Dorchester, Ltd. is an old-line confectioner specializing in high-quality chocolates.Through its facilities in the United Kingdom, Dorchester manufactures candies thatit sells throughout Western Europe and North America (United States and Canada).With its current manufacturing facilities, Dorchester has been unable to supply theU.S. market with more than 225,000 pounds of candy per year. This supply hasallowed its sales affiliate, located in Boston, to be able to penetrate the U.S. market nofarther west than St. Louis and only as far south as Atlanta. Dorchester believes thata separate manufacturing facility located in the United States would allow it to supplythe entire U.S. market and Canada (which presently accounts for 65,000 pounds peryear). Dorchester currently estimates initial demand in the North American market at390,000 pounds, with growth at a 5 percent annual rate. A separate manufacturingfacility would, obviously, free up the amount currently shipped to the United Statesand Canada. But Dorchester believes that this is only a short-run problem. Theybelieve the economic development taking place in Eastern Europe will allow it tosell there the full amount presently shipped to North America within a period offive years. Dorchester presently realizes £3.00 per pound on its North American exports.Once the U.S. manufacturing facility is operating, Dorchester expects that it will beable to initially price its product at $7.70 per pound. This price would representan operating profit of $4.40 per pound. Both sales price and operating costs areexpected to keep track with the U.S. price level; U.S. inflation is forecast at a rate of3 percent for the next several years. In the U.K., long-run inflation is expected to bein the 4 to 5 percent range, depending on which economic service one follows. Thecurrent spot exchange rate is $1.50/£1.00. Dorchester explicitly believes in PPP asthe best means to forecast future exchange rates.The manufacturing facility is expected to cost $7,000,000. Dorchester plansto finance this amount by a combination of equity' data-toggle="tooltip" data-placement="top" title="Click to view definition...">equity capital and debt. The plant willincrease Dorchester’s borrowing capacity by £2,000,000, and it plans to borrowonly that amount. The local community in which Dorchester has decided to build willprovide $1,500,000 of debt financing for a period of seven years at 7.75 percent.The principal is to be repaid in equal installments over the life of the loan. At thispoint, Dorchester is uncertain whether to raise the remaining debt it desires througha domestic bond' data-toggle="tooltip" data-placement="top" title="Click to view definition...">bond issue or a Eurodollar bond issue. It believes it can borrow poundssterling at 10.75 percent per annum and dollars at 9.5 percent. Dorchester estimatesits all-equity cost of capital to be 15 percent. The U.S. Internal Revenue Service will allow Dorchester to depreciate the newfacility over a seven-year period. After that time the confectionery equipment, whichaccounts for the bulk of the investment, is expected to have substantial market value.Dorchester does not expect to receive any special tax concessions. Further,because the corporate tax rates in the two countries are the same—35 percent in theU.K. and in the United States—transfer pricing strategies are ruled out.Should Dorchester build the new manufacturing plant in the United States?
> Briefly discuss some variants of the basic interest rate and currency swaps diagrammedin the chapter.
> A company based in the United Kingdom has an Italian subsidiary. The subsidiarygenerates €25,000,000 a year, received in equivalent semiannual installments of€12,500,000. The British company wishes to convert the euro cash flows to poundstwice a year. It
> Daimler, a German carmaker, acquired Chrysler, the third largest U.S. automaker,for $40.5 billion in 1998. But after years of declining profit and labor problems,Daimler sold off Chrysler to the U.S. private equity firm Cerberus for $7.4 billionin 2007.
> In the Modigliani-Miller equation, why is the market value of the levered firm greater than the market value of an equivalent unlevered firm?
> What problems can enter into the capital budgeting analysis if project debt is evaluated instead of the borrowing capacity created by the project?
> Suppose a Spanish MNC has a mirror-image situation and needs $2,900,000 tofinance a capital expenditure of one of its U.S. subsidiaries. It finds that it mustpay a 9 percent fixed rate in the United States for dollars, whereas it can borroweuros at 6 per
> Discuss the implications of the deviations from purchasing power parity for countries’competitive positions in the world market.
> What makes the APV capital budgeting framework useful for analyzing foreign capital expenditures?
> Assume a currency swap in which two counterparties of comparable credit riskeach borrow at the best rate available, yet the nominal rate of one counterpartyis higher than the other. After the initial principal exchange, is the counterpartythat is require
> Discuss what is meant by the incremental cash flows of a capital project.
> Define the concept of a real option. Discuss some of the various real options a firm can be confronted with when investing in real projects.
