ECO 410 Complete Test Bank – Strayer

ECO/410 Week 1 – 11 Test Bank – Strayer A+ Graded

Click on the Link Below to Purchase A+ Graded Course Material

http://budapp.net/ECO-410-Exam-and-Quizzes-Strayer-414.htm

 

For more help Contact us at: budapp247@gmail.com

ECO 410 Week 2 Quiz Solution

Chapter 1 Current Multinational Challenges and the Global Economy

True/False

1) BRICs is a term used in international finance to represent assets that are considered to be inexpensive and sturdy, but fundamentally unsound and and incapable of coping with the upheavals now apparent in international financial markets.

2) Multinational enterprises (MNEs) are firms, both for profit companies and not-for-profit organizations, that have operations in more than one country, and conduct their business through foreign subsidiaries,
branches, or joint ventures with host country firms.

3) Ownership, control, and governance changes radically across the world. The publicly traded company is not the dominant global business organization—the privately held or family-owned business is the prevalent structure—and their goals and measures of performance differ dramatically.

Multiple Choice

1) A well-established, large U.S.-based MNE will probably NOT be able to overcome which of the following obstacles to maximizing firm value?
A) an open market place
B) high quality strategic management
C) access to capital
D) none of the above

2) A well-established, large China-based MNE will probably be most adversely affected by which of the following elements of firm value?
A) an open marketplace
B) high-quality strategic management
C) access to capital
D) access to qualified labor pool

3) A well-established, large, Brazil-based MNE will probably be most adversely affected by which of the following elements of firm value?
A) an open marketplace
B) high-quality strategic management
C) access to capital
D) access to qualified labor pool

True/False

1) Comparative advantage is one of the underlying principles driving the growth of global business.

2) Your authors suggest that one way to characterize the global financial marketplace is through its assets, institutions, and linkages.

3) Eurocurrencies are domestic currencies of one country on deposit in a second country.

4) A eurodollar deposit is a demand deposit.

5) Eurocurrency markets serve two valuable purposes: 1) Eurocurrency deposits are an efficient and convenient money market device for holding excess corporate liquidity; and 2) the Eurocurrency market is a major source of short-term bank loans to finance corporate working capital needs, including the financing of imports and exports.

6) The key factor attracting both depositors and borrowers to the Eurocurrency loan market is the narrow interest rate spread within that market.

7) The Eurocurrency market continues to thrive because it is a large international money market relatively free from governmental regulation and interference. Recent events may lead to greater regulation.

Essay

1) List and explain three strategic motives why firms become multinationals and give an example of each.

Multiple Choice

1) The theory that suggests specialization by country can increase worldwide production is:
A) the theory of comparative advantage.
B) the theory of foreign direct investment.
C) the international Fisher effect.
D) the theory of working capital management.

2) Which of the following is NOT a reason governments interfere with comparative advantage?
A) Governments attempt to achieve full employment.
B) Governments promote economic development.
C) national self-sufficiency in defense-related industries
D) All are reasons governments interfere with comparative advantage.

3) Which of the following factors of production DO NOT flow freely between countries?
A) raw materials
B) financial capital
C) (non-military) technology
D) All of the above factors of production flow freely among countries.

4) Which of the following would NOT be a way to implement comparative advantage?
A) IBM exports computers to Egypt.
B) Computer hardware is designed in the United States but manufactured and assembled in Korea.
C) Water of the greatest purity is obtained from wells in Oregon, bottled, and exported worldwide.
D) All of the above are examples of ways to implement comparative advantage.

5) Of the following, which would NOT be considered a way that government interferes with comparative advantage?
A) tariffs
B) managerial skills
C) quotas
D) other non-tariff restrictions

True/False

1) The theory of comparative advantage owes it origins to Ben Bernanke as described in his book The Wealth of Bankers.

2) International trade might have approached the comparative advantage model in the 19th century, and it does so even more today.

3) Comparative advantage shifts over time as less developed countries become more developed and realize their latent opportunities.

4) Comparative advantage in the 21st century is based more on services and their cross border facilitation by telecommunications and the Internet.

5) Comparative advantage was once the cornerstone of international trade theory, but today it is archaic, simplistic, and irrelevant for explaining investment choices made by MNEs.

6) When discussing comparative advantage, it is apparent that today at least two of the factors of production, capital and technology, now flow directly and easily between countries, rather than only indirectly through traded goods and services.

7) It would be safe to make the statement that modern telecommunications now take business activities to labor rather than moving labor to the places of business.

Multiple Choice

1) Which of the following domestic financial instruments have NOT been modified for use in international financial management?
A) currency options and futures
B) interest rate and currency swaps
C) letters of credit
D) All of the above are domestic financial instruments that have also been modified for use in international financial markets.

True/False

1) MNEs must modify finance theories like cost of capital and capital budgeting because of foreign complexities.

2) Relative to MNEs, purely domestic firms tend to have GREATER political risk.

3) Domestic firms tend to make GREATER use of financial derivatives than MNEs because they can bear the greater risk presented by these financial instruments.

4) Because countries have different financial regulations and customs, it is common for MNEs to apply their domestic rules and regulations when doing financial business in a foreign country.

5) A number of financial instruments that are used in domestic financial management have been modified for use in international financial management. Examples are foreign currency options and futures, interest rate and currency swaps, and letters of credit.

Multiple Choice

1) In determining why a firm becomes multinational there are many reasons. One reason is that the firm is a market seeker. Which of the following is NOT a reason why market-seeking firms produce in foreign countries?
A) satisfaction of local demand in the foreign country
B) satisfaction of local demand in the domestic markets
C) political safety and small likelihood of government expropriation of assets
D) All of the above are market-seeking activities.

2) ________ investments are designed to promote and enhance the growth and profitability of the firm. ________ investments are designed to deny those same opportunities to the firm’s competitors.
A) Conservative; Aggressive
B) Defensive; Proactive
C) Proactive; Defensive
D) Aggressive; Proactive

True/False

1) For firms competing in a world characterized by oligopolistic competition, strategic motives can be subdivided into proactive and defensive investments.

2) Defensive measures are designed to enhance growth and profitability of the firm itself.

Multiple Choice

1) The phase of the globalization process characterized by imports from foreign suppliers and exports to foreign buyers is called the:
A) domestic phase.
B) multinational phase.
C) international trade phase.
D) import-export banking phase.

2) The authors describe the multinational phase of globalization for a firm as one characterized by the:
A) ownership of assets and enterprises in foreign countries.
B) potential for international competitors or suppliers even though all accounts are with domestic firms and are denominated in dollars.
C) imports from foreign suppliers and exports to foreign buyers.
D) requirement that all employees be multilingual.

3) A firm in the International Trade Phase of Globalization:
A) makes all foreign payments in foreign currency units and all foreign receipts in domestic currency units.
B) receives all foreign receipts in foreign currency units and makes all foreign payments in domestic currency units.
C) bears direct foreign exchange risk.
D) none of the above

4) Of the following, which was NOT mentioned by the authors as an increase in the demands of financial management services due to increased globalization by the firm?
A) evaluation of the credit quality of foreign buyers and sellers
B) foreign consumer method of payment preferences
C) credit risk management
D) evaluation of foreign exchange risk

5) Of the following, which was NOT mentioned by the authors as an increase in the demands of financial management services due to increased globalization by the firm?
A) evaluation of the credit quality of foreign buyers and sellers
B) foreign consumer method of payment preferences
C) credit risk management
D) evaluation of foreign exchange risk

6) The authors describe the multinational phase of globalization for a firm as one characterized by the:
A) ownership of assets and enterprises in foreign countries.
B) potential for international competitors or suppliers even though all accounts are with domestic firms and are denominated in dollars.
C) imports from foreign suppliers and exports to foreign buyers.
D) requirement that all employees be multilingual.

7) The twin agency problems limiting financial globalization are caused by these two groups acting in their own self-interests rather than the interests of the firm.
A) rulers of sovereign states and unsavory customs officials
B) corporate insiders and attorneys
C) corporate insiders and rulers of sovereign states
D) attorneys and unsavory customs officials

True/False

1) Typically, a firm in its domestic stage of globalization has all financial transactions in its domestic currency.

2) Typically, a “greenfield” investment abroad is considered a greater foreign investment having a greater foreign presence than a joint venture with a foreign firm.

3) The authors argue that financial inefficiency caused by influential insiders may prove to be an increasingly troublesome barrier to international finance.

4) The authors describe a process for development of a MNE that begins with a purely domestic phase, followed by the multinational phase, and topping out with the international trade phase.

5) Today it is widely assumed that there are NO LIMITS to financial globalization.

6) The growth in the influence and self-enrichment of organizational insiders is seen as an impediment to the growth of financial globalization in general.

7) The actions of corporate insiders and the actions of rulers of sovereign states are both agency costs that act as an impediment to the growth of globalization.

Chapter 2 Corporate Ownership, Goals, and Governance

Multiple Choice

1) Foreign stock markets are frequently characterized by controlling shareholders for the individual publicly traded firms. Which of the following is NOT identified by the authors as typical controlling shareholders?
A) the government (for example, privatized utilities)
B) institutions (such as banks in Germany)
C) family (such as in France)
D) All of the above were identified by the authors as controlling shareholders.

2) Which of the following is NOT typically associated with the public ownership of business organizations?
A) the state
B) the government
C) families
D) civil society

3) Which of the following is NOT typically associated with the private ownership of business organizations?
A) the government
B) families
C) individuals
D) publicly traded, widely-held organizations

4) State Owned Enterprises (SOEs):
A) are a form of public ownership.
B) are created for commercial activities rather than civil or social activities.
C) are the dominant form of business organization in some countries.
D) are all of the above.

5) The problems that may arise due to the separation of ownership and management in large business organizations is know as:
A) separation anxiety.
B) the agency problem.
C) corporate disconnect theory.
D) none of the above

6) Privatization is a term used to describe:
A) firms that are purchased by the government.
B) government operations that are purchased by corporations and other investors.
C) firms that do not use publicly available debt.
D) non-public meetings held by members of interlocking directorates.

True/False

1) In the U.S. and U.K. stock markets are characterized by ownership of firms concentrated in the hands of a few controlling shareholders. In contrast, the rest of the world tends to have more widespread ownership of shares.

2) State Owned Enterprises (SOEs) by their very name cannot be traded on stock exchanges because they are government owned.

3) In recent years the trend has been for markets to increasing focus on the shareholder wealth form of wealth maximization.

4) Non-Anglo-American markets are dominated by the “one-vote-one-share” rule.

5) According to recent research, family-owned firms in some highly-developed economies typically outperform publicly-owned firms.

Essay/Short Answer

1) What are the most important distinctions that make state owned enterprises (SOEs) different from other forms of government organizations?

Multiple Choice

1) “Maximize corporate wealth”:
A) is the primary objective of the non-Anglo-American model of management.
B) as a management objective treats shareholders on a par with other corporate stakeholders such as creditors, labor, and local community.
C) has a broader definition than just financial wealth.
D) all of the above

2) The Shareholder Wealth Maximization Model (SWM):
A) combines the interests and inputs of shareholders, creditors, management, employees, and society.
B) is being usurped by the Stakeholder Capitalism Model as those types of MNEs dominate their global industry segments.
C) clearly places shareholders as the primary stakeholder.
D) is the dominant form of corporate management in the European-Japanese governance system.

3) The Stakeholder Capitalism Model (SCM):
A) clearly places shareholders as the primary stakeholder.
B) combines the interests and inputs of shareholders, creditors, management, employees, and society.
C) has financial profit as its goal and is often termed impatient capital.
D) is the Anglo-American model of corporate governance.

4) In the Anglo-American model of corporate governance, the primary goal of management is to:
A) maximize the wealth of all stakeholders.
B) maximize shareholder wealth.
C) minimize costs.
D) minimize risk.

5) In finance, an efficient market is one in which:
A) prices are assumed to be correct.
B) prices adjust quickly and accurately to new information.
C) prices are the best allocators of capital in the macro economy.
D) all of the above

6) Systematic risk can be defined as:
A) the total risk to the firm.
B) the risk of the individual security.
C) the risk of the market in general.
D) the risk that can be systematically diversified away.

7) Unsystematic risk can be defined as:
A) the total risk to the firm.
B) the risk of the individual security.
C) the added risk that a firm’s shares bring to a diversified portfolio.
D) the risk of the market in general.

8) The study of how shareholders can motivate management to accept the prescriptions of the shareholder wealth maximization model is called:
A) market efficiency.
B) the SWM model.
C) agency theory.
D) the SCM model.

9) Under the Shareholder Wealth Maximization Model (SWM) of corporate governance, poor firm performance is likely to be faced with all but which of the following?
A) sale of shares by disgruntled current shareholders
B) shareholder activism to attempt a change in current management
C) as a maximum threat, initiation of a corporate takeover
D) prison time for executive management

10) Which of the following is a reason why managers act to maximize shareholder wealth in Anglo-American markets?
A) the use of stock options to align the goals of shareholders and managers
B) the market for corporate control that allows for outside takeover of the firm
C) performance based compensation for executive management
D) all of the above

11) Which of the following is NOT true regarding the stakeholder capitalism model?
A) Banks and other financial institutions are less important creditors than securities markets.
B) Labor unions are more powerful than in the Anglo-American markets.
C) Governments interfere more in the marketplace to protect important stakeholder groups.
D) All of the above are TRUE.

12) The stakeholder capitalism model:
A) typically avoids the flaw of impatient capital.
B) tries to meet the desires of multiple stakeholders.
C) may leave management without a clear signal about tradeoffs among the several stakeholders.
D) all of the above

13) Which of the following is generally NOT considered to be a viable operational goal for a firm?
A) maintaining a strong local currency
B) maximization of after-tax income
C) minimization of the firm’s effective global tax burden
D) correct positioning of the firm’s income, cash flows and available funds as to country and currency

14) Which of the following operational goals for the international firm may be incompatible with the others?
A) maintaining a strong local currency
B) maximization of after-tax income
C) minimization of the firm’s effective global tax burden
D) Each of these goals may be incompatible with one or more of the others.

15) The primary operational goal for the firm is to:
A) maximize after-tax profits in each country where the firm is operating.
B) minimize the total financial risk to the firm.
C) maximize the consolidated after-tax profits of the firm.
D) maximize the total risk to the firm.

16) Which of the following broad topics is NOT identified as an area to be established as good corporate governance practice by the Organization for Economic Cooperation and Development (OECD)?
A) protect the rights of shareholders
B) disclosure and transparency
C) the proper role of stakeholders in the governance of the firm
D) All of the above should be a concern of good corporate governance.

17) The relationship among stakeholders used to determine and control the strategic direction and performance of an organization is termed:
A) corporate governance.
B) Anglo-American activism.
C) capital structure.
D) working capital management.

18) When discussing the structure of corporate governance, the authors distinguish between internal and external factors. ________ is an example of an internal factor, and ________ is an example of an external factor.
A) Equity markets; executive management
B) Debt markets; board of directors
C) Executive management; auditors
D) Auditors; regulators

19) Which of the following is NOT commonly associated with a government affiliated form of corporate governance regime?
A) no minority influence
B) lack of transparency
C) state ownership of enterprise
D) All are associated with this type of corporate governance regime.

20) Generally speaking, which of the following is NOT considered an important factor in the composition and control of corporate boards of directors?
A) the number of insider vs outside directors
B) the total number of directors on the board
C) the composition of the compensation committee
D) All of the above are important factors of board composition.

21) Signed into law on July 30, 2002, the ________ Act requires CEOs of publicly traded companies to vouch for the veracity of the firm’s published financial statements.
A) Smoot-Hawley
B) Humphrey-Hawkins
C) McCain-Merrill
D) Sarbanes-Oxley

22) The Sarbanes-Oxley Act, passed by the U.S. Congress in July 2002, was designed to:
A) reinstitute heavy tariffs on international trade.
B) reform corporate governance.
C) limit the Federal Reserve Board’s ability to engage in the buying and selling of gold.
D) limit trade with countries deemed lenient on terrorism.

23) Anglo-American markets is a term used to describe business markets in:
A) North, Central, and South America.
B) the United States, Canada, and Western Europe.
C) the United States, United Kingdom, Canada, Australia and New Zealand.
D) the United States, France, Britain, and Germany.

24) The deliberation of the of the process demonstrated in the European-Japanese system of corporate governance has sometimes been termed:
A) socialism.
B) impatient capital.
C) patient capital.
D) communism.

25) With shareholder wealth maximization as the manager’s goal, capital may be termed:
A) impatient.
B) patient.
C) borrowed.
D) bought.

26) Which of the following is NOT an important concept when distinguishing between international and domestic financial management?
A) corporate governance
B) culture, history, and institutions
C) political risk
D) All of the above are important distinguishing concepts.

27) The Board of Directors:
A) consists exclusively of the officers of the corporation.
B) is the legal body which is accountable for the governance of the corporation.
C) are not subject to the external forces of the marketplace.
D) is appointed by the Securities and Exchange Commission (SEC).

28) If share price rises from $12 to $15 per share, and pays a dividend of $1 per share, what was the rate of return to shareholders?
A) 26.67%
B) -13.33%
C) 33.33%
D) 16.67%

29) PolyProduction Inc. has two classes of common stock. Class A has 5 million shares with 10 votes per share. Class B has 5 million shares with 1 vote per share. If the dividends per share are equal for both class A and B stock, then Class A shareholders have ________ of the votes and ________ of the dividends.
A) 90.91%; 90.91%
B) 90.91%; 50.00%
C) 50.00%; 50.00%
D) 83.33%; 33.33%

30) The number of publicly traded firms:
A) peaked in the U.S. in 1996.
B) peaked worldwide in 1996.
C) increased significantly in 2009 as a result of the international financial crisis.
D) all of the above

31) Which of the following is NOT a possible and appropriate response by shareholders dissatisfied with existing firm management of a publicly traded firm?
A) Shareholders could sell their shares of stock.
B) Shareholders could remain quietly disgruntled.
C) Shareholders, perhaps with the help of others, could attempt to initiate a takeover.
D) All of these responses may be possible and appropriate.

True/False

1) The stakeholder capitalism model (SCM) holds that total risk (operational and financial) is more important than just systematic risk.

2) In recent years the trend has been for markets to increasing focus on the shareholder wealth form of wealth maximization.

3) Patient Capitalism is characterized by short-term focus by both management and investors.

4) Agency theory states that unsystematic risk can be eliminated through diversification.

5) The stakeholder capitalism model does not assume that equity markets are either efficient or inefficient.

6) The stakeholder capitalism model assumes that only systematic risk “counts” or is a prime concern for management.

7) Dividend yield is the change in the share price of stock as traded in the public equity markets.

8) Regarding comparative corporate governance regimes: Bank-based regimes characterized by government influence in bank lending and a lack of transparency is often found in countries such as Korea and Germany.

9) Investor protection is typically better in countries with codified civil law (the Code Napoleon) than in countries with a legal system based in English common law.

10) The relatively low cost of compliance with the Sarbanes-Oxley Act (SOX) has been a surprising benefit of the act.

11) According to recent research, family-owned firms in some highly-developed economies typically outperform publicly-owned firms.

12) The goal of all international corporations is to maximize shareholder wealth.

13) Systematic risk can be eliminated through portfolio diversification.

14) According to the authors, dual classes of voting stock are the norm in non-Anglo-American markets.

15) A recent study shows that privately held firms use less financial leverage and enjoy lower costs of debt than publicly traded firms.

16) U.S. listings of publicly traded firms as a percentage of worldwide listings of such firms INCREASED from 11% in 1996 to approximately 33% in 2010.

17) Having Anglo-Americans as members of the board of directors of a non-Anglo-American firm signals poor corporate governance in the firm.

18) In the stakeholder capitalism model (SCM) the assumption of market efficiency is absolutely critical.

Short Answer/ Essay

1) Describe the management objectives of a firm governed by the shareholder wealth maximization model and one governed by the stakeholder wealth maximization model. Give an example of how these two models may lead to different decision-making by executive management.

2) Define patient and impatient capitalism and discuss how each may lead to different decision-making in the shareholder wealth maximization model.

ECO 410 Week 3 Quiz Solution

Chapter 3 The International Monetary System

Multiple Choice

1) Under the gold standard of currency exchange that existed from 1879 to 1914, an ounce of gold cost $20.67 in U.S. dollars and £4.2474 in British pounds. Therefore, the exchange rate of pounds per dollar under this fixed exchange regime was:
A) £4.8665/$.
B) £0.2055/$.
C) always changing because the price of gold was always changing.
D) unknown because there is not enough information to answer this question.

2) World War I caused the suspension of the gold standard for fixed international exchange rates because the war:
A) cost too much money.
B) interrupted the free movement of gold.
C) lasted too long.
D) used gold as the main ingredient in armament plating.

3) The post WWII international monetary agreement that was developed in 1944 is known as the:
A) United Nations.
B) League of Nations.
C) Yalta Agreement.
D) Bretton Woods Agreement.

4) Another name for the International Bank for Reconstruction and Development is:
A) the Recon Bank.
B) the European Monetary System.
C) the Marshall Plan.
D) the World Bank.

5) The International Monetary Fund (IMF):
A) in recent years has provided large loans to Russia, South Korea, and Brazil.
B) was created as a result of the Bretton Woods Agreement.
C) aids countries with balance of payment and exchange rate problems.
D) is all of the above.

6) Which of the following led to the eventual demise of the fixed currency exchange rate regime worked out at Bretton Woods?
A) widely divergent national monetary and fiscal policies among member nations
B) differential rates of inflation across member nations
C) several unexpected economic shocks to member nations
D) all of the above

7) Which of the following statements is NOT true?
A) The Gold Standard Era was characterized by growing openness in trade, but limited capital mobility.
B) The time period between world wars 1 and 2 (the inter war Years) witnessed significant reductions in trade barriers and a rapid acceleration in international trade.
C) The Bretton Woods Era (post WWII) realized the increasing benefits of open economies. Furthermore, trade was increasingly dominated by capital.
D) In fact, all of the above statements are true.

True/False

1) Under the terms of Bretton Woods, countries tried to maintain the value of their currencies to within 1% of a hybrid security made up of the U.S. dollar, British pound, and Japanese yen.

2) Members of the International Monetary Fund may settle transactions among themselves by transferring Special Drawing Rights (SDRs).

3) Today, the United States has been ejected from the International Monetary Fund for refusal to pay annual dues.

4) From the time of its creation through July 2012, the euro peaked versus the USD in April 2008 at around $1.60/€

Essay

1) Most Western nations were on the gold standard for currency exchange rates from 1876 until 1914. Today we have several different exchange rate regimes in use, but most larger economy nations have freely floating exchange rates today and are not obligated to convert their currency into a predetermined amount of gold on demand. Currently several parties still call for the “good old days” and a return to the gold standard. Develop an argument as to why this is a good idea.

Multiple Choice

1) Since 2009 the IMF’s exchange rate regime classification system uses a “de facto classification” methodology. Under this system, a country that has given up their own sovereignty over monetary
policy is considered to have:
A) a residual agreement.
B) hard pegs.
C) soft pegs.
D) floating arrangements.

2) Since 2009 the IMF’s exchange rate regime classification system uses a “de facto classification” methodology. Under this system, countries with “fixed exchange rates” are considered to have:
A) a residual agreement.
B) soft pegs.
C) hard pegs.
D) floating arrangements.

3) A small economy country whose GDP is heavily dependent on trade with the United States could use a(n) ________ exchange rate regime to minimize the risk to their economy that could arise due to unfavorable changes in the exchange rate.
A) pegged exchange rate with the United States
B) pegged exchange rate with the Euro
C) independent floating
D) managed float

4) Since 2009 the IMF’s exchange rate regime classification system uses a “de facto classification” methodology. Under this system, currencies that are predominantly market-driven are considered to be:
A) soft pegs.
B) hard pegs.
C) floating arrangements.
D) a residual agreement.

True/False

1) The euro is an example of a rigidly fixed system, acting as a single currency for its member countries. However, the euro itself is an independently floating currency against all other currencies.

2) Although the contemporary international monetary system is typically referred to as a “floating regime,” it is clearly not the case for the majority of the world’s nations.

Essay

1) The mobility of international capital flows is causing emerging market nations to choose between a free-floating currency exchange regime and a currency board (or taken to the limit, dollarization). Describe how each of the regimes would work and identify at least two likely economic results for each regime.

Multiple Choice

1) Based on the premise that, other things equal, countries would prefer a fixed exchange rate, which of the following statements is NOT true?
A) Fixed rates provide stability in international prices for the conduct of trade.
B) Fixed exchange rate regimes necessitate that central banks maintain large quantities of international reserves for use in the occasional defense of the fixed rate.
C) Fixed rates are inherently inflationary in that they require the country to follow loose monetary and fiscal policies.
D) Stable prices aid in the growth of international trade and lessen exchange rate risks for businesses.

2) Which of the following is NOT an attribute of the “ideal” currency?
A) monetary independence
B) full financial integration
C) exchange rate stability
D) All are attributes of an ideal currency.

3) The authors discuss the concept of the “Impossible Trinity” or the inability to achieve simultaneously the goals of exchange rate stability, full financial integration, and monetary independence. If a country chooses to have a pure float exchange rate regime, which two of the three goals is a country most able to achieve?
A) monetary independence and exchange rate stability
B) exchange rate stability and full financial integration
C) full financial integration and monetary independence
D) A country cannot attain any of the exchange rate goals with a pure float exchange rate regime.

True/False

1) Based on the premise that, other things equal, countries would prefer a fixed exchange rate: Variable rates provide stability in international prices for the conduct of trade.

2) If exchange rates were fixed, investors and traders would be relatively certain about the current and near future exchange value of each currency.

Multiple Choice

1) Which of the following is NOT a required convergence criteria to become a full member of the European Economic and Monetary Union (EMU)?
A) National birthrates must be at 2.0 or lower per person.
B) The fiscal deficit should be no more than 3% of GDP.
C) Nominal inflation should be no more than 1.5% above the average inflation rate for the three members with the lowest inflation rates in the previous year.
D) Government debt should be no more than 60% of GDP.

2) According to the authors, what is the single most important mandate of the European Central Bank?
A) Promote international trade for countries within the European Union.
B) Price, in euros, all products for sale in the European Union.
C) Promote price stability within the European Union.
D) Establish an EMU trade surplus with the United States.

