appropriate cost of capital to a U.S.-based firm for a domestic project of this risk is 8 percent. What is the dollar-denominated IRR of this project?

54) Consider the following international investment opportunity. It involves a gold mine that can be opened at a cost, then produces a positive cash flow, but then requires environmental clean-up. {MISSING IMAGE} The current exchange rate is $1.60 = €1.00. The inflation rate in the U.S. is 6 percent and in the euro zone 2 percent. The appropriate cost of capital to a U.S.-based firm for a domestic project of this risk is 8 percent. What is the euro-denominated IRR of this project?

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55) Consider the following international investment opportunity. It involves a gold mine that can be opened at a cost, then produces a positive cash flow, but then requires environmental clean-up. {MISSING IMAGE} The current exchange rate is $1.55 = €1.00. The inflation rate in the U.S. is 6 percent and in the euro zone 2 percent. The appropriate cost of capital to a U.S.-based firm for a domestic project of this risk is 8 percent. Find the euro-zone cost of capital to compute is the dollar-denominated NPV of this project.

56) Consider the following international investment opportunity. It involves a gold mine that can be opened at a cost, then produces a positive cash flow, but then requires environmental clean-up. {MISSING IMAGE} The current exchange rate is $1.55 = €1.00. The inflation rate in the U.S. is 6 percent and in the euro zone 2 percent. The appropriate cost of capital to a U.S.-based firm for a domestic project of this risk is 8 percent. Find the dollar cash flows to compute the dollar-denominated NPV of this project.

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57) Consider the following international investment opportunity. It involves a gold mine that can be opened at a cost, then produces a positive cash flow, but then requires environmental clean-up. {MISSING IMAGE} The current exchange rate is $1.55 = €1.00. The inflation rate in the U.S. is 6 percent and in the euro zone 2 percent. The appropriate cost of capital to a U.S.-based firm for a domestic project of this risk is 8 percent. What is the dollar-denominated IRR of this project?

58) Consider the following international investment opportunity. It involves a gold mine that can be opened at a cost, then produces a positive cash flow, but then requires environmental clean-up. {MISSING IMAGE} The current exchange rate is $1.55 = €1.00. The inflation rate in the U.S. is 6 percent and in the euro zone 2 percent. The appropriate cost of capital to a U.S.-based firm for a domestic project of this risk is 8 percent. What is the euro-denominated IRR of this project?

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59) A French firm is considering a one-year investment in the United Kingdom with a pounddenominated rate of return of i£ = 15%. The firm's local cost of capital is i€ = 10%. The project costs £1,000 and will return £1,150 at the end of one year. The current exchange rate is €2.00 = £1.00. Suppose that the bank of England is considering either tightening or loosening its monetary policy. It is widely believed that in one year there are only two possibilities: S1 (€|£) = €2.20 per £ S1 (€|£) = €1.80 per £ Following revaluation, the exchange rate is expected to remain steady for at least another year. Find the ex post IRR in euro for the French firm if they undertake the project today and then the exchange rate falls to S1(€|£) = €1.80 per £.

60) A French firm is considering a one-year investment in the United Kingdom with a pounddenominated rate of return of i£ = 15%. The firm's local cost of capital is i€ = 10%. The project costs £1,000 and will return £1,150 at the end of one year. The current exchange rate is €2.00 = £1.00. Suppose that the bank of England is considering either tightening or loosening its monetary policy. It is widely believed that in one year there are only two possibilities: S1 (€|£) = €2.20 per £ S1 (€|£) = €1.80 per £ Following revaluation, the exchange rate is expected to remain steady for at least another year. Find the ex post IRR in euro for the French firm if they undertake the project today and then the exchange rate rises to S1(€|£) = €2.20 per £.

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61) A French firm is considering a one-year investment in the United Kingdom with a pounddenominated rate of return of i£ = 15%. The firm's local cost of capital is i€ = 10%. The project costs £1,000 and will return £1,150 at the end of one year. The current exchange rate is €2.00 = £1.00. Suppose that the bank of England is considering either tightening or loosening its monetary policy. It is widely believed that in one year there are only two possibilities: S1 (€|£) = €2.20 per £ S1 (€|£) = €1.80 per £ Following revaluation, the exchange rate is expected to remain steady for at least another year. Find the IRR in euro for the French firm if they wait one year to undertake the project after the exchange rate rises to S1(€|£) = €2.20 per £.

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62) A French firm is considering a one-year investment in the United Kingdom with a pounddenominated rate of return of i£ = 15%. The firm's local cost of capital is i€ = 10%. The project costs £1,000 and will return £1,150 at the end of one year. The current exchange rate is €2.00 = £1.00. Suppose that the bank of England is considering either tightening or loosening its monetary policy. It is widely believed that in one year there are only two possibilities: S1 (€|£) = €2.20 per £ S1 (€|£) = €1.80 per £ Following revaluation, the exchange rate is expected to remain steady for at least another year. Find the NPV in euro for the French firm if they wait one year to undertake the project after the exchange rate rises to S1(€|£) = €2.20 per £.

63) A French firm is considering a one-year investment in the United Kingdom with a pounddenominated rate of return of i£ = 15%. The firm's local cost of capital is i€ = 10%. The project costs £1,000 and will return £1,150 at the end of one year. The current exchange rate is €2.00 = £1.00. Suppose that the bank of England is considering either tightening or loosening its monetary policy. It is widely believed that in one year there are only two possibilities: S1 (€|£) = €2.20 per £ S1 (€|£) = €1.80 per £ Following revaluation, the exchange rate is expected to remain steady for at least another year. Find the IRR in euro for the French firm if they wait one year to undertake the project after the exchange rate falls to S1(€|£) = €1.80 per £.

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64) A French firm is considering a one-year investment in the United Kingdom with a pounddenominated rate of return of i£ = 15%. The firm's local cost of capital is i€ = 10%. The project costs £1,000 and will return £1,150 at the end of one year. The current exchange rate is €2.00 = £1.00. Suppose that the bank of England is considering either tightening or loosening its monetary policy. It is widely believed that in one year there are only two possibilities: S1 (€|£) = €2.20 per £ S1 (€|£) = €1.80 per £ Following revaluation, the exchange rate is expected to remain steady for at least another year. Find the NPV in euro for the French firm if they wait one year to undertake the project after the exchange rate falls to S1(€|£) = €1.80 per £.

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65) A French firm is considering a one-year investment in the United Kingdom with a pounddenominated rate of return of i£ = 15%. The firm's local cost of capital is i€ = 10%. The project costs £1,000 and will return £1,150 at the end of one year. The current exchange rate is €2.00 = £1.00. Suppose that the bank of England is considering either tightening or loosening its monetary policy. It is widely believed that in one year there are only two possibilities: S1 (€|£) = €2.20 per £ S1 (€|£) = €1.80 per £ Following revaluation, the exchange rate is expected to remain steady for at least another year. The CFO who has a CFA notices the optionality in starting this project today. He asks you to comment and outline your valuation strategy.

66) A French firm is considering a one-year investment in the United Kingdom with a pounddenominated rate of return of i£ = 15%. The firm's local cost of capital is i€ = 10%. The project costs £1,000 and will return £1,150 at the end of one year. The current exchange rate is €2.00 = £1.00. Suppose that the bank of England is considering either tightening or loosening its monetary policy. It is widely believed that in one year there are only two possibilities: S1 (€|£) = €2.20 per £ S1 (€|£) = €1.80 per £ Following revaluation, the exchange rate is expected to remain steady for at least another year. Your banker quotes the euro-zone risk-free rate at i€ = 6% and the British risk free rate at i£ = 6%. Find the value of the option and thereby the project.

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67) A French firm is considering a one-year investment in the United Kingdom with a pounddenominated rate of return of i£ = 15%. The firm's local cost of capital is i€ = 10%. The project costs £1,000 and will return £1,150 at the end of one year. The current exchange rate is €2.00 = £1.00. Suppose that the bank of England is considering either tightening or loosening its monetary policy. It is widely believed that in one year there are only two possibilities: S1 (€|£) = €2.20 per £ S1 (€|£) = €1.80 per £ Following revaluation, the exchange rate is expected to remain steady for at least another year. Using the notion of a hedge ratio, make a recommendation vis-à-vis how to undertake the project today without "buying" the option.

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68) An American Hedge Fund is considering a one-year investment in an Italian government bond with a one-year maturity and a euro-denominated rate of return of i€ = 5%. The bond costs €1,000 today and will return €1,050 at the end of one year without risk. The current exchange rate is €1.00 = $1.50. U.S. dollar-denominated government bonds currently have a yield to maturity of 4 percent. Suppose that the European Central Bank is considering either tightening or loosening its monetary policy. It is widely believed that in one year there are only two possibilities:

S1 ($|€) = €1.80 per € S1 ($|€) = €1.40 per € Following revaluation, the exchange rate is expected to remain steady for at least another year. The hedge fund manager notices the optionality in starting this project today. He asks you to comment and outline your valuation strategy.

69) An American Hedge Fund is considering a one-year investment in an Italian government bond with a one-year maturity and a euro-denominated rate of return of i€ = 5%. The bond costs €1,000 today and will return €1,050 at the end of one year without risk. The current exchange rate is €1.00 = $1.50. U.S. dollar-denominated government bonds currently have a yield to maturity of 4 percent. Suppose that the European Central Bank is considering either tightening or loosening its monetary policy. It is widely believed that in one year there are only two possibilities:

S1 ($|€) = €1.80 per € S1 ($|€) = €1.40 per € Following revaluation, the exchange rate is expected to remain steady for at least another year. Your banker quotes the euro-zone risk-free rate at i€ = 5% and the U.S. risk free rate at i$ = 4%. Find the value of the option and thereby the correct value of the bond to a U.S. investor. Version 1

70) An American Hedge Fund is considering a one-year investment in an Italian government bond with a one-year maturity and a euro-denominated rate of return of i€ = 5%. The bond costs €1,000 today and will return €1,050 at the end of one year without risk. The current exchange rate is €1.00 = $1.50. U.S. dollar-denominated government bonds currently have a yield to maturity of 4 percent. Suppose that the European Central Bank is considering either tightening or loosening its monetary policy. It is widely believed that in one year there are only two possibilities:

S1 ($|€) = €1.80 per € S1 ($|€) = €1.40 per € Following revaluation, the exchange rate is expected to remain steady for at least another year. Using your results to the last question, make a recommendation vis-à-vis when to buy the bond.

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71) An American Hedge Fund is considering a one-year investment in an Italian government bond with a one-year maturity and a euro-denominated rate of return of i€ = 5%. The bond costs €1,000 today and will return €1,050 at the end of one year without risk. The current exchange rate is €1.00 = $1.50. U.S. dollar-denominated government bonds currently have a yield to maturity of 4 percent. Suppose that the European Central Bank is considering either tightening or loosening its monetary policy. It is widely believed that in one year there are only two possibilities:

S1 ($|€) = €1.80 per € S1 ($|€) = €1.40 per € Following revaluation, the exchange rate is expected to remain steady for at least another year. Using the notion of hedging, make a recommendation vis-à-vis how to undertake the project today without "buying" the option.

72) The Strik-it-Rich Gold Mining Company is contemplating expanding its operations. To do so it will need to purchase land that its geologists believe is rich in gold. Strik-it-Rich's management believes that the expansion will allow it to mine and sell an additional 2,000 troy ounces of gold per year. The expansion, including the cost of the land, will cost $500,000. The current price of gold bullion is $425 per ounce and one-year gold futures are trading at $450.50 = $425 × (1.06). Extraction costs are $375 per ounce. The firm's cost of capital is 10 percent. Strik-it-Rich's management is, however, concerned with the possibility that large sales of gold reserves by Russia and the United Kingdom will drive the price of gold down to $390 for the foreseeable future. On the other hand, management believes there is some possibility that the world will soon return to a gold reserve international monetary system. In the latter event, the price of gold would increase to at least $460 per ounce. The course of the future price of gold bullion should become clear within a year. Strik-it-Rich can postpone the expansion for a year by buying a purchase option on the land for $25,000. Compute the NPV at the current price of gold. Hint: think of the gold mine as a perpetuity.

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73) The Strik-it-Rich Gold Mining Company is contemplating expanding its operations. To do so it will need to purchase land that its geologists believe is rich in gold. Strik-it-Rich's management believes that the expansion will allow it to mine and sell an additional 2,000 troy ounces of gold per year. The expansion, including the cost of the land, will cost $500,000. The current price of gold bullion is $425 per ounce and one-year gold futures are trading at $450.50 = $425 × (1.06). Extraction costs are $375 per ounce. The firm's cost of capital is 10 percent. Strik-it-Rich's management is, however, concerned with the possibility that large sales of gold reserves by Russia and the United Kingdom will drive the price of gold down to $390 for the foreseeable future. On the other hand, management believes there is some possibility that the world will soon return to a gold reserve international monetary system. In the latter event, the price of gold would increase to at least $460 per ounce. The course of the future price of gold bullion should become clear within a year. Strik-it-Rich can postpone the expansion for a year by buying a purchase option on the land for $25,000. Compute the NPV at the two possible prices of gold.