> How did the credit crunch become a global financial crisis?
> How might a MNC use transfer pricing strategies? How do import duties affect transfer pricing policies?
> Discuss the difference between performing the capital budgeting analysis from the parent firm’s perspective as opposed to the subsidiary’s perspective.
> What is the intuition of discounting the various cash flows in the APV model at specific discount rates?
> What is the nature of a concessionary loan and how is it handled in the APV model?
> Discuss the different ways political events in a host country may affect local operations of a MNC.
> A U.S. company needs to raise €50,000,000. It plans to raise this money by issuingdollar-denominated bonds and using a currency swap to convert the dollars toeuros. The company expects interest rates in both the United States and the eurozone to fall. a.
> Give a full definition of arbitrage.
> Once capital markets are integrated, it is difficult for a country to maintain a fixedexchange rate. Explain why this may be so.
> Assume that the Japanese yen is trading at a spot price of 92.04 cents per 100 yen.Further assume that the premium of an American call (put) option with a strikingprice of 93 is 2.10 (2.20) cents. Calculate the intrinsic value and the time value ofthe ca
> Relate the concept of lost sales to the definition of incremental cash flows.
> Discuss the nature of the equation sequence, Equations 18.2a to 18.2f. In Equation (18.2a) s In Equation (18.2f) CF, = (R, – OC, – D, - 1)(1 - 7) + D, + IĶ(1 – 7) %3D = OCF(1 - 7) + TD, = nominal after-tax incremental cash flow for year t
> What is the intuition behind the NPV capital budgeting framework?
> Discuss the regulatory and macroeconomic factors that contributed to the creditcrunch of 2007–2008.
> Suppose that one year after the inception of the currency swap betweenCentralia and the Spanish MNC, the U.S. dollar fixed rate has fallen from8 to 6 percent and the euro zone fixed rate for euros has fallen from 6 to5.5 percent. In both dollars and euro
> Why is capital budgeting analysis so important to the firm?
> Discuss the conditions under which the capital expenditure of a foreign subsidiary might have a positive NPV in local currency terms but be unprofitable from the parent firm’s perspective.
> You plan to visit Geneva, Switzerland, in three months to attend an internationalbusiness conference. You expect to incur a total cost of SF5,000 for lodging,meals, and transportation during your stay. As of today, the spot exchange rateis $0.60/SF and t
> The current spot exchange rate is HUF250/$1.00. Long-run inflation in Hungaryis estimated at 10 percent annually and 3 percent in the United States. If PPP isexpected to hold between the two countries, what spot exchange rate should oneforecast five year
> The Beta Corporation has an optimal debt ratio of 40 percent. Its cost of equitycapital is 12 percent and its before-tax borrowing rate is 8 percent. Given a marginaltax rate of 35 percent, calculate (a) the weighted-average cost of capital, and (b) the
> Explain and compare forward versus backward internalization.
> Under what conditions will the foreign subsidiary’s financial structure become relevant?
> What methods do taxing authorities use to eliminate or mitigate the evil of double taxation?
> Derive and explain the monetary approach to exchange rate determination.
> Suppose that in the case application in the chapter the APV for Centralia had been2$60,000. How large would the after-tax terminal value of the project need to bebefore the APV would be positive and Centralia would accept the project?
> In an integrated world financial market, a financial crisis in a country can bequickly transmitted to other countries, causing a global crisis. What kind of measureswould you propose to prevent the recurrence of an Asia-type crisis?
> Discuss how the advent of the euro would affect international diversification strategies.
> Delta Company, a U.S. MNC, is contemplating making a foreign capital expenditurein South Africa. The initial cost of the project is ZAR10,000. The annual cashflows over the five-year economic life of the project in ZAR are estimated to be3,000, 4,000, 5,
> IBM purchased computer chips from NEC, a Japanese electronics concern, andwas billed ¥250 million payable in three months. Currently, the spot exchangerate is ¥105/$ and the three-month forward rate is ¥100/$. The three-month moneymarket interest rate is
> Zeda, Inc., a U.S. MNC, is considering making a fixed direct investment in Denmark. The Danish government has offered Zeda a concessionary loan of DKK 15,000,000 at a rate of 4 percent per annum. The normal borrowing rate for Zeda is 6 percent in dollars
> The Alpha Company plans to establish a subsidiary in Hungary to manufactureand sell fashion wristwatches. Alpha has total assets of $70 million, of which$45 million is equity financed. The remainder is financed with debt. Alpha consideredits current capi
> With regard to the Centralia case application in the chapter, how would the APV change if: a. The forecast of (dand/or (f are incorrect? b. Deprecation cash flows are discounted at Kudinstead of id? c. The host country did not provide the concessionary l
> The Eastern Trading Company of Singapore ships prepackaged spices to Hong Kong,the United Kingdom, and the United States, where they are resold by sales affiliates.Eastern Trading is concerned with what might happen in Hong Kong now thatcontrol has been
> Discuss the criteria for a “good” international monetary system.