3) Which of the following is a way in which the euro affects markets?
A) Countries within the Euro zone enjoy cheaper transaction costs.
B) Currency risks and costs related to exchange rate uncertainty are reduced.
C) Consumers and business enjoy price transparency and increased price-based competition.
D) all of the above

4) For the three years from early 2002 to early 2005, the euro maintained a strong and steady rise in value against the U.S. dollar (USD). After a brief respite in 2005, the euro continued its climb against the USD into 2008. Which of the following were NOT a contributing factor in the assent of the euro and the decline in the dollar?
A) severe U.S. balance of payments deficits
B) a general weakening of the dollar after the attacks of September 11, 2001
C) large U.S. balance of payment surpluses
D) All of the above were contributing factors.

5) The countries that use the euro as their currency have:
A) agreed to use a single currency (exchange rate stability), allow the free movement of capital in and out of their economies (financial integration), but give up individual control of their own money supply (monetary independence).
B) gained control over their own money supply (monetary independence), allowed the free movement of capital in and out of their economies (financial integration), but give up exchange rate stability.
C) agreed to use a single currency (exchange rate stability), allow individual control of their own money supply (monetary independence), but give up the free movement of capital in and out of their economies (financial integration).
D) none of the above

True/False

1) The Euro currency is fixed against other currencies on the international currency exchange markets, but allows member country currencies to float against each other.

2) The European Central Bank is a strong and independent central bank that has completely replaced the individual central banks of the countries that use the euro as their currency.

3) The members of the EU do have relative freedom to set their own fiscal policies— government spending, taxation, and the creation of government surpluses or deficits. They are expected to keep deficit spending within limits.

Multiple Choice

1) Beginning in 1991 Argentina conducted its monetary policy through a currency board. In January 2002, Argentina abandoned the currency board and allowed its currency to float against other currencies. The country took this step because:
A) the Argentine Peso had grown too strong against major trading powers thus the currency board policies were hurting the domestic economy.
B) the United States required the action as a prerequisite to finalizing a free trade zone with all of North, South, and Central America.
C) the Argentine government lost the ability to maintain the pegged relationship as in fact investors and traders perceived a lack of equality between the Argentine Peso and the U.S. dollar.
D) all of the above

2) In January 2002, the Argentine Peso changed in value from Peso1.00/$ to Peso1.40/$, thus, the Argentine Peso ________ against the U.S. dollar.
A) strengthened
B) weakened
C) remained neutral
D) all of the above

3) In January 2000 Ecuador officially replaced its national currency, the Ecuadorian sucre, with the U.S. dollar. This practice is known as:
A) bi-currencyism.
B) sucrerization.
C) a Yankee bailout.
D) dollarization.

4) You have been hired as a consultant to the central bank for a country that has for many years suffered from repeated currency crises and depends heavily on the U.S. financial and product markets. Which of the following policies would have the greatest effectiveness for reducing currency volatility of the client country with the United States?
A) dollarization
B) an exchange rate pegged to the U.S. dollar
C) an exchange rate with a fixed price per ounce of gold
D) an internationally floating exchange rate

5) Which of the following is NOT an argument against dollarization?
A) Dollarization causes a loss of sovereignty over domestic monetary policy.
B) Dollarization removes currency volatility against the dollar.
C) Dollarization causes the country to lose the power of seignorage.
D) The central bank of the dollarized country loses the role of lender of last resort.

6) The ability of a country to profit from its ability to print money is known as:
A) profiteering.
B) dollarization.
C) seignorage.
D) inflation.

7) Which of the following factors make it difficult for emerging market economies to choose a specific currency regime?
A) weak fiscal, financial, and monetary institutions
B) the tendency for commerce to allow currency substitution and the denomination of liabilities in dollars
C) the emerging market’s vulnerability to sudden stoppages of outside capital flows
D) all of the above

True/False

1) A currency board exists when a country’s central bank commits to back its money supply entirely with foreign reserves at all times.

2) Dollarization is a common solution for countries suffering from currency revaluation.

3) By and large, high capital mobility is forcing emerging market nations to choose between the two extremes of a free floating regime or an exchange rate regime of dollarization of a currency board.

Multiple Choice

1) Of the following, which is NOT a trade-off that must be dealt with in any exchange rate regime?
A) cooperation vs independence
B) rules vs discretionary action
C) dollars vs pounds
D) All of the above are rate regime trade-offs.

True/False

1) All exchange rate regimes must deal with the trade-off between rules and discretion as well as between cooperation and independence.

2) Regime structures like the gold standard required no cooperative policies among countries, only the assurance that all would abide by the “rules of the game.”

3) Bretton Woods required less in the way of cooperation among countries than did the gold standard.

Chapter 4 The Balance of Payments

Multiple Choice

1) Which of the following is NOT a major subaccount of the Balance of Payments?
A) the financial account
B) the accounts payable
C) the capital account
D) the current account

2) Which of the following international transactions would NOT be counted as a balance of payments (BOP) transaction?
A) An American tourist purchases cheese in Milwaukee, Wisconsin.
B) The U.S. subsidiary of a British firm pays profits (dividends) back to its parent firm in London.
C) A Canadian lumber baron purchases a U.S. corporate bond through an investment broker in
Seattle.
D) All of the above are considered BOP transactions.

3) The balance of payments as applied to a course in international finance may be defined as:
A) the amount still owed by an exporting firm after making an initial down payment.
B) the amount still owed by governments to the International Monetary Fund.
C) the measurement of all international economic transactions between the residents of a country and foreign residents.
D) the amount of a country’s merchandise trade deficit or surplus.

4) Balance of payment (BOP) data may be important for any of the following reasons:
A) BOP data helps to forecast a country’s market potential, especially in the short run.
B) The BOP is an important indicator of a country’s foreign exchange rate.
C) Changes in a country’s BOP may signal a change in controls over payment of dividends and interest.
D) all of the choices provided above

5) A country experiencing a serious BOP ________ is more likely to ________ exports than otherwise.
A) surplus; contract
B) surplus; expand
C) deficit; expand
D) none of the above

6) Which of the following would NOT be considered a typical BOP transaction?
A) Toyota U.S.A. is a U.S. distributor of automobiles manufactured in Japan by its parent company.
B) The U.S. subsidiary of European financial giant, Credit Suisse, pays dividends to its parent in Zurich.
C) A U.S. tourist purchases gifts at a museum in London.
D) All are example of BOP transactions.

True/False

1) When the world went to a system of floating exchange rates, the Balance of Payments became a relic of a system of fixed exchange rates and is no longer watched by serious economic groups.

2) Changes in the BOP may predict the imposition or removal of foreign exchange controls.

3) A country experiencing a serious trade deficit is not as likely to expand imports as it would
be if running a surplus.

Multiple Choice

1) Which of the following is NOT a part of the Current Account of BOP?
A) net export/import of goods
B) balance of trade
C) net portfolio investment
D) net export/import of services

2) Which of the following is NOT part of the Financial Account of the BOP?
A) net foreign direct investment
B) net import/export of services
C) net portfolio investment
D) other Financial items

3) Which of the following is NOT an item to be considered in BOP calculations?
A) A foreign resident purchases a U.S. Treasury Bill.
B) A U.S.-based firm manages the development of an oil field in Kazakhstan.
C) A consumer buys a VCR made in Korea from a Florida Wal-Mart store.
D) A U.S. citizen living in Minnesota travels to Winnipeg, Canada, and buys a case of LaBatt’s Canadian beer.

4) The balance of payments:
A) determines the eligibility of countries for IMF aid.
B) adds up the value of all assets and liabilities of a country on a specific date.
C) records all international transactions for a country over a period of time.
D) all of the above

5) An American tourist purchases a leather jacket while in Italy. Which of the following statements is true?
A) The leather purchase would be considered an import for the U.S. BOP.
B) This transaction would be properly accounted for in the Current Account of the U.S. BOP.
C) The leather purchase is considered an import of a good, and thus, considered part of the balance of trade as well.
D) All of these statements are true.

True/False

1) The authors identify a tip for understanding BOP accounting. They recommend that you “follow the cash flow.”

2) The BOP must be in balance, but the current account need not be.

3) Expenditures by U.S. tourists in foreign countries for foreign goods or services are factored into BOP calculations.

4) Like a balance sheet, the Balance of Payments adds up the value of all assets and liabilities
of a country on a specific date.

Essay

1) What is a country’s balance of (merchandise) trade, and why is it so widely reported in the financial and popular press?

2) What is the Official Reserves Account (ORA), and why is it more important for countries under a fixed exchange rate regime than for ones under a floating exchange rate regime?

Multiple Choice

1) Which of the following is NOT part of the balance of payments account?
A) the current account
B) the financial/capital account
C) the official reserves account
D) All of the above are BOP accounts.

2) The ________ includes all international economic transactions with income or payment flows occurring within the year.
A) capital account
B) current account
C) financial account
D) IMF account

3) If your company were to import and export textiles, the transactions would be recorded in the current account subcategory of:
A) services trade.
B) income trade.
C) goods trade.
D) current transfers.

4) The travel services provided to international travelers by United Airlines would be recorded in the current account subcategory of:
A) services trade.
B) income trade.
C) goods trade.
D) current transfers.

5) Anaconda Copper Inc. created a subsidiary in Chile last year to mine copper ore. The proportion of net income paid back to the parent company as a dividend would be recorded in the current account subcategory of:
A) services trade.
B) income trade.
C) goods trade.
D) current transfers.

6) The subcategory that typically dominates the current account is:
A) goods (merchandise) trade.
B) services trade.
C) income trade.
D) transfer accounts.

7) In 2010 the United States posted a current account deficit of -$471 billion. The bulk of the negative value came from:
A) a net transfer deficit.
B) an income balance deficit.
C) a goods trade deficit.
D) an income trade deficit.

8) Over the last two decades the surplus on U.S. services trade has typically been ________ the deficit on U.S. goods trade.
A) greater than
B) equal to
C) less than
D) The relationship is constantly shifting from greater than to less than.

True/False

1) Because current and financial/capital account balances use double-entry bookkeeping it is unusual to find serious discrepancies in the debits and credits.

2) In general, as a country’s income increases, so does the demand for imports.

3) For at least the last decade, the United States has consistently run a surplus in services trade income.

4) Expenditures by U.S. students abroad and foreign students pursuing studies in the United States would be considered a services trade and part of the U.S. current account.

Multiple Choice

1) The ________ of the balance of payments measures all international economic transactions of financial assets.
A) current account
B) merchandise trade account
C) services account
D) capital and financial accounts

2) The financial account consists COMPLETELY of which four components?
A) stock investment, bond investment, derivative investment, and mutual fund investment
B) direct investment, stock investment, net financial derivatives, and bond investment
C) direct investment, portfolio investment, net financial derivatives, and other asset investment
D) mutual fund investment, portfolio investment, derivative investment, and stock investment

3) When categorizing investments for the financial account component of the balance of payments the ________ is an investment where the investor has no control whereas the ________ is an investment where the investor has control over the asset.
A) direct investment; portfolio investment
B) direct investment; indirect investment
C) portfolio investment; indirect investment
D) portfolio investment; direct investment

4) In general there is consensus that ________ should be free, but there is no such consensus that ________ should be free.
A) international investment; international goods trade
B) international investment; international trade
C) international trade; international goods trade
D) international trade; international investment

5) The two major concerns about foreign direct investment are:
A) national defense and taxes.
B) who controls the assets and who receives the profits.
C) who receives the profits and taxes.
D) who pays the taxes and who receives the taxes.

6) Portfolio investment is capital invested in activities that are ________ rather than made for ________.
A) short term; the long term
B) long term; profit
C) profit motivated; control
D) control motivated; profit

7) Under an international regime of fixed exchange rates, countries with a BOP ________ should consider ________ their currency while countries with a BOP ________ should consider ________ their currency.
A) deficit, revaluing; surplus, revaluing
B) deficit, devaluing; surplus, devaluing
C) surplus, devaluing; deficit, revaluing
D) surplus, revaluing; deficit, devaluing

8) Consider the following: A foreign automobile company builds a manufacturing plant in Tennessee and European investors buy U.S. Treasury Bonds.
A) Both activities would be considered direct investment.
B) Both activities would be considered portfolio investment.
C) The auto manufacturer in engaging in portfolio investment, and the European investors are engaged in direct investing.
D) The auto manufacturer in engaging in direct investment, and the European investors are engaged in portfolio investing.

True/False

1) International debt security purchases and sales are defined as portfolio investments for financial account purposes because by definition debt securities do not provide the buyer with ownership or control.

2) Significant amounts of United States Treasury issues are purchased by foreign investors, therefore the U.S. must earn foreign currency to repay this debt.

3) In the United States and most developed countries, the current account and the combined financial/capital accounts tend to be inversely related in that when one is positive, the other tends to be negative.

Multiple Choice

1) China is currently experiencing a surplus in its current account and its capital/financial accounts. Which of the following is NOT a contributing factor for this unusual situation?
A) The exceptional growth in the Chinese economy contributes to the current account surplus.
B) The positive prospects for China’s continued growth contribute to the capital/financial account surplus.
C) China’s inevitable acquisition of Taiwan is driving the market for Chinese investment.
D) All of the above are contributing factors for China’s twins surpluses.

2) If China wished to reduce their accumulation of foreign exchange reserves they could:
A) allow their currency, the yuan, to float freely in the market place.
B) reduce their current account surplus by importing more goods than they export.
C) undertake both of the activities identified in choices A and B.
D) dig a big hole and bury the reserves.

True/False

1) The biggest problem that China faces in maintaining a stable value for their currency, the yuan, is their lack of foreign exchange reserves.

2) As of year-end 2010, the United States still held the world’s largest foreign exchange reserve, but the total was rapidly being approached by China.

3) China’s current political plan includes reducing their foreign exchange reserve balance by allowing the yuan to float freely and by switching their goods balance from one of a net surplus to a net deficit.

4.6 The Balance of Payments in Total

Multiple Choice

1) The largest single component of the United States current account is:
A) current transfers.
B) income payments and receipts.
C) goods (merchandise) imports and exports.
D) services imports and exports.

2) Which of the following statements about the balance of payments is NOT true?
A) The BOP is the summary statement of all international transactions between one country and all other countries.
B) The BOP is a flow statement, summarizing all international transactions that occur across the geographic borders over a period of time, typically a year.
C) Although the BOP must always balance in theory, in practice there are substantial imbalances as a result of statistical errors and misreporting of current account and financial account flows.
D) All of the above are true.

True/False

1) An excess of merchandise exports over merchandise imports results in a balance of trade deficit.

2) The BOP should always balance.

3) The transition to floating exchange rate regimes in the 1970s (described in Chapter 3) changed the focus from the total BOP to its various subaccount like the current and financial account balances.

4.7 The Balance of Payments Interaction with Key Macroeconomic Variables

Multiple Choice

1) Use the following terms for this question:
C = consumption
I = capital investment spending
G = government spending
X = exports of goods and services
M = imports of goods and services
BOP = balance of payments
GDP = gross domestic product
NPV = net present value
INF = inflation
R = real rate of return

The static equation for the nations GDP is:
A) GDP = C + I + G + (X + M ) × INF
B) GDP = C + I + G + X + M
C) GDP = C + I + G + X – M
D) GDP = C + I + X – M + R

2) Imports have the potential to lower a country’s inflation rate because of each of the following EXCEPT:
A) the import of lower priced goods limits what domestic competitors can charge for goods.
B) the import of lower priced services limits what domestic competitors can charge for services.
C) the higher prices of foreign goods spurs domestic competitors to cut prices.
D) all of the above

3) Under a fixed exchange rate system, the government bears the responsibility to ensure that the BOP is near zero. If the sum of the current and capital accounts do not approximate zero, the government is expected to intervene in the foreign exchange market by buying or selling official foreign exchange reserves. If the sum of the first two accounts is GREATER THAN ZERO, a ________ demand for the domestic currency exists in the world. To preserve the fixed exchange rate, the government must then intervene in the foreign exchange market and ________ domestic currency for foreign currencies or gold so as to bring the BOP back near zero.
A) surplus; sell
B) surplus; buy
C) deficit; sell
D) deficit; buy

4) Under a fixed exchange rate system, the government bears the responsibility to ensure that the BOP is near zero. If the sum of the current and capital accounts do not approximate zero, the government is expected to intervene in the foreign exchange market by buying or selling official foreign exchange reserves. If the sum of the first two accounts is LESS THAN ZERO, a ________ demand for the domestic currency exists in the world. To preserve the fixed exchange rate, the government must then intervene in the foreign exchange market and ________ domestic currency for foreign currencies or gold so as to bring the BOP back near zero.
A) surplus; sell
B) surplus; buy
C) deficit; sell
D) deficit; buy

True/False

1) An increase in GDP should lead to a decrease in imports.

2) The effect of an imbalance in the BOP is the same for countries on a fixed exchange rate regime as for those on a floating exchange rate regime.

3) Under a floating exchange rate system, the government bears the responsibility to ensure that the BOP is near zero.

4) A country with a managed float that wishes to WEAKEN its currency may choose to raise domestic interest rates to attract additional capital from abroad.

5) A country’s overall level of interest rates should have an impact on the financial account of the BOP. Relatively low real interest rates should normally stimulate an outflow of capital seeking higher interest rates in other country currencies.

6) Imports have the potential to lower a country’s inflation rate. In particular, imports of HIGHER-priced goods and services place a limit on what domestic competitors charge for comparable goods and services.

4.8 Trade Balances and Exchange Rates

Multiple Choice

1) Of the following, which is NOT a part of J-Curve adjustment path?
A) the currency contract period
B) the exchange rate pass-through period
C) the quantity adjustment period
D) Each of the above is part of the J-Curve adjustment path.

2) Which of the following is NOT likely to occur in the quantity adjustment phase of the J-Curve adjustment path?
A) Imports become relatively more expensive.
B) Exports become relatively less expensive.
C) The balance of trade gets worse.
D) All of the above are true.

True/False

1) When a currency is devalued the immediate impact may be an increase in a country’s trade deficit. However, this situation tends to correct itself in 2 to 5 weeks.

Comment: This situation tends to correct itself in 3 to 12 MONTHS or more.

4.9 Capital Mobility

Multiple Choice

1) The authors identify four distinct periods of capital mobility since 1860. Which do they term as a “period of global economic destruction”?
A) 1860 – 1914
B) 1914 – 1945
C) 1945 – 1971
D) 1971 – 2007

2) ________ is the cross-border purchase of assets that are then managed in a way that hides the movement of money and its ownership.
A) Capital flight
B) Capital mobility
C) Irrational exuberance
D) Money laundering

3) This was an era dominated by industrialized nation economies that were dependent on gold convertibility to maintain confidence in the system.
A) The Gold Standard, 1860-1914
B) The Interwar Years , 1914-1945
C) The Bretton Woods Era, 1945-1971
D) The Floating Era, 1971-1997

4) This dollar-based fixed exchange rate system gave rise to a long period of economic recovery and growing openness of both international trade and capital flows in and out of more and more countries.
A) The Gold Standard, 1860-1914
B) The Interwar Years , 1914-1945
C) The Bretton Woods Era, 1945-1971
D) The Floating Era, 1971-1997

5) An era of retrenchment, in which major economic powers returned to policies of isolationism and protectionism, restricting trade and nearly eliminating capital mobility.
A) The Gold Standard, 1860-1914
B) The Interwar Years , 1914-1945
C) The Bretton Woods Era, 1945-1971
D) The Floating Era, 1971-1997

6) A ________ is any restriction that limits or alters the rate or direction of capital movement into or out of a country.
A) capital budget
B) capital control
C) balance of trade deficit
D) balance of trade surplus

True/False

1) The Bretton Woods era realized a great expansion of international trade in goods and services.

Essay/Short Answer

1) Dutch Disease is a term applied to a problem in the 1970 whereby the Netherlands were experiencing massive and sudden inflows of capital from abroad. What was the cause of this sudden influx of capital, and what types of potential problems did it have for the Dutch or could it have for any small single resource country?

ECO 410 Week 4 Quiz

Chapter 5 The Continuing Global Financial Crisis

5.1 The Credit Crisis of 2008-2009

Multiple Choice

1) Investment banks and stock brokerages have traditionally been regulated by the:
A) Federal Reserve System (FED).
B) Federal Deposit Insurance Corporation (FDIC).
C) Securities and Exchange Commission (SEC).
D) Internal Revenue Service (IRS).

2) The Glass-Steagall Act of 1933:
A) separated commercial banking activities from investment banking activities.
B) created the Federal Reserve System.
C) developed the system of commercial bank deposit insurance.
D) all of the above

3) Which of the following is NOT another term for a prime mortgage loan?
A) conventional loan
B) top-qual loan
C) conforming loan
D) All of the above are suitable terms for a prime mortgage loan.

4) The process of turning an illiquid asset into a liquid saleable asset is called:
A) swapping.
B) wrapping.
C) securitization.
D) creationism.

5) Asset-backed securities (ABSs) may be securitized based on:
A) auto loans.
B) home-equity loans.
C) credit card receivables.
D) all of the above

6) A ________ is a financial intermediation device that allowed the participant to borrow short and lend long.
A) sub-prime loan
B) structured investment vehicle
C) non-conforming loan
D) all of the above

7) A ________ is a securitized financial instrument that is sold to the market in tranches representing different levels of default risk.
A) guaranteed security asset (GSA)
B) mortgaged backed security (MBS)
C) credit default swap (CDS)
D) collateralized debt obligation (CDO)

8) Which of the following statements concerning credit default swaps is FALSE?
A) As of year-end 2008, CDSs are completely outside of regulatory boundaries.
B) A CDS is a derivative security that may be used for hedging risk or for speculative purposes.
C) In order be a party to a CDO, at least one of either the buyer or seller must own the underlying asset.
D) CDSs allow banks to severe their links to their borrowers, thereby reducing their incentive to screen and monitor the ability of borrowers to repay.

9) ________ is the method of making investments more attractive to prospective buyers by reducing their perceived risk.
A) Subordination
B) Credit enhancement
C) Derivation
D) Deregulation

True/False

1) Mortgage loans in the U.S. are classified by risk into one of three types: prime, alt-A, and sub-prime.

2) Alt-A mortgage loans are NOT eligible for sale to GSEs such as Fannie Mae or Freddie Mac.

3) The Gramm-Leach-Bliley Financial Services Modernization Act of 1999 explicitly allowed corporate combinations of commercial banks with other types of financial institutions such as insurance companies and investment banking firms.

4) Subprime mortgages did not exceed 8% of all outstanding mortgage obligations by 2007, but by the end of 2008 they were the source of 65% of bankruptcy filings by homeowners in the United States.

5) Even though household debt as a percentage of disposable income rose rapidly in the United States in early 2000s, the rate was even greater in Britain, topping out at over 170% in 2008.

6) From 1990 through 2007, the amount of securitized loans outstanding dropped from over $25 trillion to less than $5 trillion and was a key element in the loss of market liquidity.

7) It is pretty clear after reading this chapter that securitization in and of itself is a poor financial idea.

8) Securitization may degrade credit quality because the process severs the link of lending and repayment (risk and reward) between the originator of the loan and the borrower.

9) The authors make it clear that the main source of market failure with collateralized debt obligations lay almost exclusively with the rating agencies.

10) Credit Default Swaps are highly regulated financial instruments as a result of the Commodity Futures Modernization Act of 2000.

Essay/Short Answer

1) What is a Collateralized Debt Obligation (CDO)? In your answer explain how CDOs are generally separated into one of three tranches. What types of mistakes were made by security rating agencies that contributed to the collapse of the CDO market?

5.2 Global Contagion

Multiple Choice

1) Which of the following is NOT identified by the authors as a “safe-haven” currency?
A) the euro
B) the British pound
C) the U.S. dollar
D) the Japanese yen

2) The accounting procedure whereby assets are revalued to market value basis on a daily basis is known as:
A) FASB rule 62.
B) market value accounting.
C) marked-to-market.
D) none of the above

3) The typical TED spread, the difference between the LIBOR and the interest rate swap index, is typically about ________ basis points.
A) 350
B) 180
C) 120
D) 80

4) The three stages of the global credit crisis of 2009-2009 were:
A) 1. The failure of commercial and investment financial institutions, 2. the failure of specific mortgage-backed securities, 3. a credit-induced global recession.
B) 1. The failure of specific mortgage-backed securities, 2. the failure of commercial and investment financial institutions, and 3. a credit-induced global recession.
C) 1. The failure of commercial and investment financial institutions, 2. a credit-induced global recession, 3. the failure of specific mortgage-backed securities credit-induced global recession.
D) 1. The failure of specific mortgage-backed securities, 2. a credit-induced global recession, 3. failure of commercial and investment financial institutions.

5) The British Bankers Association (BBA) estimates that LIBOR was used in the pricing of more than ________ in assets globally.
A) $100 billion
B) $360 billion
C) $360 trillion
D) $100 trillion

6) Which of the following pieces of U.S. legislation was developed and passed in response to the 2008-2009 international credit crisis?
A) Gramm-Leach-Bliley Financial Services Modernization Act
B) Dodd-Frank Wall Street Reform and Consumer Protection Act
C) Depository Institutions Deregulation and Monetary Control Act
D) The Glass-Steagall Act

True/False

1) Bear-Stearns is the largest single bankruptcy in U.S. history.

2) The international credit crisis began in full force in September 2008.

3) Near the end of the U.S. housing boom, many of the mortgages classified as Alt-A were in fact sub-prime.

4) LIBOR stand for the London Interbank Offered Rate.

5) The credit crisis was worsened by the destabilizing effects of speculators, in a variety of different institutions, betting that particular instruments or markets or securities would fail.

Essay/Short Answer

1) What is TARP? Provide an argument for why TARP was necessary and successful.

5.3 The European Debt Crisis of 2009-2012

Multiple Choice

1) Portfolio theory relies on combining assets with ________ return correlation exclusively to reduce risk.
A) highly positive
B) low
C) zero
D) none of the above

2) Future financial market regulation must include all of the following EXCEPT:
A) renewed regulatory requirements.
B) increased reporting.
C) greater transparency in pricing and valuation.
D) Regulation must include all of the above.

