B6 – International Finance

CMA Part 2: Section B

Topics in Section B
1. Risk and return
2. Long-term financial management
3. Raising capital
4. Working capital management
5. Corporate restructuring
6. International finance

Topics in B6
1) International Finance, Foreign Direct Investment
2) Forex Rates
3) Foreign Financing and International Payments
Multinational Corporations (MNCs) and Foreign Direct Investment

Multinational Corporations What? Large companies that have operations

in more than one country.

Benefit of MNCs
on HOME Country 1) Higher profits = > higher taxes
2) Higher Exports = > Positive Trade Balances
3) attract new businesses

Risks of MNCs
to HOME Country 1) MNC may leave for cheaper places
2) weaken competition
3) scare off potential competitors.

Benefit of MNCs
on HOST Country 1) Jobs
2) Investment of capital and technology
3) Higher exports = > Possibly better trade balance
4) Attract other MNCs

Risks of MNCs
to HOST Country 1) possibly more cash out of the country
2) prevent smaller local companies from starting or
developing.
Foreign Direct Investment What ? Investment by an MNC in real assets
(land, buildings, or plants and equipment)
in foreign countries and managing those assets
by the company directly.

Includes? 1) joint ventures with foreign firms

2) acquisition of foreign firms
4) establishing new foreign subsidiaries.

Scope ?? 1) More difficult to manage foreign operations

2) Can result in high returns, if managed properly.
3) A major financial commitment
= > large amounts of capital are at risk.

Primary Motive? Improved profitability

+ Maximized shareholder returns.

Benefits ?? 1) Cheaper/more abundant resources

2) Technology or managerial expertise
3) Job/career opportunities for locals abroad,
4) dividends (overseas profits)
5) proximity to consumers, and
6) Better political stability for those
who invest in developed countries.

Risks Impact on Cashflows

Must be balanced against the potential rewards
= > International Diversification = > key

1) Country risk
2) Political risk
3) Financial risk
4) Exchange rate risk

Country Risk
The environments in the countries in which the
company operates.

Political Risk
Government expropriation
War
Blockage of fund transfers
Inconvertible currency
Government bureaucracy, regulations, taxes
Corruption
Consumers’ attitude

Financial Risk
Current and possible future state of economy
Interest rates = > economic growth

Exchange Rate Risk

 Fluctuations affecting the demand
Fluctuations leading to higher costs
Fluctuations leading to lower revenues
Balancing These Risks

Exercises

1. Question ID: ICMA 10Q.2.019 (Topic: MNCs and Foreign Direct Investment)
All of the following are concerns that are unique to foreign investments except
 A. purchasing power parity.
 B. expropriation.
 C. changes in interest rates
 D. exchange rate changes.

2. Question ID: ICMA 08.P1.99 (Topic: MNCs and Foreign Direct Investment)
Countries sometimes privatize their state-owned enterprises. U.S. firms
considering investing in these formerly state-owned enterprises must consider
many factors prior to making investments in these countries. Which one of the
following is of least importance to U.S. investors when considering the
acquisition of one of these former state-owned enterprises?
 A. Political stability of the country.
 B. Stability of the foreign currency.
 C. Restrictions on capital flows out of the foreign country.
 D. Transfer of technology back to the U.S.
Foreign Exchange Market

The Foreign Exchange Market exists to facilitate international trade + other financial transactions.

Quoting Exchange Rates Direct quote:

1 unit of the foreign currency = X units of their national currency.

In the U.S.,
a direct quote for euros would be €1.00 = US$1.50,
or €1.00 costs US$1.50.

Indirect quote:
1 unit of their national currency = X units of the foreign currency.

In the U.S.,
an indirect quote in euros would be US$1.00 = €0.667,
or US$1.00 costs €0.667.

Example:

EUR/USD 1.3668
= > €1.00 will purchase US$1.3668
= > will cost US$1.3668 to purchase €1.00.

= > how many euros it will cost to purchase 1 U.S. dollar

divide 1 by 1.3668:
1 / 1.3668 = €0.7316 per US$1.00
It will cost a buyer of U.S. dollars €0.7316 to purchase
US$1.00.
Someone with US$1.00 will be able to purchase €0.7316.

Foreign Currency “Cross Rates” The practice of using a third currency

to calculate the exchange rate
between two thinly-traded currencies.

To refer to the currency exchange rate between any two currencies

when neither of the currencies is the official currency of the
country in which the exchange rates are quoted.

Cross rate table

A table giving the currency exchange rates
between several different pairs of currencies.

Incorporates all of the rates for specified currencies

Does not limit the quotes to only one quote per currency pair.

Shows the exchange rates quoted with either one of each pair
carrying the value of 1.
These are reciprocal pairs
Example:
The exchange rate between the Aruban florin and the Belize dollar
listed on the currency exchange is a calculated price that has been
derived from the exchange rate between the U.S. dollar and the
Aruban florin and between the U.S. dollar and the Belize dollar
because the Aruban florin and the Belize dollar are not actively
traded for each other.

The listed exchange rate between Aruban florin and Belize dollar
is 1 AWG = 1.1119 BZD, or AWG/BZD 1.1119.
Calculated using the USD/AWG and USD/BZD exchange rates.