> 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. Strikit-Rich’s management believes that the expansion will allow it to mine and sell anadd
> How would you incorporate political risk into the capital budgeting process of foreign investment projects?
> Answer problems 1, 2, and 3 based on the stock market data given by the following table. The above table provides the correlations among Telmex, a telephone/communicationcompany located in Mexico, the Mexico stock market index, and the world marketinde
> How is international financial management different from domestic financialmanagement?
> Airbus sold an A400 aircraft to Delta Airlines, a U.S. company, and billed $30 millionpayable in six months. Airbus is concerned about the euro proceeds from internationalsales and would like to control exchange risk. The current spot exchange rateis $1.
> What were the weaknesses of Basel II that became apparent during the globalfinancial crisis that began in mid-2007?
> Explain the random walk model for exchange rate forecasting. Can it be consistentwith technical analysis?
> Explain cross-hedging and discuss the factors determining its effectiveness.
> Using an example, discuss the possible effect of hedging on a firm’s tax obligations.
> There are arguments for and against the alternative exchange rate regimes. a. List the advantages of the flexible exchange rate regime. b. Criticize the flexible exchange rate regime from the viewpoint of the proponentsof the fixed exchange rate regime.
> The public corporation is owned by a multitude of shareholders but run by professionalmanagers. Managers can take self-interested actions at the expense of shareholders.Discuss the conditions under which the so-called agency problem arises.
> What is a collateralized debt obligation and what effect did they have on the credit crunch?
> Suppose your company has purchased a put option on the euro to manageexchange exposure associated with an account receivable denominated in that currency.In this case, your company can be said to have an “insurance” policy on itsreceivable. Explain in wh
> Explain the pricing-to-market phenomenon.
> Ashton Bishop is the debt manager for World Telephone, which needs €3.33 billionEuro financing for its operations. Bishop is considering the choice between issuanceof debt denominated in: • Euros (€), o
> It is Tuesday afternoon, February 14, 2012. Richard May, Assistant Treasurer atAmerican Digital Graphics (ADG), sits in his office on the thirty-fourth floor of thebuilding that dominates Rockefeller Plaza’s west perimeter. Itâ
> Discuss the pros and cons of a MNC having a centralized cash manager handle allinvestment and borrowing for all affiliates of the MNC versus each affiliate havinga local manager who performs the cash management activities of the affiliate.
> Explain the basic differences between the operation of a currency forward marketand a futures market.
> List the arguments (variables) of which an FX call or put option model price is afunction. How do the call and put premiums change with respect to a change in thearguments?
> What is meant by the terminology that an option is in-, at-, or out-of-the-money?
> Explain purchasing power parity, both the absolute and relative versions. Whatcauses deviations from purchasing power parity?
> What is the major difference in the obligation of one with a long position in afutures (or forward) contract in comparison to an options contract?
> How can the FX futures market be used for price discovery?
> Discuss and compare the costs of hedging by forward contracts and optionscontracts.
> Suppose Morgan Guaranty, Ltd. is quoting swap rates as follows: 7.75–8.10 percentannually against six-month dollar LIBOR for dollars and 11.25–11.65 percentannually against six-month dollar LIBOR for British pound sterling. At what rateswill Morgan Guara
> Discuss different ways that dominant investors may establish and maintain controlof a company with relatively small investments.
> What is the difference between the Euronote market and the Eurocommercialpaper market?
> Why are most futures positions closed out through a reversing trade rather thanheld to delivery?
> If Honda ADRs were trading at $44 when the underlying shares were trading inTokyo at ¥3,945, what could you do to earn a trading profit? Use the informationin problem 1 to help you, and assume that transaction costs are negligible.
> In order for a derivatives market to function most efficiently, two types ofeconomic agents are needed: hedgers and speculators. Explain.
> Explain how special drawing rights (SDRs) are constructed. Also, discuss the circumstancesunder which the SDRs were created.