3) In finance, a liquid asset:
A) sells quickly.
B) sells at or near its market value.
C) both A and B
D) none of the above

4) Debt issued by the national government is called:
A) debenture debt.
B) municipal debt.
C) sovereign debt.
D) none of the above

5) The member nations of the European Union have relative freedom to set their own fiscal policies EXCEPT for which of the following?
A) government spending
B) government taxation
C) government surpluses or deficits
D) government printing of the euro currency

6) When the EU moved to a single currency with the adoption of the euro, its member states agreed to each of the following EXCEPT:
A) a single currency.
B) control of their own money supply.
C) free movement of capital in and out of their economies.
D) In fact, the member states agreed to ALL of the above.

7) As of 2011, the European countries with the highest debt/GDP ratio were, in order:
A) Greece, Italy, Portugal, and Slovenia.
B) Greece, Italy, France, and Germany.
C) Greece, Italy, Ireland, and Portugal.
D) Greece, Italy, Great Britain, and Portugal.

8) In October 2009, the new government of Greece estimated the size of the 2009 government budget deficit as 12.7% of GDP rather than the previously published:
A) 3.4%.
B) 6.7%.
C) 8.6%.
D) 10.2%.

True/False

1) The authors conclude the chapter with a specific road map for future financial regulation.

2) Baring the (hopefully temporary setback of 2008) capital is more mobile today than ever before.

3) Securitization is likely to be declared illegal in the U.S. though it may still exist elsewhere in the world.

4) Every EU member nation has the right to simply print more euros.

5) The members of the EU’s eurozone (euro participants) do NOT have the ability to conduct independent monetary policy.

6) The European Financial Stability Facility (EFSF) has a mandate to safeguard financial stability in Europe by providing financial assistance to euro area Member States.

7) Ireland and Greece had the same issues lead to their financial crises in 2009. In each case, the previous government had dramatically understated the size of their federal budget deficit as a percentage of GDP.

Chapter 6 The Foreign Exchange Theory and Markets

6.1 Geographical Extent of the Foreign Exchange Market

Multiple Choice

1) Which of the following is NOT true regarding the market for foreign exchange?
A) The market provides the physical and institutional structure through which the money of one country is exchanged for another.
B) The rate of exchange is determined in the market.
C) Foreign exchange transactions are physically completed in the foreign exchange market.
D) All of the above are true.

2) A/An ________ is an agreement between a buyer and seller that a fixed amount of one currency will be delivered at a specified rate for some other currency.
A) Eurodollar transaction
B) import/export exchange
C) foreign exchange transaction
D) interbank market transaction

3) While trading in foreign exchange takes place worldwide, the major currency trading centers are located in:
A) London, New York, and Tokyo.
B) New York, Zurich, and Bahrain.
C) Paris, Frankfurt, and London.
D) Los Angeles, New York, and London.

True/False

1) Because the market for foreign exchange is worldwide, the volume of foreign exchange currency transactions is level throughout the 24-hour day.

2) Business firms in countries with exchange controls, for example, China (mainland), often must surrender foreign exchange earned from exports to the central bank at the daily fixing price.

Essay

1) Define spot, forward, and swap transactions in the foreign exchange market and give an example of how each could be used.

6.2 Functions of the Foreign Exchange Market

Multiple Choice

1) The ________ is the mechanism by which participants transfer purchasing power between countries, obtain or provide credit for international trade transactions, and minimize exposure to the risks of exchange rate changes.
A) futures market
B) federal open market
C) foreign exchange market
D) LIBOR

2) Which of the following is NOT a motivation identified by the authors as a function of the foreign exchange market?
A) the transfer of purchasing power between countries
B) obtaining or providing credit for international trade transactions
C) minimizing the risks of exchange rate changes
D) All of the above were identified as functions of the foreign exchange market.

True/False

1) Foreign exchange markets are a relatively recent phenomenon, beginning with the agreement at Bretton Woods.

6.3 Market Participants

Multiple Choice

1) The authors identify two tiers of foreign exchange markets:
A) bank and nonbank foreign exchange.
B) commercial and investment transactions.
C) interbank and client markets.
D) client and retail market.

2) It is characteristic of foreign exchange dealers to:
A) bring buyers and sellers of currencies together but never to buy and hold an inventory of currency for resale.
B) act as market makers, willing to buy and sell the currencies in which they specialize.
C) trade only with clients in the retail market and never operate in the wholesale market for foreign exchange.
D) All of the above are characteristics of foreign exchange dealers.

3) Which of the following may be participants in the foreign exchange markets?
A) bank and nonbank foreign exchange dealers
B) central banks and treasuries
C) speculators and arbitrageurs
D) all of the above

4) ________ seek to profit from trading in the market itself rather than having the foreign exchange transaction being incidental to the execution of a commercial or investment transaction.
A) Speculators and arbitrageurs
B) Foreign exchange brokers
C) Central banks
D) Treasuries

5) In the foreign exchange market, ________ seek all of their profit from exchange rate changes while ________ seek to profit from simultaneous exchange rate differences in different markets.
A) wholesalers; retailers
B) central banks; treasuries
C) speculators; arbitrageurs
D) dealers; brokers

6) Foreign exchange ________ earn a profit by a bid-ask spread on currencies they purchase and sell. Foreign exchange ________, on the other hand, earn a profit by bringing together buyers and sellers of foreign currencies and earning a commission on each sale and purchase.
A) central banks; treasuries
B) dealers; brokers
C) brokers; dealers
D) speculators; arbitrageurs

7) ________ are agents who facilitate trading between dealers without themselves becoming principals in the transaction.
A) Central banks
B) Foreign exchange brokers
C) Arbitrageurs
D) Foreign exchange dealers

True/False

1) Dealers in foreign exchange departments at large international banks act as market makers and maintain inventories of the securities in which they specialize.

2) Currency trading lacks profitability for large commercial and investment banks but is maintained as a service for corporate and institutional customers.

3) The primary motive of foreign exchange activities by most central banks is profit.

4) Banks, and a few nonbank foreign exchange dealers, operate ONLY in the interbank markets.

5) Dealers in the foreign exchange departments of large international banks often function as “market makers.” Such dealers stand willing at all times to buy and sell those currencies in which they specialize and thus maintain an “inventory” position in those currencies.

6) Currency trading is a service center rather than a profit center for commercial and investment banks.

7) For individuals and firms involved in the import and export of goods and services ,using the foreign exchange market is necessary, but incidental, to their underlying commercial or investment purpose.

Essay/Short Answer

1) What are some of the reasons central banks and treasuries enter the foreign exchange markets, and in what important ways are they different from other foreign exchange participants?

6.4 Transactions in the Foreign Exchange Market

Multiple Choice

1) ________ are NOT one of the three categories reported for foreign exchange.
A) Spot transactions
B) Swap transactions
C) Strip transactions
D) Futures transactions

2) The greatest amount of foreign exchange trading takes place in the following three cities:
A) New York, London, and Tokyo.
B) New York, Singapore, and Zurich.
C) London, Frankfurt, and Paris.
D) London, Tokyo, and Zurich.

3) The four currencies that constitute about 80% of all foreign exchange trading are:
A) U.K pound, Chinese yuan, euro, and Japanese yen.
B) U.S. dollar, euro, Chinese yuan, and U.K. pound.
C) U.S. dollar, Japanese yen, euro, and U.K. pound.
D) U.S. dollar, U.K. pound, yen, and Chinese yuan.

4) A ________ transaction in the foreign exchange market requires an almost immediate delivery (typically within two days) of foreign exchange.
A) spot
B) forward
C) futures
D) none of the above

5) A ________ transaction in the foreign exchange market requires delivery of foreign exchange at some future date.
A) spot
B) forward
C) swap
D) currency

6) A forward contract to deliver British pounds for U.S. dollars could be described either as ________ or ________.
A) buying dollars forward; buying pounds forward
B) selling pounds forward; selling dollars forward
C) selling pounds forward; buying dollars forward
D) selling dollars forward; buying pounds forward

7) A common type of swap transaction in the foreign exchange market is the ________ where the dealer buys the currency in the spot market and sells the same amount back to the same bank in the forward market.
A) “forward against spot”
B) “forspot”
C) “repurchase agreement”
D) “spot against forward”

8) The ________ is a derivative forward contract that was created in the 1990s. It has the same characteristics and documentation requirements as traditional forward contracts except that they are only settled in U.S. dollars and the foreign currency involved in the transaction is not delivered.
A) nondeliverable forward
B) dollar only forward
C) virtual forward
D) internet forward

9) Which of the following is NOT true regarding nondeliverable forward (NDF) contracts?
A) NDFs are used primarily for emerging market currencies.
B) Pricing of NDFs reflects basic interest rate differentials plus an additional premium charged for dollar settlement.
C) NDFs can only be traded by central banks.
D) All of the above are true.

10) A ________ transaction in the interbank market is the simultaneous purchase and sale of a given amount of foreign exchange for two different value dates.
A) spot
B) forward-forward
C) swap
D) futures

True/False

1) A spot transaction in the interbank market for foreign exchange would typically involve a two-day delay in the actual delivery of the currencies, while such a transaction between a bank and its commercial customer would not necessarily involve a two-day wait.

2) Swap and forward transactions account for an insignificant portion of the foreign exchange market.

3) Nondeliverable Forwards were originally envisioned as a method of currency speculation, but it is now estimated that 70% of NDFs are trading for hedging purposes.

4) In general, NDF markets normally develop for country currencies having large cross-border capital movements, but still subject to convertibility restrictions.

5) NDFs are traded and settled inside the country of the subject currency, and therefore are within the control of the country’s government.

6) A contract to deliver dollars for euros in six months is both “buying euros forward for dollars” and “selling dollars forward for euros.”

6.5 Size of the Foreign Exchange Market

Multiple Choice

1) Daily trading volume in the foreign exchange market was about ________ per ________ in 2010.
A) $3,200 billion; month
B) $1,000 billion; month
C) $3,200 billion; day
D) $1,000 billion; day

2) The greatest volume of daily foreign exchange transactions are:
A) spot transactions.
B) forward transactions.
C) swap transactions.
D) This question is inappropriate because the volume of transactions are approximately equal across the three categories above.

3) The United Kingdom and United States together make up nearly ________ of daily currency trading.
A) 25%
B) 35%
C) 45%
D) 55%

4) The top three currency pairs traded with the U.S. dollar are:
A) U.K. pound, Chinese Yuan, Japanese yen.
B) Swiss franc, euro, Japanese yen.
C) U.K. pound, euro, Japanese yen.
D) euro, Chinese Yuan, Japanese yen.

True/False

1) As you might expect, the foreign exchange daily trading volume in in New York City is roughly twice as large as the daily trading volume in London.

2) The low level of interest rates around the globe in recent years, combined with slowing economic growth and new debt issuances, has had a dampening impact on the swap market.

3) Since the global financial crisis of 2008-2009, the Chinese renminbi (yuan) has become the most widely traded currency with the U.S. dollar surpassing the euro, yen, and pound as dollar trading pairs.

6.6 Foreign Exchange Rates and Quotations

Multiple Choice

1) A foreign exchange ________ is the price of one currency expressed in terms of another currency. A foreign exchange ________ is a willingness to buy or sell at the announced rate.
A) quote; rate
B) quote; quote
C) rate; quote
D) rate; rate

2) Most foreign exchange transactions are through the U.S. dollar. If the transaction is expressed as the foreign currency per dollar this known as ________ whereas ________ are expressed as dollars per foreign unit.
A) European terms; indirect
B) American terms; direct
C) American terms; European terms
D) European terms; American terms

3) The following is an example of an American term foreign exchange quote:
A) $20/£
B) €0.85/$
C) ¥100/€
D) none of the above

4) American and British meanings differ for the word billion. Therefore, when traders refer to an American billion, they call it a/an:
A) Kiwi.
B) Loony.
C) Uncle Sam.
D) Yard.

5) From the viewpoint of a British investor, which of the following would be a direct quote in the foreign exchange market?
A) SF2.40/£
B) $1.50/£
C) £0.55/€
D) $0.90/€

6) A/an ________ quote in the United States would be foreign units per dollar, while a/an ________ quote would be in dollars per foreign currency unit.
A) direct; direct
B) direct; indirect
C) indirect; indirect
D) indirect; direct

7) If the direct quote for a U.S. investor for British pounds is $1.43/£, then the indirect quote for the U.S. investor would be ________ and the direct quote for the British investor would be ________.
A) £0.699/$; £0.699/$
B) $0.699/£; £0.699/$
C) £1.43/£; £0.699/$
D) £0.699/$; $1.43/£

8) ________ make money on currency exchanges by the difference between the ________ price, or the price they offer to pay, and the ________ price, or the price at which they offer to sell the currency.
A) Dealers; ask; bid
B) Dealers; bid; ask
C) Brokers; ask; bid
D) Brokers; bid; ask

TABLE 6.1
Use the table to answer following question(s).

9) Refer to Table 6.1. The current spot rate of dollars per pound as quoted in a newspaper is ________ or ________.
A) £1.4484/$; $0.6904/£
B) $1.4481/£; £0.6906/$
C) $1.4484/£; £0.6904/$
D) £1.4487/$; $0.6903/£

10) Refer to Table 6.1. The one-month forward bid price for dollars as denominated in Japanese yen is:
A) -¥20.
B) -¥18.
C) ¥129.74/$.
D) ¥129.62/$.

11) Refer to Table 6.1. The ask price for the two-year swap for a British pound is:
A) $1.4250/£.
B) $1.4257/£.
C) -$230.
D) -$238.

12) Refer to Table 6.1. According to the information provided in the table, the 6-month yen is selling at a forward ________ of approximately ________ per annum. (Use the mid rates to make your calculations.)
A) discount; 2.09%
B) discount; 2.06%
C) premium; 2.09%
D) premium; 2.06%

13) Given the following exchange rates, which of the multiple-choice choices represents a potentially profitable intermarket arbitrage opportunity?
¥129.87/$
€1.1226/$
€0.00864/¥
A) ¥115.69/€
B) ¥114.96/€
C) $0.8908/€
D) $0.0077/¥

14) The U.S. dollar suddenly changes in value against the euro moving from an exchange rate of $0.8909/euro to $0.08709/€. Thus, the dollar has ________ by ________.
A) appreciated; 2.30%
B) depreciated; 2.30%
C) appreciated; 2.24%
D) depreciated; 2.24%

15) A German firm is attempting to determine the euro/pound exchange rate and has the following exchange rate information: USD/pound = $1.5509/£ and the USD/euro rate = $1.2194/€. Therefore, the euro/pound rate must be:
A) £1.2719/€.
B) €1.2719/£.
C) €0.7316/£.
D) €0.7863/£.

True/False

1) The European and American terms for foreign currency exchange are square roots of one another.

2) When the cross rate for currencies offered by two banks differs from the exchange rate offered by a third bank, a triangular arbitrage opportunity exists.

3) Most transactions in the interbank foreign exchange trading are primarily conducted via telecommunication techniques and little is conducted face-to-face.

4) A confusing “quirk” of international exchange rates occurs when calculating the percentage change in spot rates from one period to another. The percent change in the spot rate from one period to another when quoted using foreign currency terms is always greater than the percent changes quoted when using home currency terms.

ECO 410 Week 5 Quiz Solution

Chapter 7 International Parity Conditions

7.1 Prices and Exchange Rates

Multiple Choice

1) If an identical product can be sold in two different markets, and no restrictions exist on the sale or transportation costs, the product’s price should be the same in both markets. This is known as:
A) relative purchasing power parity.
B) interest rate parity.
C) the law of one price.
D) equilibrium.

2) The Economist publishes annually the “Big Mac Index” by which they compare the prices of the McDonald’s Corporation’s Big Mac hamburger around the world. The index estimates the exchange rates for currencies based on the assumption that the burgers in question are the same across the world and therefore, the price should be the same. If a Big Mac costs $2.54 in the United States and 294 yen in Japan, what is the estimated exchange rate of yen per dollar as hypothesized by the Hamburger index?
A) $0.0086/¥
B) ¥124/$
C) $0.0081/¥
D) ¥115.75/$

3) If the current exchange rate is 113 Japanese yen per U.S. dollar, the price of a Big Mac hamburger in the United States is $3.41, and the price of a Big Mac hamburger in Japan is 280 yen, then other things equal, the Big Mac hamburger in Japan is:
A) correctly priced.
B) under priced.
C) over priced.
D) There is not enough information to determine if the price is appropriate or not.

4) The price of a Big Mac in the U.S. is $3.41 and the price in Mexico is Peso 29.0. What is the implied PPP of the Peso per dollar?
A) Peso 8.50/$1
B) Peso 10.8/$1
C) Peso 11.76/$1
D) None of the above

5) Assume the implied PPP rate of exchange of Mexican Pesos per U.S. dollar is 8.50 according to the Big Mac Index. Further, assume the current exchange rate is Peso 10.80/$1. Thus, according to PPP and the Law of One Price, at the current exchange rate the peso is:
A) overvalued.
B) undervalued.
C) correctly valued.
D) There is not enough information to answer this question.

6) According to the Big Mac Index, the implied PPP exchange rate is Mexican peso 8.50/$1 but the actual exchange rate is peso10.80/$1. Thus, at current exchange rates the peso appears to be ________ by ________.
A) overvalued; approximately 21%
B) overvalued; approximately 27%
C) undervalued; approximately 21%
D) undervalued; approximately 27%

7) Other things equal, and assuming efficient markets, if a Honda Accord costs $24,682 in the U.S., then at an exchange rate of $1.57/£, the Honda Accord should cost ________ in Great Britain.
A) £24,682
B) £38,751
C) £10,795
D) £15,721

8) One year ago the spot rate of U.S. dollars for Canadian dollars was $1/C$1. Since that time the rate of inflation in the U.S. has been 4% greater than that in Canada. Based on the theory of Relative PPP, the current spot exchange rate of U.S. dollars for Canadian dollars should be approximately:
A) $0.96/C$
B) $1/C$
C) $1.04/C$
D) Relative PPP provides no guide for this type of question.

9) ________ states that differential rates of inflation between two countries tend to be offset over time by an equal but opposite change in the spot exchange rate.
A) The Fisher Effect
B) The International Fisher Effect
C) Absolute Purchasing Power Parity
D) Relative Purchasing Power Parity

10) Two general conclusions can be made from the empirical tests of purchasing power parity (PPP):
A) PPP holds up well over the short run but poorly for the long run, and the theory holds better for countries with relatively low rates of inflation.
B) PPP holds up well over the short run but poorly for the long run, and the theory holds better for countries with relatively high rates of inflation.
C) PPP holds up well over the long run but poorly for the short run, and the theory holds better for countries with relatively low rates of inflation.
D) PPP holds up well over the long run but poorly for the short run, and the theory holds better for countries with relatively high rates of inflation.

11) A country’s currency that strengthened relative to another country’s currency by more than that justified by the differential in inflation is said to be ________ in terms of PPP.
A) overvalued
B) over compensating
C) undervalued
D) under compensating

12) If we set the real effective exchange rate index between Canada and the United States equal to 100 in 1998, and find that the U.S. dollar has risen to a value of 112.6, then from a competitive perspective the U.S. dollar is:
A) overvalued.
B) undervalued.
C) very competitive.
D) There is not enough information to answer this question.

13) If we set the real effective exchange rate index between the United Kingdom and the United States equal to 100 in 2005, and find that the U.S. dollar has changed to a value of 91.4, then from a competitive perspective the U.S. dollar is:
A) overvalued.
B) undervalued.
C) equally valued.
D) There is not enough information to answer this question.

14) The government just released international exchange rate statistics and reported that the real effective exchange rate index for the U.S. dollar vs the Japanese yen decreased from 105 last year to 95 currently and is expected to fall still further in the coming year. Other things equal U.S. ________ to/from Japan think this is good news and U.S. ________ to/from Japan think this is bad news.
A) importers; exporters
B) importers; importers
C) exporters; exporters
D) exporters; importers

True/False

1) If a market basket of goods cost $100 is the US and €70 in France, then the PPP exchange rate would be $.70/€.

2) The assumptions for relative PPP are more rigid than the assumptions for absolute PPP.

3) Empirical tests prove that PPP is an accurate predictor of future exchange rates.

4) Consider the price elasticity of demand. If a product has price elasticity less than one it is considered to have relatively elastic demand.

Essay

1) The authors state that empirical tests of purchasing power parity “have, for the most part, not proved PPP to be accurate in predicting future exchange rates.” The authors then state that PPP does hold up reasonably well in two situations. What are some reasons why PPP does not accurately predict future exchange rates, and under what conditions might we reasonably expect PPP to hold?

7.2 Exchange Rate Pass-Through

Multiple Choice

1) ________ states that nominal interest rates in each country are equal to the required real rate of return plus compensation for expected inflation.
A) Absolute PPP
B) Relative PPP
C) The Law of One Price
D) The Fisher Effect

2) In its approximate form the Fisher effect may be written as ________. Where: i = the nominal rate of interest, r = the real rate of return and π = the expected rate of inflation.
A) i = (r)(π)
B) i = r + π + (r)(π)
C) i = r + π
D) i = r + 2π

3) Assume a nominal interest rate on one-year U.S. Treasury Bills of 2.60% and a real rate of interest of 1.00%. Using the Fisher Effect Equation, what is the approximate expected rate of inflation in the U.S. over the next year?
A) 2.10%
B) 2.05%
C) 1.60%
D) 1.00%

4) Assume a nominal interest rate on one-year U.S. Treasury Bills of 3.80% and a real rate of interest of 2.00%. Using the Fisher Effect Equation, what is the exact expected rate of inflation in the U.S. over the next year?
A) 1.84%
B) 1.80%
C) 1.76%
D) 1.72%

5) The relationship between the percentage change in the spot exchange rate over time and the differential between comparable interest rates in different national capital markets is known as:
A) absolute PPP.
B) the law of one price.
C) relative PPP.
D) the international Fisher Effect.

6) According to the international Fisher Effect, if an investor purchases a five-year U.S. bond that has an annual interest rate of 5% rather than a comparable British bond that has an annual interest rate of 6%, then the investor must be expecting the ________ to ________ at a rate of at least 1% per year over the next 5 years.
A) British pound; appreciate
B) British pound; revalue
C) U.S. dollar; appreciate
D) U.S. dollar; depreciate

7) ________ states that the spot exchange rate should change in an equal amount but in the opposite direction to the difference in interest rates between two countries.
A) Fisher-open
B) Fisher-closed
C) The Fisher Effect
D) none of the above

8) Exchange rate pass-through may be defined as:
A) the bid/ask spread on currency exchange rate transactions.
B) the degree to which the prices of imported and exported goods change as a result of exchange rate changes.
C) the PPP of lesser-developed countries.
D) the practice by Great Britain of maintaining the relative strength of the currencies of the Commonwealth countries under the current floating exchange rate regime.

9) Phillips NV produces DVD players and exports them to the United States. Last year the exchange rate was $1.25/euro and Plillips charged 120 euro per player in Euroland and $150 per DVD player in the United States. Currently the spot exchange rate is $1.45/euro and Phillips is charging $160 per DVD player. What is the degree of pass through by Phillips NV on their DVD players?
A) 92%
B) 33.3%
C) 41.7%
D) 4.1%

10) Jaguar has full manufacturing costs of their S-type sedan of £22,803. They sell the S-type in the UK with a 20% margin for a price of £27,363. Today these cars are available in the US for $55,000 which is the UK price multiplied by the current exchange rate of $2.01/£. Jaguar has committed to keeping the US price at $55,000 for the next six months. If the UK pound appreciates against the USD to an exchange rate of $2.15/£, and Jaguar has not hedged against currency changes, what is the amount the company will receive in pounds at the new exchange rate?
A) £22,803
B) £25,581
C) £27,363
D) £55,000

11) Jaguar has full manufacturing costs of their S-type sedan of £22,803. They sell the S-type in the UK with a 20% margin for a price of £27,363. Today these cars are available in the US for $55,000 which is the UK price multiplied by the current exchange rate of $2.01/£. Jaguar has committed to keeping the US price at $55,000 for the next six months. If the UK pound appreciates against the USD to an exchange rate of $2.15/£, and Jaguar has not hedged against currency changes, what is the percentage margin the company will realize given the new exchange rate?
A) 20.0%
B) 15.3%
C) 12.4%
D) 7.2%

12) The price elasticity of demand for DVD players manufactured by Sony of Japan is greater than one. If the Japanese yen appreciates against the U.S. dollar by 10% and the price of the Sony DVD players in the U.S also rises by 10%, then other things equal, the total dollar sales revenues of Sony DVDs would:
A) decline.
B) increase.
C) stay the same.
D) insufficient information

True/False

1) The final component of the equation for the Fisher Effect, (r)(π), where r = the real rate of return and π = the expected rate of inflation, is often dropped from the equation because the number is simply too large for most Western economies.

2) Empirical studies show that the Fisher Effect works best for short-term securities.

3) The current U.S. dollar-yen spot rate is ¥125/$. If the 90-day forward exchange rate is ¥127/$ then the yen is at a forward premium.

4) The premium or discount on forward currency exchange rates between any two countries is visually obvious when you plot the interest rates of each country on the same yield curve. The currency of the country with the higher yield curve should be selling at a forward discount.

5) Use interest rate parity to answer this question. A U.S. investor has a choice between a risk-free one-year U.S. security with an annual return of 4%, and a comparable British security with a return of 5%. If the spot rate is $1.43/£, the forward rate is $1.44/£, and there are no transaction costs, the investor should invest in the U.S. security.

6) Both covered and uncovered interest arbitrage are risky operations in the sense that even without default in the securities, the returns are unknown until all transactions are complete.

7) All that is required for a covered interest arbitrage profit is for interest rate parity to not hold.

Essay/Short Answer

1) The authors describe an application of uncovered interest arbitrage (UIA) known as “yen carry trade.” Define UIA and describe the example of yen carry trade. Why would an investor engage in the practice of yen carry trade and is there any risk of loss or lesser profit from this investment strategy?

2) The Fisher Effect is a familiar economic theory in the domestic market. In words, define the Fisher Effect and explain why you think it is also appropriately applied to international markets.

7.3 The Forward Rate

Multiple Choice

1) If the forward rate is an unbiased predictor of the expected spot rate, which of the following is NOT true?
A) The expected value of the future spot rate at time 2 equals the present forward rate for time 2 delivery, available now.
B) The distribution of possible actual spot rates in the future is centered on the forward rate.
C) The future spot rate will actually be equal to what the forward rate predicts.
D) All of the above are true.