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Answer Key Test name: Chap 18_9e 1) D 2) D 3) C 4) A 5) A 6) A 7) B 8) D 9) D 10) B 11) B 12) C 13) C 14) A 15) B 16) B 17) B 18) C 19) C 20) A 21) C 22) A 23) A 24) A 25) D 26) D Version 1

27) B 28) B 29) D 30) B 31) A 32) B 33) D 34) A 35) A 36) D 37) C 38) C 39) D 40) A 41) A 42) B 43) $(1,180,000.00) = $1 million investment + after-tax cost of $300,000 lease payment 44) T = 1,2,3,4 Revenue

1,000,000.00

Variable cost

250,000.00

Fixed cost

300,000.00

Depreciation

198,000.00 = (1,000,000 − 10,000)/5

EBIT

252,000.00

151,200.00

OCF

349,200.00 = 151,200 + 198,000

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45) T = 5 Revenue

1,000,000.00

Variable cost

250,000.00

Fixed cost

–

Depreciation

198,000.00

EBIT

552,000.00

331,200.00

OCF

539,200.00 = 529,200 + 198,000 + 10,000

Note that in year 5 we've prepaid the lease and there's the salvage value 46) NPV$ = $299,349.95 CF0 = −$1,180,000 CF1 = $349,200 F1 = 4 CF2 = $539,200 F2 = 1 I = (1.03/1.02)(1.08) − 1 47) IRR$ = $17.826% CF0 = −$1,180,000 CF1 = $349,200 F1 = 4 CF2 = $539,200 F2 = 1 I = (1.03/1.02)(1.08) − 1 48) Just convert IRR$ using PPP: IRR€ = 16.68% using 1 + IRR$ 1 + i$

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1 + IRR€ 1 + i€

1.17826 1.03

1 + IRR€ 1.02

49) PBE 17.43 QBE 41,435.77To find these first find the pv of the costs of the project (equipment, rent). Then find the equivalent annual cost by solving for payment. Then Work back through the income statement.CF0 = −1,180,000 CF1 = −100,800 = −180,000 + 198,000 × 0.4 = after-tax rent + depreciation tax shield CF5 = 89,200 = 10,000 + 198,000 × 0.4 NPV at 9.06% = −1,448,324.86 Solve for PMT over 5 year and you have 372,921.89 Notice that we have already taken depreciation into account so to solve for P and Q solve 372,921.89/0.60 = 621,536.48 = QP − 5Q If P = $20 then Q = 41,435.77 If Q = 50,000 then P = $17.43 50) This is likely too much work for a test but here it is: CF0 = −€841,666.67 1

Revenue

€ 660,194.1 € 653,784.5 € 647,437.1 € 641,151.3 € 660,194.1 7 2 0 0 7 Variable € 165,048.5 € 163,446.1 € 161,189.2 € 160,287.8 € 165,048.5 cost 4 3 8 3 4 Fixed cost € 198,058.2 € 196,135.3 € 194,231.1 € 192,345.3 € − 5 6 3 9 Depreciatio € 132,063.4 € 132,063.4 € 132,063.4 € 132,063.4 € 132,063.4 n 8 8 8 8 8 EBIT € 165,023.9 € 162,139.5 € 159.283.2 € 156,454.6 € 363,082.1 0 5 1 1 5 NI € 144,395.9 € 141,872.1 € 139,372.8 € 136.897.7 € 317,696.8 1 1 1 8 8 OCF € 276,459.3 € 273,935.5 € 271,436.2 € 268,961.2 € 456,109.6 9 9 9 6 3

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This includes salvage value. Note that salvage value of $10,000 is converted to euro the spot rate expected to prevail in 5 years. Notice that NPV and IRR are much higher with a tax rate of 12.5% instead of 40%: NPV = €372,759 IRR = 22.45% PBE €16.73 QBE 39,103.22503

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51) There are two equally valid approaches each of these problems Convert the cash flows to dollars use i$ = 8% as a discount rate%media:18formula4.mml%%media:18formula5.mml%%media:18fo rmula6.mml%i$ = 8% Compute NPV = −$4,211.32 Convert the interest rate from i$ = 8% to i€ = 3.92% using%media:27formula3.mml%CF0 = −€64,000 CF1 = €160,000 CF2 = −€100,000%media:18formula7.mml%i€ = 3.92% Compute NPV = −€598.18 Convert to dollars at spot rate%media:18formula8.mml%

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52) There are two equally valid approaches each of these problems Convert the cash flows to dollars use i$ = 8% as a discount rate%media:21formula4.mml%%media:21formula5.mml%%media:21fo rmula6.mml%i$ = 8% Compute NPV = −$4,211.32 Convert the interest rate from i$ = 8% to i€ = 3.92% using%media:30formula3.mml%CF0 = −€64,000 CF1 = €160,000 CF2 = −€100,000%media:21formula7.mml%i€ = 3.92% Compute NPV = −€598.18 Convert to dollars at spot rate%media:21formula8.mml% 53) 29.90%

1 + IRR$ 1 + i$

1 + IRR€ 1 + i€

1.25 1.02

1 + IRR€ 1.06 54) Use IRR button with cash flow menu or solve this quadratic:100X2 −

160X + 64 = 0 (10X − 8) (10X − 8) = 0 → 10X − 8 = 0%media:4formula9.mml%25.00%

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55) There are two equally valid approaches each of these problems Convert the euro cash flows to dollars use i$ = 8% as a discount rate%media:14formula10.mml%%media:15formula11.mml%%media:1 4formula12.mml%i$ = 8% Compute NPV = −$957.09 Convert the interest rate from i$ = 8% to i€ = 3.92% using%media:35formula3.mml%CF0 = −€25,000 CF1 = €60,000 CF2 = −€36,000%media:19formula13.mml%i€ = 3.92% Compute NPV = −€598.18 Convert to dollars at spot rate%media:15formula14.mml%

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56) There are two equally valid approaches each of these problems Convert the euro cash flows to dollars use i$ = 8% as a discount rate%media:17formula10.mml%%media:18formula11.mml%%media:1 7formula12.mml%i$ = 8% Compute NPV = −$957.09 Convert the interest rate from i$ = 8% to i€ = 3.92% using%media:38formula3.mml%CF0 = −€25,000 CF1 = €60,000 CF2 = −€36,000%media:22formula13.mml%i€ = 3.92% Compute NPV = −€598.18 Convert to dollars at spot rate%media:18formula14.mml% 57) Easily computed with a financial calculator if you converted the cash flows into dollars. 58) Use IRR button with cash flow menu or solve this quadratic:36X2 − 60X + 25 = 0 (6X − 5) (6X − 5) = 0 → 6X − 5 = 0%media:4formula16.mml%20.00% 59) <img alt="" src="/extMedia/bne/Eun_9e/chapter_18/Ch18-79.JPG" style="width: 250px; height: 103px;"> 60) <img alt="" src="/extMedia/bne/Eun_9e/chapter_18/Ch18-80.JPG" style="width: 200px; height: 100px;"> 61) <img alt="" src="/extMedia/bne/Eun_9e/chapter_18/Ch18-81.JPG" style="width: 200px; height: 100px;">

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62) <img alt="" src="/extMedia/bne/Eun_9e/chapter_18/Ch18-82.JPG" style="width: 250px; height: 83px;"> 63) <img alt="" src="/extMedia/bne/Eun_9e/chapter_18/Ch18-83.JPG" style="width: 230px; height: 100px;"> 64) <img alt="" src="/extMedia/bne/Eun_9e/chapter_18/Ch18-84.JPG" style="width: 300px; height: 110px;"> 65) <img alt="" src="/extMedia/bne/Eun_9e/chapter_18/Ch18-85.JPG" style="height: 598px; width: 600px;"> 66) Using the risk-neutral valuation methods of chapter 7, the risk neutral probability is 1/2%media:16formula22.mml%The value of the option is thereby €216.98 = 1/2 × €460 / 1.06 The NPV of the project if undertaken today is −€2,000 + $2,070/1.06 + €216.98 = €169.81 67) Notice that the hedge ratio of the option is 1 = (€460 − 0)/(€2530 − €2070) Recall from chapter 7 that if you write a call you hedge with a long position in the underlying. Here we own the call so we hedge with a short position in the underlying. So if we were to sell forward £1,150 today at the 1-year forward rate prevailing today, our gains and losses would be invariant to the exchange rate: If the exchange rate that prevails in one year is[MISSING IMAGE: , ] Given that we have the same riskless rates in both countries, the forward rate equals today's spot rate so the IRR = 15% 68) [MISSING IMAGE: , ]

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69) %media:6formula24.mml%The value of the option is $86.54 = 0.2143 × $420/1.04 The NPV of the bond if purchased today is $1500 + $1470/104 + $86.54 =0 This can be interpreted as the bond does not represent an arbitrage opportunity for the American hedge fund manager—it is appropriately priced. 70) If we buy the bond today the NPV = $0 If we wait 1 year then NPV is either $13.64 or $17.30 clearly buying the bond today is less desirable than waiting one year. 71) <img alt="" src="/extMedia/bne/Eun_9e/chapter_18/Ch18-098.JPG" style="height: 300px; width: 700px;"> 72) NPV = $500,000

($425 − $375) × 2,000 0.10

−$500,000

73) NPV = $1,200,000 = ($460 − $375) × 2,000 −$500,000 0.10 NPV = $0 =

Version 1

($390 − $375) × 2,000 0.10

−$500,000

CHAPTER 19 TRUE/FALSE - Write 'T' if the statement is true and 'F' if the statement is false. 1) Many of the skills necessary for effective cash management are the same regardless of whether the firm has only domestic operations or if it operates internationally. ⊚ ⊚

true false

2) The cash manager of a domestic firm should source funds internationally to obtain the lowest borrowing cost and to place excess funds wherever the greatest return can be earned regardless of currency. ⊚ ⊚

true false

A netting center necessarily implies that the MNC has a central cash manager. ⊚ ⊚

true false

4) A multilateral netting system is beneficial in reducing the number of and the expense associated with interaffiliate foreign exchange transactions. ⊚ ⊚

true false

5) A central cash manager has a global view of the most favorable borrowing rates and most advantageous investment rates. ⊚ ⊚

true false

6) A centralized cash pool assists in reducing the problem of mislocated funds and in funds mobilization.

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⊚ ⊚

true false

7) A centralized cash management system with a cash pool can reduce the investment the MNC has in precautionary cash balances, saving the firm money. ⊚ ⊚

true false

8) Precautionary cash balances are necessary in case a firm has overestimated the amount needed to cover transactions. ⊚ ⊚

true false

With a centralized cash depository, excess cash is remitted to the central cash pool. ⊚ ⊚

true false

10) Multilateral netting is an efficient and cost-effective mechanism for handling interaffiliate foreign exchange transactions. ⊚ ⊚

true false

MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 11) Efficient cash management techniques can A) B) C) D)

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reduce the investment in cash balances and foreign exchange transaction expenses. provide for maximum return from the investment of excess cash. result in borrowing at lowest rate when a temporary cash shortage exists. all of the options

12)

The foundation of any cash management system is its A) B) C) D)

13)

Cash management refers to A) B) C) D)

14)

cash flow. cash budget. transactional balances. precautionary cash balances.

the decision to grant credit to customers or to remain "cash and carry." the investment the firm has in transaction balances and precautionary balances. a domestic firm's investment in foreign currency. none of the options

Precautionary cash balances

A) are necessary in case the firm has underestimated the amount of cash needed to cover transactions. B) are necessary to cover scheduled outflows of funds during a cash budgeting period. C) are necessary in case the firm has underestimated the amount of cash needed to cover transactions, and are also necessary to cover scheduled outflows of funds during a cash budgeting period. D) none of the options

15)

Precautionary cash balances

A) represent an increasingly-important source of interest income for many MNCs. B) are necessary in case the firm has underestimated the amount needed to cover transactions. C) are synonymous with speculative cash balances. D) none of the options

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16)

Multinational cash management

A) is really no different for an MNC than for a purely domestic firm in a closed economy. B) concerns itself with the size of cash balances, their currency denominations, and where these cash balances are located among the MNC's affiliates. C) concerns itself with the size of cash balances and their currency denominations, but not where these cash balances are located among the MNC's affiliates, since intra-affiliate default risk is not an issue. D) none of the options

17)

Good cash management encompasses

A) investing excess funds at the most favorable interest rate and borrowing at the lowest rate when there is a temporary cash shortage. B) investing excess funds at the lowest rate and borrowing at the highest rate when there is a temporary cash shortage. C) hedging currency exposure with judicious use of futures, forwards, and currency option contracts. D) none of the options

18) ABC Trading Company of Singapore purchases spices in bulk from around the world, packages them into consumer size quantities and sells them through sales affiliates in Hong Kong and the Unites States. For a recent month, the following payments matrix of interaffiliate cash flows, stated in Singapore dollars, was forecasted. ABC Trading Company Payments Matrix (S$000) Disbursements by: Singapore

Hong Kong

U.S.

110

Receipts by: Singapore Hong Kong

Version 1

U.S.

Calculate, in Singapore dollars, the amount that the interaffiliate foreign exchange transaction will be reduced by with multilateral netting. A) B) C) D)

19)

S$152,000 S$170,000 S$322,000 S$405,000

Under a bilateral netting system

A) each pair of affiliates determines the net amount due between them, and only the net amount is transferred. B) each affiliate nets all its interaffiliate receipts against all its disbursements C) both of the options D) neither of the options

20) ABC Trading Company of Singapore purchases spices in bulk from around the world, packages them into consumer size quantities and sells them through sales affiliates in Hong Kong and the Unites States. For a recent month, the following payments matrix of interaffiliate cash flows, stated in Singapore dollars, was forecasted. ABC Trading Company Payments Matrix (S$000) Disbursements by: Singapore

Hong Kong

U.S.

110

Receipts by: Singapore Hong Kong

U.S.