> Suppose you are interested in investing in shares of Samsung Electronics of Korea,which is a world leader in mobile phones, TVs, and home appliances. But beforeyou make an investment decision, you would like to learn about the company. Visitthe website o
> Use the European option-pricing models developed in the chapter to value the call ofproblem 9 and the put of problem 10. Assume the annualized volatility of the Swissfranc is 14.2 percent. This problem can be solved using the FXOPM.xls spreadsheet.
> Explain the following three concepts of purchasing power parity (PPP): a. The law of one price. b. Absolute PPP. c. Relative PPP.
> How would you define transaction exposure? How is it different from economicexposure?
> Discuss the risks confronting an interest rate and currency swap dealer.
> Suppose that the treasurer of IBM has an extra cash reserve of $100,000,000 toinvest for six months. The six-month interest rate is 8 percent per annum in theUnited States and 7 percent per annum in Germany. Currently, the spot exchangerate is €1.01 per
> When the euro was introduced in January 1999, the United Kingdom was conspicuouslyabsent from the list of European countries adopting the common currency.Although the previous Labour government led by Prime Minister Tony Blair appearedto be in favor of j
> Suppose you conduct currency carry trade by borrowing $1,000,000 at the start ofeach year and investing in the New Zealand dollar for one year. One-year interestrates and the exchange rate between the U.S. dollar ($) and New Zealand dollar(NZ$) are provi
> How does the deposit-loan rate spread in the Eurodollar market compare with thedeposit-loan rate spread in the domestic U.S. banking system? Why?
> James Clark is a currency trader with Wachovia. He notices the following quotes: Spot exchange rate ……………………………………………….SFr1.2051/$ Six-month forward exchange rate ………………………….SFr1.1922/$ Six-month dollar interest rate ……………………………….2.50% per year Six-mon
> After studying Iris Hamson’s credit analysis, George Davies is consideringwhether he can increase the holding period return on Yucatan Resort’s excess cashholdings (which are held in pesos) by investing those cash holdings in the Mexicanbond market. Alth
> Lured by extremely low labor costs in Bangladesh, many MNCs in the so-calledfast-fashion business, including H&M, Inditex (parent of the popular Zara brand),Marks&Spencer, and Gap, are heavily outsourcing to Bangladesh. As a result,the garment industry h
> Due to the integrated nature of their capital markets, investors in both the UnitedStates and the U.K. require the same real interest rate, 2.5 percent, on their lending.There is a consensus in capital markets that the annual inflation rate is likelyto b
> Suppose that the current spot exchange rate is €1.50/£ and the one-year forwardexchange rate is €1.60/£. The one-year interest rate is 5.4 percent in euros and5.2 percent in pounds. You can borrow at most €1,000,000 or the equivalent poundamount, that is
> Should a firm hedge? Why or why not?
> Explain the arrangements and workings of the European Monetary System (EMS).
> Omni Advisors, an international pension fund manager, uses the concepts of purchasingpower parity (PPP) and the International Fisher Effect (IFE) to forecastspot exchange rates. Omni gathers the financial information as follows: Base price level……………………
> As of November 1, 1999, the exchange rate between the Brazilian real and U.S.dollar was R$1.95/$. The consensus forecast for the U.S. and Brazil inflation ratesfor the next one-year period was 2.6 percent and 20.0 percent, respectively. Whatwould you hav
> Do problem 9 again assuming an American put option instead of a call option. Data from Problem 9: Assume the spot Swiss franc is $0.7000 and the six-month forward rate is $0.6950. What is the minimum price that a six-month American call option with a st
> Following corporate scandals and failures in the United States and abroad, therehas been a growing demand for corporate governance reform. What should bethe key objectives of corporate governance reform? What kinds of obstacles canthwart reform efforts?
> Suppose that the pound is pegged to gold at 6 pounds per ounce, whereas thefranc is pegged to gold at 12 francs per ounce. This, of course, implies that theequilibrium exchange rate should be two francs per pound. If the current marketexchange rate is 2.
> In the October 23, 1999, issue, The Economist reports that the interest rate perannum is 5.93 percent in the United States and 70.0 percent in Turkey. Why doyou think the interest rate is so high in Turkey? On the basis of the reported interestrates, how
> Explain how a country can run an overall balance-of-payments deficit or surplus.
> Discuss the various ways the exporter can receive payment in a foreign tradetransaction after the importer’s bank accepts the exporter’s time draft and itbecomes a banker’s acceptance.