2) Which of the following is NOT an assumption of market efficiency?
A) Instruments denominated in other currencies are perfect substitutes for one another.
B) Transaction costs are low or nonexistent.
C) All relevant information is quickly reflected in both spot and forward exchange markets.
D) All of the above are true.

3) Empirical tests have yielded ________ evidence about market efficiency with a general consensus that developing foreign markets are ________.
A) conflicting; not efficient
B) conflicting; efficient
C) consistent; inefficient
D) none of the above

4) A ________ is an exchange rate quoted today for settlement at some time in the future.
A) spot rate
B) forward rate
C) currency rate
D) yield curve

5) Assume the current U.S. dollar-British spot rate is 0.6993£/$. If the current nominal one-year interest rate in the U.S. is 5% and the comparable rate in Britain is 6%, what is the approximate forward exchange rate for 360 days?
A) £1.42/$
B) £1.43/$
C) £0.6993/$
D) £0.7060/$

6) Assume the current U.S. dollar-yen spot rate is 90 ¥/$. Further, the current nominal 180-day rate of return in Japan is 1% and 2% in the United States. What is the approximate forward exchange rate for 180 days?
A) ¥89.12/$
B) ¥89.55/$
C) ¥90.89/$
D) ¥90.45/$

7) The current U.S. dollar-yen spot rate is 125¥/$. If the 90-day forward exchange rate is 127 ¥/$ then the yen is selling at a per annum ________ of ________.
A) premium; 1.57%
B) premium; 6.30%
C) discount; 1.57%
D) discount; 6.30%

8) The theory of ________ states that the difference in the national interest rates for securities of similar risk and maturity should be equal to but opposite in sign to the forward rate discount or premium for the foreign currency, except for transaction costs.
A) international Fisher Effect
B) absolute PPP
C) interest rate parity
D) the law of one price

9) With covered interest arbitrage:
A) the market must be out of equilibrium.
B) a “riskless” arbitrage opportunity exists.
C) the arbitrageur trades in both the spot and future currency exchange markets.
D) all of the above

10) Covered interest arbitrage moves the market ________ equilibrium because ________.
A) toward; purchasing a currency on the spot market and selling in the forward market narrows the differential between the two
B) toward; investors are now more willing to invest in risky securities
C) away from; purchasing a currency on the spot market and selling in the forward market increases the differential between the two
D) away from; demand for the stronger currency forces up interest rates on the weaker security

True/False

1) If exchange markets were not efficient, it would pay for a firm to spend resources on forecasting exchange rates.

2) If the forward exchange rate is an unbiased predictor of future spot rates, then future spot rates will always be equal to current forward rates.

3) COVERED interest arbitrage (CIA), is where investors borrow in countries and currencies exhibiting relatively low interest rates and convert the proceeds into currencies that offer much higher interest rates. The transaction is “covered,” because the investor does not sell the higher yielding currency proceeds forward.

7.4 Prices, Interest Rates, and Exchange Rates in Equilibrium

Multiple Choice

1) According to the International Fisher Effect, the forecast change in the spot rate between two countries is equal to:
A) the current spot rate multiplied by the ratio of the inflation rates in the respective countries.
B) but the opposite sign to the difference between nominal interest rates.
C) but the opposite sign to the difference between inflation rates.
D) but the opposite sign to the difference between real interest rates.

True/False

1) In their approximate form, PPP, IRP, and forward rates as an unbiased predictor of the future spot rate lead to similar forecasts of the future spot rate.

Multinational Business Finance, 13e (Eiteman/Stonehill/Moffett)
Chapter 8 Foreign Currency Derivatives and Swaps

8.1 Foreign Currency Futures

Multiple Choice

1) Financial derivatives are powerful tools that can be used by management for purposes of:
A) speculation.
B) hedging.
C) human resource management.
D) A and B above

2) A foreign currency ________ contract calls for the future delivery of a standard amount of foreign exchange at a fixed time, place, and price.
A) futures
B) forward
C) option
D) swap

3) Which of the following is NOT a contract specification for currency futures trading on an organized exchange?
A) size of the contract
B) maturity date
C) last trading day
D) All of the above are specified.

4) About ________ of all futures contracts are settled by physical delivery of foreign exchange between buyer and seller.
A) 0%
B) 5%
C) 50%
D) 95%

5) Futures contracts require that the purchaser deposit an initial sum as collateral. This deposit is called a:
A) collateralized deposit.
B) marked market sum.
C) margin.
D) settlement.

6) A speculator in the futures market wishing to lock in a price at which they could ________ a foreign currency will ________ a futures contract.
A) buy; sell
B) sell; buy
C) buy; buy
D) none of the above

7) A speculator that has ________ a futures contract has taken a ________ position.
A) sold; long
B) purchased; short
C) sold; short
D) purchased; sold

8) Peter Simpson thinks that the U.K. pound will cost $1.43/£ in six months. A 6-month currency futures contract is available today at a rate of $1.44/£. If Peter was to speculate in the currency futures market, and his expectations are correct, which of the following strategies would earn him a profit?
A) Sell a pound currency futures contract.
B) Buy a pound currency futures contract.
C) Sell pounds today.
D) Sell pounds in six months.

9) Jack Hemmings bought a 3-month British pound futures contract for $1.4400/£ only to see the dollar appreciate to a value of $1.4250 at which time he sold the pound futures. If each pound futures contract is for an amount of £62,500, how much money did Jack gain or lose from his speculation with pound futures?
A) $937.50 loss
B) $937.50 gain
C) £937.50 loss
D) £937.50 gain

10) Which of the following statements regarding currency futures contracts and forward contracts is NOT true?
A) A futures contract is a standardized amount per currency whereas the forward contact is for any size desired.
B) A futures contract is for a fixed maturity whereas the forward contract is for any maturity you like up to one year.
C) Futures contracts trade on organized exchanges whereas forwards take place between individuals and banks with other banks via telecom linkages.
D) All of the above are true.

11) Which of the following is NOT a difference between a currency futures contract and a forward contract?
A) The futures contract is marked to market daily, whereas the forward contract is only due to be settled at maturity.
B) The counterparty to the futures participant is unknown with the clearinghouse stepping into each transaction, whereas the forward contract participants are in direct contact setting the forward specifications.
C) A single sales commission covers both the purchase and sale of a futures contract, whereas there is no specific sales commission with a forward contract because banks earn a profit through the bid-ask spread.
D) All of the above are true.

12) A foreign currency ________ gives the purchaser the right, not the obligation, to buy a given amount of foreign exchange at a fixed price per unit for a specified period.
A) future
B) forward
C) option
D) swap

13) A foreign currency ________ option gives the holder the right to ________ a foreign currency, whereas a foreign currency ________ option gives the holder the right to ________ an option.
A) call, buy, put, sell
B) call, sell, put, buy
C) put, hold, call, release
D) none of the above

14) The price at which an option can be exercised is called the:
A) premium.
B) spot rate.
C) strike price.
D) commission.

15) An ________ option can be exercised only on its expiration date, whereas a/an ________ option can be exercised anytime between the date of writing up to and including the exercise date.
A) American; European
B) American; British
C) Asian; American
D) European; American

16) An ________ option can be exercised only on its expiration date, whereas a/an ________ option can be exercised anytime between the date of writing up to and including the exercise date.
A) American; European
B) American; British
C) Asian; American
D) European; American

17) A call option whose exercise price exceeds the spot price is said to be:
A) in-the-money.
B) at-the-money.
C) out-of-the-money.
D) over-the-spot.

18) A call option whose exercise price is less than the spot price is said to be:
A) in-the-money.
B) at-the-money.
C) out-of-the-money.
D) under-the-spot.

19) An option whose exercise price is equal to the spot rate is said to be:
A) in-the-money.
B) at-the-money.
C) out-of-the-money.
D) on-the-spot.

20) The main advantage(s) of over-the-counter foreign currency options over exchange traded options is (are):
A) expiration dates tailored to the needs of the client.
B) amounts that are tailor made.
C) client desired expiration dates.
D) all of the above

21) As a general statement, it is safe to say that businesses generally use the ________ for foreign currency option contracts, and individuals and financial institutions typically use the ________.
A) exchange markets; over-the-counter
B) over-the-counter; exchange markets
C) private; government sponsored
D) government sponsored; private

TABLE 8.1
Use the table to answer following question(s).

April 19, 2009, British Pound Option Prices (cents per pound, 62,500 pound contracts).

22) Refer to Table 8.1. What was the closing price of the British pound on April 18, 2009?
A) $1.448/£
B) £1.448/$
C) $14.48/£
D) none of the above

23) Refer to Table 8.1. The exercise price of ________ giving the purchaser the right to sell pounds in June has a cost per pound of ________ for a total price of ________.
A) 1460; 0.68 cents; $425.00
B) 1440; 1.06 cents; $662.50
C) 1450; 1.02 cents; $637.50
D) 1440; 1.42 cents; $887.50

24) Refer to Table 8.1. The May call option on pounds with a strike price of 1440 mean:
A) $88/£ per contract.
B) $0.88/£.
C) $0.0088/£.
D) none of the above

25) Dash Brevenshure works for the currency trading unit of ING Bank in London. He speculates that in the coming months the dollar will rise sharply vs. the pound. What should Dash do to act on his speculation?
A) Buy a call on the pound.
B) Sell a call on the pound.
C) Buy a put on the pound.
D) Sell a put on the pound.

26) A put option on yen is written with a strike price of ¥105.00/$. Which spot price maximizes your profit if you choose to exercise the option before maturity?
A) ¥100/$
B) ¥105/$
C) ¥110/$
D) ¥115/$

27) A call option on euros is written with a strike price of $1.30/euro. Which spot price maximizes your profit if you choose to exercise the option before maturity?
A) $1.20/euro
B) $1.25/euro
C) $1.30/euro
D) $1.35/euro

28) A call option on UK pounds has a strike price of $2.05/£ and a cost of $0.02. What is the break-even price for the option?
A) $2.03/£
B) $2.07/£
C) $2.05/£
D) The answer depends upon if this is a long or a short call option.

29) Your U.S firm has an accounts payable denominated in UK pounds due in 6 months. To protect yourself against unexpected changes in the dollar/pound exchange rate you should:
A) buy a pound put option.
B) sell a pound put option.
C) buy a pound call option.
D) sell a pound call option.

30) Jasper Pernik is a currency speculator who enjoys “betting” on changes in the foreign currency exchange market. Currently the spot price for the Japanese yen is ¥129.87/$ and the 6-month forward rate is ¥128.53/$. Jasper thinks the yen will move to ¥128.00/$ in the next six months. Jasper should ________ at ________ to profit from changing currency values.
A) buy yen; the forward rate
B) buy dollars; the forward rate
C) sell yen; the forward rate
D) There is not enough information to answer this question.

31) Jasper Pernik is a currency speculator who enjoys “betting” on changes in the foreign currency exchange market. Currently the spot price for the Japanese yen is ¥129.87/$ and the 6-month forward rate is ¥128.53/$. Jasper thinks the yen will move to ¥128.00/$ in the next six months. If Jasper buys $100,000 worth of yen at today’s spot price and sells within the next six months at ¥128/$, he will earn a profit of:
A) $146.09
B) $101,460.94
C) $1460.94
D) nothing; he will lose money

32) Jasper Pernik is a currency speculator who enjoys “betting” on changes in the foreign currency exchange market. Currently the spot price for the Japanese yen is ¥129.87/$ and the 6-month forward rate is ¥128.53/$. Jasper thinks the yen will move to ¥128.00/$ in the next six months. If Jasper buys $100,000 worth of yen at today’s spot price her potential gain is ________ and her potential loss is ________.
A) $100,000; unlimited
B) unlimited; unlimited
C) $100,000; $100,000
D) unlimited; $100,000

33) Jasper Pernik is a currency speculator who enjoys “betting” on changes in the foreign currency exchange market. Currently the spot price for the Japanese yen is ¥129.87/$ and the 6-month forward rate is ¥128.53/$. Jasper thinks the yen will move to ¥128.00/$ in the next six months. If Jasper’s expectations are correct, then he could profit in the forward market by ________ and then ________.
A) buying yen for ¥128.00/$; selling yen at ¥128.53/$
B) buying yen for ¥128.53/$; selling yen at ¥128.00/$
C) There is not enough information to answer this question
D) He could not profit in the forward market.

34) The maximum gain for the purchaser of a call option contract is ________ while the maximum loss is ________.
A) unlimited; the premium paid.
B) the premium paid; unlimited.
C) unlimited; unlimited.
D) unlimited; the value of the underlying asset.

35) The buyer of a long call option:
A) has a maximum loss equal to the premium paid.
B) has a gain equal to but opposite in sign to the writer of the option.
C) has an unlimited maximum gain potential.
D) all of the above

36) Which of the following is NOT true for the writer of a call option?
A) The maximum loss is unlimited.
B) The maximum gain is unlimited.
C) The gain or loss is equal to but of the opposite sign of the buyer of a call option.
D) All of the above are true.

37) Which of the following is NOT true for the writer of a put option?
A) The maximum loss is limited to the strike price of the underlying asset less the premium.
B) The gain or loss is equal to but of the opposite sign of the buyer of a put option.
C) The maximum gain is the amount of the premium.
D) All of the above are true.

38) The buyer of a long put option:
A) has a maximum loss equal to the premium paid.
B) has a gain equal to but opposite in sign to the writer of the option.
C) has maximum gain potential limited to the difference between the strike price and the premium paid.
D) all of the above

39) The value of a European style call option is the sum of two components:
A) the present value plus the intrinsic value.
B) the time value plus the present value.
C) the intrinsic value plus the time value.
D) the intrinsic value plus the standard deviation.

True/False

1) Currency futures contracts have become standard fare and trade readily in the world money centers.

2) The major difference between currency futures and forward contracts is that futures contracts are standardized for ease of trading on an exchange market whereas forward contracts are specialized and tailored to meet the needs of clients.

3) The writer of the option is referred to as the seller, and the buyer of the option is referred to as the holder.

4) Foreign currency options are available both over-the-counter and on organized exchanges.

5) Jasper Pernik is a currency speculator who enjoys “betting” on changes in the foreign currency exchange market. Currently the spot price for the Japanese yen is ¥129.87/$ and the 6-month forward rate is ¥128.53/$. Jasper would earn a higher rate of return by buying yen and a forward contract than if he had invested her money in 6-month US Treasury securities at an annual rate of 2.50%.

6) Most option profits and losses are realized through taking actual delivery of the currency rather than offsetting contracts.

Essay

1) Why are foreign currency futures contracts more popular with individuals and banks while foreign currency forwards are more popular with businesses?

2) Compare and contrast foreign currency options and futures. Identify situations when you may prefer one vs. the other when speculating on foreign exchange.

8.2 Option Pricing and Valuation

Multiple Choice

1) Which of the following is NOT a factor in determining the premium price of a currency option?
A) the present spot rate
B) the time to maturity
C) the standard deviation of the daily spot price movement
D) All of the above are factors in determining the premium price.

2) The ________ of an option is the value if the option were to be exercised immediately. It is the option’s ________ value.
A) intrinsic value; maximum
B) intrinsic value; minimum
C) time value; maximum
D) time value; minimum

3) Assume that a call option has an exercise price of $1.50/£. At a spot price of $1.45/£, the call option has:
A) a time value of $0.04.
B) a time value of $0.00.
C) an intrinsic value of $0.00.
D) an intrinsic value of -$0.04.

4) The single largest interest rate risk of a firm is:
A) interest sensitive securities.
B) debt service.
C) dividend payments.
D) accounts payable.

5) ________ is the possibility that the borrower’s creditworthiness is reclassified by the lender at the time of renewing credit. ________ is the risk of changes in interest rates charged at the time a financial contract rate is set.
A) Credit risk; Interest rate risk
B) Repricing risk; Credit risk
C) Interest rate risk; Credit risk
D) Credit risk; Repricing risk

Instruction 8.1:
For the following problem(s), consider these debt strategies being considered by a corporate borrower. Each is intended to provide $1,000,000 in financing for a three-year period.

• Strategy #1: Borrow $1,000,000 for three years at a fixed rate of interest of 7%.
• Strategy #2: Borrow $1,000,000 for three years at a floating rate of LIBOR + 2%, to be reset annually. The current LIBOR rate is 3.50%
• Strategy #3: Borrow $1,000,000 for one year at a fixed rate, and then renew the credit annually. The current one-year rate is 5%.

6) Refer to Instruction 8.1. Choosing strategy #1 will:
A) guarantee the lowest average annual rate over the next three years.
B) eliminate credit risk but retain repricing risk.
C) maintain the possibility of lower interest costs, but maximizes the combined credit and repricing risks.
D) preclude the possibility of sharing in lower interest rates over the three-year period.

7) Refer to Instruction 8.1. Choosing strategy #2 will:
A) guarantee the lowest average annual rate over the next three years.
B) eliminate credit risk but retain repricing risk.
C) maintain the possibility of lower interest costs, but maximizes the combined credit and repricing risks.
D) preclude the possibility of sharing in lower interest rates over the three-year period.

8) Refer to Instruction 8.1. Choosing strategy #3 will:
A) guarantee the lowest average annual rate over the next three years.
B) eliminate credit risk but retain repricing risk.
C) maintain the possibility of lower interest costs, but maximizes the combined credit and repricing risks.
D) preclude the possibility of sharing in lower interest rates over the three-year period.

9) Refer to Instruction 8.1. Which strategy (strategies) will eliminate credit risk?
A) Strategy #1
B) Strategy #2
C) Strategy #3
D) Strategies #1 and #2

10) Refer to Instruction 8.1. If your firm felt very confident that interest rates would fall or, at worst, remain at current levels, and were very confident about the firm’s credit rating for the next 10 years, which strategy would you likely choose? (Assume your firm is borrowing money.)
A) Strategy #3
B) Strategy #2
C) Strategy #1
D) Strategy #1, #2, or #3; you are indifferent among the choices.

11) Refer to Instruction 8.1. The risk of strategy #1 is that interest rates might go down or that your credit rating might improve. The risk of strategy #2 is: (Assume your firm is borrowing money.)
A) that interest rates might go down or that your credit rating might improve.
B) that interest rates might go up or that your credit rating might improve.
C) that interest rates might go up or that your credit rating might get worse.
D) none of the above

12) Refer to Instruction 8.1. The risk of strategy #1 is that interest rates might go down or that your credit rating might improve. The risk of strategy #3 is: (Assume your firm is borrowing money.)
A) that interest rates might go down or that your credit rating might improve.
B) that interest rates might go up or that your credit rating might improve.
C) that interest rates might go up or that your credit rating might get worse.
D) none of the above

13) Refer to Instruction 8.1. After the fact, under which set of circumstances would you prefer strategy #1? (Assume your firm is borrowing money.)
A) Your credit rating stayed the same and interest rates went up.
B) Your credit rating stayed the same and interest rates went down.
C) Your credit rating improved and interest rates went down.
D) Not enough information to make a judgment.

14) Refer to Instruction 8.1. After the fact, under which set of circumstances would you prefer strategy #2? (Assume your firm is borrowing money.)
A) Your credit rating stayed the same and interest rates went up.
B) Your credit rating stayed the same and interest rates went down.
C) Your credit rating improved and interest rates went down.
D) Not enough information to make a judgment.

15) Refer to Instruction 8.1. After the fact, under which set of circumstances would you prefer strategy #3? (Assume your firm is borrowing money.)
A) Your credit rating stayed the same and interest rates went up.
B) Your credit rating stayed the same and interest rates went down.
C) Your credit rating improved and interest rates went down.
D) Not enough information to make a judgment.

True/False

1) The time value is asymmetric in value as you move away from the strike price (i.e., the time value at two cents above the strike price is not necessarily the same as the time value two cents below the strike price).

8.3 Interest Rate Derivatives

Multiple Choice

1) An interbank-traded contract to buy or sell interest rate payments on a notional principal is called a/an:
A) forward rate agreement.
B) interest rate future.
C) interest rate swap.
D) none of the above

2) A/an ________ is a contract to lock in today interest rates over a given period of time.
A) forward rate agreement
B) interest rate future
C) interest rate swap
D) none of the above

3) An agreement to exchange interest payments based on a fixed payment for those based on a variable rate (or vice versa) is known as a/an:
A) forward rate agreement.
B) interest rate future.
C) interest rate swap.
D) none of the above

4) The financial manager of a firm has a variable rate loan outstanding. If she wishes to protect the firm against an unfavorable increase in interest rates she could:
A) sell an interest rate futures contract of a similar maturity to the loan.
B) buy an interest rate futures contract of a similar maturity to the loan.
C) swap the adjustable rate loan for another of a different maturity.
D) none of the above

5) An agreement to swap a fixed interest payment for a floating interest payment would be considered a/an:
A) currency swap.
B) forward swap.
C) interest rate swap.
D) none of the above

6) An agreement to swap the currencies of a debt service obligation would be termed a/an:
A) currency swap.
B) forward swap.
C) interest rate swap.
D) none of the above

7) Which of the following would be considered an example of a currency swap?
A) exchanging a dollar interest obligation for a British pound obligation
B) exchanging a eurodollar interest obligation for a dollar obligation
C) exchanging a eurodollar interest obligation for a British pound obligation
D) All of the above are examples of a currency swap.

8) A firm with fixed-rate debt that expects interest rates to fall may engage in a swap agreement to:
A) pay fixed-rate interest and receive floating rate interest.
B) pay floating rate and receive fixed rate.
C) pay fixed rate and receive fixed rate.
D) pay floating rate and receive floating rate.

9) A firm with variable-rate debt that expects interest rates to rise may engage in a swap agreement to:
A) pay fixed-rate interest and receive floating rate interest.
B) pay floating rate and receive fixed rate.
C) pay fixed rate and receive fixed rate.
D) pay floating rate and receive floating rate.

10) The interest rate swap strategy of a firm with fixed rate debt and that expects rates to go up is to:
A) do nothing.
B) pay floating and receive fixed.
C) receive floating and pay fixed.
D) none of the above

11) The potential exposure that any individual firm bears that the second party to any financial contract will be unable to fulfill its obligations under the contract is called:
A) interest rate risk.
B) credit risk.
C) counterparty risk.
D) clearinghouse risk.

12) Which of the following is an unlikely reason for firms to participate in the swap market?
A) To replace cash flows scheduled in an undesired currency with cash flows in a desired currency.
B) Firms may raise capital in one currency but desire to repay it in another currency.
C) Firms desire to swap fixed and variable payment or receipt of funds.
D) All of the above are likely reasons for a firm to enter the swap market.

True/False

1) Historically, interest rate movements have shown less variability and greater stability than exchange rate movements.

2) Unlike the situation with exchange rate risk, there is no uncertainty on the part of management for shareholder preferences regarding interest rate risk. Shareholders prefer that managers hedge interest rate risk rather than having shareholders diversify away such risk through portfolio diversification.

3) Interest rate futures are relatively unpopular among financial managers because of their relative illiquidity and their difficulty of use.

4) A basis point is one-tenth of one percent.

5) A swap agreement may involve currencies or interest rates, but never both.

6) Some of the world’s largest and most financially sound firms may borrow at variable rates less than LIBOR.

7) Counterparty risk is greater for exchange-traded derivatives than for over-the-counter derivatives.

8) Swap rates are derived from the yield curves in each major currency.

Essay

1) Your firm is faced with paying a variable rate debt obligation with the expectation that interest rates are likely to go up. Identify two strategies using interest rate futures and interest rate swaps that could reduce the risk to the firm.

2) How does counterparty risk influence a firm’s decision to trade exchange-traded derivatives rather than over-the-counter derivatives?
Answer: With exchange-traded derivatives, the exchange is the clearinghouse. Thus, firms do not need to worry about the other party making good on its obligations and it is easier to trade the derivative products.

ECO 410 Week 6 Quiz Solution

Chapter 9 Foreign Exchange Rate Determination and Forecasting

9.1 Exchange Rate Determination: The Theoretical Thread

Multiple Choice

1) An important thing to remember about foreign exchange rate determination is that parity conditions, asset approach, and balance of payments approaches are ________ theories rather than ________ theories.
A) competing; complementary
B) competing; contemporary
C) complementary; contiguous
D) complementary; competing

2) Which of the following did NOT contribute to the exchange rate collapse in emerging markets in the 1990s?
A) infrastructure weaknesses
B) speculation on the part of market participants
C) the sharp reduction of cross-border foreign direct investment
D) All of the above contributed to the emerging markets exchange rate collapse of the 1990s.

3) The ________ provides a means to account for international cash flows in a standardized and systematic manner.
A) parity conditions
B) asset approach
C) balance of payments
D) International Fisher Effect

4) The ________ approach argues that equilibrium exchange rates are achieved when the net inflow of foreign exchange arising from current account activities is equal to the net outflow of foreign exchange arising from financial account activities.
A) balance of payments
B) monetary
C) asset market
D) law of one price

5) The ________ approach states that the exchange rate is determined by the supply and demand for national currency stocks, as well as the expected future levels and rates of growth of monetary stock.
A) balance of payments
B) monetary
C) asset market
D) law of one price

6) The ________ approach argues that exchange rates are determined by the supply and demand for a wide variety of financial assets
A) balance of payments
B) monetary
C) asset market
D) law of one price

7) The ________ approach to the determination of spot exchange rates hypothesizes that the most important factors are the relative real interest rate and a country’s outlook for economic growth and profitability.
A) balance of payments
B) parity conditions
C) managed float
D) asset market

8) The asset market approach to forecasting assumes that whether foreigners are willing to hold claims in monetary form depends on an extensive set of investment considerations. These include all but which of the following choices?
A) relative real interest rates
B) capital market liquidity
C) political safety
D) All of the above are considered by investors in their decision process.

9) ________ is defined as the spread of a crisis in one country to its neighboring countries and other countries with similar characteristics.
A) Speculation
B) Contagion
C) Capital market liquidity
D) Political science

10) Critics of the balance of payments approach to exchange rate determination point to the emphasis on ________ of currency and capital rather than ________ of money or financial assets.
A) flows; stocks
B) stocks; flows
C) import; export
D) export; import

11) Which of the following versions of PPP is thought to be the most relevant to possibly explaining what drives exchange rate values?
A) The Law of One Price
B) Absolute Purchasing Power Parity
C) Relative Purchasing Power Parity
D) The International Fisher Effect

True/False

1) It is safe to say that most determinants of the spot exchange rate are also affected by changes in the spot rate. i.e., they are linked AND mutually determined.