Version 1

44 50

If foreign exchange transactions cost ABC 0.45 percent, what savings results from netting? A) B) C) D)

S$684 S$765 S$1,449 S$1,823

21) Consider a U.S. MNC with three subsidiaries and the following foreign exchange transactions shown. Use bilateral netting to reduce the number of foreign exchange transactions

by half. A) B) C) D)

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[MISSING IMAGE: "", "" ] [MISSING IMAGE: "", "" ] [MISSING IMAGE: "", "" ] none of the options

22) Consider a U.S. MNC with three subsidiaries and the following foreign exchange transactions shown. Use multilateral netting to reduce the number of foreign exchange

transactions. A) B) C) D)

[MISSING IMAGE: "", "" ] [MISSING IMAGE: "", "" ] [MISSING IMAGE: "", "" ] none of the options

23) Consider a U.S. MNC with three subsidiaries and the following foreign exchange transactions shown. Use multilateral netting with a central depository to reduce the number of

foreign exchange transactions.

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A) B) C) D)

[MISSING IMAGE: "", "" ] [MISSING IMAGE: "", "" ] [MISSING IMAGE: "", "" ] none of the options

24) ABC Trading Company of Singapore purchases spices in bulk from around the world, packages them into consumer size quantities and sells them through sales affiliates in Hong Kong and the Unites States. For a recent month, the following payments matrix of interaffiliate cash flows, stated in Singapore dollars, was forecasted. ABC Trading Company Payments Matrix (S$000) Disbursements by: Singapore

Hong Kong

U.S.

110

Receipts by: Singapore Hong Kong

U.S.

44 50

Which of the following is an accurate chart of their current situation? A) B) C) D)

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[MISSING IMAGE: "", "" ] [MISSING IMAGE: "", "" ] [MISSING IMAGE: "", "" ] [MISSING IMAGE: "", "" ]

25)

Find the net exposure of the U.S. MNC with the following intra-affiliate transactions

shown. A) B) C) D)

26)

$55 $65 $800 none of the options

Find the net exposure of the British subsidiary of the U.S. MNC with the following intra

affiliate transactions shown. A) B) C) D)

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$40 out $65 out ₤20 out none of the options

27)

Benefits of a multilateral netting system include

A) the decrease in the expense associated with funds transfer, which in some cases can be over $1,000 for a large international transfer of foreign exchange. B) the reduction in the number of foreign exchange transactions and the associated cost of making fewer but larger transactions. C) the reduction in intra-company float, which is frequently as high as five days even for wire transfers. D) the benefits that accrue from the establishment of a formal information system, which serves as the foundation for centrally managing transaction exposure and the investment of excess funds. E) all of the options

28)

With a centralized cash depository A) B) C) D)

29)

With a centralized cash depository A) B) C) D)

30)

there is less chance for an MNC's funds to be denominated in the wrong currency. the central cash manager has a global view of the MNC's overall cash position. there is less chance of mislocated funds. all of the options

a MNC can facilitate fund mobilization. system-wide excess cash is invested at the most advantageous rates. system-wide cash shortages are borrowed at the most advantageous rates. all of the options

Not all countries allow MNCs the freedom to net payments,

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A) by limiting netting, more needless foreign exchange transactions flow through the local banking system. B) MNCs can avoid these restrictions by using a Centralized Cash Depository. C) MNCs can avoid these restrictions by using wire transfers. D) MNCs can avoid these restrictions by using a Centralized Cash Depository, as well as by using wire transfers.

31)

Which of the following is not a frequently cited benefit of a multilateral netting system?

A) The reduction in the number of foreign exchange transactions and the associated cost of making fewer but larger transactions. B) The reduction in intracompany float, which is frequently as high as five days even for wire transfers. C) The savings in administrative time. D) none of the options.

32) With regard to cash management systems in practice, studies suggest that the benefits of a multilateral netting system include A) the decrease in the expense associated with funds transfer, which in some cases can be over $1,000 for a large international transfer of foreign exchange. B) the savings in administrative time. C) the reduction in intracompany float, which is frequently as high as five days, even for wire transfers. D) all of the options

33)

Several international banks offer multilateral netting software packages. These packages

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A) calculate the net currency positions of each affiliate. B) can integrate the netting function with foreign exchange exposure management. C) only work on the Mac platform. D) calculate the net currency positions of each affiliate and can integrate the netting function with foreign exchange exposure management.

34)

MNCs can reduce their exchange rate expense A) B) C) D)

by using bilateral netting. by using a centralized cash management system. by using multilateral netting. all of the options

35) Which of the following statements about multilateral netting system are correct?(i) Each affiliate nets all its interaffiliate receipts against all its disbursements.(ii) Each affiliate transfers or receives a balance, depending on whether it is a net payer or receiver.(iii) The net funds to be received by the affiliates will equal the net disbursements to be made by the affiliates.(iv) Only two foreign exchange transactions are necessary since the affiliates' net receipts will always be equal to zero.(v) Only two foreign exchange transactions are necessary since the affiliates' net disbursements will always be equal to zero. A) B) C) D)

(i) and (ii) (i), (ii), and (iii) (i), (ii), (iii), and (iv) (i), (ii), (iii), and (v)

36) Assuming that the interaffiliate cash flows are uncorrelated with one another, calculate the standard deviation of the portfolio of cash held by the centralized depository for the following affiliate members:

Affiliate

Version 1

Expected

Standard

Transactions

Deviation

U.S.

$ 100,000

$ 40,000

Canada

$ 150,000

$ 60,000

Mexico

$ 175,000

$ 30,000

Chile

$ 200,000

$ 70,000

A) B) C) D)

$34,960.33 $139,841.33 $104,880.88 none of the options

37) Assuming that the interaffiliate cash flows are uncorrelated with one another, calculate the minimum cash balance to have if the firm follows a conservative policy of having three standard deviations of cash for precautionary purposes. Expected

Standard

Transactions

Deviation

U.S.

$ 100,000

$ 40,000

Canada

$ 150,000

$ 60,000

Mexico

$ 175,000

$ 30,000

Chile

$ 200,000

$ 70,000

Affiliate

A) B) C) D)

Version 1

$34,960.33 $314,642.65 $104,880.88 none of the options

38) If French-based Affiliate A owes U.S.-based affiliate B $1,000 and Affiliate B owes Affiliate A €2,000 when the exchange rate is $1.10 = €1.00. The net payment between A and B should be A) B) C) D)

€1,091 from B to A. €1,091 from A to B. $1,200 from B to A. none of the options

39) For a recent month, the following payments matrix of interaffiliate cash flows was forecasted: Disbursement From: Receipts by:

France

France Britain

U.S.

$ 1,000

Britain

U.S.

€ 500

€ 800

300

£ 400 $ 500

Use bilateral netting to find the net payment from the U.S. affiliate to the British affiliate.The spot exchange rates are $1.20 = €1.00 and $1.80 = £1.00; affiliates get paid in home currency. A) B) C) D)

$220 $40 $60 none of the options

40) For a recent month, the following payments matrix of interaffiliate cash flows was forecasted: Disbursement From: Receipts by:

Version 1

France

Britain

U.S.

France

€ 500

Britain

300

U.S.

$ 1,000

€ 800 £ 400

$ 500

The spot exchange rates are $1.20 = €1.00 and $1.80 = £1.00; affiliates get paid in home currency. Use multilateral netting to find the net payments to and from all parties.Which of the following is an accurate chart of their current situation? A) B) C) D)

[MISSING IMAGE: "", "" ] [MISSING IMAGE: "", "" ] [MISSING IMAGE: "", "" ] none of the options

41) For a recent month, the following payments matrix of interaffiliate cash flows was forecasted: Disbursement From: Receipts by:

France

France Britain

£ 480

U.S.

$ 600

Britain

U.S.

€ 500

€ 800 £ 300

$ 960

The spot exchange rates are $1.20 = €1.00 and $2.00 = £1.00; affiliates get paid in home currency. Use multilateral netting to find the net payments to and from all parties.Which of the following is an accurate chart of their current situation? A) B) C) D)

Version 1

[MISSING IMAGE: "", "" ] [MISSING IMAGE: "", "" ] [MISSING IMAGE: "", "" ] none of the options

42) Simplify the following set of intracompany cash flows for this U.S. firm.Use the following exchange rates:

£ 1.00

$ 2.00

€ 1.00

$ 1.50

SFr 1.00

$ 0.80

The fewest number of intra-affiliate cash flows is{MISSING IMAGE} A) B) C) D)

zero. one. two. three.

43) Simplify the following set of intra-company cash flows for this Swiss firm.Use the following exchange rates:

£ 1.00

$ 2.00

€ 1.00

$ 1.50

SFr 1.00

$ 0.80

The fewest number of intra-affiliate cash flows is{MISSING IMAGE} A) B) C) D)

Version 1

zero. one. two. three.

44)

Which will reduce the number of foreign exchange transactions the most for an MNC? A) B) C) D)

45)

Multilateral netting Bilateral netting Fish netting none of the options

Under multilateral netting

A) each affiliate nets all its interaffiliate receipts against all its disbursements. It then transfers or receives the balance, respectively, if it is the net payer or receiver. B) each pair of affiliates determines the net amount due between them, and only the net amount is transferred. C) no interaffiliate payments are made or even computed, since no real cash flows are involved. D) all of the options

46)

One benefit of a centralized cash depository is

A) the MNC's investment in precautionary cash balances can be substantially reduced without a reduction in its ability to cover unforeseen expenses. B) each affiliate will have greater autonomy in managing its own cash balances. C) exchange rate restrictions can be easily circumvented. D) none of the options

47) If French-based Affiliate A owes U.S.-based affiliate B $1,000 and Affiliate B owes Affiliate A €2,000 when the exchange rate is $1.50 = €1.00. The net payment between A and B should be closest to

Version 1

A) B) C) D)

$2,000 from B to A. €2,000 from A to B. $1,000 from B to A. none of the options

48) For the U.S. affiliate shown below, net all its interaffiliate receipts against all its disbursements.Use the following exchange rates.

£ 1.00

$ 2.00

€ 1.00

$ 1.50

SFr 1.00

$ 0.80

The net interaffiliate cash flow for the U.S. affiliate is{MISSING IMAGE} A) B) C) D)

49)

$0. −$135. $135. $405.

When engaged in multilateral netting

A) total interaffiliate receipts will always equal total interaffiliate disbursements. B) we can reduce the number of foreign exchange transactions among an MNC with N affiliates to (N − 1) or less. C) each affiliate nets all its interaffiliate receipts against all its disbursements. It then transfers or receives the balance, respectively, if it is a net payer or receiver. D) all of the options

50)

Which one of the following is a false statement when engaged in bilateral netting?

Version 1

A) Total interaffiliate receipts will always equal total interaffiliate disbursements. B) We can reduce the number of foreign exchange transactions among an MNC with N affiliates to or less. C) Each affiliate nets all its interaffiliate receipts against all its disbursements. It then transfers or receives the balance, respectively, if it is a net payer or receiver. D) all of the options

51)

Which one of the following is a false statement when engaged in bilateral netting? A) Total interaffiliate receipts will always equal total interaffiliate disbursements. B) We can reduce the number of foreign exchange transactions among an MNC with N

affiliates to or less. C) Each affiliate nets all its interaffiliate receipts against all its disbursements. It then transfers or receives the balance, respectively, if it is a net receiver or payer respectively. D) all of the options

52)

Which one of the following is a false statement when engaged in bilateral netting? A) Total interaffiliate receipts need not always equal total interaffiliate disbursements. B) We can reduce the number of foreign exchange transactions among an MNC with N

53) Bilateral netting can reduce the number of foreign exchange transactions among an MNC with N affiliates to

Version 1

A) B) C) D) none of the options

54)

Mislocated funds are defined as A) B) C) D)

funds being found in the wrong account. funds being denominated in the wrong currency. funds being invested with the wrong maturity. none of the options

55) A firm keeps a precautionary cash balance to cover unexpected transactions during the budget period. The size of this balance depends on how safe the firm desires to be in its ability to meet unexpected transactions. A) The larger the precautionary cash balance, the greater is the firm's ability to meet unexpected expenses. B) The larger the precautionary cash balance, the less is the risk of financial embarrassment and loss of credit standing. C) The larger the precautionary cash balance, the greater the potential opportunity cost. D) all of the options

56) The formula for the standard deviation of cash held by the centralized depository for N affiliates is

Version 1

A) The formula assumes that interaffiliate cash flows have a correlation coefficient of −1. B) The formula assumes that interaffiliate cash flows have a correlation coefficient of +1. C) The formula assumes that interaffiliate cash flows have a correlation coefficient of 0. D) none of the options

57) is,

Some countries allow interaffiliate transactions to be settled only on a gross basis. That

A) all receipts for a settlement period must be grouped into a single large receipt and all disbursements must be grouped into a single large payment. B) all receipts and disbursements for a settlement period must be handled individually. C) all receipts and disbursements for a settlement period must be netted against each other and then a single large payment is made. D) each affiliate nets all its interaffiliate receipts against all its disbursements. It then transfers or receives the balance, respectively, if it is a net payer or receiver.

58)

Not all countries allow MNCs the freedom to net payments, A) the U.S., Canada, and Great Britain allow only netting between each other. B) some countries require the MNC to ask permission, and some countries limit netting. C) but that is fine, since netting typically has costs that outweigh the benefits for an

MNC. D) All of the options may be correct.

59)

Your firm's interaffiliate cash receipts and disbursements matrix is shown here ($000): Disbursements

Receipts

Version 1

U.S.

Canada

Germany

U.K.

Total Receipts

U.S.

125

Canada

Germany

U.K.