The exchange rate between U.S. dollar and Aruban florin is

1 USD = 1.7898 AWG (USD/AWG 1.7898).

The exchange rate between U.S. dollar and Belize dollar is

1 USD = 1.99 BZD (USD/BZD 1.99).

= > The listed exchange rate for AWG/BZD

1.99 ÷ 1.7898 = 1.1119
Changing Exchange Rates The amount of change in the price of a currency over time
Can be calculated as a percentage Which will be
the percentage of appreciation or depreciation of the currency.

Example:
Calculate
1) appreciation or depreciation rates of the USD in respect to the EURO
2) appreciation or depreciation rates of the EURO in respect to the USD.

The two currencies are quoted on currency exchanges as follows:

January EUR/USD = $0.606 = > €1.00 = US$0.606
February EUR/USD = $0.667 = > €1.00 = US$0.667

= > 1 EUR can now buy more USD

= > The value of the base currency (the euro) has increased
= > EUR appreciated by 10.07%
(0.667 − 0.606) ÷ 0.606 = 0.1007 or 10.07%

To calculate whether the USD has appreciated or depreciated

= > set the USD = 1
January = > 1 ÷ 0.606 = 1.65, so US$1.00 = €1.65
February = > 1 ÷ 0.667 = 1.50, so US$1.00 = €1.50

= > 1 USD can buy fewer EUR

= > The value of the USD decreased
= > USD depreciated by 9.09%:
(1.50 – 1.65) ÷ 1.65 = −.0909 or −9.09%
Effect of Appreciation on Imports USD has become more valuable.
One USD will buy more units of the other currenc
= > will require more units of that other currency to buy one USD.
= > imports into U.S. relatively cheaper even if their prices do not change.
= > Demand for imported goods will increase
U.S. citizens can purchase more imported goods at the same cost
as they paid before the dollar appreciated.

Effect of Appreciation on Exports For citizens of the other country,

the USD has become more expensive to buy.
= > The price of U.S. exports to the other country increases
because the citizens of the other country now need to spend more
of their national currency to buy enough USD to purchase the same
amount of U.S. goods as they could purchase before the dollar
appreciated and their currency depreciated.
= > the price of U.S. exports to their country will increase
= > demand in the other country for U.S. goods will fall
= > U.S. exports will fall.

Effect of Depreciation the opposite

The Discount or Premium of a Currency in the Forward Market

Spot Exchange Rate the rate at which Foreign currency is traded for immediate delivery

Traded = bought / sold = > through intermediaries = > Large commercial banks

Intermediaries profit through the = > spread = > bid (buy) – ask (sell) price

Forward Exchange Rate the rate used for forward contracts

for transactions that will be completed at a future date
= > monies will be exchanged in the future

Spot =/= Forward ?? Interest Rate Parity Theorem explains

the difference on any given date between the spot rate and the forward rate
for one currency in terms of another currency
is determined only by the difference in interest rates between the two countries.

Foreign interest rate > domestic interest rate

= > forward foreign currency = > will sell at a discount to the spot rate.

Foreign interest rate < domestic interest rate

= > forward foreign currency = > will sell at a premium to the spot rate.

According to the Interest Rate Parity Theorem,

this difference between the spot rate and the forward rate at any given time
must exist.

If it did not,
investors would be able to borrow money in one country at a low rate
then invest those same funds in another country
= > earn a higher interest rate than they need to pay to borrow in first country.

Example:

An investor could borrow 10,000 USD in Country A at an interest rate of 5%,

convert it to the currency of Country B where the interest rate was 7%,
and invest it for one year in Country B.

The investor would at the same time sell the principal and interest expected in
Country B’s currency on the maturity date of the investment using a forward
contract at the same exchange rate as the current spot rate, to be settled on the
investment’s maturity date in one year.

On the investment’s maturity date, the investor would use the principal returned
and the interest received in Currency B from the investment to settle the forward
contract, converting the Country B currency to 10,700 Country A currency units,
pay the incurred interest of 500 Country A currency units, and have a 200
Country A currency unit gain on the transactions.

Example:
The spot exchange rate between the (USD) and the Indian rupee (INR)
is USD/INR 60.000 (US$1= ₹60.000)
 and the forward rate for 60 days is USD/INR 60.199 (US$1 = ₹60.199).

The 60-day interest rate in the U.S. is 4%,

and the 60-day interest rate in India is 6%.

To find the premium or discount of the rupee in terms of the USD in the forward
market, convert the quotes to the price of 1 rupee in dollars:
• The price of rupees in USD at the spot rate: 1 rupee costs $0.0167 (1 / 60.000)
• The price of rupees in USD at the forward rate: 1 rupee costs $0.0166 (1 / 60.199)

Because the interest rate in India is higher than the interest rate in the U.S.,
the forward rate (price) for the INR in U.S. dollars is a discount to its spot rate.

A U.S. investor uses US$1,000 to buy ₹60,000 at the spot rate

and invests the ₹60,000 in India for 60 days at 6% per annum.

At the same time,

the investor sells forward ₹60,600 (60,000 + [60,000 × 0.06 ÷ 12 × 2],
the amount the investor expects to receive in 60 days from the Indian investment)
on a forward contract at USD/INR 60.199 (US$1 = ₹60.199).