2) The balance of payments approach of exchange rate theory is largely dismissed by the academic community today, while the practitioner public still rely on different variations of the theory for their decision making.

3) Technical analysis of exchange rates developed in part due to the forecasting inadequacies of fundamental exchange rate theories.

4) The authors claim that theoretical and empirical studies appear to show that fundamentals do apply to the long-term for foreign exchange.

5) The authors claim that random events, institutional frictions, and technical factors may cause currency values to deviate significantly from their long-term fundamental path.

6) The asset market approach to forecasting is not applicable to emerging markets.

7) Most theories of technical analysis differentiate fair value from market value.

Essay

1) Describe the asset market approach to exchange rate determination. How is this consistent with economic theory of (say, security) prices in general?

9.2 Currency Market Intervention

Multiple Choice

1) ________ is the active buying and selling of the domestic currency against foreign currencies.
A) Indirect Intervention
B) Direct Intervention
C) Foreign Direct Investment
D) Federal Funding

2) Which of the following is NOT a technique used by governments or central banks to impact domestic currency valuation?
A) Indirect Intervention
B) Direct Intervention
C) Capital Controls
D) All of the above are techniques used to control currency valuation.

3) Which of the following is NOT a motivation for a government or central bank to manipulate domestic currency valuation?
A) fight inflation
B) slow too rapid economic growth
C) spur too slow economic growth
D) All of the above are motivations for the government or central bank to manipulate currency values.

True/False

1) Slow economic growth and continued unemployment problems are common reasons for central banks to hold currency values down.

2) The fall in the value of the domestic currency will sharply reduce the purchasing power of foreign tourists in the country whose currency values are falling.

3) The International Monetary Fund, as one of its basic principles (Article IV), encourages members to pursue “currency manipulation” to gain competitive advantages over other members as opposed to engaging in military action to achieve the same advantage.

4) If a central bank wishes to “defend its currency,” it might follow an expansive monetary policy, which would drive real rates of interest up.

5) A country wishing for its currency to fall in value, particularly when confronted with a continual appreciation of its value against major trading partner currencies, the central bank may work to lower real interest rates, reducing the returns to capital.

6) Indirect intervention for domestic currency valuation typically uses tools of monetary policy as opposed to using tools of fiscal policy.

7) Direct intervention for currency valuation involves limiting the ability to exchange domestic currency for foreign currency.

Essay

1) Explain how a central bank would engage in direct intervention to decrease the value of its domestic currency. Since the 1970s it has been difficult for central banks alone to engage in direct intervention to alter the value of their domestic currency. Identify and explain at least two other activities in which a central bank could engage to alter the value of their domestic currency.

9.3 Disequilibrium: Exchange Rates in Emerging Markets

Multiple Choice

1) Which of the following was NOT an international currency crisis in the 1990s and early 2000s?
A) the Asian Crisis
B) the Canadian Crisis
C) the Argentine Crisis
D) All of the above were currency crises in the 1990s and 2000s.

2) The Asian Currency crisis appeared to begin in:
A) South Korea.
B) Taiwan.
C) Thailand.
D) Japan.

3) The “tequila effect” is a slang term used to describe a form of financial panic called:
A) run on the market.
B) speculation.
C) contrary investing.
D) contagion.

4) Prior to July 2, 1997, the Thai government:
A) allowed the Thai Bhat to float against major currencies.
B) fixed the Bhat’s value against the Korean won only.
C) fixed the Bhat’s value against major currencies especially the U.S. dollar.
D) none of the above

5) The authors did NOT identify which of the following as a root of the Asian currency crisis?
A) the collapse of some Asian currencies
B) the rate of inflation in the United States
C) corporate socialism
D) banking stability and management

6) The authors refer to the practice of many Asian firms being largely controlled by families of groups related to the governing body of the country as:
A) illegal.
B) insider trading.
C) cronyism.
D) not in my back yard.

7) The principle focus of the IMF bailout efforts during the Asian financial crisis was:
A) banking liquidity.
B) shareholder’s wealth.
C) reestablishing fixed currency exchange rates in Asia.
D) dollarization of Asian currencies.

8) The ________ is the Argentine currency unit.
A) peso
B) dollar
C) real
D) peseta

9) A currency board is:
A) a structure, rather than a mere commitment, to limiting the growth of the money supply in the economy.
B) a recipe for conservative and prudent financial management.
C) designed to eliminate the power of politicians to exercise judgment by relying on an automatic and unbendable rule.
D) all of the above

10) Argentina’s economic performance in the 1990s while their peso was pegged to the U.S. dollar can be characterized as ________ rates of inflation and ________ rates of unemployment.
A) high; high
B) low; low
C) low; high
D) high; low

11) Which of the following did NOT contribute to the Russian currency crisis of 1998?
A) an accelerated flight of capital
B) generally deteriorating economic conditions
C) a surprisingly healthy government surplus that was neither funding internal investment nor external debt service
D) all of the above

True/False

1) In 1991 the Argentine peso was fixed to the value of the U.S. dollar on a one-to-one basis.

2) Leading up to the Russian currency collapse of 1998, Russia followed a currency policy of managed float that allowed their currency to slide daily at a 1.5% per month rate.

9.4 Forecasting in Practice

Multiple Choice

1) ________, traditionally referred to as chartists, focus on price and volume data to determine past trends that are expected to continue into the future.
A) Mappists
B) Trappist monks
C) Filibusters
D) Technical analysts

2) Examples of a business motivation for long-run exchange rate forecasts include all but which of the following?
A) a major capital investment in a foreign country
B) the desire to hedge a 90-day security
C) a portfolio manager considering investing in foreign securities
D) All of the above are examples of a business motivation for long-run exchange rate forecast.

3) Short-term foreign exchange forecasts are often motivated by such activities as ________ whereas long-term forecasts are more likely motivated by ________.
A) long-term investment; long-term capital appreciation
B) long-term capital appreciation; desire to hedge a receivable
C) the desire to hedge a payable; the desire for long-term investment
D) the desire for long-term investment; the desire to hedge a payable

4) A major U.S. multinational firm has forecast the euro/dollar rate to be €1.10/$ one year hence, and an exchange rate of $1.40 for the British pound (£) in the same time period. What does this imply the company’s expected rate for the euro per pound to be in one year?
A) €1.40/£
B) £1.40/€
C) £1.54/€
D) €1.54/£

True/False

1) The longer the time horizon of the technical analyst the more accurate the prediction of foreign exchange rates is likely to be.

Comment: The shorter the time horizon of the technical analyst the more accurate the prediction of foreign exchange rates is likely to be.

2) The single most important element of technical analysis is that future exchange rates are based on the current exchange rate.

3) The more efficient the foreign exchange market is, the more likely it is that exchange rate movements are random walks.

4) Technical analysts, traditionally referred to as chartists, focus on fundamental data to determine past trends that are expected to continue into the future.

Essay

1) Foreign exchange forecasting can be either long-term, or short-term in duration. Compare and contrast the motivation for and the techniques a forecaster might use for each of the time periods.
Answer: Short-run forecasts are usually more tactical in nature as a firm may desire to reduce exchange rate risk associated with foreign receivable or payables. Technical factors and short-term market expectations are often more important for short-run forecasters than long-run parity or fundamental economic conditions.
Long-run forecasts are more strategic in nature as firms make key decisions about entering new foreign markets. Longer time horizons tend to be less accurate but also require less accuracy. What forecasters typically desire is a general long-run understanding of the relationships between markets. Fundamental analysis and parity conditions tend to be more important than technical factors in this type of forecasting.

Chapter 10 Transaction Exposure

10.1 Types of Foreign Exchange Exposure

Multiple Choice

1) ________ exposure deals with cash flows that result from existing contractual obligations.
A) Operating
B) Transaction
C) Translation
D) Economic

2) ________ exposure measures the change in the present value of the firm resulting from unexpected changes in exchange rates.
A) Operating
B) Transaction
C) Translation
D) Accounting

3) Each of the following is another name for operating exposure EXCEPT:
A) economic exposure.
B) strategic exposure.
C) accounting exposure.
D) competitive exposure.

4) Transaction exposure and operating exposure exist because of unexpected changes in future cash flows. The difference between the two is that ________ exposure deals with cash flows already contracted for, while ________ exposure deals with future cash flows that might change because of changes in exchange rates.
A) transaction; operating
B) operating; transaction
C) operating; accounting
D) none of the above

5) ________ exposure is the potential for accounting-derived changes in owner’s equity to occur because of the need to translate foreign currency financial statements into a single reporting currency.
A) Transaction
B) Operating
C) Economic
D) Accounting (aka translation)

6) Losses from ________ exposure generally reduce taxable income in the year they are realized. ________ exposure losses may reduce taxes over a series of years.
A) accounting; Operating
B) operating; Transaction
C) transaction; Operating
D) transaction; Accounting

7) Losses from ________ exposure generally reduce taxable income in the year they are realized. ________ exposure losses are not cash losses and therefore, are not tax deductible.
A) transaction; Operating
B) accounting; Operating
C) accounting; Transaction
D) transaction; Translation

8) MNE cash flows may be sensitive to changes in which of the following?
A) exchange rates
B) interest rates
C) commodity prices
D) all of the above

9) Assuming no transaction costs (i.e., hedging is “free”), hedging currency exposures should ________ the variability of expected cash flows to a firm and at the same time, the expected value of the cash flows should ________.
A) increase; not change
B) decrease; not change
C) not change; increase
D) not change; not change

10) Which of the following is NOT cited as a good reason for hedging currency exposures?
A) Reduced risk of future cash flows is a good planning tool.
B) Reduced risk of future cash flows reduces the probability that the firm may not meet required cash flows.
C) Currency risk management increases the expected cash flows to the firm.
D) Management is in a better position to assess firm currency risk than individual investors.

11) Which of the following is cited as a good reason for NOT hedging currency exposures?
A) Shareholders are more capable of diversifying risk than management.
B) Currency risk management through hedging does not increase expected cash flows.
C) Hedging activities are often of greater benefit to management than to shareholders.
D) All of the above are cited as reasons NOT to hedge.

12) The stages in the life of a transaction exposure can be broken into three distinct time periods. The first time period is the time between quoting a price and reaching an actual sale agreement or contract. The next time period is the time lag between taking an order and actually filling or delivering it. Finally, the time it takes to get paid after delivering the product. In order, these stages of transaction exposure may be identified as:
A) backlog, quotation, and billing exposure.
B) billing, backlog, and quotation exposure.
C) quotation, backlog, and billing exposure.
D) quotation, billing, and backlog exposure.

13) A U.S. firm sells merchandise today to a British company for £150,000. The current exchange rate is $1.55/£ , the account is payable in three months, and the firm chooses to avoid any hedging techniques designed to reduce or eliminate the risk of changes in the exchange rate. The U.S. firm is at risk today of a loss if:
A) the exchange rate changes to $1.52/£.
B) the exchange rate changes to $1.58/£.
C) the exchange rate doesn’t change.
D) all of the above

14) A U.S. firm sells merchandise today to a British company for £150,000. The current exchange rate is $1.55/£ , the account is payable in three months, and the firm chooses to avoid any hedging techniques designed to reduce or eliminate the risk of changes in the exchange rate. If the exchange rate changes to $1.58/£ the U.S. firm will realize a ________ of ________.
A) loss; $4,500
B) gain; $4,500
C) loss; £4,500
D) gain; £4,500

15) A U.S. firm sells merchandise today to a British company for £150,000. The current exchange rate is $1.55/£ , the account is payable in three months, and the firm chooses to avoid any hedging techniques designed to reduce or eliminate the risk of changes in the exchange rate. If the exchange rate changes to $1.52/£ the U.S. firm will realize a ________ of ________.
A) loss; $4,500
B) gain; $4,500
C) loss; £4,500
D) gain; £4,500

16) ________ is NOT a commonly used contractual hedge against foreign exchange transaction exposure.
A) Forward market hedge
B) Money market hedge
C) Options market hedge
D) All of the above are contractual hedges.

17) A ________ hedge refers to an offsetting operating cash flow such as a payable arising from the conduct of business.
A) financial
B) natural
C) contractual
D) futures

True/False

1) As a generalized rule, only realized foreign exchange losses are deductible for tax purposes.

2) Many MNE s manage foreign exchange exposure centrally, thus gains or losses are always matched with the country of origin.

3) Hedging, or reducing risk, is the same as adding value or return to the firm.

4) There is considerable question among investors and managers about whether hedging is a good and necessary tool.

5) The key arguments in opposition to currency hedging such as market efficiency, agency theory, and diversification do not have financial theory at their core.

6) The structure of a money market hedge is similar to a forward hedge. The difference is the cost of the money market hedge is determined by the differential interest rates, while the forward hedge is a function of the forward rates quotation.

7) In efficient markets, interest rate parity should assure that the costs of a forward hedge and money market hedge should be approximately the same.

8) Management often conducts hedging activities that benefit management at the expense of the shareholders. The field of finance called agency theory frequently argues that management is generally LESS risk averse than are shareholders.

9) Managers CAN outguess the market. If and when markets are in equilibrium with respect to parity conditions, the expected net present value of hedging should be POSITIVE.

10) Shareholders are LESS capable of diversifying currency risk than is the management of the firm.

11) Hedging can be advantageous to shareholders because management is in a better position than shareholders to recognize disequilibrium conditions and to take advantage of single opportunities to enhance firm value through selective hedging.

12) TRANSACTION exposure measures gains or losses that arise from the settlement of existing financial obligations whose terms are stated in a foreign currency.

13) Transaction exposure could arise when borrowing or lending funds when repayment is to be made in the firm’s domestic currency.

Essay

1) Does foreign currency exchange hedging both reduce risk and increase expected value? Explain, and list several arguments in favor of currency risk management and several against.

2) Currency risk management techniques include forward hedges, money market hedges, and option hedges. Draw a diagram showing the possible outcomes of these hedging alternatives for a foreign currency receivable contract. In your diagram, be sure to label the X and Y-axis, the put option strike price, and show the possible results for a money market hedge, a forward hedge, a put option hedge, and an uncovered position. (Note: Assume the forward currency receivable is British pounds and the put option strike price is $1.50/£, the price of the option is $0.04 the forward rate is $1.52/£ and the current spot rate is $1.48/£.)

10.2 Trident’s Transaction Exposure

Multiple Choice

Instruction 10.2:
Use the information for the following problem(s).

Central Valley Transit Inc. (CVT) has just signed a contract to purchase light rail cars from a manufacturer in Germany for euro 3,000,000. The purchase was made in June with payment due six months later in December. Because this is a sizable contract for the firm and because the contract is in euros rather than dollars, CVT is considering several hedging alternatives to reduce the exchange rate risk arising from the sale. To help the firm make a hedging decision you have gathered the following information.

• The spot exchange rate is $1.250/euro
• The six month forward rate is $1.22/euro
• CVT’s cost of capital is 11%
• The Euro zone 6-month borrowing rate is 9% (or 4.5% for 6 months)
• The Euro zone 6-month lending rate is 7% (or 3.5% for 6 months)
• The U.S. 6-month borrowing rate is 8% (or 4% for 6 months)
• The U.S. 6-month lending rate is 6% (or 3% for 6 months)
• December call options for euro 750,000; strike price $1.28, premium price is 1.5%
• CVT’s forecast for 6-month spot rates is $1.27/euro
• The budget rate, or the highest acceptable purchase price for this project, is
$3,900,000 or $1.30/euro

1) Refer to Instruction 10.2. If CVT chooses NOT to hedge their euro payable, the amount they pay in six months will be:
A) $3,500,000.
B) $3,900,000.
C) €3,000,000.
D) unknown today

2) Refer to Instruction 10.2. If CVT chooses to hedge its transaction exposure in the forward market, it will ________ euro 3,000,000 forward at a rate of ________.
A) buy; $1.22
B) buy; $1.25
C) sell; $1.22
D) sell; €1.25

3) Refer to Instruction 10.2. CVT chooses to hedge its transaction exposure in the forward market at the available forward rate. The required amount in dollars to pay off the accounts payable in 6 months will be:
A) $3,000,000.
B) $3,660,000.
C) $3,750,000.
D) $3,810,000.

4) Refer to Instruction 10.2. If CVT locks in the forward hedge at $1.22/euro, and the spot rate when the transaction was recorded on the books was $1.25/euro, this will result in a “foreign exchange accounting transaction ________ of ________.
A) loss; $90,000.
B) loss; €90,000.
C) gain; $90,000.
D) gain; €90,000.

5) Refer to Instruction 10.2. CVT would be ________ by an amount equal to ________ with a forward hedge than if they had NOT hedged and their predicted exchange rate for 6 months had been correct.
A) better off; $150,000
B) better off; €150,000
C) worse off; $150,000
D) worse off; €150,000

6) Refer to Instruction 10.2. What is the cost of a call option hedge for CVT’s euro receivable contract? (Note: Calculate the cost in future value dollars and assume the firm’s cost of capital as the appropriate interest rate for calculating future values.)
A) $57,600
B) $59,904
C) $62,208
D) $63,936

7) Refer to Instruction 10.2. The cost of a put option to CVT would be:
A) $52,500.
B) $55,388.
C) $58,275.
D) There is not enough information to answer this question.

8) ________ are transactions for which there are, at present, no contracts or agreements between parties.
A) Backlog exposure
B) Quotation exposure
C) Anticipated exposure
D) none of the above

9) According to a survey by Bank of America, the type of foreign exchange risk most often hedged by firms is:
A) translation exposure.
B) transaction exposure.
C) contingent exposure.
D) economic exposure.

True/False

1) When attempting to manage an account payable denominated in a foreign currency, the firm’s only choice is to remain unhedged.

2) The treasury function of most firms, the group typically responsible for transaction exposure management, is NOT usually considered a profit center.

3) According to the authors, firms that employ proportional hedges increase the percentage of forward-cover as the maturity of the exposure lengthens.

4) Remaining unhedged is NOT an option when dealing with foreign exchange transaction exposure.

5) A forward hedge involves a put or call option contract and a source of funds to fulfill that contract.

6) Like a forward market hedge, a money market hedge also involves a contract and a source of funds to fulfill that contract. In this instance, the contract is a loan agreement.

7) Hedging transaction exposure with option contracts allows the firm to benefit if exchange rates are favorable but protects the firm if exchange rates turn unfavorable.

8) A firm’s risk tolerance is a combination of management’s philosophy toward transaction exposure and the specific goals of treasury activities.

9) Although rarely acknowledged by the firms themselves, selective hedging is essentially speculation.

ECO 410 Week 7 Quiz Solution

Chapter 11 Translation Exposure

11.1 Overview of Translation

Multiple Choice

1) Translation exposure may also be called ________ exposure.
A) transaction
B) operating
C) accounting
D) currency

2) ________ exposure is the potential for an increase or decrease in the parent company’s net worth and reported net income caused by a change in exchange rates since the last transaction.
A) Transaction
B) Operating
C) Currency
D) Translation

3) Translation exposure measures:
A) changes in the value of outstanding financial obligations incurred prior to a change in exchange rates.
B) the potential for an increase or decrease in the parent company’s net worth and reported net income caused by a change in exchange rates since the last consolidation of international operations.
C) an unexpected change in exchange rates impact on short run expected cash flows.
D) none of the above

4) According to your authors, the main purpose of translation is:
A) to prepare consolidated financial statements.
B) to help management assess the performance of foreign subsidiaries.
C) to act as an interpreter for managers without foreign language skills.
D) none of the above

5) Historical exchange rates may be used for ________, while current exchange rates may be used for ________.
A) fixed assets and current assets; income and expense items
B) equity accounts and fixed assets; current assets and liabilities
C) current assets and liabilities; equity accounts and fixed assets
D) equity accounts and current liabilities; current assets and fixed assets

6) If an imbalance results from the accounting method used for translation, the imbalance is taken either to ________ or ________.
A) the bank; the post office
B) depreciation; the market for foreign exchange swaps
C) current income; equity reserves
D) current liabilities; equity reserves

7) Generally speaking, translation methods by country define the translation process as a function of what two factors?
A) size; location
B) a firm’s functional currency; location
C) location; foreign subsidiary independence
D) foreign subsidiary independence; a firm’s functional currency

8) A/An ________ subsidiary is one in which the firm operates as an extension of the parent company with cash flows highly interrelated with the parent.
A) self-sustaining foreign
B) integrated foreign entity
C) foreign
D) none of the above

9) Consider two different foreign subsidiaries of Georgia-Pacific Wood Products Inc. The first subsidiary mills trees in Canada and ships its entire product to the Georgia-Pacific U.S. The second subsidiary is also owned by the parent firm but is located in Japan and retails tropical hardwood furniture that it buys from many different sources. The first subsidiary is likely a/an ________ foreign entity with most of its cash flows in U.S. dollars, and the second subsidiary is more of a/an ________ foreign entity.
A) domestic; integrated
B) self-sustaining; domestic
C) integrated; self-sustaining
D) self-sustaining; integrated

10) A foreign subsidiary’s ________ currency is the currency used in the firm’s day-to-day operations.
A) local
B) integrated
C) notational dollar
D) functional

11) The ________ determines accounting policy for U.S. firms.
A) Securities and Exchange Commission (SEC)
B) Federal Reserve System (Fed)
C) Financial Accounting Standards Board (FASB)
D) General Agreement on Tariffs and Trade (GATT)

True/False

1) It is possible to use different exchange rates for different line items on a financial statement.

2) If the same exchange rate were used to remeasure every line on a financial statement, then there would be no imbalances from remeasuring.

3) A foreign subsidiary”s functional currency is the currency of the primary economic environment in which the subsidiary operates and in which it generates cash flows.

4) It is highly unusual for a multinational firm to have both integrated foreign entities AND self-sustaining foreign entities.

11.2 Translation Methods

Multiple Choice

1) The two basic methods for the translation of foreign subsidiary financial statements are the ________ method and the ________ method.
A) current rate; temporal
B) temporal; proper timing
C) current rate; future rate
D) none of the above

2) Gains or losses caused by translation adjustments when using the current rate method are reported separately on the:
A) consolidated statement of cash flow.
B) consolidated income statement.
C) consolidated balance sheet.
D) none of the above

3) The basic advantage of the ________ method of foreign currency translation is that foreign nonmonetary assets are carried at their original cost in the parent’s consolidated statement while the most important advantage of the ________ method is that the gain or loss from translation does not pass through the income statement.
A) monetary; current rate
B) temporal; current rate
C) temporal; monetary
D) current rate; temporal

4) Under the U.S. method of translation procedures, if the financial statements of the foreign subsidiary of a U.S. company are maintained in U.S. dollars:
A) translation is accomplished through the current rate method.
B) translation is accomplished through the temporal method.
C) translation is not required.
D) the translation method to be used is not obvious.

5) Under the U.S. method of translation procedures, if the financial statements of the foreign subsidiary of a U.S. company are maintained in the local currency, and the local currency is the functional currency, then:
A) the translation method to be used is not obvious.
B) translation is accomplished through the temporal method.
C) translation is not required.
D) translation is accomplished through the current rate method.

6) Under the U.S. method of translation procedures, if the financial statements of the foreign subsidiary of a U.S. company are maintained in the local currency, and the U.S. dollar is the functional currency, then:
A) translation is not required.
B) translation is accomplished through the current rate method.
C) translation is accomplished through the temporal method.
D) none of the above

7) If the European subsidiary of a U.S. firm has net exposed assets of €750,000, and the euro drops in value from $1.30/euro to $1.20/€ the U.S. firm has a translation:
A) gain of $75,000.
B) loss of $75,000.
C) gain of $625,000.
D) loss of €576,923.

8) If the European subsidiary of a U.S. firm has net exposed assets of €200,000, and the euro increases in value from $1.22/€ to $1.26/€ the U.S. firm has a translation:
A) gain of $8,000.
B) loss of $8,000.
C) gain of $252,000.
D) loss of €252,000.

9) If the British subsidiary of a European firm has net exposed assets of £125,000, and the pound increases in value from €1.40/£ to €1.44/£, the European firm has a translation:
A) gain of €5,000.
B) loss of €5,000.
C) gain of £5,000.
D) loss of £5,000.

10) If the British subsidiary of a European firm has net exposed assets of £250,000, and the pound drops in value from €1.35/£ to €1.30/£, the European firm has a translation:
A) gain of €12,500.
B) loss of €12,500.
C) loss of £12,500.
D) gain of £12,500.

True/False

1) Exchange rate imbalances that are passed through the balance sheet affect a firm’s reported income, but imbalances transferred to the income statement do not.

2) The current rate method is the most prevalent method today for the translation of financial statements.

3) The temporal rate method is the most prevalent method today for the translation of financial statements.

4) The biggest advantage of the current rate method of reporting translation adjustments is the fact that the gain or loss goes directly to the reserve account on the consolidated balance sheet and does not pass through the consolidated income statement.

5) Under the temporal rate method, specific assets and liabilities are translated at exchange rates consistent with the timing of the item’s creation.

6) The temporal method of foreign currency translation gains or losses resulting from remeasurement are carried directly to current consolidated income and thus introduces volatility to consolidated earnings.

7) : The current rate method and the temporal method are two basic methods for translation that are employed worldwide

Essay

1) The two methods for the translation of foreign subsidiary financial statements are the current rate and temporal methods. Briefly, describe how each of these methods translates the foreign subsidiary financial statements into the parent company’s consolidated statements. Identify when each technique should be used and the major advantage(s) of each.

11.3 U.S. Translation Procedures

Multiple Choice

1) Under U.S. accounting and translation practices, use of the current rate method is termed ________ while use of the temporal method is termed ________.
A) translation; the same
B) translation; remeasurement
C) remeasurement; the same
D) remeasurement; translation

2) Which of the following primary principles of U.S. translation procedures in NOT true?
A) If the financial statements of the foreign subsidiary of a U.S. company are maintained in U.S. dollars, translation is not required.
B) If the financial statements of the foreign subsidiary are maintained in the local currency and the local currency is the functional currency, they are translated by the temporal method.
C) If the financial statements of the foreign subsidiary are maintained in the local currency and the U.S. dollar is the functional currency, they are remeasured by the temporal method.
D) All of the above are true.