Total Disbursements

90 130

Find the net cash flow in (out of) the U.S. affiliate. A) B) C) D)

60)

$55,000 in $15,000 out $0 in or out $40,000 out

Your firm's interaffiliate cash receipts and disbursements matrix is shown here ($000): Disbursements

Receipts

U.S.

Canada

Germany

U.K.

Total Receipts 125

Canada

Germany

U.K.

Total Disbursements

90 130

Find the net cash flow in (out of) the Canadian affiliate.

Version 1

A) B) C) D)

61)

$55,000 in $15,000 out $0 in or out $40,000 out

Your firm's interaffiliate cash receipts and disbursements matrix is shown here ($000): Disbursements

Receipts

U.S.

Canada

Germany

U.K.

Total Receipts 125

Canada

Germany

U.K.

Total Disbursements

90 130

Find the net cash flow in (out of) the German affiliate. A) B) C) D)

62)

$55,000 in $15,000 out $0 in or out $40,000 out

Your firm's interaffiliate cash receipts and disbursements matrix is shown here ($000): Disbursements

Receipts U.S.

Version 1

U.S.

Canada

Germany

U.K.

Total Receipts 125

Canada

Germany

U.K.

Total Disbursements

65 90

130

Find the net cash flow in (out of) the U.K. affiliate. A) B) C) D)

63)

$55,000 in $15,000 out $0 in or out $40,000 out

Your firm's interaffiliate cash receipts and disbursements matrix is shown here ($000): Disbursements

Receipts

U.S.

Canada

Germany

U.K.

Total Receipts 40

Canada

Germany

U.K.

Total Disbursements

60 30

Find the net cash flow in (out of) the U.S. affiliate. A) B) C) D)

Version 1

$5,000 in $5,000 out $30,000 in $30,000 out

64)

Your firm's interaffiliate cash receipts and disbursements matrix is shown here ($000): Disbursements

Receipts

U.S.

Canada

Germany

U.K.

Total Receipts 40

Canada

Germany

U.K.

Total Disbursements

60 30

Find the net cash flow in (out of) the Canadian affiliate. A) B) C) D)

65)

$5,000 in $5,000 out $30,000 in $30,000 out

Your firm's interaffiliate cash receipts and disbursements matrix is shown here ($000): Disbursements

Receipts

U.S.

Canada

Germany

U.K.

Total Receipts 40

Canada

Germany

U.K.

Total Disbursements

Version 1

60 30

Find the net cash flow in (out of) the German affiliate. A) B) C) D)

66)

$5,000 in $5,000 out $30,000 out $30,000 in

Your firm's interaffiliate cash receipts and disbursements matrix is shown here ($000): Disbursements

Receipts

U.S.

Canada

Germany

U.K.

Total Receipts 40

Canada

Germany

U.K.

Total Disbursements

60 30

Find the net cash flow in (out of) the U.K. affiliate. A) B) C) D)

67)

$5,000 in $5,000 out $30,000 out $30,000 in

Your firm's interaffiliate cash receipts and disbursements matrix is shown here ($000): Disbursements

Receipts

Version 1

U.S.

Canada

Germany

U.K.

U.S.

Canada

Germany

U.K.

20 5

Find the net cash flow in (out of) the U.S. affiliate. A) B) C) D)

68)

$0 in or out $5,000 out $10,000 in $15,000 out

Your firm's interaffiliate cash receipts and disbursements matrix is shown here ($000): Disbursements

Receipts U.S.

U.S.

Canada 10

Canada

Germany

U.K.

Germany 5

U.K. 15

20 5

Find the net cash flow in (out of) the Canadian affiliate. A) B) C) D)

69)

$0 in or out $20,000 out $15,000 in $30,000 out

Your firm's interaffiliate cash receipts and disbursements matrix is shown here ($000):

Version 1

Disbursements Receipts U.S.

U.S.

Canada 10

Canada

Germany

U.K.

Germany 5

U.K. 15

20 5

Find the net cash flow in (out of) the German affiliate. A) B) C) D)

70)

$0 in or out $5,000 out $30,000 in $30,000 out

Your firm's interaffiliate cash receipts and disbursements matrix is shown here ($000): Disbursements

Receipts U.S.

U.S.

Canada 10

Canada

Germany

U.K.

Germany 5

U.K. 15

20 5

Find the net cash flow in (out of) the U.K. affiliate. A) B) C) D)

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$0 in or out $5,000 out $30,000 in $30,000 out

71)

Your firm's interaffiliate cash receipts and disbursements matrix is shown here ($000): Disbursements

Receipts U.S.

U.S.

Canada 10

Canada

Germany

U.K.

Germany 5

U.K. 15

20 5

Find the net cash flow for the entire firm A) B) C) D)

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$0 in or out $5,000 out $30,000 in $30,000 out

Answer Key Test name: Chap 19_9e 1) FALSE 2) TRUE 3) FALSE 4) TRUE 5) TRUE 6) TRUE 7) TRUE 8) FALSE 9) TRUE 10) TRUE 11) D 12) B 13) B 14) A 15) B 16) B 17) A 18) A 19) A 20) A 21) A 22) D 23) B 24) A 25) A 26) D Version 1

27) E 28) D 29) D 30) A 31) D 32) D 33) D 34) D 35) B 36) C 37) B 38) A 39) A 40) C 41) D 42) C 43) B 44) A 45) A 46) A 47) A 48) A 49) D 50) B 51) C 52) A 53) C 54) B 55) D 56) C Version 1

57) A 58) B 59) A 60) B 61) C 62) D 63) A 64) B 65) C 66) D 67) A 68) A 69) A 70) A 71) A

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CHAPTER 20 TRUE/FALSE - Write 'T' if the statement is true and 'F' if the statement is false. 1) A clearing arrangement introduces the concept of credit to barter transactions and means that bilateral trade can take place and does not have to be immediately settled. ⊚ ⊚

true false

2) In a switch trade the third buyer uses the account balance to purchase goods and services from the original clearing agreement counterparty who had the account imbalance. ⊚ ⊚

true false

3) The major difference between a buy-back and a counterpurchase transaction is that in the latter, the merchandise the Western seller agrees to purchase is unrelated and has not been produced on the exported equipment. ⊚ ⊚

true false

4) Offset transactions are reciprocal trade agreements between an industrialized country and a country that has defense and/or aerospace industries. ⊚ ⊚

true false

MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 5) International trade is more difficult and riskier than domestic trade from the exporter's perspective because

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A) the exporter may not be familiar with the buyer, and thus not know if the importer is a good credit risk. B) if the merchandise is exported abroad and the buyer does not pay, it may prove difficult, if not impossible, for the exporter to have any legal recourse. C) political instability makes it risky to ship merchandise abroad to certain parts of the world. D) all of the options

6) Conducting international trade transactions is difficult in comparison to domestic trades. Which of the following are false statements regarding this reality? A) Commercial and political risks enter into the equation, which are not factors in domestic trade. B) It is important for a country to be competitively strong in international trade in order for its citizens to have the goods and services they need and demand. C) It is generally the case that the costs of international trade outweigh the benefits. D) all of the options

A typical foreign trade transaction requires three basic documents: A) B) C) D)

letter of credit, time draft, and bill of lading. letter of credit, banker's acceptance, and bill of lading. letter of credit, time draft, and a banker's acceptance. none of the options

A time draft can become a negotiable money market instrument called A) B) C) D)

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Eurodollars. a banker's acceptance. a letter of credit. a bill of lading.

9) When a bank purchases a series of promissory notes from an importer in favor of an exporter at a discount, this is called A) B) C) D)

10)

The Export-Import Bank provides competitive assistance to U.S. exporters through A) B) C) D)

11)

accounts receivable financing. asset backed commercial paper. discounting. forfaiting.

direct loans to foreign importers. loan guarantees. credit insurance to U.S. exporters. all of the options

Countertrade transactions are

A) becoming obsolete as a means of conducting international trade transactions. B) gaining renewed prominence as a means of conducting international trade transactions. C) strictly a form of barter. D) none of the options

12)

Which of the following statements regarding bartering is not true?

A) is the direct exchange of goods between two parties B) transactions are typically one-time exchanges of merchandise that takes place when circumstances warrant C) can be described as a primitive way to do business D) is a type of forfaiting

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13)

There are several types of countertrade transactions

A) none of which involve the use of money. B) and in each type, the seller provides the buyer with goods or services in return for a reciprocal promise from the seller to purchase goods or services from the buyer. C) and in each type, the seller provides the buyer with goods or services in return for a reciprocal promise from the buyer to stand ready to sell goods or services to the buyer. D) none of the options

14) The primary methods of payment for foreign trades, ranked in the order of most secure to least secure for the exporter is A) B) C) D)

15)

open account, consignment, letter of credit/time draft, and cash in advance. consignment, letter of credit/time draft, cash in advance, and open account. cash in advance, letter of credit/time draft, consignment, and open account. cash in advance, letter of credit/time draft, open account, and consignment.

A bill of lading

A) is a document issued by the common carrier specifying that it has received the goods for shipment; it can serve as title to the goods. B) later becomes a banker's acceptance. C) is a time draft that calls for payment upon physical delivery of goods. D) none of the options

16)

A time draft

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A) is a document issued by the common carrier specifying that it has received the goods for shipment; it can serve as title to the goods. B) later becomes a banker's acceptance. C) is a written order instructing the importer or his agent that calls for payment of the amount specified on its face on a certain date. D) none of the options

17)

A banker's acceptance is created when

A) a document issued by the common carrier specifies that it has received the goods for shipment; it can serve as title to the goods. B) after taking title to the goods via a bill of lading, the importer's bank accepts the time draft. C) a time draft calls for payment upon physical delivery of goods matures. D) none of the options

18)

In a consignment sale A) B) C) D)

the importer only pays the exporter once he sells the merchandise. the exporter retains title to the merchandise that is shipped. if the goods do not sell, the importer can return them to the exporter. all of the options

19) Suppose the face amount of a promissory note is $1,000,000 and the importer's bank charges an acceptance commission of 1.5 percent. The note is for 60 days. Calculate the amount of the acceptance commission that the bank will charge. A) B) C) D)

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$997,500 $15,000 $2,500 none of the options

20) In a banker's acceptance, the __________ sends a purchase order to the __________. The __________ applies to his bank for a letter of credit. A) B) C) D)

importer; exporter; exporter exporter; importer; importer importer; exporter; importer exporter; importer; exporter

21) In a banker's acceptance, the __________'s bank sends the letter of credit to the __________'s bank. After sending the merchandise, the __________ gives the shipping documents and time draft to his bank. A) B) C) D)

22)

importer; exporter; exporter exporter; importer; importer importer; exporter; importer exporter; importer; exporter

Banker's acceptances usually have maturities ranging from A) B) C) D)

30 to 180 days. 90 to 360 days. 1 year to 5 years. over 5 years.

23) Assume the time from acceptance to maturity on a $2,000,000 banker's acceptance is 90 days. Further assume that the importing bank's acceptance commission is 1.25 percent and that the market rate for 90-day B/As is 6.0 percent. Calculate the amount the exporter will receive if he discounts the B/A with the importer's bank.

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A) B) C) D)

$1,993,750 $1,999,375 $1,963,750 $1,009,375

24) Assume the time from acceptance to maturity on a $1,000,000 banker's acceptance is 180 days. Further assume that the importing bank's acceptance commission is 1.25 percent and that the market rate for 180-day B/As is 5.0 percent. Calculate the amount the exporter will receive if he discounts the B/A with the importer's bank. A) B) C) D)

$906,250 $909,375 $968,750 $993,750

25) Assume the time from acceptance to maturity on a $5,000,000 banker's acceptance is 90 days. Further assume that the importing bank's acceptance commission is 1.5 percent and that the market rate for 90-day B/As is 6.0 percent. Calculate the amount the exporter will receive if he discounts the B/A with the importer's bank. A) B) C) D)

$4,981,750 $4,906,250 $4,009,375 none of the options

26) Assume the time from acceptance to maturity on a $4,000,000 banker's acceptance is 180 days. Further assume that the importing bank's acceptance commission is 1.25 percent and that the market rate for 90-day B/As is 3.0 percent. Calculate the amount the exporter will receive if he discounts the B/A with the importer's bank.

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A) B) C) D)

$3,993,750 $3,915,000 $3,975,000 $3,009,375

27) Assume the time from acceptance to maturity on a $10,000,000 banker's acceptance is 90 days. Further assume that the importing bank's acceptance commission is 1 percent and that the market rate for 90-day B/As is 3.0 percent. Calculate the amount the exporter will receive if he discounts the B/A with the importer's bank. A) B) C) D)

$9,993,750 $9,900,000 $9,975,000 $9,009,375

28) Assume the time from acceptance to maturity on a $10,000,000 banker's acceptance is 90 days. Further assume that the importing bank's acceptance commission is 1 percent and that the market rate for 90-day B/As is 3.0 percent. Calculate the commission amount the banker will receive if the exporter discounts the B/A with the importer's bank. A) B) C) D)

$200,000 $100,000 $25,000 $75,000

29) Assume the time from acceptance to maturity on a $2,000,000 banker's acceptance is 90 days. Further assume that the importing bank's acceptance commission is 1.25 percent and that the market rate for 90-day B/As is 6.0 percent. Calculate the amount the exporter will receive if he holds it to maturity.

