FIN 4144 Practice Exam Final Dec03 21 PDF

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practice final exam for international financial management...

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Total Points: 100 -

FIN4144 International Finance Practice Final Exam Fall 2021 Student Name / ID #____________________________ Honor Pledge: On my honor, I have neither given nor received any aid on this examination. Signature ______________________ Instructions:

You can use a financial calculator, and the formula sheet with the requirements that your instructor indicated. Any correspondence with your classmates regarding the exam during the exam period is a violation of the Virginia Tech honor code

Please be sure to show your work. Wrong numerical answers with work shown will receive partial credit. Correct answers with no work shown will not receive any credit.

There should be enough room to show all the work on the exam. If necessary, add pages.

If you feel that there is not enough information given to answer a question, state clearly any additional assumptions that you make. You can round up to two decimals.

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1. Answer 3 out of the 5 following conceptual questions. Total points: 15. Keep your answers concise.

1. Explain some of the advantages and disadvantages of a fixed exchange rate and a floating exchange rate regime. 5 points

2. Explain how Interest Rates, Inflation Rates and GDP growth affect the exchange rates. Explain the economic mechanism for each variable. 5 points

3. Discuss and compare hedging transaction exposure using the forward contract vs. money market instruments. When do the alternative hedging approaches produce the same result? 5 points

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4. Discuss and compare the costs of hedging via the forward contract and the options contract. 5 points

5. What are the advantages of a currency options contract as a hedging tool compared with the forward contract? 5 points

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2. Covered Interest Rate Parity. Total points 10.

Suppose that the current spot exchange rate is €1.50/₤ and the one-year forward exchange rate is €1.60/₤. The one-year interest rate is 5.4% in euros and 5.2% in pounds. You can borrow at most €1,000,000 or the equivalent pound amount, i.e., ₤666,667, at the current spot exchange rate.

a. Show how you can realize a guaranteed profit from covered interest arbitrage. Assume that you are a euro-based investor. Also determine the size of the arbitrage profit. 5 points b. Discuss how the interest rate parity may be restored as a result of the above transactions. 5 points

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3. Triangular Arbitrage. Total Points 10. Assume you are a trader with Deutsche Bank. From the quote screen on your computer terminal, you notice that Dresdner Bank is quoting €0.7627/$1.00 and Credit Suisse is offering SFr1.1806/$1.00. You learn that UBS is making a direct market between the Swiss franc and the euro, with a current €/SFr quote of .6395. Show how you can make a triangular arbitrage profit by trading at these prices. (Ignore bid-ask spreads for this problem.)

Assume you have

$5,000,000 with which to conduct the arbitrage. What happens if you initially sell dollars for Swiss francs? What €/SFr price will eliminate triangular arbitrage?

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4. Forward Hedging Versus Money Markey Hedging. Total Points 10.

Boeing just signed a contract to sell a Boeing 737 aircraft to Air France. Air France will be billed €20 million which is payable in one year. The current spot exchange rate is $1.05/€ and the oneyear forward rate is $1.10/€. The annual interest rate is 6.0% in the U.S. and 5.0% in France. Boeing is concerned with the volatile exchange rate between the dollar and the euro and would like to hedge exchange exposure. (a) It is considering two hedging alternatives: sell the euro proceeds from the sale forward or borrow euros from Credit Lyonnaise against the euro receivable. Which alternative would you recommend? Why? 5 points (b) Other things being equal, at what forward exchange rate would Boeing be indifferent between the two hedging methods? 5 points

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5. Options. Total points 15 points You plan to visit Geneva, Switzerland in three months to attend an international business conference. You expect to incur the total cost of SF 5,000 for lodging, meals and transportation during your stay. As of today, the spot exchange rate is $0.60/SF and the three-month forward rate is $0.63/SF. You can buy the three-month call option on SF with the exercise rate of $0.64/SF for the premium of $0.05 per SF. Assume that your expected future spot exchange rate is the same as the forward rate. The three-month interest rate is 6 percent per annum in the United States and 4 percent per annum in Switzerland. (a) Calculate your expected dollar cost of buying SF5,000 if you choose to hedge via call option on SF. 5 points. (b) Calculate the future dollar cost of meeting this SF obligation if you decide to hedge using a forward contract. 5 points. (c) At what future spot exchange rate will you be indifferent between the forward and option market hedges? 5 points.

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6. Investments. Total points 15. 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 $1.40. If the British economy slows down, on the other hand, the land will be worth less, i.e., £1,500, but the pound will be stronger, i.e., $1.50/£. You feel that the British economy will experience a boom with a 60% probability and a slow-down with a 40% probability. (a) Estimate expected value of the property value E(P), the expected value and the variance of the exchange rate ((E(S), and Var(S)). 5 points. (b) Calculate the covariance between the value of the property and the exchange rate (Cov (P, S)). 5 points. (c) Calculate your exposure to the exchange risk, define as beta= covariance (P, S)/Var(S). Discuss how you can hedge your exchange risk exposure and examine the consequences of hedging. 5 points.

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7. International Capital Budgeting. 25 points. Deli-Delights Inc. is a U.S. company that is considering expanding its operations into the UK. The company supplies processed foods to store front delicatessens in large cities. This requires Deli-Delights to have a centralized production and warehousing facility in each of these cities. Deli-Delights has located a possible site for a subsidiary in UK. The cost to purchase and equip the facility is USD 500 million, and the initial Working Capital requirement is USD 100 million. Perform an Adjusted Net Present Value (ANPV) analysis to determine whether this is a good investment, under the following assumptions: Data/Year USD Inflation UK Inflation Exchange rate: $/GBP Retail price (Dollar) Unit Sales (million) Labor Cost per unit (Dollar) Import Part Cost (Dollar)

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1 2 3 2% 2% 2% 1% 1% 1% 1.5 1.9 1.7 Subsidiary basic data 10 12 18.00 15 16 16.54

4 2% 1% 2

5 2% 1% 2.5

18.00 17.36

22 17.71

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10

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Assumptions: a. There will be a 4% royalty paid by the UK subsidiary to its U.S. parent. (The 4 percent is over the total revenues) b. Subsidiary administrative cost is 3% of the revenues. c. The UK corporate income tax rate is 37.5%, and there is a 10% withholding tax on dividends and royalty payments. d. The discount rate for the project is 13%. Assume that free cash flows after year 5 will grow at the US inflation rate in perpetuity. e. From year one to five, the change in Net Working Capital will be 10 % of total sales revenue. f. Assume straight line depreciation in 5 years. g. All the UK subsidiary’s free cash flow will be paid to the US parent as dividends. h. The corporate income tax rate for the United States is 34%. i. Deli-Delights Inc. does not plan to issue any debt associated with this project. 1) First calculate the NPV of the subsidiary alone. 10 points 2) Calculate the ANPV from the perspective of the parent company. Do you accept or reject the project? 15 points 9...