True/False

1) Under U.S. accounting and translation practices, use of the current rate method is termed “translation” while use of the temporal method is termed “remeasurement.”

2) If the financial statements of the foreign subsidiary are maintained in the local currency and the U.S. dollar is the functional currency, they are remeasured by the temporal method.

11.4 Trident Corporation’s Translation Exposure

Multiple Choice

1) ________ occur as a result of changes in the value of currency, whereas ________ occur as a result of ongoing business activities.
A) Operating gains or losses; translation gains or losses
B) Swap losses; translation gains or losses
C) Translation gains or losses; operating gains or losses
D) all of the above

True/False

1) Translation gains or losses can be quite different from operating gains or losses not only in magnitude but also in sign.

11.5 Trident Corporation’s Translation Exposure: Income

Multiple Choice

1) The main technique to minimize translation exposure is called a/an ________ hedge.
A) balance sheet
B) income statement
C) forward
D) translation

2) A balance sheet hedge requires that the amount of exposed foreign currency assets and liabilities:
A) have a 2:1 ratio of assets to liabilities.
B) have a 2:1 ratio of liabilities to assets.
C) have a 2:1 ratio of liabilities to equity.
D) be equal.

3) If a firm’s balance sheet has an equal amount of exposed foreign currency assets and liabilities and the firm translates by the temporal method, then:
A) the net exposed position is called monetary balance.
B) the change is value of liabilities and assets due to a change in exchange rates will be of equal but opposite direction.
C) Both A and B are true.
D) none of the above

4) If a firm’s subsidiary is using the local currency as the functional currency, which of the following is NOT a circumstance that could justify the use of a balance sheet hedge?
A) The foreign subsidiary is about to be liquidated, so that the value of its Cumulative Translation Adjustment (CTA) would be realized.
B) The firm has debt covenants or bank agreements that state the firm’s debt/equity ratio will be maintained within specific limits.
C) The foreign subsidiary is operating is a hyperinflationary environment.
D) All of the above are appropriate reasons to use a balance sheet hedge.

5) If the parent firm and all subsidiaries denominate all exposed assets and liabilities in the parent’s reporting currency this will ________ exposure but each subsidiary would have ________ exposure.
A) maximize translation; no transaction
B) eliminate translation; transaction
C) maximize transaction; no translation
D) eliminate transaction; translation

6) A Canadian subsidiary of a U.S. parent firm is instructed to bill an export to the parent in U.S. dollars. The Canadian subsidiary records the accounts receivable in Canadian dollars and notes a profit on the sale of goods. Later, when the U.S. parent pays the subsidiary the contracted U.S. dollar amount, the Canadian dollar has appreciated 10% against the U.S. dollar. In this example, the Canadian subsidiary will record a:
A) 10% foreign exchange loss on the U.S. dollar accounts receivable.
B) 10% foreign exchange gain on the U.S. dollar accounts receivable.
C) Since the Canadian firm is a U.S. subsidiary, neither a gain nor loss will be recorded.
D) Any gain or loss will be recorded only by the parent firm.

7) ________ gains and losses are “realized” whereas ________ gains and losses are only “paper.”
A) Translation; transaction
B) Transaction; translation
C) Translation; operating
D) none of the above

True/False

1) It is possible that efforts to decrease translation exposure may result in an increase in transaction exposure.

2) One possible reason for a balance sheet hedge could be because the foreign subsidiary is about to be liquidated, so that value of its Cumulative Translation Adjustment (CTA)would be realized.

3) One possible reason for a balance sheet hedge could be because the firm has debt covenants or bank agreements that state the firm”s debt/equity ratios will be maintained within specific limits.

4) If management expects a foreign currency to depreciate, it could minimize translation exposure by increasing net exposed assets.

5) If management anticipates an appreciation of the foreign currency, it should decrease net exposed assets to benefit from a gain.

Essay

1) Describe a balance sheet hedge and give at least two examples of when such a hedge could be justified.
balance sheet hedge attempts to equalize the amount of assets and liabilities of a foreign subsidiary exposed to translation risk. Thus, the gain to the firm from a change in exchange rates will be perfectly offset by an equal and opposite loss. Firms may engage in balance sheet hedges under conditions of hyperinflation, or when the subsidiary is about to be liquidated and the value of the CTA account would be realized. The author on page 16 lists other examples.

Chapter 12 Operating Exposure

12.1 Trident Corporation: A Multinational’s Operating Exposure

Multiple Choice

1) Another name for operating exposure is ________ exposure.
A) economic
B) competitive
C) strategic
D) all of the above

2) What type of international risk exposure measures the change in present value of a firm resulting from changes in future operating cash flows caused by any unexpected change in exchange rates?
A) transaction exposure
B) accounting exposure
C) operating exposure
D) translation exposure

3) ________ cash flows arise from intracompany and intercompany receivables and payments, while ________ cash flows are payments for the use of loans and equity.
A) Financing; operating
B) Operating; financing
C) Operating; accounting
D) Accounting; financing

4) Which of the following is NOT an example of a financial cash flow?
A) parent invested equity capital
B) interest on intrafirm lending
C) payment for goods and services
D) intrafirm principal payments

5) Which of the following is NOT an example of an operating cash flow?
A) management fees and distributed overhead
B) royalties and license fees
C) rent and lease payments
D) dividend paid to parent company

6) ________ exposure is far more important for the long-run health of a business than changes caused by ________ or ________ exposure.
A) Operating; translation; transaction
B) Transaction; operating; translation
C) Accounting; translation; transaction
D) Translation; operating; transaction

7) Simpson Sign Company based in Frostbite Falls, Minnesota has a 6-month C$100,000 contract to complete sign work in Winnipeg, Manitoba, Canada. The current spot rate is $1.02/C$ and the forward rate is $1.01/C$. Under conditions of equilibrium, management would use ________ today when preparing operating budgets.
A) $102,000
B) $101,000
C) $100,000
D) none of the above

8) When considering the phases of adjustment and response to operating exposure in the LONG RUN, price changes tend to be ________ and volume changes tend to be ________.
A) fixed/contracted; contracted.
B) fixed/contracted; completely flexible.
C) completely flexible; completely flexible.
D) completely flexible; contracted.

True/False

1) The goal of operating exposure analysis is to identify strategic operating techniques the firm might adopt to enhance value in the face of unanticipated exchange rate changes.

2) Operating cash flows may occur in different currencies and at different times, but financing cash flows may occur only in a single currency.

Comment: Financing of cash flows may also be in several currencies.

3) Expected changes in foreign exchange rates should already be factored into anticipated operating results by management and investors.

4) Moral hazard may occur when a firm or individual takes on more risk when it knows that someone else will “pick up the tab.”

5) Even though contracts are often fixed in the short run, as time passes, prices and costs can be changed to reflect the new competitive realities caused by a change in exchange rates.

12.2 Measuring Operating Exposure: Trident Germany

Multiple Choice

1) Recently the British Pound suffered an unexpected depreciation in value. Which of the following actions being considered by Coventry Furniture of London, a purely domestic furniture manufacturer and retailer, would be considered a highly unlikely response to the depreciation of the pound?
A) Coventry might choose to maintain its domestic sales prices constant in pound terms.
B) Coventry might try to raise domestic prices because competing imports are now priced higher in England.
C) Coventry might try to lower domestic prices because competing imports are now priced higher in England.
D) none of the above

2) Recently the Canadian dollar realized an unexpected appreciation in value. Which of the following actions being considered by Tall Timber Exports, a Canadian logging firm specializing in exporting raw forest products, would be considered a highly unlikely response to the appreciation of the Canadian dollar?
A) Tall Timber Exports might lower export prices in an effort to maintain market share.
B) Tall Timber Exports might raise export prices only slightly in an effort to increase market share.
C) Tall Timber Exports might leave export prices as they are and wait to determine what actions to take if any in the future.
D) all of the above

3) For a firm that competes internationally to sell its products, a depreciation of its domestic currency relative to markets where the firm exports goods, should eventually result in ________ sales at home and ________ sales abroad, other things equal.
A) fewer; greater
B) fewer; fewer
C) greater; greater
D) greater; fewer

4) Brimmo Motorcycles Inc., a U.S.-based firm, manufactures and sells electric motorcycles both domestically and internationally. A sudden and unexpected appreciation of the U.S. dollar should allow sales to ________ at home and ________ abroad. (Assume other factors remain unchanged.)
A) increase; increase
B) decrease; decrease
C) increase; decrease
D) decrease; increase

True/False

1) The strategy management undertakes in response to unexpected changes in exchange rates depends to a large measure on their opinion about the price elasticity of demand.

2) Unexpected changes in exchange rates is never good news for a firm’s operating income.

12.3 Strategic Management of Operating Exposure

Multiple Choice

1) Which of the following is NOT an example of diversifying operations?
A) diversifying sales
B) diversifying location of operations
C) raising funds in more than one country
D) sourcing raw materials in more than one country

2) Which of the following is NOT an example of diversification in financing?
A) raising funds in more than one market
B) raising funds in more than one country
C) diversifying sales
D) All of the above qualify.

3) When disequilibria in international markets occur, management can take advantage by:
A) doing nothing if they are already diversified and able to realize beneficial portfolio effects.
B) recognizing disequilibria faster than purely domestic competitors.
C) shifting operational of financing activities to take advantage of the disequilibria.
D) all of the above

4) Purely domestic firms will be at a disadvantage to MNEs in the event of market disequilibria because:
A) domestic firms lack comparative data from its own sources.
B) international firms are already so large.
C) all of the domestic firm’s raw materials are imported.
D) None of the above; domestic firms are not at a disadvantage.

5) Which of the following is probably NOT an advantage of foreign exchange risk management?
A) the reduction of the variability of cash flows due to domestic business cycles
B) increased availability of capital
C) reduced cost of capital
D) All of the above are potential advantages of foreign exchange risk management.

6) Which of the following is NOT an example of a form of political risk that might be avoided or reduced by foreign exchange risk management?
A) expropriation of assets
B) destruction of raw materials through natural disaster
C) war
D) unfavorable legal changes

True/False

1) Management must be able to predict disequilibria in international markets to take advantage of diversification strategies.

2) If a firm diversifies its financing sources, it will be pre-positioned to take advantage of temporary deviations from the International Fisher Effect.

3) Diversifying the financing base means diversifying sales, location of production facilities, and raw material sources.

4) The variability of a firm’s operating cash flows is probably reduced by international diversification of its production, sourcing, and sales because exchange rate changes under disequilibrium conditions are likely to increase the firm”s competitiveness in some markets while reducing it in others.

Essay

1) Diversification is possibly the best technique for reducing the problems associated with international transactions. Provide one example each of international financial diversification and international operational diversification and explain how the action reduces risk.

12.4 Proactive Management of Operating Exposure

Multiple Choice

1) Which of the following is NOT identified by your authors as a proactive management technique to reduce exposure to foreign exchange risk?
A) matching currency cash flows
B) cross-currency swaps
C) remaining a purely domestic firm
D) parallel loans

2) Which one of the following management techniques is likely to best offset the risk of long-run exposure to receivables denominated in a particular foreign currency?
A) Borrow money in the foreign currency in question.
B) Lend money in the foreign currency in question.
C) Increase sales to that country.
D) Increase sales in this country.

3) Which one of the following management techniques is likely to best offset the risk of long-run exposure to payables denominated in a particular foreign currency?
A) Borrow money in the foreign currency in question.
B) Lend money in the foreign currency in question.
C) Rely on the Federal Reserve Board to enact monetary policy favorable to your exposure risk.
D) none of the above

4) The particular strategy of trying to offset stable inflows of cash from one country with outflows of cash in the same currency is known as:
A) hedging.
B) diversification.
C) matching.
D) balancing.

5) Which of the following is NOT an acceptable hedging technique to reduce risk caused by a relatively predictable long-term foreign currency inflow of Japanese yen?
A) Import raw materials from Japan denominated in yen to substitute for domestic suppliers.
B) Pay suppliers from other countries in yen.
C) Import raw materials from Japan denominated in dollars.
D) Acquire debt denominated in yen.

6) An MNE has a contract for a relatively predictable long-term inflow of Japanese yen that the firm chooses to hedge by seeking out potential suppliers in Japan. This hedging strategy is referred to as:
A) a natural hedge.
B) currency-switching.
C) matching.
D) diversification.

7) An MNE has a contract for a relatively predictable long-term inflow of Japanese yen that the firm chooses to hedge by paying for imports from Canada in Japanese yen. This hedging strategy is known as:
A) a natural hedge.
B) currency-switching.
C) matching.
D) diversification.

8) A U.S. timber products firm has a long-term contract to import unprocessed logs from Canada. To avoid occasional and unpredictable changes in the exchange rate between the U.S. dollar and the Canadian dollar, the firms agree to split between the two firms the impact of any exchange rate movement. This type of agreement is referred to as:
A) risk-sharing.
B) currency-switching.
C) matching.
D) a natural hedge.

9) A ________ occurs when two business firms in separate countries arrange to borrow each other’s currency for a specified period of time.
A) natural hedge loan
B) forward loan
C) currency switch loan
D) back-to-back loan

10) A Canadian firm with a U.S. subsidiary and a U.S. firm with a Canadian subsidiary agree to a parallel loan agreement. In such an agreement, the Canadian firm is making a/an ________ loan to the ________ subsidiary while effectively financing the ________ subsidiary.
A) indirect; U.S.; Canadian
B) indirect; Canadian; U.S.
C) direct; U.S.; Canadian
D) direct; Canadian; U.S.

11) Which of the following is NOT an important impediment to widespread use of parallel loans?
A) difficulty in finding an appropriate counterparty
B) the risk that one of the parties will fail to return the borrowed funds when agreed
C) the process does not avoid exchange rate risk
D) All of the above are significant impediments.

12) A ________ resembles a back-to-back loan except that it does not appear on a firm’s balance sheet.
A) forward loan
B) currency hedge
C) counterparty
D) currency swap

13) A ________ is the term used to describe a foreign currency agreement between two parties to exchange a given amount of one currency for another, and after a period of time, to give back the original amounts.
A) matched flow
B) currency swap
C) back-to-back loan
D) none of the above

14) A British firm and a U.S. Corporation each wish to enter into a currency swap hedging agreement. The British firm is receiving U.S. dollars from sales in the U.S. but wants pounds. The U.S. firm is receiving pounds from sales in Britain but wants dollars. Which of the following choices would best satisfy the desires of the firms?
A) The British firm pays dollars to a swap dealer and receives pounds from the dealer. The U.S. firm pays pounds to the swap dealer and receives dollars.
B) The U.S. firm pays dollars to a swap dealer and receives pounds from the dealer. The British firm pays pounds to the swap dealer and receives dollars.
C) The British firm pays pounds to a swap dealer and receives pounds from the dealer. The U.S. firm pays dollars to the swap dealer and receives dollars.
D) The British firm pays dollars to a swap dealer and receives dollars from the dealer. The U.S. firm pays pounds to the swap dealer and receives pounds.

15) Reinvoicing centers provide the following benefit(s):
A) aid in the management of foreign exchange exposure.
B) effectively guarantee the exchange rate for future orders.
C) help manage intra-subsidiary cash flows.
D) all of the above

16) NorthRim Inc. (NRI), imports extreme condition outdoor wear and equipment from the Allofit Territories Company (ATC) located in Canada. With the steady decline of the U.S dollar against the Canadian dollar NRI is finding a continued relationship with ATC to be an increasingly difficult proposition. In response to NRI’s request, ATC has proposed the following risk-sharing arrangement. First, set the current spot rate as the base rate. As long as spot rates stay within 5% (up or down) NRI will pay at the base rate. Any rate outside of the 5% range, ATC will share equally with NRI the difference between the spot rate and the base rate. If the current spot rate is C$1.20/$, what are the upper and lower limits for trading to take place at C$1.20?
A) C$1.205/$ – C$1.195/$
B) C$1.15/$ – C$1.25/$
C) C$1.14/$ – C$1.26/$
D) none of the above

17) NorthRim Inc. (NRI), imports extreme condition outdoor wear and equipment from The Allofit Territories Company (ATC) located in Canada. With the steady decline of the U.S dollar against the Canadian dollar NRI is finding a continued relationship with ATC to be an increasingly difficult proposition. In response to NRI’s request, ATC has proposed the following risk-sharing arrangement. First, set the current spot rate as the base rate. As long as spot rates stay within 5% (up or down) NRI will pay at the base rate. Any rate outside of the 5% range, ATC will share equally with NRI the difference between the spot rate and the base rate. If NRI has a payable of C$100,000 due today and the current spot rate is C$1.17/$, how much does LBC owe in U.S. dollars?
A) $83,333
B) $85,470
C) $85,837
D) $117,000

18) Costs associated with the purchase of sizeable put options positions include each of the following EXCEPT:
A) the purchase price of the options.
B) the opportunity cost of buying the options rather than diversifying operations to reduce risk.
C) executive salaries of having corporate offices in more than one country.
D) none of the above

True/False

1) Currency swaps are exclusively for periods of time under one year.

2) Most swap dealers arrange swaps so that each firm that is a party to the transaction does not know who the counterparty is.

3) Most swap dealers arrange swaps so that each firm that is a party to the transaction knows who the counterparty is.

4) Swap agreements are treated as off-balance sheet transactions via U.S. accounting methods.

5) Swap agreements are treated as line items on the balance sheet via U.S. accounting methods.

6) After being introduced in the 1980s, currency swaps have remained a relatively insignificant financial derivative instrument.

7) After being introduced in the 1980s, currency swaps have gained increasing importance as financial derivative instruments.

8) The empirical evidence strongly supports the proposition that contractual hedges can effectively eliminate operating exposure.

Essay

1) A British firm has a subsidiary in the U.S., and a U.S. firm, known to the British firm, has a subsidiary in Britain. Define and then provide an example for each of the following management techniques for reducing the firm’s operating cash flows. The following are techniques to consider:
a) matching currency cash flows
b) risk-sharing agreements
c) back-to-back or parallel loans

ECO 410 Week 8 Quiz Solution

Chapter 13 The Global Cost and Availability of Capital

13.1 Financial Globalization and Strategy

Multiple Choice

1) If a firm lies within a country with ________ or ________ domestic capital markets, it can achieve lower global cost and greater availability of capital with a properly designed and implemented strategy to participate in international capital markets.
A) liquid; segmented
B) liquid; large
C) illiquid; segmented
D) large; illiquid

2) Other things equal, a firm that must obtain its long-term debt and equity in a highly illiquid domestic securities market will probably have a:
A) relatively low cost of capital.
B) relatively high cost of capital.
C) relatively average cost of capital.
D) cost of capital that we cannot estimate from this question.

3) Relatively high costs of capital are more likely to occur in:
A) highly illiquid domestic securities markets.
B) highly liquid domestic securities markets.
C) unsegmented domestic securities markets.
D) none of the above

4) Reasons that firms may find themselves with relatively high costs of capital include:
A) The firms reside in emerging countries with undeveloped capital markets.
B) The firms are too small to easily gain access to their own national securities market.
C) The firms are family owned and they choose not to access public markets and lose control of the firm.
D) all of the above

5) Which of the following is NOT a contributing factor to the segmentation of capital markets?
A) excessive regulatory control
B) perceived political risk
C) anticipated foreign exchange risk
D) All of the above are contributing factors.

6) Which of the following is NOT a contributing factor to the segmentation of capital markets?
A) lack of transparency
B) asymmetric availability of information
C) insider trading
D) All of the above are contributing factors.

7) The weighted average cost of capital (WACC) is:
A) the required rate of return for all of a firm’s capital investment projects.
B) the required rate of return for a firm’s average risk projects.
C) not applicable for use by MNE.
D) equal to 13%.

8) The capital asset pricing model (CAPM) is an approach:
A) to determine the price of equity capital.
B) used by marketers to determine the price of saleable product.
C) that can be applied only to domestic markets.
D) none of the above

9) Which of the following is NOT a key variable in the equation for the capital asset pricing model?
A) the risk-free rate of interest
B) the expected rate of return on the market portfolio
C) the marginal tax rate
D) All are important components of the CAPM.

10) ________ risk is a function of the variability of expected returns of the firm’s stock relative to the market index and the measure of correlation between the expected returns of the firm and the market.
A) Systematic
B) Unsystematic
C) Total
D) Diversifiable

11) Systematic risk:
A) is the standard deviation of a security’s return.
B) is measured with beta.
C) is measured with standard deviation.
D) none of the above

12) Which of the following is generally unnecessary in measuring the cost of debt?
A) a forecast of future interest rates
B) the proportions of the various classes of debt a firm proposes to use
C) the corporate income tax rate
D) All of the above are necessary for measuring the cost of debt.

13) The after-tax cost of debt is found by:
A) dividing the before-tax cost of debt by (1 – the corporate tax rate).
B) subtracting (1 – the corporate tax rate) from the before-tax cost of debt.
C) multiplying the before-tax cost of debt by (1 – the corporate tax rate).
D) subtracting the corporate tax rate from the before-tax cost of debt.

14) A firm whose equity has a beta of 1.0:
A) has greater systematic risk than the market portfolio.
B) stands little chance of surviving in the international financial market place.
C) has less systematic risk than the market portfolio.
D) None of the above is true.

15) The difference between the expected (or required) return for the market portfolio and the risk-free rate of return is referred to as:
A) beta.
B) the geometric mean.
C) the market risk premium.
D) the arithmetic mean.

16) In general the geometric mean will be ________ the arithmetic mean for a series of returns.
A) less than
B) greater than
C) equal to
D) greater than or equal to

17) The beginning share price for a security over a three-year period was $50. Subsequent year-end prices were $62, $58 and $64. The arithmetic average annual rate of return and the geometric average annual rate of return for this stock was:
A) 9.30% and 8.58% respectively.
B) 9.30% and 7.89% respectively.
C) 9.30% and 7.03% respectively.
D) 9.30% and 6.37% respectively.

18) If a company fails to accurately predict it’s cost of equity, then:
A) the firm’s wacc will also be inaccurate.
B) the firm may not be using the proper interest rate to estimate NPV.
C) the firm may incorrectly accept or reject projects based on decisions made using the cost of capital computed with an incorrect cost of equity.
D) All of the above are true.

19) Which of the following statements is NOT true regarding beta?
A) Beta will have a value of less than 1.0 if the firm’s returns are less volatile than the market.
B) Beta will have a value of greater than 1.0 if the firm’s returns are more volatile than the market.
C) Beta will have a value of equal to 1.0 if the firm’s returns are of equal volatility to the market.
D) All of the statements above are true.

20) Which of the following will NOT affect a firm’s beta?
A) the choice of the market portfolio against which to compare the variability of a firm’s returns
B) the choice of the risk-free security
C) the choice of the time period used to calculate the firm’s beta
D) None of the above, because each of them affects the calculation of a firm’s beta.

True/False

1) A national securities market is segmented if the required rate of return on securities in that market differs from comparable securities traded in other, unsegmented markets.

2) Other things equal, an increase in the firm’s tax rate will increase the WACC for a firm that has both debt and equity financing.

3) If a firm’s expected returns are more volatile than the expected return for the market portfolio, it will have a beta less than 1.0.

4) The WACC is usually used as the risk-adjusted required rate of return for new projects that are of the same average risk as the firm’s existing projects.

5) One of the elegant beauties of international equity markets is that over the last 100 or so years, the average market risk premium is almost identical across major industrial countries.

6) Firms acquire debt in either the form of loans from commercial banks, or by selling new common stock.

7) When estimating an average corporate after-tax cost of capital, the component cost of equity is multiplied by (1-t) to allow for the tax-deductibility of dividend payments.

8) International CAPM (ICAPM) assumes that there is a global market in which the firm’s equity trades, and estimates of the firm’s beta, and the market risk premium, must then reflect this global portfolio.

9) Use of the International CAPM (ICAPM) assures that the WACC will be lower than if a purely domestic market portfolio had been used in the estimation of the cost of equity.

10) A global portfolio is an index of all the securities in the world, whereas a world portfolio represents those securities actually available to an investor.

11) The CAPM has now become very widely accepted in global business as the preferred method of calculating the cost of equity for a firm. As a result of this, there is now little debate over what numerical values should be used in its application.

12) The geometric mean will, in all but a few extreme circumstances, yield a larger return than the arithmetic mean return.

Essay

1) What are the components of the weighted average cost of capital (WACC) and how do they differ for an MNE compared to a purely domestic firm?

13.2 The Demand for Foreign Securities: The Role of International Portfolio Investors

Multiple Choice

1) The primary goal of both domestic and international portfolio managers is:
A) to maximize return for a given level of risk, or to minimize risk for a given level of return.
B) to minimize the number of unique securities held in their portfolio.
C) to maximize their WACC.
D) all of the above

2) Which of the following is NOT a portfolio diversification technique used by portfolio managers?
A) diversify by type of security
B) diversify by the size of capitalization of the securities held
C) diversify by country
D) All of the above are diversification techniques.

3) If all capital markets are fully integrated, securities of comparable expected return and risk should have the same required rate of return in each national market after adjusting for:
A) time of day and language requirements.
B) political risk and time lags.
C) foreign exchange risk and political risk.
D) foreign exchange risk and the spot rate.

4) Capital market segmentation is a financial market imperfection caused mainly by:
A) government constraints.
B) institutional practices.
C) investor perceptions.
D) all of the above

5) Capital market imperfections leading to financial market segmentation include:
A) asymmetric information between domestic and foreign-based investors.
B) high securities transaction costs.
C) foreign exchange risks.
D) all of the above

6) Capital market imperfections leading to financial market segmentation include:
A) political risks.
B) corporate governance differences.
C) regulatory barriers.
D) all of the above

7) The authors refer to companies that have access to a ________ as MNEs, and firms without such access are identified as ________.
A) global cost and availability of capital; domestic firms.
B) large domestic capital market; geographically challenged.
C) world financial markets; antiquated.
D) none of the above

8) The MNE can ________ its ________ by gaining access to markets that are more liquid and/or less segmented than its own.
A) increase; MCC.
B) decrease; MCC.
C) maintain; MRR.
D) none of the above

True/False

1) Internationally diversified portfolios often have a lower rate of return and almost always have a higher level of portfolio risk than their domestic counterparts.