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A) B) C) D)

$1,993,750 $1,999,375 $1,963,750 $1,009,375

30) Assume the time from acceptance to maturity on a $1,000,000 banker's acceptance is 180 days. Further assume that the importing bank's acceptance commission is 1.25 percent and that the market rate for 180-day B/As is 5.0 percent. Calculate the amount the exporter will receive if he holds it to maturity. A) B) C) D)

$906,250 $909,375 $968,750 $993,750

31) Assume the time from acceptance to maturity on a $5,000,000 banker's acceptance is 90 days. Further assume that the importing bank's acceptance commission is 1.5 percent and that the market rate for 90-day B/As is 6.0 percent. Calculate the amount the exporter will receive if he holds it to maturity. A) B) C) D)

$4,981,250 $4,906,250 $4,009,375 none of the options

32) Assume the time from acceptance to maturity on a $4,000,000 banker's acceptance is 180 days. Further assume that the importing bank's acceptance commission is 1.25 percent and that the market rate for 90-day B/As is 6.0 percent. Calculate the amount the exporter will receive if he holds it to maturity.

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A) B) C) D)

$3,993,750 $3,999,375 $3,975,000 $3,009,375

33) Assume the time from acceptance to maturity on a $10,000,000 banker's acceptance is 90 days. Further assume that the importing bank's acceptance commission is 1 percent and that the market rate for 90-day B/As is 3.0 percent. Calculate the amount the exporter will receive if he holds it to maturity. A) B) C) D)

$9,993,750 $9,999,375 $9,975,000 $9,009,375

34) Assume the time from acceptance to maturity on a $10,000,000 banker's acceptance is 90 days. Further assume that the importing bank's acceptance commission is 1 percent and that the market rate for 90-day B/As is 3.0 percent. The bond equivalent yield that the exporter pays in discounting the B/A is A) B) C) D)

3.05 percent. 3.01 percent. 3.07 percent. none of the options

35) The time from acceptance to maturity on a $3,000,000 banker's acceptance is 90 days. If the importing bank's acceptance commission is 1.25 percent, determine the amount the exporter will receive if he holds the B/A until maturity.

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A) B) C) D)

$2,945,625 $2,990,625 $2,906,250 $3,009,375

36) The time from acceptance to maturity on a $3,000,000 banker's acceptance is 90 days. If the market rate for 90-day B/As is 6.0 percent, calculate the amount the exporter will receive if he discounts the B/A with the importer's bank. A) B) C) D)

$2,945,625 $2,990,625 $3,000,000 $3,009,375

37) The time from acceptance to maturity on a $3,000,000 banker's acceptance is 90 days. The bond equivalent yield that the exporter pays in discounting the B/A is A) B) C) D)

6.10 percent. 9.29 percent. 6.02 percent. none of the options

38) Assume the time from acceptance to maturity on a $10,000,000 banker's acceptance is 90 days. Further assume that the importing bank's acceptance commission is 1 percent and that the market rate for 90-day B/As is 3.0 percent. The bond equivalent yield that the bank earns in holding the B/A to maturity is: A) B) C) D)

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0.2287 percent 0.102 percent 0.406 percent none of the options

39) Assume the time from acceptance to maturity on a $2,000,000 banker's acceptance is 180 days. Further assume that the importing bank's acceptance commission is 1.25 percent and that the market rate for 180-day B/As is 5.0 percent. The bond equivalent yield that the bank earns in holding the B/A to maturity is A) B) C) D)

40)

13.08 percent. 6.54 percent. 4.06 percent. none of the options

The term "forfaiting"

A) means relinquishing, waiving, yielding, and penalty. B) is a type of medium-term trade financing used to finance the sale of capital goods. C) involves the sale of promissory notes signed by the importer in favor of the exporter, who might sell the notes at a discount from face value. D) Both B & C are correct.

41)

In a forfaiting transaction, the forfait is usually A) B) C) D)

42)

the importer. the exporter. the bank. the title to the goods, or the bill of lading.

In a forfaiting transaction, the forfait A) B) C) D)

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buys the notes at a discount from face value from the importer. buys the notes at a discount from face value from the exporter. redeems the notes at a face value to the exporter. none of the options

43)

In the event of a default

A) importer. B) importer C) D)

44)

the forfait does not have recourse against the exporter in the event of a default by the the forfait does have recourse against the exporter in the event of a default by the the exporter will have to return the goods to the importer. none of the options

Among the reasons put forth for government assistance in exporting

A) success in international trade is fundamentally important for a country. B) success in exporting implies that there is demand for a country's products, that its labor force is employed, and that some resources are used for technological advancement. C) to be successful in international trade means that the government is popular. D) Both A & B are correct.

45) Export-Import Bank (Ex-Im bank) is an independent agency of the United States government that facilitates and finances U.S. export trade. Ex-Im bank's purpose is to provide financing in situations where private financial institutions are unable or unwilling to because of which of the following reasons:(i) The loan maturity is too long.(ii) The amount of the loan is too large.(iii) The loan risk is too great.(iv) The importing firm has difficulty obtaining hard currency for payment.(v) There are no futures or forward contracts available for foreign exchange transactions. A) B) C) D)

(i) and (ii) (i), (ii), and (iii) (i), (ii), (iii), and (iv) (i), (ii), (iii), (iv), and (v)

46) Through its Export Credit Insurance Program, Ex-Im bank helps U.S. exporters develop and expand their overseas sales by

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A) protecting them against loss should a foreign buyer default. B) guaranteeing the loans made by private financial institutions to foreign importers. C) providing liquidity via the purchase of notes issued by Ex-Im bank to finance the loans. D) none of the options

47) Through its LoanGuarantee Program, Ex-Im bank helps U.S. exporters develop and expand their overseas sales by A) protecting them against loss should a foreign buyer default. B) guaranteeing the loans made by private financial institutions to foreign importers. C) providing liquidity via the purchase of notes issued by Ex-Im bank to finance the loans. D) none of the options

48)

The British version of the Ex-Im bank A) B) C) D)

49)

helps U.S. exporters develop and expand their overseas sales. is called Inland Revenue. is called the Exports Credits Guarantee Department. is called Ex-Im bank U.K.

The term "countertrade" refers to

A) many different types of transactions in which the seller provides a buyer with goods or services and promises in return to purchase goods or services from the buyer. B) barter, clearing arrangement, and switch trading. C) buy-back, counterpurchase, and offset. D) all of the options

50)

A clearing arrangement

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A) is also called a bilateral clearing agreement. B) is a form of barter. C) involves two parties agreeing to buy a specified amount of goods or services from one another. D) all of the options

51)

A switch trade

A) is the purchase by a third party of one country's a clearing agreement balance for hard currency. B) is a form of barter. C) involves two parties agreeing to buy a specified amount of goods or services from one another. D) all of the options

52)

A buy-back transaction

A) is also called a bilateral clearing agreement. B) involves a technology transfer via the sale of a manufacturing plant: as part of the terms, the seller of the plant agrees to purchase a certain portion of the plant output. C) involves two parties agreeing to buy a specified amount of goods or services from one another. D) all of the options

53)

A counterpurchase

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A) involves a technology transfer via the sale of a manufacturing plant: as part of the terms, the seller of the plant agrees to purchase a certain portion of the plant output. B) is similar to a buy-back transaction but the seller of the plant agrees to buy unrelated goods. C) is a form of barter. D) involves two parties agreeing to buy a specified amount of goods or services from one another.

54)

An offset transaction

A) can be viewed as a counterpurchase trade agreement involving the aerospace/defense industry. B) involves a technology transfer via the sale of a manufacturing plant: as part of the terms, the seller of the plant agrees to purchase a certain portion of the plant output. C) is the purchase by a third party of one country's a clearing agreement balance for hard currency. D) none of the options

55)

A buy-back transaction A) B) C) D)

56)

can be viewed as direct foreign investment in the purchasing country. can be viewed as direct foreign investment in the exporting country. can be viewed as indirect foreign investment in the purchasing country. none of the options

Countertrade transactions

A) B) C) D) deficits.

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are included in official trade statistics. are not included in official trade statistics. reduce trade imbalances and trade deficits. are included in official trade statistics, and also reduce trade imbalances and trade

57)

Arguments in favor ofcountertrade include benefits such as A) B) C) D)

conservation of cash or hard currency. improvement of trade imbalances. maintenance of export prices. all of the options

SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question. 58) The time from acceptance to maturity on a $2,000,000 banker's acceptance is 90 days. The importing bank's acceptance commission is 1.25 percent and the market rate for 90-day B/As is 6 percent.Determine the amount the exporter will receive if he holds the B/A until maturity.

59) The time from acceptance to maturity on a $2,000,000 banker's acceptance is 90 days. The importing bank's acceptance commission is 1.25 percent and the market rate for 90-day B/As is 6 percent.Determine the amount the exporter will receive if he discounts the B/A with the importer's bank.

60) The time from acceptance to maturity on a $2,000,000 banker's acceptance is 90 days. The importing bank's acceptance commission is 1.25 percent and the market rate for 90-day B/As is 6 percent.Determine the bond equivalent yield the importer's bank will earn from discounting the B/A with the exporter.

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61) The time from acceptance to maturity on a $2,000,000 banker's acceptance is 90 days. The importing bank's acceptance commission is 1.25 percent and the market rate for 90-day B/As is 6 percent. If the exporter's opportunity cost of capital is 11 percent, should he discount the B/A or hold it to maturity?

62) The time from acceptance to maturity on a $2,000,000 banker's acceptance is 90 days. The importing bank's acceptance commission is 1.25 percent and the market rate for 90-day B/As is 6 percent. Calculate the amount the banker will receive if the exporter discounts the B/A with the importer's bank.

63) The time from acceptance to maturity on a $1,000,000 banker's acceptance is 60 days. The importing bank's acceptance commission is 1.00 percent and that the market rate for 60-day B/As is 5 percent. Determine the amount the exporter will receive if he holds the B/A until maturity.

64) The time from acceptance to maturity on a $1,000,000 banker's acceptance is 60 days. The importing bank's acceptance commission is 1.00 percent and that the market rate for 60-day B/As is 5 percent. Determine the amount the exporter will receive if he discounts the B/A with the importer's bank.

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65) The time from acceptance to maturity on a $1,000,000 banker's acceptance is 60 days. The importing bank's acceptance commission is 1.00 percent and that the market rate for 60-day B/As is 5 percent. Determine the bond equivalent yield the importer's bank will earn from discounting the B/A with the exporter.

66) The time from acceptance to maturity on a $1,000,000 banker's acceptance is 60 days. The importing bank's acceptance commission is 1.00 percent and that the market rate for 60-day B/As is 5 percent. If the exporter's opportunity cost of capital is 11 percent, should he discount the B/A or hold it to maturity?

67) The time from acceptance to maturity on a $1,000,000 banker's acceptance is 60 days. The importing bank's acceptance commission is 1.00 percent and that the market rate for 60-day B/As is 5 percent. Calculate the amount the banker will receive if the exporter discounts the B/A with the importer's bank.

68) The time from acceptance to maturity on a $500,000 banker's acceptance is 270 days. The importing bank's acceptance commission is 0.75 percent and that the market rate for 270-day B/As is 4 percent. Determine the amount the exporter will receive if he holds the B/A until maturity.

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69) The time from acceptance to maturity on a $500,000 banker's acceptance is 270 days. The importing bank's acceptance commission is 0.75 percent and that the market rate for 270-day B/As is 4 percent. Determine the amount the exporter will receive if he discounts the B/A with the importer's bank.

70) The time from acceptance to maturity on a $500,000 banker's acceptance is 270 days. The importing bank's acceptance commission is 0.75 percent and that the market rate for 270-day B/As is 4 percent. Determine the bond equivalent yield the importer's bank will earn from discounting the B/A with the exporter.

71) The time from acceptance to maturity on a $500,000 banker's acceptance is 270 days. The importing bank's acceptance commission is 0.75 percent and that the market rate for 270-day B/As is 4 percent. If the exporter's opportunity cost of capital is 11 percent, should he discount the B/A or hold it to maturity?

72) The time from acceptance to maturity on a $500,000 banker's acceptance is 270 days. The importing bank's acceptance commission is 0.75 percent and that the market rate for 270-day B/As is 4 percent. Calculate the amount the banker will receive if the exporter discounts the B/A with the importer's bank.

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73) The time from acceptance to maturity on a $6,000,000 banker's acceptance is 360 days. The importing bank's acceptance commission is 2 percent and the market rate for 360-day B/As is 3 percent.Determine the amount the exporter will receive if he holds the B/A until maturity.

74) The time from acceptance to maturity on a $6,000,000 banker's acceptance is 360 days. The importing bank's acceptance commission is 2 percent and the market rate for 360-day B/As is 3 percent.Determine the amount the exporter will receive if he discounts the B/A with the importer's bank.

75) The time from acceptance to maturity on a $6,000,000 banker's acceptance is 360 days. The importing bank's acceptance commission is 2 percent and the market rate for 360-day B/As is 3 percent. Determine the bond equivalent yield the importer's bank will earn from discounting the B/A with the exporter.

76) The time from acceptance to maturity on a $6,000,000 banker's acceptance is 360 days. The importing bank's acceptance commission is 2 percent and the market rate for 360-day B/As is 3 percent.If the exporter's opportunity cost of capital is 11 percent, should he discount the B/A or hold it to maturity?

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77) The time from acceptance to maturity on a $6,000,000 banker's acceptance is 360 days. The importing bank's acceptance commission is 2 percent and the market rate for 360-day B/As is 3 percent. Calculate the amount the banker will receive if the exporter discounts the B/A with the importer's bank.