After 60 days,
the investor receives back the ₹60,000 investment + ₹600 interest from his
investment and settles the forward contract, converting the rupees into U.S.
dollars at the forward contract rate of US$1 = ₹60.199. The investor receives
US$1,006.66 (60,600 ÷ 60.199) for the rupees, or US$6.66 in interest income.

If the investor had invested the $1,000 in the U.S. instead at 4% for 60 days,
the $1,000 would have earned $1,000 × 0.04 ÷ 12 × 2, or $6.67 in interest.

The investor’s return from the Indian investment has been almost exactly the
same as it would have been had the $1,000 been invested in the U.S. (the 1 cent
difference results from rounding in the exchange rate and is not material).

According to the Interest Rate Parity Theorem,

if the exchange rate is freely floating, the spot and forward rates will adjust so that
the gain that investors will earn from doing what is described above will be the
same as the interest that could be earned by investing in their own country.

Example:

The spot exchange rate between the U.S. dollar (USD) and the Indian rupee (INR)
is USD/INR 60.000 (US$1= ₹60.000) and the forward rate for 60 days is
USD/INR 60.199 (US$1 = ₹60.199).

Therefore, the spot rate (the price) for 1 rupee is $0.0167 (1÷60)
while the forward rate (the price under a forward contract) for 1 rupee is $0.0166
(1÷60.199).
The discount for the rupee in the forward market for the 60-day period is
(0.0166 – 0.0167) = -0.006 or -0.6% discount
0.0167
However, the 0.6% discount in the forward market is for a period of only 2
months. To calculate the annualized discount in the forward market, adjust the
above formula as follows for the number of 2-month periods in one year:
(0.0166 – 0.0167) x 6 = -0.036 or -3.6% discount
0.0167
Determining Exchange Rates Floating
Fixed
Managed Float
Pegged

Floating Exchange Rates

- currencies bought / sold freely without government intervention
- Demand / supply regulate the market price of the currency until the
equilibrium exchange rate is reached.
- can fluctuate to extreme exchange rates in the short term due to
1. Relative inflation rates
the country with higher relative inflation
= > currency depreciates
against currencies with lower relative inflation.

2. Relative interest rates

the country with the higher relative interest rate
= > their currency appreciate
against currencies with lower relative interest rates.

3. Relative income levels

the country with the higher relative income levels
= > their currency depreciate
against currencies with lower relative levels of income.

4. The expectations of future exchange rates.

5. All government controls.

Purchasing Power Parity Theorem (PPP)

A theory that says that
the price for a particular good should be the same in any country.
And for that
exchange rates will automatically adjust
until the prices for similar goods are the same in all countries.

Calculates the exchange rate between two currencies as follows:

Foreign Price Level for the Good
Domestic Price Level for the Good

Example:
The price of a tablet computer purchased in Canada is C$799
The price of the exact same model purchased in U.S. is US$599.

According to the PPP

the exchange rate between the C$ and USD should be
799 ÷ 599 = 1.334

At the exchange rate of 1.3206,

someone in Canada could theoretically purchase US$599 for
C$791.04 ($599 × 1.3206), cross the border and buy the tablet
computer in the U.S. for $599, the equivalent of C$791.04, return
with the tablet to Canada, and sell the tablet there for C$799 at a
C$7.96 profit.

Of course, this calculation ignores transaction costs, sales or value

added taxes, travel costs and possibly customs fees. When those
are factored in, the U.S. price for a Canadian resident would be
close to the Canadian price.

At 1.3206, the actual exchange rate is close enough to the

calculated exchange rate of 1.334 to demonstrate the effect of the
purchasing power parity theorem.

Fixed Exchange Rate

the exchange rate fixed by the country’s government
the problem = > if the wrong fixed rate

1. When exchange rate is above the free market,

= > the currency will be overvalued.
= > People will keep selling the currency,
forcing the government to sell its foreign currency.
2. When exchange rate is below free market,
= > the currency will be undervalued.
= > People will keep buying it
and giving foreign currency to the government.
Managed Float Exchange Rates

Government allows the market to determine the currency price,

but intervenes if/when necessary
to prevent excessive fluctuations in the rate.

Example:

Assume a government lets the national currency exchange rate be

set by free market forces of demand and supply. Initially this
country produces high quality goods at a competitive price due to
lower input costs than in other countries. As a result, other
residents of countries buy the goods and services of this country at
the market rate. To some extent, the value of the national currency
has been increased by the demand for its currency by foreigners in
order to buy the nation’s services and goods.

Unfortunately for this country, the increased demand for its

currency causes the price of its currency to increase. The increased
currency price results in increased prices for the country’s goods
abroad. Because these goods become more expensive, some of the
foreign buyers will look elsewhere for substitute goods that are less
expensive. As a result of this increase in the relative cost of the
country’s production, the demand for the country’s exports falls,
leading to a decrease in the demand for its currency. The decreased
demand for its currency causes the exchange rate for its currency
to decrease.

Pegged Exchange Rates

the government fixed the exchange rate of its currency

to the currency of another country
or to a basket of currencies.