2) Empirical tests of market efficiency fail to show that most major national markets are reasonably efficient.

3) A MNEs marginal cost of capital is constant for considerable ranges in its capital budget, but this statement cannot be made for most domestic firms.

4) Capital market segmentation is a financial market imperfection caused mainly by government constraints, institutional practices, and investor perceptions.

5) Since the 1980s and 1990s, segmentation in global financial markets has been reduced. As a result of this, the correlation among securities markets has increased, thereby reducing, but not eliminating, the benefits of international portfolio diversification.

13.3 The Cost of Capital for MNEs Compared to Domestic Firms

Multiple Choice

1) Theoretically, most MNEs should be in a position to support higher ________ than their domestic counterparts because their cash flows are diversified internationally.
A) equity ratios
B) debt ratios
C) temperatures
D) none of the above

2) According to your authors, diversifying cash flows internationally may help MNEs reduce the variability of cash flows because:
A) of a lack of competition among international firms.
B) of an offset to cash flow variability caused by exchange rate variability.
C) returns are not perfectly correlated between countries.
D) none of the above

3) Which of the following statements is NOT true regarding MNEs when compared to purely domestic firms?
A) MNEs tend to rely more on short and intermediate term debt.
B) MNEs have greater foreign exchange risk.
C) MNEs have greater costs of asymmetric information.
D) MNEs have higher agency costs.

4) Empirical research has found that systematic risk for MNEs is greater than that for their domestic counterparts. This could be due to:
A) the fact that the increase in the correlation of returns between the market and the firm is less than the increase in the standard deviation of returns of the firm.
B) the fact that the decrease in the correlation of returns between the market and the firm is greater than the increase in the standard deviation of returns of the firm.
C) the reduction in the correlation of returns between the firm and the market is less than the increase in the variability of returns caused by factors such as asymmetric information, foreign exchange risk, and the like.
D) None of the above; systematic risk is less for MNEs than for their domestic counterparts.

5) The optimal capital budget:
A) occurs where the marginal cost of capital equals the marginal rate of return of the opportunity set of projects.
B) is typically larger for purely domestic firms than for MNEs.
C) is an illusion found only in international finance textbooks.
D) none of the above

6) Empirical studies indicate that MNEs have higher costs of capital than purely domestic firms. This could be due to higher levels of:
A) political risk.
B) exchange rate risk.
C) agency costs.
D) all of the above

7) Despite the theoretical elegance of this hypothesis, empirical studies have come to the opposite conclusion.Despite the favorable effect of international diversification of cash flows, bankruptcy risk was only about the same for MNEs as for domestic firms. However, MNEs faced higher costs for each of the following EXCEPT:
A) agency costs.
B) political risk.
C) asymmetric information.
D) In fact, each of these costs were higher for the MNE than for the domestic firm.

True/False

1) Because of the international diversification of cash flows, the risk of bankruptcy for MNEs is significantly lower than that for purely domestic firms.

2) The opportunity set of projects is typically smaller for MNEs than for purely domestic firms because international markets are typically specialized niches.

3) Surprisingly, empirical studies find that MNEs have a higher level of systematic risk than their domestic counterparts.

Essay

1) What do theory and empirical evidence say about capital structure and the cost of capital for MNEs versus their domestic counterparts?

13.4 The Riddle: Is the Cost of Capital Higher for MNEs?

Multiple Choice

1) Empirical studies indicate that WACC for an MNE is higher than for their domestic competitors. Reasons cited for this increased cost include all of the following EXCEPT:
A) agency costs.
B) foreign exchange risk.
C) political risk.
D) All of the above are cited as reasons for an MNE’s increased WACC.

True/False

1) Empirical studies indicate that MNEs have a lower debt/capital ratio than domestic counterparts, indicating that MNEs have a lower cost of capital.

Chapter 14 Raising Equity and Debt Globally

14.1 Designing a Strategy to Source Capital Globally

Multiple Choice

1) The choice of when and how to source capital globally is usually aided early on by the advice of:
A) an investment banker.
B) your stock broker.
C) a commercial banker.
D) an underwriter.

2) Investment banking services include which of the following?
A) advising when a security should be cross-listed
B) preparation of stock prospectuses
C) help to determine the price of the issue
D) all of the above

3) Which of the following is the typical order of sourcing capital abroad?
A) an international bond issue, then cross listing the outstanding issues on other exchanges, then an international bond issue in the target market
B) an international bond issue in the target market, then cross listing the outstanding issues on other exchanges, then an international bond issue
C) an international bond issue in less prestigious markets, then an international bond issue in the target market, and ultimately a eurobond issue
D) cross listing the outstanding issues on other exchanges, then an international bond issue, then an international bond issue in the target market

4) By cross listing and selling its shares on a foreign stock exchange, a firm typically tries to accomplish which of the following?
A) improve the liquidity of its existing shares
B) increase its share price
C) increase the firm’s visibility
D) all of the above

True/False

1) Most firms raise their initial capital in foreign markets.

14.2 Optimal Financial Structure

Multiple Choice

1) Which financial economists are most closely associated with the financial theory of optimal capital structure?
A) Modigliani and Miller
B) Fama, Fisher, Jensen, and Roll
C) Black and Scholes
D) Markowitz and Sharpe

2) For most firms, the cost of capital decreases to a low point as the firm ________ debt financing. At some point beyond this optimal level, the cost of capital increases as the amount of debt ________.
A) decreases; increases
B) decreases; decreases
C) increases; increases
D) increases; decreases

3) One of the most important factors in making debt less expensive than equity is:
A) the tax deductibility of depreciation.
B) the tax deductibility of equity.
C) the tax deductibility of dividends.
D) the tax deductibility of interest.

4) One of the most important factors in making debt less expensive than equity is:
A) the seniority of equity obligations to debt claims.
B) the tax deductibility of dividends.
C) the tax deductibility of equity.
D) the seniority of debt obligations to equity claims.

5) Which of the following is NOT a factor offsetting the tax advantage of debt as a source of financing?
A) increased agency costs
B) increased probability of financial distress (bankruptcy) due to fixed interest payments
C) alternative tax shields to those supplied by interest payments
D) All of the above offset the tax advantage of debt as a source of financing.

6) Most financial theorists believe that the optimal capital structure is a ________ with a debt to total value ratio somewhere around ________.
A) point; 50%
B) point; 25%
C) range; 30%-60%
D) range; 10%-40%

7) Not all firms have the same optimal capital structure. Factors that might influence a firm’s capital structure include:
A) the industry in which it operates.
B) the volatility of its sales and operating income.
C) the collateral value of its assets.
D) all of the above

8) MNEs situated in countries with small illiquid and segmented markets are most like:
A) small domestic U.S. firms in that they must rely on internally generated funds and bank borrowing.
B) large U.S. MNEs in that they are all MNEs and have worldwide markets and sources of financing.
C) small domestic U.S. firms in that they have a strong niche market in the U.S.
D) None of the above is true.

9) In theory, the MNE should support ________ debt ratios than a purely domestic firm because their cash flows are ________.
A) lower; more stable due to international diversification
B) lower; less stable due to international diversification
C) higher; more stable due to international diversification
D) higher; less stable due to international diversification

10) TropiKana Inc., a U.S firm, has just borrowed $1,000,000 to make improvements to an Italian fruit plantation and processing plant. If the interest rate is 6.00% per year, how much interest will they pay in the first year?
A) $6,000
B) $60,000
C) $600,000
D) €60,000

11) TropiKana Inc., a U.S firm, has just borrowed euro 1,000,000 to make improvements to an Italian fruit plantation and processing plant. If the interest rate is 5.50% per year and the Euro depreciates against the dollar from $1.40/€ at the time the loan was made to $1.35/€ at the end of the first year, how much interest will TropiKana pay at the end of the first year (rounded)?
A) $55,000
B) €74,250
C) $74,250
D) $77,000

12) TropiKana Inc., a U.S firm, has just borrowed euro 1,000,000 to make improvements to an Italian fruit plantation and processing plant. If the interest rate is 5.50% per year and the Euro appreciates against the dollar from $1.40/€ at the time the loan was made to $1.45/€ at the end of the first year, how much interest will TropiKana pay at the end of the first year (rounded)?
A) $55,000
B) $79,750
C) $77,000
D) $37,931

13) TropiKana Inc., a U.S firm, has just borrowed euro 1,000,000 to make improvements to an Italian fruit plantation and processing plant. If the interest rate is 5.50% per year and the Euro appreciates against the dollar from $1.40/€ at the time the loan was made to $1.45/€ at the end of the first year, how much interest and principle will TropiKana pay at the end of the first year if they repay the entire loan plus interest (rounded)?
A) $1,529,750
B) €1,529,750
C) $1,055,000
D) $1,477,000

14) TropiKana Inc., a U.S firm, has just borrowed euro 1,000,000 to make improvements to an Italian fruit plantation and processing plant. If the interest rate is 5.50% per year and the Euro depreciates against the dollar from $1.40/€ at the time the loan was made to $1.35/€ at the end of the first year, how much interest and principle will TropiKana pay at the end of the first year if they repay the entire loan plus interest (rounded)?
A) $1,477,000
B) $1,055,000
C) €1,424,250
D) $1,424,250

15) TropiKana Inc., a U.S firm, has just borrowed euro 1,000,000 to make improvements to an Italian fruit plantation and processing plant. If the interest rate is 5.50% per year and the Euro appreciates against the dollar from $1.40/€ at the time the loan was made to $1.45/€ at the end of the first year, what is the before tax cost of capital if the firm repays the entire loan plus interest (rounded)?
A) 1.73%
B) 5.50%
C) 10.50%
D) 9.27%

True/False

1) Financial theory has at last provided us with a single optimal capital structure for domestic firms.

2) Financial practice suggests that there is a range for an optimal capital structure for a firm within an industry rather than a specific optimal ratio of debt to equity.

3) In part because of access to global markets, MNEs are better able than their domestic counterparts to maintain their desired debt ratio even when raising new capital.

4) When a firm borrows in a foreign currency, the effective cost is the foreign interest rate plus an adjustment for changes in the exchange rate.

5) The domestic theory of optimal capital structure does not need to be modified for MNEs.

6) Portfolio diversification of domestic firms reduces risk because cash flows are not perfectly correlated. The same reasoning is often argued for MNEs diversifying into international markets.

7) A significant advantage of borrowing foreign currency-denominated bonds is that the borrower need not worry about relative changes in the value of the home currency.

8) For firms to raise capital in international markets, it is more important to adhere to capital structure ratios similar to those found in the United States and United Kingdom than to those in the firm’s home country.

14.3 Raising Equity Globally

Multiple Choice

1) The stock exchange with the greatest value of shares traded is:
A) NYSE.
B) Tokyo.
C) Nasdaq.
D) London.

2) The number of foreign firms traded on the London exchange is ________ than the number traded on the NYSE, and the costs of listing and disclosure in London are ________ those for the NYSE.
A) less than; less than
B) less than; greater than
C) greater than; less than
D) greater than; greater than

True/False

1) The Tokyo exchange is the number one choice of firms looking to gain liquidity by cross-listing their equity securities.

2) The least liquid stock markets as identified by the authors offer little liquidity for their own domestic firms, and are of little value to foreign firms.

14.4 Depositary Receipts

Multiple Choice

1) ________ are negotiable certificates issued by a bank to represent the underlying shares of stock, which are held in trust at a foreign custodian bank.
A) Negotiable CDs
B) International mutual funds
C) Depositary receipts
D) Eurodeposits

2) Depositary receipts traded outside the United States are called ________ depositary receipts.
A) Euro
B) Global
C) American
D) none of the above

3) Each ADR represents ________ of the shares of the underlying foreign stock.
A) a multiple
B) 100
C) 1
D) ADRs have nothing to do with foreign stocks.

4) Which of the following is NOT an advantage of ADRs to U.S. shareholders?
A) Transfer of ownership is done in the U.S. in accordance with U.S. laws.
B) In the event of the death of the shareholder, the estate does not go through a foreign court.
C) Settlement for trading is generally faster in the United States.
D) All of the above are advantages of ADRs.

5) ADRs that are created at the request of a foreign firm wanting its shares traded in the United States are:
A) facilitated.
B) unfacilitated.
C) sponsored.
D) unsponsored.

6) Who pays the costs of creating a sponsored ADR?
A) the foreign firm whose stocks underlie the ADR
B) the U.S. bank creating the ADR
C) both the U.S. bank and the foreign firm
D) the SEC since they require the regulation

7) Level I ADRs trade primarily:
A) on the New York Stock Exchange.
B) on the American Stock Exchange.
C) over the counter or pink sheets.
D) Level I ADRs typically do not trade at all, but instead are privately issued and held until maturity.

8) Level II ADRs must meet:
A) U.S. GAAP standards.
B) home country accounting standards.
C) both U.S. GAAP and home country standards.
D) none of the above

9) Level ________ is the easiest standard to satisfy for issuing ADRs.
A) 144a
B) III
C) II
D) I

10) Level III ADR commitment applies to:
A) firms that want to list existing shares on the NYSE.
B) banks issuing foreign mutual funds.
C) ADR issues of under $25,000.
D) the sale of a new equity issued in the United States.

True/False

1) ADRs cannot be exchanged for the underlying shares of the foreign stock, therefore, arbitrage cannot keep the prices in line with the foreign price of the stock.

2) An unsponsored ADR may be initiated without the approval of the foreign firm with the underlying stock.

3) ADRs are considered an effective way for firms to improve the liquidity of their stock, especially if the home market is small and illiquid.

Essay

1) ADRs are a popular investment tool for many U.S. investors. In recent years several alternatives for investing in foreign equity securities have become available for U.S. investors, yet ADRs remain popular. Define what an ADR is and provide at least three examples of the advantages they may hold over alternative foreign investment vehicles for U.S. investors.

14.5 Private Placement

Multiple Choice

1) Which of the following were NOT identified by the authors as an alternative instrument to source equity in global markets?
A) sale of a directed public share issue to investors in a target market
B) private placements under SEC rule 144a
C) sale of shares to private equity funds
D) All of the above are alternatives to source equity instruments.

2) A/An ________ is defined as one that is targeted at investors in a single country and underwritten in whole or part by investment institutions from that country.
A) SEC rule 144a placement
B) directed public share issue
C) Euroequity public issue
D) strategic alliance

3) The term “euro” as used in the euro equity market implies:
A) the issuers are located in Europe.
B) the investors are located in Europe.
C) both A and B
D) none of the above

4) Private equity funds (PEF) differ from traditional venture capital (VC) funds in that:
A) VC operates mainly in lesser-developed countries while PEF do not.
B) VC typically invests in family business whereas PEF do not.
C) VC is almost unavailable to emerging markets while PEF capital is available.
D) All of the above are true.

5) Strategic alliances are normally formed by firms that expect to gain synergies from which of the following?
A) economies of scale
B) economies of scope
C) complementary marketing
D) all of the above

True/False

1) SEC rule 144A permits institutional buyers to trade privately placed securities without the previous holding periods restrictions and without requiring SEC registration.

14.6 Foreign Equity Listing and Issuance

Multiple Choice

1) Your authors note several empirical studies that have found:
A) no share price effect for foreign firms that cross-list on major U.S. exchanges.
B) a positive share price effect for foreign firms that cross-list on major U.S. exchanges.
C) a negative share price effect for foreign firms that cross-list on major U.S. exchanges.
D) none of the above

2) Empirical evidence shows that new issues of equity by domestic firms in the U.S. market typically has a ________ stock price reaction and new equity issues in the U.S. markets by foreign firms with segmented domestic markets have a ________ stock price reaction.
A) negative; negative
B) positive; negative
C) negative; positive
D) positive; positive

3) In addition to gaining liquidity, which of the following could also be considered a legitimate reason for cross-listing equity?
A) enhance a firm’s local image
B) become more familiar with the local financial community
C) get better local press coverage
D) all of the above

4) Another school of thought about the worldwide trend toward fuller and more standardized disclosure rules is that the cost of U.S. level equity capital disclosure:
A) chases away potential listers of equity.
B) is an onerous costly burden.
C) leads to fewer foreign firms cross listing in U.S. equity markets.
D) all of the above

5) According to the U.S. school of thought, the worldwide trend toward fuller and more standardized disclosure rules should ________ the cost of equity capital.
A) increase
B) decrease
C) have no impact on
D) none of the above

6) For the most part, U.S. SEC disclosure requirements are ________ other, non-U.S. equity market rules.
A) more stringent than
B) less stringent than
C) equally stringent to
D) none of the above

True/False

1) The combined impact of a new equity issue undertaken simultaneously with a cross-listing has a more favorable impact on stock price than cross-listing alone.

2) Because of stringent SEC rules, American companies typically do not find foreign disclosure rules to be overly onerous.

Essay

1) What are the two schools of thought regarding the worldwide trend toward increased financial disclosure by publicly traded firms. Explain which school of thought you hold to and why.

14.7 Raising Debt Globally

Multiple Choice

1) ________ are domestic currencies of one country on deposit in a second country.
A) LIBORs
B) Eurocurrencies
C) Federal funds
D) Discount window deposits

2) Of the following, which was NOT cited by the authors as a valuable function provided by the Eurocurrency market?
A) Eurocurrency deposits are an efficient and convenient money market device for holding excess corporate liquidity.
B) Eurocurrency deposits are a tool used by the Federal Reserve to regulate the money supply of countries that peg their currency against the U.S. dollar.
C) The Eurocurrency market is a major source of short-term bank loans to finance corporate working capital needs.
D) All of the above were cited by the authors.

3) Eurobanks are:
A) banks where Eurocurrencies are deposited.
B) major world banks that conduct a Eurocurrency business in addition to normal banking activities.
C) financial intermediaries that simultaneously bid for time deposits in and make loans in a currency other than that of the currency of where it is located.
D) All of the above are descriptions of a Eurobank.

4) Eurocredits are:
A) bank loans to MNEs and others denominated in a currency other than that of the country where the bank is located.
B) typically variable rate and tied to the LIBOR.
C) usually for maturities of six months or less.
D) All of the above are true.

5) In general, which has the shorter maturity and is more appropriate for funding short-term inventory needs?
A) commercial paper
B) Euro-Medium-Term notes (EMTNs)
C) the international bond market
D) all of the above

6) Foreign bonds sold in the United States are nicknamed “Yankee bonds,” foreign bonds sold in Japan are called “Samurai bonds.” What are foreign bonds sold in the United Kingdom nicknamed?
A) “Union Jacks”
B) “Royalty”
C) “Bulldogs”
D) “Churchill’s”

7) A ________ is a bond underwritten by a syndicate from a single country, sold within in that country, denominated in that country’s currency, but the issuer is from outside that country.
A) foreign bond
B) Eurobond
C) domestic bond
D) none of the above

True/False

1) Eurocurrencies are NOT the same as the euro developed for the common European currency.

2) The Eurocurrency market continues to thrive because it is a large international money market relatively free of governmental regulation and interference.

3) Moody’s rates international bonds at the request of the issuer with the stipulation that Moody’s will publish the ratings even if the ratings are unfavorable.

Essay

1) The Euro-medium-term-note (EMTN) has filled a substantial niche market in global financing. What are the distinguishing characteristics of the EMTN and why is it such a popular form of financing for MNEs?

ECO 410 Week 9 Quiz Solution

Chapter 15 Multinational Tax Management

15.1 Tax Principles

Multiple Choice

1) The issue of ethics in the reporting of income and the payment of taxes is a considerable one. The authors state that most MNEs operating in foreign countries tend to follow the general principle of:
A) “when in Rome, do as the Romans do.”
B) full disclosure to the tax authorities.
C) maintain a competitive playing field by cheating as much as the local competition, no more, no less.
D) none of the above

2) Which of the following is an unlikely objective of U.S. government policy for the taxation of foreign MNEs?
A) to raise revenues
B) to provide an incentive for U.S. private investment in developing countries
C) to improve the U.S. balance of payments
D) All of the above are objectives.

3) A ________ tax policy is one that has no impact on private decision-making, while a ________ policy is designed to encourage specific behavior.
A) flat; tax incentive
B) neutral; flat
C) neutral; tax incentive
D) none of the above

4) Which of the following is NOT an example of a tax incentive policy?
A) The federal government gives a tax credit to MNEs that make domestic capital improvements but not foreign capital improvements.
B) Corporations are allowed to take a direct tax credit for each dollar of matching donations they make to institutions of higher education.
C) A tax law is passed that makes interest on property non tax-deductible, but interest payments on durable goods are.
D) All are examples of a tax incentive policy.

5) Toyota Motor Company operates in many different countries and pays taxes at many different rates. However, they always pay the same rate as their local competitors. Toyota Motor Company is operating in an environment of ________ tax policy.
A) domestic neutrality
B) foreign neutrality
C) territorial approach
D) none of the above

6) The United States taxes the domestic and remitted foreign earnings of U.S. based MNEs no matter where the earnings occurred. This is an example of a/an ________ approach to levying taxes.
A) worldwide
B) territorial
C) neutral
D) equitable

7) The United States taxes all earnings on U.S. soil by both domestic and foreign firms. This is an example of a ________ approach to levying taxes.
A) worldwide
B) neutral
C) territorial
D) none of the above

8) Bacon Signs Inc. is based in a country with a territorial approach to taxation but generates 100% of its income in a country with a worldwide approach to taxation. The tax rate in the country of incorporation is 25%, and the tax rate in the country where they earn their income is 50%. In theory, and barring any special provisions in the tax codes of either country, Bacon should pay taxes at a rate of:
A) 75%.
B) 62.5%.
C) 0%.
D) 50%.

9) The territorial approach to taxation policy is also termed the ________ approach.
A) source
B) ethical
C) greedy
D) location

10) A tax that is effectively a sales tax at each stage of production is defined as a/an ________ tax.
A) flat
B) equitable
C) value-added tax
D) none of the above

11) What is the total value of taxes paid in the following example if the value added tax is 10%? A farmer raises wheat that he sells for $1.50 to the grain company. The grain company sells to the processor for $2.00 per bushel. The processor turns the wheat into a breakfast cereal and wholesales it for $3.00 per bushel. The retailer sells the cereal for $4.00 per bushel.
A) $0.15
B) $0.20
C) $0.30
D) $0.40

TABLE 15.1
Use the information to answer following question(s).

BayArea Designs Inc., located in Northern California, has two international subsidiaries, one located in the Ukraine, the other in Korea. Consider the information below to answer the next several questions.

12) Refer to Table 15.1. If BayArea pays out 50% of its earnings from each subsidiary, what are the additional U.S. taxes due on the foreign sourced income from the Ukraine and Korea respectively.
A) Ukraine = $0; Korea = ($30,000)
B) Ukraine = $100,000; Korea = $0
C) Ukraine = $0; Korea = $66,250
D) none of the above

13) Refer to Table 15.1. The additional U.S. taxes due on the repatriation of income from the Ukraine to the United States, alone, assuming a 50% payout rate, is:
A) excess foreign tax credits of $110,000.
B) additional U.S. taxes due of $97,000.
C) additional U.S. taxes due of $36,500.
D) excess foreign tax credits of $18,500.

14) Refer to Table 15.1. How much in additional U.S. taxes would be due if BayArea averaged the tax credits and liabilities of the two foreign units, assuming a 50% payout rate from each?
A) $3,750
B) $13,750
C) $2,500
D) $0

15) Refer to Table 15.1. If BayArea set the payout rate from the Ukraine subsidiary at 25%, how should BayArea set the payout rate of the Korean subsidiary (approximately) to more efficiently manage its total foreign tax bill?
A) 28.5%
B) 24.5%
C) 42.6%
D) 82.3%

16) Refer to Table 15.1. What is the minimum effective tax rate that BayArea can achieve on its foreign-sourced income?
A) 26%
B) 35%
C) 40%
D) 0%

17) Tax-haven subsidiaries are typically established in a country that can meet the following requirements:
A) a low tax on foreign investment or sales income earned by resident corporations and a low dividend withholding tax on dividends paid to the parent firm.
B) the facilities to support financial services, for example, good communications, professional qualified office workers, and reputable banking services.
C) a stable government that encourages the establishment of foreign-owned financial and service facilities within its borders.
D) all of the above

18) A tax that is a form of social redistribution of income is defined as a/an ________ tax.
A) un-American
B) transfer
C) flat
D) none of the above

19) A ________ is a direct reduction of taxes whereas a ________ reduces the taxable income before taxes.
A) foreign tax credit; domestic tax credit
B) tax deduction; tax credit
C) tax credit; tax deduction
D) none of the above

Instruction 15.1:
Use the information to answer the following question(s).

Green Valley Exporters USA has $100,000 of before tax foreign income. The host country has a corporate income tax rate of 25% and the U.S. has a corporate income tax rate of 35%.

20) Refer to Instruction 15.1. If the U.S. has no bilateral trade agreement with the host country, what is the total amount of income taxes Green Valley Exporters will pay?
A) $25,000
B) $35,000
C) $51,250
D) $60,000

21) Refer to Instruction 15.1. If the U.S. has a bilateral trade agreement with the host country that calls for the total tax paid to be equal to the maximum amount that could be paid in the highest taxing country, what is the total amount of income taxes Green Valley Exporters will pay to the host country, and how much will they pay in U.S income taxes on the foreign earned income?
A) $25,000; $10,000
B) $25,000; $26,250
C) $35,000; $0
D) none of the above

22) Refer to Instruction 15.1. If the U.S. treated the taxes paid on income earned in the host country as a tax-deductible expense, then Green Valley’s total U.S. corporate tax on the foreign earnings would be:
A) $10,000.
B) $26,250.
C) $35,000.
D) $51,250.

23) Refer to Instruction 15.1. If the U.S. treated the taxes paid on income earned in the host country as a tax-credit, then Green Valley’s total U.S. corporate tax on the foreign earnings would be:
A) $51,250.
B) $35,000.
C) $26,250.
D) $10,000.

24) Tax treaties typically result in ________ between the two countries in question.
A) lower property taxes for U.S. citizens overseas
B) elimination of differential tax rates
C) increased double taxation
D) reduced withholding tax rates

25) Transfer pricing is a strategy that may be used by MNEs to:
A) reduce consolidated corporate income taxes.
B) partially finance a subsidiary in another country.
C) transfer funds from a subsidiary to the parent corporation.
D) all of the above

26) ________ is the pricing of goods, services, and technology between related companies.
A) Among pricing
B) Retail pricing
C) Transfer pricing
D) Wholesale pricing

True/False

1) The primary objective of multinational tax planning is to minimize the firm’s worldwide tax burden.