78) The time from acceptance to maturity on a $50,000 banker's acceptance is 180 days. The importing bank's acceptance commission is 2.50 percent and the market rate for 180-day B/As is 2 percent.Determine the amount the exporter will receive if he holds the B/A until maturity.

79) The time from acceptance to maturity on a $50,000 banker's acceptance is 180 days. The importing bank's acceptance commission is 2.50 percent and the market rate for 180-day B/As is 2 percent.Determine the amount the exporter will receive if he discounts the B/A with the importer's bank.

80) The time from acceptance to maturity on a $50,000 banker's acceptance is 180 days. The importing bank's acceptance commission is 2.50 percent and the market rate for 180-day B/As is 2 percent.Determine the bond equivalent yield the importer's bank will earn from discounting the B/A with the exporter.

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81) The time from acceptance to maturity on a $50,000 banker's acceptance is 180 days. The importing bank's acceptance commission is 2.50 percent and the market rate for 180-day B/As is 2 percent.If the exporter's opportunity cost of capital is 11 percent, should he discount the B/A or hold it to maturity?

82) The time from acceptance to maturity on a $50,000 banker's acceptance is 180 days. The importing bank's acceptance commission is 2.50 percent and the market rate for 180-day B/As is 2 percent. Calculate the amount the banker will receive if the exporter discounts the B/A with the importer's bank.

83) The time from acceptance to maturity on a $300,000 banker's acceptance is 30 days. The importing bank's acceptance commission is 3 percent and the market rate for 30-day B/As is 4 percent. Determine the amount the exporter will receive if he holds the B/A until maturity.

84) The time from acceptance to maturity on a $300,000 banker's acceptance is 30 days. The importing bank's acceptance commission is 3 percent and the market rate for 30-day B/As is 4 percent.Determine the amount the exporter will receive if he discounts the B/A with the importer's bank.

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85) The time from acceptance to maturity on a $300,000 banker's acceptance is 30 days. The importing bank's acceptance commission is 3 percent and the market rate for 30-day B/As is 4 percent. Determine the bond equivalent yield the importer's bank will earn from discounting the B/A with the exporter.

86) The time from acceptance to maturity on a $300,000 banker's acceptance is 30 days. The importing bank's acceptance commission is 3 percent and the market rate for 30-day B/As is 4 percent.If the exporter's opportunity cost of capital is 11 percent, should he discount the B/A or hold it to maturity?

87) The time from acceptance to maturity on a $300,000 banker's acceptance is 30 days.The importing bank's acceptance commission is 3 percent and the market rate for 30-day B/As is 4 percent.Calculate the amount the banker will receive if the exporter discounts the B/A with the importer's bank.

88) The time from acceptance to maturity on a $30,000,000 banker's acceptance is 45 days. The importing bank's acceptance commission is 1.5 percent and that the market rate for 45-day B/As is 4½ percent.Determine the amount the exporter will receive if he holds the B/A until maturity.

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89) The time from acceptance to maturity on a $30,000,000 banker's acceptance is 45 days. The importing bank's acceptance commission is 1.5 percent and that the market rate for 45-day B/As is 4½ percent.Determine the amount the exporter will receive if he discounts the B/A with the importer's bank.

90) The time from acceptance to maturity on a $30,000,000 banker's acceptance is 45 days. The importing bank's acceptance commission is 1.5 percent and that the market rate for 45-day B/As is 4.5 percent. Determine the bond equivalent yield the importer's bank will earn from discounting the B/A with the exporter.

91) The time from acceptance to maturity on a $30,000,000 banker's acceptance is 45 days. The importing bank's acceptance commission is 1.5 percent and that the market rate for 45-day B/As is 4½ percent.If the exporter's opportunity cost of capital is 11 percent, should he discount the B/A or hold it to maturity?

92) The time from acceptance to maturity on a $30,000,000 banker's acceptance is 45 days. The importing bank's acceptance commission is 1.5 percent and that the market rate for 45-day B/As is 4½ percent.Calculate the amount the banker will receive if the exporter discounts the B/A with the importer's bank.

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93) The time from acceptance to maturity on a $1,000,000 banker's acceptance is 90 days. The importing bank's acceptance commission is 3½ percent and that the market rate for 90-day B/As is 5 percent.Determine the amount the exporter will receive if he holds the B/A until maturity.

94) The time from acceptance to maturity on a $1,000,000 banker's acceptance is 90 days. The importing bank's acceptance commission is 3½ percent and that the market rate for 90-day B/As is 5 percent.Determine the amount the exporter will receive if he discounts the B/A with the importer's bank.

95) The time from acceptance to maturity on a $1,000,000 banker's acceptance is 90 days. The importing bank's acceptance commission is 3.5 percent and that the market rate for 90-day B/As is 5 percent. Determine the bond equivalent yield the importer's bank will earn from discounting the B/A with the exporter.

96) The time from acceptance to maturity on a $1,000,000 banker's acceptance is 90 days. The importing bank's acceptance commission is 3½ percent and that the market rate for 90-day B/As is 5 percent.If the exporter's opportunity cost of capital is 11 percent, should he discount the B/A or hold it to maturity?

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97) The time from acceptance to maturity on a $1,000,000 banker's acceptance is 90 days. The importing bank's acceptance commission is 3½ percent and that the market rate for 90-day B/As is 5 percent. Calculate the amount the banker will receive if the exporter discounts the B/A with the importer's bank.

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Answer Key Test name: Chap 20_9e 1) TRUE 2) FALSE 3) TRUE 4) TRUE 5) D 6) C 7) A 8) B 9) D 10) D 11) B 12) D 13) B 14) C 15) A 16) C 17) B 18) D 19) C 20) C 21) A 22) A 23) C 24) C 25) B 26) B Version 1

27) B 28) C 29) A 30) D 31) A 32) C 33) C 34) A 35) B 36) A 37) A 38) C 39) B 40) D 41) C 42) B 43) A 44) D 45) C 46) A 47) B 48) C 49) D 50) D 51) A 52) B 53) B 54) A 55) A 56) B Version 1

57) D 58) %media:43formula1.mml% 59) %media:formula2.mml% 60) If the exporter discounts the B/A with the importer bank he will receive%media:formula3.mml% The bond equivalent yield is[($2,000,000/$1,963,750) − 1] × (365/90) = 0.0749 = 7.49% 61) If his cost of funds > 6.1% compounded quarterly (EAR = 6.24%), he should discount the B/A. The exporter pays the acceptance commission regardless of whether he discounts the B/A or holds it to maturity, hence it is not marginal to a decision to discount the B/A. You could also make this determination based on this calculation:%media:formula8.mml% 62) %media:formula11.mml% 63) %media:formula13.mml% 64) %media:formula15.mml% 65) If the exporter holds the B/A to maturity, he will receive %media:formula17.mml% If the exporter discounts the B/A with the importer bank he will receive %media:formula16.mml% The bond equivalent yield that the importer bank receives is exporter pays in discounting the B/A is[($1,000,000/$990,000) − 1] × (365/60) = 0.0614 = 6.14%

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66) If his cost of funds > 5% compounded six times per year (EAR = 5.11%), he should discount the B/A. The exporter pays the acceptance commission regardless of whether he discounts the B/A or holds it to maturity, hence it is not marginal to a decision to discount the B/A. You could also make this determination based on this calculation: %media:formula21.mml% 67) %media:34formula23.mml% 68) %media:formula25.mml% 69) %media:formula27.mml% 70) If the exporter holds the B/A to maturity, he will receive %media:formula28.mml% If the exporter discounts the B/A with the importer bank he will receive %media:formula29.mml% The bond equivalent yield that the exporter pays in discounting the B/A is: [($500,000/$482,187.50) − 1] × (365/270) = 0.0499 = 4.99% 71) If his cost of funds > 4.08% compounded 1⅓ times per year (EAR = 4.10%), he should discount the B/A. The exporter pays the acceptance commission regardless of whether he discounts the B/A or holds it to maturity, hence it is not marginal to a decision to discount the B/A. You could also make this determination based on this calculation: %media:formula33.mml% 72) %media:formula35.mml% 73) %media:formula37.mml% 74) %media:formula38.mml% Version 1

75) If the exporter holds the B/A to maturity, he will receive %media:formula39.mml% If the exporter discounts the B/A with the importer bank he will receive %media:formula40.mml% The bond equivalent yield that the exporter pays in discounting the B/A is %media:formula42.mml% 76) If his cost of funds > 3.1% compounded annually (EAR = 3.10%), he should discount the B/A. The exporter pays the acceptance commission regardless of whether he discounts the B/A or holds it to maturity, hence it is not marginal to a decision to discount the B/A. You could also make this determination based on this calculation: %media:25formula44.mml% 77) %media:formula46.mml% 78) %media:23formula47.mml% 79) %media:formula48.mml% 80) If the exporter holds the B/A to maturity, he will receive %media:formula49.mml% If the exporter discounts the B/A with the importer bank he will receive %media:formula50.mml% The bond equivalent yield that the exporter pays in discounting the B/A is [($50,000/$48,875) − 1] × (365/180) = 0.0467 = 4.67%

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81) If his cost of funds > 2.05% compounded semiannually (EAR = 2.06%), he should discount the B/A. The exporter pays the acceptance commission regardless of whether he discounts the B/A or holds it to maturity, hence it is not marginal to a decision to discount the B/A. You could also make this determination based on this calculation: %media:formula54.mml% 82) %media:formula57.mml% 83) %media:formula59.mml% 84) %media:formula61.mml% 85) If the exporter holds the B/A to maturity, he will receive %media:formula62.mml% If the exporter discounts the B/A with the importer bank he will receive %media:formula63.mml% The bond equivalent yield that the exporter pays in discounting the B/A is: [($300,000/$298,250) − 1] × (365/30) = 0.0714 = 7.14% 86) If his cost of funds > 4.07% compounded monthly (EAR = 4.14%), he should discount the B/A. The exporter pays the acceptance commission regardless of whether he discounts the B/A or holds it to maturity, hence it is not marginal to a decision to discount the B/A. You could also make this determination based on this calculation: %media:formula67.mml% 87) %media:formula70.mml% 88) %media:formula73.mml% 89) %media:formula75.mml%

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90) If the exporter holds the B/A to maturity, he will receive %media:formula77.mml% If the exporter discounts the B/A with the importer bank he will receive %media:formula76.mml% The bond equivalent yield that the exporter pays in discounting the B/A is[($30,000,000/$29,775,000) − 1] × (365/45) = 0.0613 = 6.13% 91) If his cost of funds > 4.57% compounded semi quarterly (EAR = 4.66%), he should discount the B/A. The exporter pays the acceptance commission regardless of whether he discounts the B/A or holds it to maturity, hence it is not marginal to a decision to discount the B/A. You could also make this determination based on this calculation: %media:formula81.mml% 92) %media:formula84.mml% 93) %media:formula86.mml% 94) %media:formula88.mml% 95) If the exporter holds the B/A to maturity, he will receive %media:formula89.mml% If the exporter discounts the B/A with the importer bank he will receive %media:formula90.mml% The bond equivalent yield that the exporter pays in discounting the B/A is[($1,000,000/$978,750) − 1] × (365/90) = 0.0881 = 8.81% 96) If his cost of funds > 5.11% compounded quarterly (EAR = 5.21%), he should discount the B/A. The exporter pays the acceptance commission regardless of whether he discounts the B/A or holds it to maturity, hence it is not marginal to a decision to discount the B/A. You could also make this determination based on this calculation: %media:formula94.mml% 97) %media:formula97.mml%

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CHAPTER 21 TRUE/FALSE - Write 'T' if the statement is true and 'F' if the statement is false. 1) An income tax is a direct tax. ⊚ ⊚

true false

2) The U.S. Tax Cuts and Jobs Act (TCJA) enacted in December 2017 moved the United States from a worldwide system towards a 100% dividend exemption territorial system for foreign-source dividends received from a specified 10% owned foreign corporation by a domestic C corporation for tax years beginning after December 31, 2017. ⊚ ⊚

true false

3) Foreign tax credits are allowed for foreign taxes paid on amounts that are eligible for the new 100% dividend exemption under the territorial system. ⊚ ⊚

true false

4) The 100% dividends-received deduction enacted as part of the 2017 TCJA or Tax Cuts and Jobs Act legislation exempts a U.S. parent C corporation from any U.S. tax liability when the foreign-source income is repatriated from a 10% owned foreign corporation ⊚ ⊚

true false

MULTIPLE CHOICE - Choose the one alternative that best completes the statement or answers the question. 5) The two main objectives of taxation are

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A) B) C) D)

The three basic types of taxation are A) B) C) D)

by one criterion. by two criteria. by three criteria. by four criteria.

Tax neutrality is determined by three criteria: which of the following doesn't belong? A) B) C) D)

income tax, withholding tax, and value-added tax. income tax, withholding tax, and business tax. withholding tax, value-added tax, and corporate tax. personal tax, corporate tax, and operating tax.

Tax neutrality is determined A) B) C) D)

tax neutrality and tax equity. complexity and revenue. social engineering and tax equity. progressive taxation and tax neutrality.

Capital-export neutrality Capital-import neutrality National neutrality Income neutrality

Tax neutrality

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A) has its foundations in the principles of economic efficiency and equality. B) can be a difficult principle to apply in practice. C) is determined by three criteria: capital export neutrality, capital import neutrality and national neutrality. D) all of the options

10) The idea that an ideal tax should be effective in raising revenue for the government but not have any negative effects on the economic decision-making process of the taxpayer is referred to as A) B) C) D)

capital-export neutrality. capital-import neutrality. national neutrality. none of the options

11) The idea that taxable income is taxed in the same manner by the taxpayer's national tax authority regardless of where in the world it is earned is referred to as A) B) C) D)

12)

capital-export neutrality. capital-import neutrality. national neutrality. none of the options

Capital-export neutrality A) B) C) D)

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is a goal based on worldwide economic efficiency. is an example of Mercantilism. is based on host country economic efficiency. is based on MNC home country economic efficiency.