The country’s currency’s value moves with that currency against

other currencies.
Managing Exchange Rate Risk

A company will want to minimize and manage exchange rate risks as best it can.
1. Natural hedges
2. Operational hedges
3. International financing hedges
4. Currency market hedges

Natural Hedges If a subsidiary’s costs are determined by the global market

and its products are also sold in the global market,
= > very little exposure to exchange rate fluctuations.

Or,
if a subsidiary’s costs are determined by the country in which it is located
and its products are also sold in that same country
= > very little exposure to exchange rate fluctuations.

Operational Hedges The best policy is one of balancing monetary assets against monetary liabilities
to neutralize as much as possible the effect of exchange-rate fluctuations.

Maintain a balance between payables and receivables denominated in a foreign currency.

Or
Through currency diversification.

International Financing Hedges borrow in a foreign currency

to offset a net receivables position in that currency.

A company with a foreign subsidiary can borrow

in the country where the subsidiary is located
to offset its exposure.

Currency Hedges Foreign currency forward contracts

Foreign currency futures
Foreign currency options
Exercises

1. Question ID: ICMA 10Q.2.012 (Topic: Foreign Currency Exchange Rates)

An appreciation of the U.S. dollar against the Japanese yen would
 A. make travel in Japan more expensive for U.S. citizens.
 B. increase the translated earnings of U.S. subsidiaries domiciled in Japan.
 C. make U.S. goods more expensive to Japanese consumers.
 D. increase the cost of buying supplies for U.S. firms.

2. Question ID: CIA 1196 IV.73 (Topic: Foreign Currency Exchange Rates)
If the exchange rate has changed from 1 U.S. dollar being worth 0.75 euro to a
rate of 1 U.S. dollar being worth 0.90 euro over a period of one year,
 A. The U.S. dollar has depreciated by 20%.
 B. The euro has depreciated by 10%.
 C. The euro has appreciated by 10%.
 D. The U.S. dollar has appreciated by 20%.

3. Question ID: CMA 1286 1.20 (Topic: Foreign Currency Exchange Rates)
Given a spot exchange rate for the U.S. dollar against the pound sterling of
$1.4925 and a 90-day forward rate of $1.4775:
 A. The pound sterling is selling at a premium against the dollar and is
overvalued in the forward market.
 B. The forward pound sterling is selling at a premium against the dollar in
the forward market.
 C. The forward pound sterling is selling at a discount against the dollar in
the forward market.
 D. The pound sterling is selling at a discount against the dollar and is
undervalued in the forward market.

4. Question ID: CMA 1285 1.33 (Topic: Foreign Currency Exchange Rates)
The purchasing-power parity exchange rate
 A. results in an undervalued currency of countries that are net importers.
 B. is always equal to the market exchange rate.
 C. holds constant the relative price levels in two countries when measured
in a common currency.
 D. is a fixed (pegged) exchange rate.

5. Question ID: CMA 1287 1.30 (Topic: Foreign Currency Exchange Rates)
If the U.S. dollar declines in value relative to the currencies of many of the U.S.
trading partners, the likely result is that
 A. The U.S. balance of payments deficit will become worse.
 B. Foreign currencies will depreciate against the dollar.
 C. U.S. exports will tend to increase.
 D. U.S. imports will tend to increase.
6. Question ID: CMA 1285 1.30 (Topic: Foreign Currency Exchange Rates)
The dominant reason countries devalue their currencies is to:
 A. Slow what is regarded as too rapid an accumulation of international
reserves.
 B. Curb inflation by increasing imports.
 C. Improve the balance of payments.
 D. Discourage exports without having to impose controls.

8. Question ID: CMA 1287 1.29 (Topic: Foreign Currency Exchange Rates)
If consumers in Japan decide they would like to increase their purchases of
consumer products made in the United States, in foreign currency markets there
will be a tendency for:
 A. The demand for dollars to increase.
 B. The supply of dollars to decrease.
 C. The supply of dollars to increase.
 D. The Japanese yen to appreciate relative to the U.S. dollar.

9. Question ID: ICMA 10.P2.195 (Topic: Foreign Currency Exchange Rates)

Country R's currency would tend to depreciate relative to Country T's currency
when
 A. Country R has a rate of inflation that is lower than the rate of inflation in
Country T.
 B. Country R has real interest rates that are lower than real interest rates in
Country T.
 C. Country T has a rapid rate of growth in income that causes imports to lag
behind exports.
 D. Country R switches to a more restrictive monetary policy.

10. Question ID: CMA 1287 1.28 (Topic: Foreign Currency Exchange Rates)
If the value of the U.S. dollar in foreign currency markets changes from $1 = 1.15
Swiss francs to $1 = 0.95 Swiss francs,
 A. Swiss imported products in the U.S. will become more expensive.
 B. U.S. tourists in Switzerland will find their dollars will buy more Swiss
products.
 C. The Swiss franc has depreciated against the dollar.
 D. U.S. exports to Switzerland should decrease.

11. Question ID: ICMA 10.P2.194 (Topic: Foreign Currency Exchange Rates)
Country A's currency would tend to appreciate relative to Country B's currency
when
 A. Country A has a slower rate of growth in income that causes its imports
to lag behind its exports.
 B. Country B has real interest rates that are greater than real interest rates
in Country A.
 C. Country A has a higher rate of inflation than Country B.
  D. Country B switches to a more restrictive monetary policy.