13) The idea that the tax burden a host country imposes on the foreign subsidiary of an MNC should be the same regardless of the country in which the MNC is incorporated and the same as that placed on domestic firms is earned is referred to as A) B) C) D)

14)

capital-export neutrality. capital-import neutrality. national neutrality. none of the options

Capital-export neutrality

A) is the criterion that an ideal tax should be effective in raising revenue of the government and not have any negative effects on the economic decision-making process of the taxpayer. B) requires that taxable income is taxed in the same manner by the taxpayer's national tax authority regardless of where in the world it is earned. C) implies that the tax burden a host country imposes on the foreign subsidiary of the MNC should be the same regardless of which country the MNC is incorporated and the same as that placed on domestic firms. D) none of the options

15)

National neutrality

16)

Capital-import neutrality

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17)

The term "capital-import neutrality" refers to

A) the criterion that an ideal tax should be effective in raising revenue for the government and not have any negative effects on the economic decision-making process of the taxpayer. B) the fact that taxable income is taxed in the same manner by the taxpayer's national tax authority regardless of where in the world it is earned. C) the criterion that the tax burden a host country imposes on the foreign subsidiary of an MNC should be the same regardless in which country the MNC is incorporated and the same as that placed on domestic firms. D) the underlying principle that all similarly situated taxpayers should participate in the cost of operating the government according to the same rules.

18) The criteria of tax neutrality: capital-export neutrality, capital-import neutrality and national neutrality A) B) C) D)

19)

are all consistent with one another. are not always consistent with one another. are all identical with one another. none of the options

Implementing capital-import neutrality means that

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A) a sovereign government follows the taxation policies of foreign tax authorities on the foreign-source income of its resident MNCs. B) the tax burden a host country imposes on the foreign subsidiary of an MNC should be the same regardless of the country in which the MNC is incorporated. C) the tax burden a host country imposes on the foreign subsidiary of an MNC should be the same as that placed on domestic firms. D) all of the options

20)

Tax equity means that

A) similarly situated taxpayers should participate in the cost of operating the government according to the same rules. B) regardless of the country in which an affiliate of an MNC earns taxable income, the same tax rate and tax due date apply. C) a dollar earned by a foreign affiliate is taxed under the same rules as a dollar earned by a domestic affiliate of the MNC. D) all of the options

21)

The underlying principle of tax equity is that

A) all similarly situated taxpayers should participate in the cost of operating the government according to the same rules. B) all similarly situated taxpayers should participate in the cost of operating the government on an equal basis. C) none of the options

22) If a dollar earned by a foreign affiliate is taxed under the same rules as a dollar earned by a domestic affiliate of the MNC, then we have achieved

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A) B) C) D)

23)

capital-export neutrality. capital-import neutrality. national neutrality. tax equity.

The organizational form of an MNC can affect the timing of a tax liability. This means

A) the principle of tax equity might be violated. B) as long as, regardless of the country in which an affiliate of an MNC earns taxable income, the same tax rates apply, then the tax due date doesn't matter. C) tax timing will even out over a reporting cycle, so there is no big deal here. D) none of the options

24) use:

There are three basic types of taxation that national governments throughout the world

A) B) C) D)

25)

An income tax is defined in your textbook as A) B) C) D)

26)

income tax, withholding tax, and value-added tax. property tax, wealth tax, and death tax. import quotas, duties, and tariffs. tariffs, ad valorem taxes, and income taxes.

a direct tax. an indirect tax. being collected with a withholding tax. none of the options

Which statement is false?

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A) Active income is defined as income that results from production by the firm or individual or from services that have been provided. B) Passive income includes dividends and interest income, and income from royalties, patents, or copyrights paid to the taxpayer. C) A withholding tax is a tax levied on passive income earned by an individual or corporation of one country within the tax jurisdiction of another country. D) The current marginal U.S. income tax rate is positioned towards the lower end of the rates assessed by the majority of other countries.

27)

The current marginal U.S. income tax rate is positioned A) B) C) D)

28)

pretty well in the middle of the rates assessed by the majority of other countries. towards the upper end of the rates assessed by the majority of other countries. towards the lower end of the rates assessed by the majority of other countries. none of the options

A withholding tax is defined in your textbook as

A) the money that the government takes for every worker's paycheck. B) social security taxes. C) a tax levied on income earned by an individual (or corporation) of one country within the tax jurisdiction of another county. D) a tax levied on passive income earned by an individual (or corporation) of one country within the tax jurisdiction of another county.

29)

The purpose of a withholding tax

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A) is to assure the local tax authority that it will receive the tax due on the active income earned within its tax jurisdiction. B) is to assure the local tax authority that it will receive the tax due on the passive income earned within its tax jurisdiction. C) is to assure the local tax authority that it will receive the tax due on all income earned within its tax jurisdiction. D) none of the options

30)

A withholding tax is A) B) C) D)

31)

an indirect tax. a direct tax. both a direct and an indirect tax. none of the options

Withholding tax rates imposed through tax treaties are A) B) C) D)

bilateral. multilateral. netted. none of the options

32) The United States withholds __________ of passive income from taxpayers that reside in countries with which it does not have withholding tax treaties. A) B) C) D)

33)

10 percent 20 percent 30 percent 40 percent

A withholding tax

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A) is borne by a taxpayer who did not directly generate the income that serves as the source of the passive income. B) is a direct tax on workers. C) assures the local tax authority that it will receive the tax due on the passive income earned within its tax jurisdiction. D) Both A & C are correct.

34)

Many countries have tax treaties with one another. These generally specify

A) B) C) income. D)

35)

the withholding tax rate applied to various types of passive income. that withholding tax rates imposed through tax treaties are bilateral. the two countries agree as to what tax rates apply to various categories of passive all of the options

Value-added tax (VAT) is

A) a direct national tax levied on the value added in the production of a good (or service) as it moves through various stages of production. B) an indirect national tax levied on the value added in the production of a good (or service) as it moves through various stages of production. C) the equivalent of imposing a national sales tax. D) Both B & C are correct.

36)

Assume that a product has the following three stages of production:

Production Stage Selling Price 1 € 600 2 € 1,400 3 € 1,700

If the value-added tax (VAT) rate is 15 percent, what is the incremental VAT at Stage 2 of production? Version 1

A) B) C) D)

37)

€75 €120 €210 €255

Assume that a product has the following three stages of production:

Production Stage Selling Price 1 € 600 2 € 1,400 3 € 1,700

If the value-added tax (VAT) rate is 15 percent, what would be the VAT over all stages of production? A) B) C) D)

38)

€90 €120 €465 €255

Assume that a product has the following three stages of production:

Production Stage Selling Price 1 € 100 2 € 200 3 € 1,500

If the value-added tax (VAT) rate is 15 percent, what would be the VAT over all stages of production?

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A) B) C) D)

39)

€90 €120 €465 €225

Assume that a product has the following three stages of production:

Production Stage Selling Price 1 € 100 2 € 250 3 € 750

If the value-added tax (VAT) rate is 20 percent, what would be the VAT over all stages of production? A) B) C) D)

40)

€110 €120 €150 €225

Assume that a product has the following three stages of production: Production Stage 1 2 3

Selling Price € € €

80 160 320

If the value-added tax (VAT) rate is 20 percent, what would be the VAT over all stages of production?

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A) B) C) D)

41)

€64 €120 €465 €225

Assume that a product has the following three stages of production:

Production Stage Selling Price 1 € 10 2 € 250 3 € 1,500

If the value-added tax (VAT) rate is 20 percent, what would be the VAT over all stages of production? A) B) C) D)

42)

€90 €120 €300 €225

Assume that a product has the following three stages of production:

Production Stage Selling Price 1 € 100 2 € 250 3 € 750

If the value-added tax (VAT) rate is 25 percent, what would be the VAT over all stages of production?

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A) B) C) D)

43)

€187.50 €120 €150 €225

Assume that a product has the following three stages of production: Production Stage 1 2 3

Selling Price € € €

80 160 320

If the value-added tax (VAT) rate is 10 percent, what would be the VAT over all stages of production? A) B) C) D)

44)

€64 €36 €465 €225

Assume that a product has the following three stages of production:

Production Stage Selling Price 1 € 1,000 2 € 2,000 3 € 3,000

If the value-added tax (VAT) rate is 15 percent, what would be the VAT over all stages of production?

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A) B) C) D)

45)

€390 €120 €450 €225

Assume that a product has the following three stages of production:

Production Stage Selling Price 1 € 1,000 2 € 2,000 3 € 3,000

If the value-added tax (VAT) rate is 20 percent, what would be the VAT over all stages of production? A) B) C) D)

46)

€150 €600 €350 €225

Assume that a product has the following three stages of production:

Production Stage Selling Price 1 € 800 2 € 960 3 € 15,000

If the value-added tax (VAT) rate is 20 percent, what would be the VAT over all stages of production?

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A) B) C) D)

€64 €120 €2,808 €3,000

47) A value-added tax (VAT) is __________ national tax levied on the value added in the production of a good (or service) as it moves through the various stages of production. A) B) C) D)

48)

a direct an indirect an income tax none of the options

Tax evasion is more difficult under a VAT because

A) at each stage in the production process producers have an incentive to obtain documentation from the previous stage that the VAT was paid in order to get the greatest tax credit possible. B) customers can't convince retailers to sell things without a receipt. C) the cost of record keeping under a VAT system imposes an economic hardship on small businesses. D) none of the options

49)

Which of the following are true?

A) A VAT fosters national saving. B) An income tax is a disincentive to save because the returns from savings are taxed. C) National tax authorities find that a VAT is easier to collect than an income tax because tax evasion is more difficult. D) All of the options are true.

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50)

Many economists prefer a VAT to an income tax because

A) these economists are pin heads with no real world experience. B) an income tax provides a disincentive to work, whereas a VAT is a disincentive to unnecessary consumption. C) an income tax is an incentive to work, whereas a VAT is a disincentive to consumption. D) all of the options

51)

In a growing economy, the VAT would raise prodigious amounts of money A) B) C) D)

52)

Fundamentally, there are two types of tax jurisdiction. A) B) C) D)

53)

in a way almost invisible to tax-paying voters. in a way obvious to tax-paying voters. but would discourage savings. none of the options

The worldwide and the territorial The residential and the visiting The passive and the active income The earned and the unearned

The worldwide method of declaring a national tax jurisdiction

A) is to tax national residents of the country on their worldwide income no matter in which country it is earned. B) is to tax all income earned within the country by any taxpayer, domestic or foreign. C) is to tax national residents of the country on their domestic income but not foreignearned income. D) none of the options

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54)

The worldwide method of declaring a national tax jurisdiction

A) is also known as the residential method. B) is to tax national residents of the country on their worldwide income no matter in which country it is earned. C) is different from the territorial method of declaring a national tax jurisdiction. D) all of the options

55)

The territorial method of declaring a national tax jurisdiction is to

A) tax all income earned within the country by any taxpayer, domestic or foreign. B) tax national residents of the country on their worldwide income no matter in which country it is earned. C) also known as the residential method. D) none of the options

56)

Affiliates of foreign MNCs are taxed on the income earned in the source country under A) B) C) D)

57)

the territorial method of declaring a national tax jurisdiction. the source method of declaring a tax jurisdiction. both of the options none of the options

Under the territorial method of declaring a national tax jurisdiction

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A) the possibility of double taxation exists if the parent county of a foreign affiliate also levies a tax on worldwide income. B) tax is levied on all income earned within the country by any taxpayer, domestic or foreign. C) tax is levied on foreign residents of the country on their home-country income but not foreign-earned income. D) none of the options

58)

The typical approach to avoiding double taxation is

A) for a nation to grant the parent firm credit against its domestic tax liability for taxes paid to foreign tax authorities on foreign-source income. B) for a nation not to tax foreign-source income of its national residents. C) for a company to use both worldwide and the territorial methods. D) none of the options

59) The foreign tax credit method followed by the United States on many types of foreignsource income is A) to grant the parent firm credit against its U.S. tax liability for taxes paid to foreign tax authorities on foreign-source income. B) in place for the purpose of avoiding double taxation. C) to grant the parent firm credit against its U.S. tax liability for taxes paid to foreign tax authorities on foreign-source income, and is in place for the purpose of avoiding double taxation. D) none of the options

60)

A direct foreign tax credit is

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A) computed for direct taxes paid on active foreign-source income of a foreign branch of a U.S. MNC. B) computed on the indirect withholding taxes withheld form passive income distributed by the foreign subsidiary to the U.S. parent. C) computed for income taxes deemed paid by the subsidiary. D) Both A & B are correct.

61)

In a given year, the U.S. IRS places an overall limitation applied to foreign tax credits.

A) The overall limitation is limited to the amount of tax due on the foreign-source income. B) The overall limitation is limited to the amount of tax actually paid during the tax year on the foreign-source income. C) The overall limitation is limited to the amount of tax that would have been due on the foreign-source income if it had been earned in the United States. D) none of the options

62)

In a given year, the U.S. IRS places an overall limitation applied to foreign tax credits.

A) the maximum tax credit is figured on world-wide foreign-source income; losses in one country can offset profits in another. B) the maximum tax credit is figured on foreign-source income in each country; losses in one country cannot offset profits in another. C) the overall limitation is limited to the amount of tax that would be due on the foreign-source income if it had been earned in the United States. D) Both A & C are correct.