12. Question ID: CMA 688 1.25 (Topic: Foreign Currency Exchange Rates)
In foreign currency markets, the phrase "managed float" refers to the
 A. Fact that actual exchange rates are set by private business people in
trading nations.
 B. Discretionary buying and selling of currencies by central banks.
 C. Necessity of maintaining a highly liquid asset, such as gold, to conduct
international trade.
 D. Tendency for most currencies to depreciate in value.

13. Question ID: I22 2.33 (Topic: Foreign Currency Exchange Rates)
The exchange rate between the Turkish lira and the Indian rupee is currently 1
Turkish lira equals 12 Indian rupees. Assuming the inflation rate in Turkey will be
20% next year, and in India the inflation rate will be 8% next year, purchasing
power parity would predict that the exchange rate next year should
be closest to
 A. 1 Turkish lira = 10.8 Indian rupees.
 B. 1 Turkish lira = 14.4 Indian rupees.
 C. 1 Turkish lira = 12.9 Indian rupees.
 D. 1 Turkish lira = 13.3 Indian rupees.

14. Question ID: ICMA 10.P2.193 (Topic: Foreign Currency Exchange Rates)
If the U.S. dollar appreciated against the British pound, other things being equal,
we would expect that
 A. U.S. demand for British products would increase.
 B. trade between the U.S. and Britain would decrease.
 C. the British demand for U.S. products would increase.
 D. U.S. demand for British products would decrease.

16. Question ID: I22 2.32 (Topic: Foreign Currency Exchange Rates)
BikeCo is a German-based manufacturer of bicycles planning to geographically
diversify its business. The company currently manufactures and sells all bicycles
in Germany. BikeCo plans to open a new manufacturing facility in India that will
both sell into an expanding German market (70% of anticipated production) and
sell bicycles in India through a local distributor (30% of anticipated production).
The current exchange rate is 50 Indian rupees (INR) to 1 euro (EUR). The
anticipated selling price is 250 EUR in Germany and 10,000 INR. BikeCo
anticipates that the new plant will earn a 30% gross profit margin. Which one of
the following statements represents the most significant exchange rate risk to
BikeCo?
 A. INR appreciates against the EUR, increasing labor and other plant costs
at the new facility when translated to Euros in the consolidation.
 B. INR depreciates against the EUR, decreasing the value of sales through
the local distributor.
  C. INR appreciates against the EUR, decreasing the value of sales through
the local distributor.
 D. INR depreciates against the EUR, increasing labor and other plant costs
at the new facility when translated to Euros in the consolidation.

17. Question ID: ICMA 10.P2.192 (Topic: Foreign Currency Exchange Rates)
Under a floating exchange rate system, which one of the following should result
in a depreciation of the British pound sterling?
 A. U.S. inflation declines relative to British inflation.
 B. Decrease in outflows of British capital to the U.S.
 C. U.S. income levels improve relative to the British.
 D. British interest rates rise relative to the U.S. rates.

19. Question ID: I22 2.31 (Topic: Foreign Currency Exchange Rates)
The data below show the exchange rates for countries X, Y, and Z last year.
USD/X pounds
[$1 US = 3.85 X pounds]
3.85
USD/Y pesos 19.6 [$1 US = 19.6 Y pesos]
USD/Z crowns 44.6 [$1 US = 44.6 Z crowns]
The data below show the current exchange rates for countries X, Y, and Z this
year.
USD/X pounds
[$1 US = 4.20 X pounds]
4.20
USD/Y pesos 22.5 [$1 US = 22.5 Y pesos]
USD/Z crowns 48.0 [$1 US = 48.0 Z crowns]
Given these exchange rates, what statement about the Y peso is true?
 A. It appreciated against the Z crown and depreciated against the X pound.
 B. It depreciated against the Z crown and depreciated against the X pound.
 C. It appreciated against the Z crown and appreciated against the X pound.
 D. It depreciated against the Z crown and appreciated against the X pound.

21. Question ID: HTB 2.1.116 (Topic: Foreign Currency Exchange Rates)
Le Croissant is a French firm that conducts a significant amount of business in
the United States and Great Britain. The company uses the Euro (EUR) in its
financial statements. The Controller, Annette Deville, is reviewing the results
from the most recent quarter and is attempting to explain variances due to
exchange rate fluctuations between the Euro and the U.S. Dollar (USD) and the
Euro and the British Pound (GBP). She used the following currency cross rates
from a leading financial publication (FCU = foreign currency unit).
Currency Cross Rates – Beginning of Quarter
USD EUR GBP
U.S. $ per FCU -- 1.20 1.801
 2
0.83
Euro per FCU -- 1.503
2
UK Pound per 0.55 0.66
--
FCU 3 5
Currency Cross Rates – End of Quarter
USD EUR GBP
1.30
U.S. $ per FCU -- 1.919
7
0.76
Euro per FCU -- 1.468
5
UK Pound per 0.52 0.68
--
FCU 1 1
Based on the above information, during the quarter the Euro
 A. Appreciated relative to the USD and depreciated relative to the GBP.
 B. Appreciated relative to the GBP and depreciated relative to the USD.
 C. Depreciated relative to the GBP and to the USD.
 D. Appreciated relative to the GBP and to the USD.