63)

In a given year, the U.S. IRS places an overall limitation applied to foreign tax credits.

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A) The maximum tax credit is figured on world-wide foreign-source income; losses in one country can offset profits in another. B) Value-added taxes paid cannot be included in determining the amount of the foreign tax credit. C) The overall limitation is limited to the amount of tax that would be due on the foreign-source income if it had been earned in the United States. D) all of the options

64)

Countries differ in how they tax foreign-source income of their domestic MNCs.

A) Therefore, different forms of structuring a multinational organization within a country can result in different tax liabilities for the firm. B) However, due to tax treaties and foreign tax credits, this is not an issue for a U.S.based MNC. C) But all countries tax domestic income of their domestic MNCs in the same way. D) all of the options

65)

A foreign branch is

A) an extension of the parent and is not an independently incorporated firm separate from the parent. B) an affiliate organization of the MNC that is independently incorporated in the foreign country, and one in which the U.S. MNC owns at least 10 percent of the voting equity stock. C) either a minority foreign subsidiary (an uncontrolled foreign corporation) or a controlled foreign corporation. D) an affiliate organization of the MNC that is independently incorporated in the foreign country, and one in which the U.S. MNC owns at least 10 percent of the voting equity stock. In addition, a foreign branch is either a minority foreign subsidiary (an uncontrolled foreign corporation) or a controlled foreign corporation.

66)

A foreign subsidiary is

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67)

An uncontrolled foreign corporation is

A) an extension of the parent and is not an independently incorporated firm separate from the parent. B) an affiliate organization of the MNC that is independently incorporated in the foreign country, and one in which the U.S. MNC owns at least 51 percent of the voting equity stock. C) an affiliate organization of the MNC that is independently incorporated in the foreign country, and one in which the U.S. MNC owns at least 10 percent but less than 50 percent of the voting equity stock. D) an affiliate organization of the MNC that is independently incorporated in the foreign country, and one in which the U.S. MNC owns at least 51 percent of the voting equity stock. In addition, an uncontrolled foreign corporation is an affiliate organization of the MNC that is independently incorporated in the foreign country, and one in which the U.S. MNC owns at least 10 percent but less than 50 percent of the voting equity stock.

68)

As a general rule, A) B) C) D)

69)

excess tax credits can be carried back two years. excess tax credits can be carried forward five years. excess tax credits must be used in the year recognized. excess tax credits can be carried back one year and can be carried forward ten years.

An overseas affiliate of a U.S. MNC can be organized

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A) B) C) D)

as a branch. as a subsidiary. as a branch, as well as a subsidiary. none of the options

70) When excess tax credits go unused, the foreign tax liability for a foreign subsidiary is greater than the corresponding U.S. tax liability when the foreign income tax rate is greater than the U.S. rate. Calculate the total tax liability for a wholly-owned foreign subsidiary when excess tax credits cannot be used in a country given: U.S. tax rate = 35 percentForeign tax rate = 39 percentWithholding tax rate = 5 percent A) B) C) D)

44.00 percent 35.00 percent 43.36 percent 42.05 percent

71) When excess tax credits go unused, the foreign tax liability for a foreign subsidiary is greater than the corresponding U.S. tax liability when the foreign income tax rate is greater than the U.S. rate. Calculate the total tax liability for a wholly-owned foreign subsidiary when excess tax credits cannot be used in a country given:

35% U.S. tax rate 41% Foreign tax rate 4% Withholding tax rate

A) B) C) D)

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35.00 percent 37.00 percent 43.36 percent 42.05 percent

72)

As a rule, payments to and from foreign affiliates

A) B) affiliates. C) D)

73)

involve the issue of transfer pricing. involve accounting values assigned to goods or services exchanged between foreign involve tax credits trading between affiliates. Both A & B are correct.

A transfer price

A) is the price for a good or service that one division of a firm charges to another division of a firm. B) is an accounting issue, not a finance issue. C) does not involve actual cash flows, therefore does not impact the share price. D) none of the options

74) Suppose a U.S.-based MNC makes bicycles with parts from its subsidiary in a low-tax East Asian country. The bicycle frames are made here, the component parts (cranksets, wheels, and so on) are made abroad, and the bicycles are assembled in Japan and reimported to the U.S. It can reduce its reported U.S. income—and increase its subsidiary's profits—by A) B) C) D)

75)

overcharging its subsidiaries for the U.S.-made frames. undercharging its subsidiaries for the U.S.-made frames. assembling the bicycles in the U.S. none of the options

The higher the transfer price

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A) B) division. C) division. D)

the higher the net profit reported by the MNC. the higher the gross profit of the receiving division relative to the transferring the higher the gross profit of the transferring division relative to the receiving none of the options

76) Affiliate A sells a million units to Affiliate B per year. The marginal income tax rate for Affiliate A is 20 percent and the marginal income tax rate for Affiliate B is 50 percent. The transfer price can be set at any level between $100 and $200. Which transfer price between A and B should the parent select? A) B) C) D)

77)

$200 $100 $150 none of the options

The U.S. IRS allows transfer prices to be set using the arms-length price.

A) This is a very straight-forward method to use in practice—just use the eBay price. B) This method is difficult to apply in practice because many factors enter into the pricing of goods and services. C) both of the options D) none of the options

78)

The lower the transfer price,

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A) B) division. C) division. D)

the higher the net profit reported by the MNC. the lower the gross profit of the transferring division relative to the receiving the lower the gross profit of the receiving division relative to the transferring none of the options

79) A "tax haven" country is one that has a low, or zero percent, national tax rates. Some of the countries that fall into this category are A) B) C) D)

80)

Bahrain, Bermuda, and the Cayman Islands. Denmark, Norway, Switzerland, and Sweden. Bulgaria, Canada, Saudi Arabia, and South Africa. Congo, Egypt, Kuwait, and Zaire.

These days the benefits of "tax haven" subsidiaries have been reduced by

A) the present corporate income tax rate in the United States is not especially high in comparison to most non-tax haven countries. B) the rules governing controlled foreign corporations have effectively eliminated the ability to defer passive income in a tax haven subsidiary. C) both of the options D) none of the options

81)

A controlled foreign corporation (CFC) is

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A) a foreign corporation established as an affiliate of a U.S. corporation for the purpose of "buying" from the U.S. corporation property for resale and use abroad. B) a foreign subsidiary that has more than 50 percent of its voting equity owned by U.S. shareholders. C) a separate domestic U.S. corporation actively engaged in business in a U.S. possession (Puerto Rico and the U.S. Virgin Islands). D) one that has no "overall limitation" in regards to its foreign tax credits.

82)

The undistributed Subpart F income of a Controlled Foreign Corporation of a U.S. MNC A) B) C) D)

is tax deferred until it is remitted via a dividend. is subject to immediate taxation. is withheld under subpart U.S. income restrictions. none of the options

83) There are three production stages required before a bicycle produced by MasiBicicletia S.A. can be sold at retail for €4,500. The VAT rate is 15 percent. Find the total tax liability due. Production Stage 1

Selling Price

€ 2,750

€ 4,500

A) B) C) D)

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Value Added

Incremental VAT

€ 1,000

€525 €675 €3,500 none of the options

84) There are three production stages required before a bicycle produced by MasiBicicletia S.A. can be sold at retail for €3,500. The VAT rate is 15 percent. Find the total tax liability due. Production Stage 1

Selling Price

€ 1,750

€ 3,500

A) B) C) D)

Value Added

Incremental VAT

€ 1,000

€525 €150 €3,500 none of the options

85) If U.S. taxing authorities did not limit the amount of the foreign tax credit to the equivalent amount of the U.S. tax A) payers would arguably subsidize part of the tax liabilities of U.S. MNC's foreign earned income. B) national neutrality would suffer. C) MNCs would all depart our shores. D) all of the options

86)

Active income is income

A) that results from production by the firm or individual (of goods or services). B) earned by professional athletes. C) that includes dividend and interest income, since the tax court has ruled that taking risk is a form of work. D) none of the options

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87)

The current U.S. marginal tax rate for domestic nonfinancial corporations is 21 percent.

A) This is positioned pretty well in the middle of the rates assessed by the majority of countries, as reported in the PricewaterhouseCoopers annual Corporate Taxes: Worldwide Tax Summaries. B) Is positioned toward the upper end of the rates assessed by the majority of countries. C) But this is reduced on a dollar-for-dollar basis for any and all taxes paid to foreign governments, so this is an upper limit for the tax rate faced by U.S. MNCs. D) all of the options

88) Transfer pricing can have an effect on how divisions of an MNC are perceived by the local banks. Which transfer price would leave a local affiliate that imports components from the parent with less impressive financial statements? A) High transfer price B) Low transfer price C) none of the options

89) For a parent that sells goods to a subsidiary, transfer pricing can have an effect on international capital expenditure analysis. A very low markup policy makes the APV of a subsidiary's capital expenditure appear A) B) C) D)

90)

more attractive. less attractive. no impact. none of the options

Transfer pricing can have an effect on share value

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A) to the extent that financial markets are inefficient. B) to the extent that security analysts do not understand the transfer pricing strategy being used. C) to the extent that third parties benefit from the transfer price. D) Both A & B are correct.

91)

With an MNC

A) the decision to set a transfer price can be complicated by import duty considerations. B) the decision to set a transfer price can be complicated by exchange rate restrictions imposed by governments. C) the decision to set a transfer price can be complicated by tax considerations, if there is a difference in tax rates between the host country and the home country. D) all of the options

92)

Using transfer pricing "creativity" MNCs can

A) try to move blocked funds (but the host country might be watching). B) evade tax liabilities (but the host country might be watching). C) Both A & B are correct. D) try to move blocked funds (but the host country might be watching), as well as evade tax liabilities (but, again, the host country might be watching). There's nothing that the host country government can do about it.

93) Suppose a U.S.-based MNC makes computers with parts from its subsidiary in a low-tax East Asian country. It can reduce its reported U.S. income—and increase its subsidiary's profits—by A) B) C) D)

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overpaying for the computer components. underpaying for the computer components. paying an arm's length price. none of the options

94)

The U.S. IRS allows transfer prices to be set using A) B) C) D)

comparable uncontrolled price method. resale price method. cost plus approach. all of the options

95) When the income tax rate in the host country is greater than the tax rate in the parent country, A) it is beneficial to follow a high markup policy on transferred goods and services from the parent to a foreign affiliate. B) it is beneficial to follow a low markup policy on transferred goods and services from the parent to a foreign affiliate. C) transfer pricing will not affect the total tax liability, net of foreign tax credit offsets. D) none of the options

96) In the United States foreign-source income is taxed at the same rate as U.S.-earned income and a foreign tax credit is given against taxes paid to a foreign government. However, A) the foreign tax credit is limited to the amount of tax that would be due on that income if it were earned in the United States. B) if the tax rate paid on foreign-source income is greater than the U.S. tax rate, part of the credit may go unused. C) both of the options D) none of the options

97) Suppose you are a citizen of the United States with foreign-source income. In the foreign country the tax rate is 40 percent and your U.S. rate is 30 percent. For every $10,000 of foreignsource income you will

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A) B) C) D)

receive a tax credit of $3,000. receive a tax credit of $3,500. receive a tax credit of $4,000. receive a tax credit of $1,000.

98) You are a U.S. MNC with a 40 percent U.S. tax rate. You have an Irish subsidiary. The corporate income tax there is 12½ percent. For every $10,000,000 of income the subsidiary reports, you will owe taxes to the U.S. Treasury in the amount of A) B) C) D)

99)

$4,000,000. $1,250,000. $2,750,000. none of the options

In general the United States claims

A) only a limited taxing jurisdiction over nonresident alien individuals and foreign corporations. B) unlimited taxing jurisdiction over nonresident alien individuals and foreign corporations. C) unlimited taxing jurisdiction over resident alien individuals and foreign corporations. D) none of the options

100)

A tax haven is

A) a country that has a low corporate income tax rate and low withholding tax rates on passive income. B) a country with no taxes and no enforcement of foreign tax laws within its borders. C) any country with a higher tax rate than available domestically. D) none of the options

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101) When a host country imposes an ad valorem import duty on goods shipped across its borders from another country: A) the import tax raises the cost of doing business within the country B) the ad valorem import duty is a percentage tax levied at customs on the assessed value of the imported goods. C) both of the options D) neither of the options.

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Answer Key Test name: Chap 21_9e 1) TRUE 2) TRUE 3) FALSE 4) TRUE 5) A 6) A 7) C 8) D 9) D 10) A 11) C 12) A 13) B 14) A 15) B 16) C 17) C 18) B 19) D 20) D 21) A 22) D 23) A 24) A 25) A 26) D Version 1

27) A 28) D 29) B 30) A 31) A 32) C 33) D 34) D 35) D 36) B 37) D 38) D 39) C 40) A 41) C 42) A 43) B 44) C 45) B 46) D 47) B 48) A 49) D 50) B 51) A 52) A 53) A 54) A 55) A 56) C Version 1

57) A 58) B 59) C 60) D 61) C 62) D 63) D 64) A 65) A 66) D 67) C 68) D 69) C 70) D 71) C 72) D 73) A 74) B 75) C 76) A 77) B 78) B 79) A 80) C 81) B 82) B 83) B 84) A 85) A 86) A Version 1

87) A 88) A 89) A 90) D 91) D 92) C 93) A 94) D 95) A 96) C 97) A 98) C 99) A 100) A 101) C

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