22. Question ID: CMA 1288 1.17 (Topic: Foreign Currency Exchange Rates)
Caroline Brown, the product manager for a U.S. computer manufacturer, is being
asked to quote prices of desktop computers to be used in Kuwait. The Kuwaiti
government wants the price in British pounds, for delivery next year. Brown
knows that the general price level in the United States will increase by 3%. Her
banker forecasts that the British pound will depreciate about 5% this year with
respect to the U.S. dollar. If Brown is able to quote 700 pounds for immediate
delivery, the price that should be quoted for delivery to Kuwait next year is about
 A. £759.
 B. £721.
 C. £737.
 D. £757.

24. Question ID: CIA 592 IV.70 (Topic: Foreign Currency Exchange Rates)
A short-term speculative rise in the world-wide value of domestic currency could
be moderated by a central bank decision to
 A. Buy domestic currency in the foreign exchange market.
 B. Increase domestic interest rates.
 C. Sell domestic currency in the foreign exchange market.
 D. Sell foreign currency in the foreign exchange market.

26. Question ID: CMA 1282 1.14 (Topic: Foreign Currency Exchange Rates)
Given a spot rate of $1.8655 and a 90-day forward rate of $1.8723, the pound
sterling in the forward market is:
  A. Overvalued.
 B. Undervalued.
 C. Being quoted at a premium.
 D. Being quoted at a discount.

27. Question ID: CMA 694 1.4 (Topic: Foreign Currency Exchange Rates)
If the central bank of a country raises interest rates sharply, the country's
currency will most likely
 A. Decrease in relative value.
 B. Increase in relative value.
 C. Remain unchanged in value.
 D. Decrease sharply in value at first and then return to its initial value.

28. Question ID: CMA 1288 1.15 (Topic: Foreign Currency Exchange Rates)
The U.S. dollar has a free-floating exchange rate. When the dollar has fallen
considerably in relation to other currencies, the
 A. Fall in the dollar's value cannot be expected to have any effect on the
U.S. trade balance.
 B. Capital account in the U.S. balance of payments is neither in a deficit nor
in a surplus because of the floating exchange rates.
 C. Cheaper dollar helps U.S. exporters of domestically produced goods.
 D. Trade account in the U.S. balance of payments is neither in a deficit nor
in a surplus because of the floating exchange rates.

29. Question ID: CMA 695 1.24 (Topic: Foreign Currency Exchange Rates)
Assuming exchange rates are allowed to fluctuate freely, which one of the
following factors would likely cause a nation's currency to appreciate on the
foreign exchange market?
 A. A relatively rapid rate of growth in income that stimulates imports.
 B. A slower rate of growth in income than in other countries, which causes
imports to lag behind exports.
 C. Domestic real interest rates that are lower than real interest rates
abroad.
 D. A high rate of inflation relative to other countries.

30. Question ID: ICMA 13.P2.036 (Topic: Foreign Currency Exchange Rates)
Suppose that Swiss wrist watches priced in Swiss Francs become very popular
among U.S. consumers while at the same time Britain experiences relatively
higher inflation than the United States. Assuming that all other economic
parameters remain constant, which one of the following statements
is most accurate?
 A. The U.S. dollar will depreciate relative to the Swiss Franc and appreciate
relative to the British pound.
 B. The U.S. dollar will appreciate relative to both the Swiss Franc and the
British pound.
  C. The U.S. dollar will appreciate relative to the Swiss Franc and depreciate
relative to the British pound.
 D. The U.S. dollar will depreciate relative to both the Swiss Franc and the
British pound.

7. Question ID: ICMA 19.P2.089 (Topic: Foreign Currency Exchange Rates)

A firm involved in major international market trading can best minimize foreign
exchange risk by
 A. factoring in the cost of interest in the commodity price.
 B. requiring collect on delivery payment from customers to avoid exchange
rate fluctuations.
 C. having customers use the spot rate.
 D. entering into a forward exchange rate contract.

18. Question ID: CMA 1288 1.18 (Topic: Foreign Currency Exchange Rates)
Consider a world consisting of only two countries, Canada and the United
Kingdom. Inflation in Canada in 1 year was 5%, and in the United Kingdom it was
10%. Which one of the following statements about the Canadian exchange rate
(rounded) with the U.K. pound sterling during that year will be true?
 A. The Canadian dollar will depreciate by 5% against the pound sterling.
 B. Inflation has no effect on the exchange rates.
 C. The Canadian dollar will depreciate by 15% against the pound sterling.
 D. The Canadian dollar will appreciate by 5% against the pound sterling.

20. Question ID: ICMAF 041A (Topic: Foreign Currency Exchange Rates)
A U.S. tool manufacturer has just signed a contract to sell $100,000 worth of
machine tools to a foreign company. However, the foreign company insists on
paying in foreign currency units (FCUs) 90 days after shipment. Which one of the
following actions can protect the profit that the company expects to earn on this
transaction?
 A. Selling a call option for $100,000 worth of FCUs, expiring in 90 days.
 B. Buying a futures contract for $100,000 worth of FCUs, to be settled in 90
days.
 C. Selling a put option for $100,000 worth of FCUs, expiring in 90 days.
 D. Selling a futures contract for $100,000 worth of FCUs, to be settled in 90
days.

23. Question ID: CMA 680 1.17 (Topic: Foreign Currency Exchange Rates)
The value of the U.S. dollar in relation to other foreign currencies is
 A. Set along with the value of other currencies held by the International
Monetary Fund.
 B. Determined directly by the price of gold because the value of the U.S.
dollar is tied to the price of gold.
 C. Set by the U.S. government in consultation with other foreign
governments.
  D. Determined by the forces of supply and demand on the foreign exchange
markets.

25. Question ID: CMA 1288 1.16 (Topic: Foreign Currency Exchange Rates)
One U.S. dollar is being quoted at 120 Japanese yen on the spot market and at
123 Japanese yen on the 90-day forward market; hence, the annual effect in the
forward market is that the
 A. U.S. dollar is at a premium of 0.025%.
 B. U.S. dollar is at a premium of 2.5%.
 C. U.S. dollar is at a discount of 10%.
 D. U.S. dollar is at a premium of 10%.
Using Foreign Financing to Reduce Costs

What ?? Borrow in a foreign currency if interest rates are attractive.

Example
U.S. based multinational corporation might be able to borrow US$ in the Eurocurrency market
at a lower rate than it could get from a U.S. bank.

Or,
They may borrow non-US$, and then convert it into US$.

The Effective Interest Rate What? The actual cost of a loan in a foreign currency

Determined by Two things:

1. The interest rate on the loan, and
2. The change in the borrowed currency’s value
over the term of the loan.

Calculation? Rf = (1 + If) × (1 + Ef) − 1

Rf = The effective financing rate

If = The interest rate of the foreign currency loan
Ef = The percentage change
appreciation/depreciation
in the foreign currency against the U.S.
dollar
Ef = (St+1 – S) / S

Example:

MNC Corporation, a U.S. multinational corporation, is seeking to finance a project in the U.S.
that will require $2,000,000 in financing for one year.

MNC’s preference is to borrow the full amount with no down payment.

MNC can borrow locally at a fixed interest rate of 6%.

Alternatively, MNC can borrow in Japan in yen at a fixed interest rate of 1%.

MNC borrows in Japanese yen.

The spot exchange rate for USD/JPY is $1 = ¥121.35 on the day that MNC receives the loan.
= > MNC borrows ¥242,700,000 (2,000,000 × 121.35) at 1% for one year.

When MNC receives the proceeds of the loan,

it converts the yen to US$2,000,000 (242,700,000 ÷ 121.35)
and uses the funds for its project.

One year later,

MNC is obligated to repay ¥245,127,000 (¥242,700,000 principal plus ¥2,427,000 interest at 1%)

During the course of the year,

the U.S. dollar depreciates against the Japanese yen,
and the exchange rate on the maturity date of the loan is US$1 = ¥117.71.
MNC will need US$2,082,465.38 to purchase the necessary yen to repay the loan (245,127,000 ÷ 117.71),
which is equivalent to US$2,000,000 principal and US$82,465.38 interest.

MNC’s effective annual interest rate on the loan in U.S. dollars is

$82,465.38 ÷ $2,000,000, or 4.12%

MNC has been able to borrow in Japan at a lower rate than it would have paid to borrow in the U.S.
Financing for International

Trade Transactions Financing International Trade

1. Prepayment
2. Open account
3. Sight draft
4. Countertrade, or barter
5. Commercial letter of credit
6. Cross-border factoring
7. Bankers’ acceptances
8. Forfaiting

Exercises

1. Question ID: ICMA 19.P2.088 (Topic: Using Foreign Financing)

A publicly-traded company based in Japan is planning on expanding its operations
into Germany. The expansion is estimated to cost ¥500 million, but the company
needs euros to implement the expansion. The company is not well known in
Germany and therefore hesitant to issue a euro-denominated bond in the German
marketplace. If the company were to issue a yen-denominated twenty-year bond
in Japan, which one of the following contracts should the company use?
 A. Currency swap.
 B. Currency futures.
 C. Currency options.
 D. Currency forward.

5. Question ID: ICMA 10Q.2.027 (Topic: Using Foreign Financing)

The Baker Company, a U.S. corporation headquartered in California, has a
manufacturing affiliate in Mexico. Baker wants to expand the capability of this
plant. The plant is very profitable and generates a substantial positive cash flow.
Approximately $1,000,000 (U.S.) is available to be paid in dividends to the U.S.
parent from the Mexican affiliate. In addition, another affiliate, located in Brazil,
has $750,000 (U.S.) available to be paid in dividends.
Which one of the following would be the best way to finance a $500,000
investment in the Mexican facility?
 A. Have Brazil transfer the $500,000.
 B. Have the Mexican facility reduce its dividends to the U.S. parent by the
$500,000.
  C. Have the parent transfer funds for the $500,000 investment.
 D. Have the parent transfer $250,000, and Brazil transfer $250,000.

6. Question ID: HTB 2.1.118 (Topic: Using Foreign Financing)

A firm in Australia imports chairs from Bangladesh and resells them in Australia
for 45 AUD (Australian dollars) per unit. The firm placed an order for 1,000 chairs
with the supplier in Bangladesh at a cost of 60 BDT (Bangladeshi Taka) per unit.
As per the terms of the agreement, payment is not required until the goods arrive
in 30 days. The current exchange rate is BDT 1.5753 for AUD 1. The firm expects
the exchange rate to decline to BDT 1.5500 to AUD 1. In order to manage short-
term exchange rate risk, the firm decides to hedge and lock in an exchange rate
of BDT 1.5650 for AUD 1. What would be the pre-tax profit from the sale of chairs?
 A. AUD 9,585
 B. AUD 6,290
 C. AUD 6,910
 D. AUD 6,660

8. Question ID: ICMA 1603.P2.054 (Topic: Using Foreign Financing)

A U.S. company has an account receivable from a Swiss company for 100,000
Swiss Francs (CHF) due in three months. At the time of contract, the exchange
rate was 1.0 CHF = 1.0 USD. The U.S. company wishes to manage its foreign
exchange exposure and therefore
 A. buys Swiss Franc futures.
 B. sells Swiss Franc futures.
 C. buys a currency swap.
 D. sells a Swiss Franc interest rate swap.

9. Question ID: CMA 680 1.20 (Topic: Using Foreign Financing)

When the U.S. dollar is expected to rise in value against foreign currencies, a U.S.
company with foreign currency denominated receivables and payables should
 A. Slow down collections and speed up payments.
 B. Slow down collections and slow down payments.
 C. Speed up collections and slow down payments.
 D. Speed up collections and speed up payments.

11. Question ID: ICMA 08.P1.96 (Topic: Using Foreign Financing)

Which one of the following is least likely to be a reason why U.S. multinational
corporations utilize the foreign exchange market?
 A. To improve the return on investments of a foreign subsidiary.
 B. To offset accounts payable transaction exposure to foreign firms.
 C. To counter some of the currency risk of dividend payments from foreign
subsidiaries to the U.S. parent.
 D. To hedge the currency risk of accounts receivable transactions in foreign
currencies.
12. Question ID: ICMAF 040 (Topic: Using Foreign Financing)
Last year, the treasurer of a multinational firm headquartered in the U.S. obtained
a loan from a bank in a foreign country denominated in foreign currency units
(FCUs) at an interest rate of 25%. The exchange rate was $1 US = 5 FCU. The
principal amount of the loan was 10 million FCU. After twelve months, the
treasurer has repaid the loan when the exchange rate is $1 US = 5.7 FCU.
Assuming that the interest is paid at the end of the loan period, what is the
effective interest rate, based on U.S. dollars?
 A. 11.00%.
 B. 14.00%.
 C. 21.93%.
 D. 9.65%.

2. Question ID: CMA 1285 1.34 (Topic: Using Foreign Financing)

An American importer of English clothing has contracted to pay an amount fixed
in British pounds three months from now. If the importer worries that the U.S.
dollar may depreciate sharply against the British pound in the interim, it would be
well advised to:
 A. Buy dollars in the forward exchange market.
 B. Sell pounds in the forward exchange market.
 C. Sell dollars in the forward exchange market.
 D. Buy pounds in the forward exchange market.

3. Question ID: CMA 676 1.34 (Topic: Using Foreign Financing)

Which of the following economic policies would not tend to correct a balance of
payments deficit in the U.S.?
 A. Increase productivity in the manufacturing of U.S. exports.
 B. More effective use of monetary and fiscal policies to reduce inflation.
 C. Increase value of U.S. currency in relation to foreign currencies.
 D. A reduction in the economic aid and humanitarian aid provided to other
nations.

4. Question ID: ICMA 13.P2.013 (Topic: Using Foreign Financing)

FreezeIt Inc. is a manufacturer of refrigeration systems based out of the United
States with one subsidiary in Canada. The Canadian subsidiary exports all of its
manufactured products to the United States and does not currently sell any of its
manufactured products in Canada. The Canadian subsidiary incurs all of its
expenses in Canadian dollars and all of its revenues are in U.S. dollars. The U.S.
operations are conducted only in U.S. dollars. What financial impact will a rise in
the Canadian dollar against the U.S. dollar have on the Canadian subsidiary
assuming no operational changes?
 A. An increase in cash flows.
 B. A reduction in expenses.
 C. A reduction in revenues.
  D. An increase in profit margins.

7. Question ID: ICMA 13.P2.037 (Topic: Using Foreign Financing)

A U.S. company has an account payable it must pay in six months with one
Japanese company, and an account receivable to be received in six months with
another Japanese company. The U.S. company would not have transaction
exposure if
 A. both the account payable and the account receivable are denominated in
Japanese Yen and the Yen account receivable is greater than the Yen
account payable.
 B. the account payable is denominated in dollars and the account receivable
is denominated in Yen.

 C. both the account payable and the account receivable are denominated in
Japanese Yen and the Yen account receivable is less than the Yen account
payable.
 D. both the account payable and account receivable are denominated in U.S.
dollars.

10. Question ID: CMA 690 5.11 (Topic: Using Foreign Financing)
A bill of lading is a document that
 A. Reduces a customer's account for goods returned to the seller.
 B. Is sent with the goods giving a listing of the quantities of items included
in the shipment.
 C. Summarizes data relating to a disbursement and represents final
authorization for payment.
 D. Is used to transfer responsibility for goods between the seller of goods
and a common carrier.