2) A country CANNOT have both a territorial and a worldwide approach as a national tax policy.

3) Tax treaties generally have the effect of increasing the withholding taxes between the countries that are negotiating the treaties.

4) A value-added tax has gained widespread usage in Western Europe, Canada, and parts of Latin America.

5) All indications are that the value-added tax will soon be the dominant form of taxation in the U.S.

6) Among the G7 nations, the U.S. has a below average corporate income tax rate that makes it attractive for other countries to invest in the U.S.

7) In the mid 1980s the U.S. led the way to higher corporate income tax rates worldwide. Today, most of the G7 nations have surpassed the U.S. and have higher corporate income tax rates than the U.S.

8) The ideal tax should not only raise revenue efficiently but also have as few negative effects on economic behavior as possible.

9) The worldwide approach, also referred to as the residential or national approach to tax policy, levies taxes on the income earned by firms that are incorporated in the host country, regardless of where the income was earned (domestically or abroad).

10) The territorial approach, also referred to as the source approach to tax policy, levies taxes on the income earned by firms that are incorporated in the host country, regardless of where the income was earned (domestically or abroad).

11) Of the OECD 30 countries, most employ a worldwide approach to tax policy, but a few, including the United States, use the worldwide approach.

12) FEW governments rely on income taxes, both personal and corporate, for their primary revenue source.

13) Between 2006 – 2012, global corporate tax rates have trended upward.

14) Tax credits are LESS valuable on a dollar-for-dollar basis than are deductible expenses.

15) Tax treaties typically result in reduced withholding tax rates between the two signatory countries.

16) Tax credits are less valuable on a dollar-for-dollar basis than are tax-deductible expenses.

17) The U.S. Internal Revenue Service can reallocate revenues and expenses between parent corporations and their subsidiaries to more clearly reflect a proper allocation of income. In such instances it is the responsibility of the corporation to prove that the IRS has been arbitrary in its decision-making, thus establishing a “guilty until proved innocent” tax approach.

18) Tax haven subsidiaries of MNEs are categorically referred to as international offshore financial centers.

Essay

1) Explain the worldwide and territorial approaches of national taxation. The authors state that the United States uses both approaches. How can this be? Give an example of each taxation approach.

2) What is a value-added tax? Where is this type of tax in wide usage? Why do you suppose this form of taxation has NOT been widely accepted in the United States?

Chapter 16 International Portfolio Theory and Diversification

16.1 International Diversification and Risk

Multiple Choice

1) Beta may be defined as:
A) the measure of systematic risk.
B) a risk measure of a portfolio.
C) the ratio of the variance of the portfolio to the variance of the market.
D) all of the above

2) ________ risk is measured with beta.
A) Systematic
B) Unsystematic
C) International
D) Domestic

3) A fully diversified domestic portfolio has a beta of:
A) 0.0
B) 1.0
C) -1.0
D) There is not enough information to answer this question.

4) Unsystematic risk:
A) is the remaining risk in a well-diversified portfolio.
B) is measured with beta.
C) can be diversified away.
D) all of the above

5) A well-diversified portfolio has about ________ of the risk of the typical individual stock.
A) 8%
B) 19%
C) 27%
D) 52%

6) An internationally diversified portfolio:
A) should result in a portfolio with a lower beta than a purely domestic portfolio.
B) has the same overall risk shape as a purely domestic portfolio.
C) is only about 12% as risky as the typical individual stock.
D) all of the above

7) In some respects, internationally diversified portfolios are the same in principle as a domestic portfolio because:
A) the investor is attempting to combine assets that are perfectly correlated.
B) investors are trying to reduce systematic risk.
C) investors are trying to reduce the total risk of the portfolio.
D) all of the above

8) In some respects, internationally diversified portfolios are different from a domestic portfolio because:
A) investors may also acquire foreign exchange risk.
B) international portfolio diversification increases expected return but does not decrease risk.
C) investors must leave the country to acquire foreign securities.
D) all of the above

Instruction 16.1:
Use the information to answer the following question(s).

In September 2009 a U.S. investor chooses to invest $500,000 in German equity securities at a then current spot rate of $1.30/euro. At the end of one year the spot rate is $1.35/euro.

9) Refer to Instruction 16.1. How many euros will the U.S. investor acquire with his initial $500,000 investment?
A) €650,000
B) €370,370
C) €500,000
D) €384,615

10) Refer to Instruction 16.1. At an average price of €60/share, how many shares of stock will the investor be able to purchase?
A) 8333 shares
B) 6410 shares
C) 6173 shares
D) 10,833 shares

11) Refer to Instruction 16.1. At the end of the year the investor sells his stock that now has an average price per share of €57. What is the investor’s average rate of return before converting the stock back into dollars?
A) 5.0%
B) -3.0%
C) -5.0%
D) 3.0%

12) Refer to Instruction 16.1. At the end of the year the investor sells his stock that now has an average price per share of €57. What is the investor’s average rate of return after converting the stock back into dollars?
A) -1.35%
B) 5.0%
C) -5.0%
D) -7.24%

13) A U.S. investor makes an investment in Britain and earns 14% on the investment while the British pound appreciates against the U.S. dollar by 8%. What is the investor’s total return?
A) 22.00%
B) 23.12%
C) 6.00%
D) 4.88%

14) Which of the following statements is NOT true?
A) International diversification benefits induce investors to demand foreign securities.
B) An international security adds value to a portfolio if it reduces risk without reducing return.
C) Investors will demand a security that adds value.
D) All of the above are true.

True/False

1) Portfolio diversification can eliminate 100% of risk.

2) Increasing the number of securities in a portfolio reduces the unsystematic risk but not the systematic risk.

3) International diversification benefits may induce investors to demand foreign securities.

4) If the addition of a foreign security to the portfolio of the investor aids in the reduction of risk for a given level of return, then the security adds value to the portfolio.

5) If the addition of a foreign security to the portfolio of the investor decreases the expected return for a given level of risk, then the security adds value to the portfolio.

16.2 Internationalizing the Domestic Portfolio

Multiple Choice

1) Portfolio theory assumes that investors are risk-averse. This means that investors:
A) cannot be induced to make risky investments.
B) prefer more risk to less for a given return.
C) will accept some risk, but not unnecessary risk.
D) All of the above are true.

2) The efficient frontier of the domestic portfolio opportunity set:
A) runs along the extreme left edge of the opportunity set.
B) represents optimal portfolios of securities that represent minimum risk for a given level of expected portfolio return.
C) contains the portfolio of risky securities that the logical investor would choose to hold.
D) all of the above

3) The addition of foreign securities to the domestic portfolio opportunity set shifts the efficient frontier:
A) down and to the left.
B) up and to the right.
C) up and to the left.
D) down and to the right.

4) Relative to the efficient frontier of risky portfolios, it is impossible to hold a portfolio that is located ________ the efficient frontier.
A) to the left of
B) to the right of
C) on
D) to the right or left of

5) The ________ connects the risk-free security with the optimal domestic portfolio.
A) security market line
B) capital asset pricing model
C) capital market line
D) none of the above

Instruction 16.2:
Use the information to answer the following question(s).

A U.S. investor is considering a portfolio consisting of 60% invested in the U.S. equity index fund and 40% invested in the British equity index fund. The expected returns for the funds are 10% for the U.S. and 8% for the British, standard deviations of 20% for the U.S. and 18% for the British, and a correlation coefficient of 0.15 between the U.S. and British equity funds.

6) Refer to Instruction 16.2. What is the expected return of the proposed portfolio?
A) 9.2%
B) 9.0%
C) 19.2%
D) 19%

7) Refer to Instruction 16.2. What is the standard deviation of the proposed portfolio?
A) 38.00
B) 19.20
C) 19.00
D) 14.45

True/False

1) The graph for the efficient frontier has beta on the vertical axis and standard deviation of the horizontal axis.

2) The portfolio with the least risk among all those possible in the domestic portfolio opportunity set is called the minimum risk domestic portfolio.

3) The optimal domestic portfolio of risky securities is always the portfolio of minimum risk.

4) The standard deviation of a portfolio is the sum of the weighted average standard deviations of the individual assets.

5) The optimal domestic portfolio combines the risk-free asset and a portfolio of domestic securities found on the efficient frontier.

6) The internationally diversified portfolio opportunity set shifts TO THE RIGHT of the purely domestic opportunity set.

Essay

1) Draw the curve representing the Optimal Domestic Efficient Frontier. Be sure to draw and label the following: The vertical axis and the horizontal axis, the risk-free security, the minimum risk portfolio, the domestic portfolio opportunity set, the optimal domestic portfolio, and the capital market line. Choose a point along the domestic portfolio opportunity set between the optimal domestic portfolio and the minimum risk domestic portfolio and explain why that point is not the optimal risky domestic portfolio for investors to hold.

16.3 National Markets and Asset Performance

Multiple Choice

1) The authors present a comparison of correlation coefficients between major global equity markets over a variety of different periods. The comparison yields a number of conclusions listed here EXCEPT:
A) the correlation between equity markets for the full twentieth century shows quite low levels of correlation between some of the largest markets (close to 0.50 in some cases).
B) that same century of data, however, yields a high correlation between the U.S. and Canada (0.80).
C) the correlation coefficients between those same equity markets for selected sub periods over the last quarter of the twentieth century, however, show significantly different correlation coefficients.
D) None of the answers listed are inaccurate conclusions.

True/False

1) Capital markets around the world are on average less integrated today than they were 20 years ago.

2) In an empirical study on national market returns in the 20th century, Dimson, Marsh, and Staunton (2002) determined that the equity returns in the United States out-performed the other 15 countries in the study.

3) In an empirical study on national market returns in the 20th century, Dimson, Marsh, and Staunton (2002) found that just under one-half of the 16 countries in the study had negative average returns in their equity markets.

4) In an empirical study on national market returns in the 20th century, Dimson, Marsh, and Staunton (2002) determined that due to high levels of correlation or returns between countries, there is almost NO BENEFIT to international portfolio diversification.

5) Of the major trading partners with the United States, Canada has among the LOWEST correlation of returns with the U.S.

Essay

1) If an investor is able to determine a global beta for his portfolio and holds a portfolio that is well-diversified with international investments, which performance measure is more appropriate, the Sharpe Measure or the Treynor Measure? Why? Explain each performance measure.

16.4 Market Performance Adjusted for Risk: The Sharpe and Treynor Performance Measures

Multiple Choice

1) The Sharpe measure uses ________ as the measure of risk and the Treynor measure uses ________ as the measure of risk.
A) standard deviation; variance
B) beta; variance
C) standard deviation; beta
D) beta; standard deviation

TABLE 16.1
Use the information to answer following question(s).

2) Refer to Table 16.1. What is the value of the Sharpe Measure for France?
A) 0.113
B) 0.0071
C) either A or B
D) neither A nor B

3) Refer to Table 16.1. What is the value of the Treynor Measure for the Netherlands?
A) 0.197
B) 0.0109
C) either A or B
D) neither A nor B

4) Refer to Table 16.1. ________ appears to have the greatest amount of risk as measured by monthly standard deviation, but ________ has the best return per unit of risk according to the Sharpe Measure.
A) United States; Austria
B) France; Austria
C) United States; Netherlands
D) France; Netherlands

5) The Sharpe and Treynor Measures tend to be consistent in their ranking of portfolios when the portfolios:
A) are poorly diversified.
B) are properly diversified.
C) contain only U.S. equity investments.
D) none of the above

True/False

1) The Sharpe and Treynor measures are each measures of return per unit of risk.

2) Good financial advice would suggest that investors should examine returns by the amount of return per unit of risk accepted, rather than in isolation.

3) The denominator of the Treynor measure is portfolio risk as measured by the standard deviation of the portfolio.

4) The denominator of the Sharpe measure is portfolio risk as measured by the standard deviation of the portfolio.

5) The denominator of the Sharpe measure is the portfolio’s beta, the systematic risk of the portfolio, as measured against the world market portfolio.

6) The denominator of the Treynor measure is the portfolio’s beta, the systematic risk of the portfolio, as measured against the world market portfolio.

ECO 410 Week 10 Quiz Solution

Chapter 17 Foreign Direct Investment and Political Risk

17.1 Sustaining and Transferring Competitive Advantage

Multiple Choice

1) An example of economies of scale in financing include:
A) being able to access the Euroequity, Eurobond, and Eurocurrency markets.
B) being able to ship product in shiploads or carloads.
C) being able to use large-scale plant and equipment.
D) all of the above

2) Which of the following is NOT a factor of Porter’s “diamond of national advantage”?
A) factor conditions
B) demand conditions
C) related and supporting industries
D) All of the above are factors of the diamond of national advantage.

3) The OLI paradigm is an attempt to create a framework to explain why MNEs choose ________ rather than some other form of international venture.
A) licensing
B) joint ventures
C) foreign direct investment
D) strategic alliances

4) The O in OLI refers to an advantage in a firm’s home market that is:
A) operator independent.
B) owner-specific.
C) open-market.
D) official designation.

5) The owner-specific advantages of OLI must be:
A) firm-specific.
B) not easily copied.
C) transferable to foreign subsidiaries.
D) all of the above

6) A/An ________ would be an example of an owner-specific advantage for an MNE.
A) patent
B) economy of scale
C) economy of scope
D) all of the above

7) The L in OLI refers to an advantage in a firm’s home market that is a:
A) liability in the domestic market.
B) location-specific advantage.
C) longevity in a particular market.
D) none of the above

8) A/An ________ would be an example of a location-specific advantage for an MNE.
A) patent
B) economy of scale
C) unique source of raw materials
D) possession of proprietary information

9) The I in OLI refers to an advantage in a firm’s home market that is an:
A) internalization.
B) industry-specific advantage.
C) international abnormality.
D) none of the above

10) A/An ________ would be an example of an internalization advantage for an MNE.
A) patent
B) economy of scale
C) unique source of raw materials
D) possession of proprietary information

True/False

1) MNEs that are resident in liquid and unsegmented capital markets are more likely to be able to demonstrate financial strength by achieving and maintaining a global cost and availability of capital.

2) A strongly competitive home market tends to dull the competitive advantage relative to firms located in less competitive home markets.

3) The authors were unable to identify in lesser developed countries specific firms that are nearing the status of global MNE.

Essay

1) List and explain three strategic motives why firms become multinationals and give an example of each.

2) What does the OLI Paradigm propose to explain? Define each component and provide an example of each.

17.2 Deciding Where to Invest

Multiple Choice

1) Which of the following is NOT true regarding behavioral observations of firms making a decision to invest internationally?
A) MNEs initially invest in countries with a similar “national psychic.”
B) Firms eventually take greater risks in terms of the national psychic of countries in which they invest.
C) Initial investments tend to be much larger than subsequent ones.
D) All of the above have been observed.

True/False

1) In practice, when expanding into other countries, firms have been observed to follow a sequential search pattern as described in the behavioral theory of the firm.

2) As a general rule, the decision about where to invest abroad for the first time is the same as the decision about where to reinvest abroad.

17.3 How to Invest Abroad: Modes of Foreign Involvement

Multiple Choice

1) Which of the following is NOT an advantage to exporting goods to reach international markets rather than entering into some form of FDI?
A) fewer political risks
B) greater agency costs
C) lower front-end investment
D) All of the above are advantages.

2) Which of the following is an advantage to exporting goods to reach international markets rather than entering into some form of FDI?
A) fewer agency costs
B) fewer direct advantages from research and development
C) a greater risk of losing markets to copycat goods producers
D) an inability to exploit R&D as effectively as if also invested abroad

3) Which of the following is NOT a form of FDI?
A) wholly-owned affiliate
B) joint venture
C) exporting
D) greenfield investment

4) With licensing the ________ is likely to be lower than with FDI because of lower profits; however, the ________ is likely to be higher due to a greater return per dollar invested.
A) IRR; NPV
B) NPV; IRR
C) cost of capital; NPV
D) IRR; cost of capital

5) Which of the following is NOT a potential disadvantage of licensing relative to FDI?
A) possible loss of quality control
B) establishment of a potential competitor in third-country markets
C) possible improvement of the technology by the local licensee, which then enters the original firm’s home market
D) All of the above are potential disadvantages to licensing.

6) A ________ is a shared ownership in a foreign business.
A) licensing agreement
B) greenfield investment
C) joint venture
D) wholly-owned affiliate

7) Which of the following is NOT an advantage to a joint venture?
A) Possible loss of opportunity to enter the foreign market with FDI later.
B) The local partner understands the customs and mores of the foreign market.
C) The local partner can provide competent management at many levels.
D) May be a realistic alternative when 100% foreign ownership is not allowed.

8) Greenfield investments are typically ________ and ________ than cross-border acquisition.
A) slower; more uncertain
B) faster; of greater certainty
C) slower; of greater certainty
D) faster; more uncertain

9) All of the following may be justification for a strategic alliance EXCEPT:
A) takeover defense.
B) a joint venture to pool resources for research and development.
C) joint marketing and serving agreements.
D) All of the above are legitimate reasons for strategic alliances.

True/False

1) Licensing is a popular form of foreign investment because it does not need a sizable commitment of funds, and political risk is often minimized.

2) MNEs typically used licensing with independent firms rather than with their own foreign subsidiaries.

3) Joint ventures are a more common FDI than wholly owned subsidiaries.

4) Local partners in a foreign country and in a joint venture with an MNE are likely to make decisions that maximize the value of the subsidiary. Such actions probably will not maximize the value of the entire firm.

17.4 Political Risk

Multiple Choice

1) ________ risks are those that affect the MNE at the local or project level, but originate at the country level.
A) Country-specific
B) Firm-specific
C) Global-specific
D) none of the above

2) Which of the following is NOT an example of a country-specific risk?
A) transfer risk
B) war and ethnic strife
C) cultural and religious heritage
D) All of the above are examples of country-specific risk.

3) According to your authors, MNEs can anticipate government regulations that are discriminatory or wealth depriving from a/an ________ or ________ level view.
A) foreign; domestic
B) micro; macro
C) internal; external
D) local; global

4) ________ is the ability to exercise effective control over a foreign subsidiary within a country’s legal and political environment.
A) Political risk
B) Portfolio risk
C) Interest rate risk
D) Governance risk

5) Of the following, which would NOT be considered an issue for an investment agreement prior to investing in a foreign country?
A) the basis for setting transfer prices
B) the right to export to third-country markets
C) provision for arbitration of disputes
D) All of the above could be negotiated prior to investing.

6) OPIC stands for:
A) Organization for the Prevention of Insufficient Capitalization.
B) Organization of Petroleum Importing Countries.
C) Overseas Private Investment Corporation.
D) Overseas Public Insurance Commission.

7) ________ is a type of political risk that OPIC does NOT cover.
A) Inconvertibility
B) Expropriation
C) War
D) OPIC covers all of the above.

8) ________ is the risk that the host government will take specific steps that prevent the foreign affiliate from exercising control over the firm’s assets.
A) Inconvertibility
B) Expropriation
C) Business income risk
D) none of the above

9) ________ is NOT one of the three main country-specific risks as outlined by your authors.
A) Transfer risk
B) Cultural differences
C) Thin equity base
D) Protectionism

10) Of the following, which was NOT identified by the authors as a type of cultural difference that MNEs must consider when expanding to foreign countries?
A) differences in human resource norms
B) differences in religious heritage
C) differences in allowable ownership structures
D) All of the above must be considered.

11) An alternative strategy to engaging in bribery in international investments include:
A) refuse bribery outright.
B) retain local advisors to diffuse requests for bribes.
C) educate management and local employees about the firm’s bribery policy.
D) all of the above

12) ________ industries are NOT typically “protected” by government policy.
A) Textiles
B) Defense
C) Agriculture
D) “Infant” industries

13) Forming regional alliances is one way to help mitigate the practice of government protectionism. Which of the following is NOT a regional trade organization formed by government treaty?
A) EU
B) NAFTA
C) NATO
D) MERCOSUR

14) Terrorism, cyber attacks, and the anti-globalization movement are each examples of ________ risks.
A) firm-specific
B) country-specific
C) institutional
D) global-specific

15) Governance risk due to goal conflict between an MNE and its host government is the main political ________ risk.
A) firm-specific
B) country-specific
C) global-specific
D) cultural-specific

16) The speed at which inventory moves through a manufacturing process is known as:
A) supply chain management.
B) working capital management.
C) inventory velocity.
D) warp speed.

17) As a result of the terrorist attacks of September 11, 2001, many firms have employed a wide range of tactics to ensure continued flow of inventory in the face of government steps to curb terrorism. Which of the following is an inventory sourcing strategy response (as opposed to an inventory management response, or a transportation response)?
A) carrying more inventory on-hand
B) minimizing cross-border exposure from suppliers
C) shifting to air cargo shipments instead of co-habitation of products and passengers on commercial air flights
D) increasing the on-hand supply of critical parts

18) Blocked funds are cash flows that:
A) come in regular intervals in standardized amounts or blocks.
B) have been restricted in transfer out of a local country.
C) come from a certain sector or region of the world.
D) none of the above

19) A ________ loan, also known as ________ is a parent-to-affiliate loan channeled through a financial intermediary such as a large commercial bank.
A) fronting; link financing
B) parallel; a back-to-back loan
C) fronting; a back-to-back loan
D) link financing; parallel loan

20) Which of the following is NOT a typical characteristic of a fronting loan made to an international subsidiary?
A) The parent makes a deposit equal to the size of the desired loan into a large commercial bank.
B) The bank lends to the subsidiary firm an amount equal to the parent deposit at a slightly higher interest rate.
C) The lending bank is located in the subsidiary’s country.
D) All of the above are typical characteristics of a fronting loan.

21) Which of the following could be considered an example of forced reinvestment if the blockage of funds was expected to be temporary?
A) vertical reinvestment by an automobile manufacturer to buy parts suppliers and showrooms
B) A lumber cutting company subsequently builds a paper mill with blocked funds.
C) purchase of local money market instruments and short-term loans
D) all of the above

True/False

1) When faced with additional risk from a foreign investment, firms typically account for the additional risk by adjusting the discount rates or by adjusting cash flows.

2) A number of institutional services provide updated country risk ratings on a regular basis. This is an example of micro-risk information for MNEs using this data.

3) A country can react to the potential for blocked funds prior to making an investment, during operations, or by investing in the local country in assets than maintain their value.

4) Banks are very hesitant to engage in fronting loans because of the low probability of repayment and thus their risk exposure up to a 100% loss.

5) Many problems such as poverty, environmental concerns, and cyber attacks are beyond the capabilities of MNEs alone to correct and require government participation as well.

6) Business risk can be measured through sensitivity analysis but from only the project viewpoint.

Essay

1) What are blocked funds? List and explain two of the three methods the authors list in this chapter for dealing with blocked funds.

Chapter 18 Multinational Capital Budgeting and Cross-Border Acquisitions

18.1 Complexities of Budgeting for a Foreign Project

Multiple Choice

1) The traditional financial analysis applied to foreign or domestic projects, to determine the project’s value to the firm is called:
A) cost of capital analysis.
B) capital budgeting.
C) capital structure analysis.
D) agency theory.

2) Which of the following is NOT a basic step in the capital budgeting process?
A) Identify the initial capital invested.
B) Estimate the cash flows to be derived from the project over time.
C) Identify the appropriate interest rate at which to discount future cash flows.
D) All of the above are steps in the capital budgeting process.

3) Of the following capital budgeting decision criteria, which does NOT use discounted cash flows?
A) net present value
B) internal rate of return
C) accounting rate of return
D) All of these techniques typically use discounted cash flows.

4) Which of the following is NOT a reason why capital budgeting for a foreign project is more complex than for a domestic project?
A) Parent cash flows must be distinguished from project cash flows.
B) Parent firms must specifically recognize remittance of funds due to differing rules and regulations concerning remittance of cash flows, taxes, and local norms.
C) Differing rates of inflation exist between the foreign and domestic economies.
D) All of the above add complexity to the international capital budgeting process.

5) For purposes of international capital budgeting, which of the following statements is NOT true?
A) Managers must evaluate political risk because political events can drastically reduce the value or availability of expected cash flows.
B) Parent cash flows must be distinguished from project cash flows. Each of these two types of flows contributes to a different view of value.
C) An array of nonfinancial payments can generate cash flows from subsidiaries to the parent, including payment of license fees and payments for imports from the parent.
D) All of the above are true statements.

True/False

1) When engaged in international capital budgeting, the analyst must identify the initial amount of capital invested or put at risk.

2) In international capital budgeting, the appropriate discount rate for determining the present value of the
expected cash flows is always the firm’s domestic WACC.

3) For purposes of international capital budgeting, it is NOT important to distinguish between parent and total project cash flows.

4) For purposes of international capital budgeting, parent cash flows often depend on the form of financing. Thus, we cannot clearly separate cash flows from financing decisions, as we can in domestic capital budgeting.

18.2 Project Versus Parent Valuation

Multiple Choice

1) Project evaluation from the ________ viewpoint serves some useful purposes and/but should ________ the ________ viewpoint.
A) local; be subordinated to; parent’s
B) local; not be subordinated to; parent’s
C) parent’s; be subordinated to; local
D) none of the above

2) For financial reporting purposes, U.S. firms must consolidate the earnings of any subsidiary that is over ________ owned.
A) 20%
B) 40%
C) 50%
D) 75%

3) A foreign firm that is 20% to 49% owned by a parent is called a/an:
A) subsidiary.
B) affiliate.
C) partner.
D) rival.

4) Affiliate firms are consolidated on the parent’s financial statements on a ________ basis.
A) pro rated
B) 50%
C) 75%
D) 100%

True/False

1) There are no important differences between domestic and international capital budgeting methods.

2) It is important that firms adopt a common standard for the capital budgeting process for choosing among foreign and domestic projects.

3) The only proper way to estimate the NPV of a foreign project is to discount the appropriate cash flows first and then convert them to the domestic currency at the current spot rate.

4) When dealing with international capital budgeting projects, the value of the project is NOT sensitive to the firm’s cost of capital.

5) For purposes of international capital budgeting, evaluation of a project from the PARENT viewpoint serves some useful purposes, but it should be subordinated to evaluation from the LOCAL’s viewpoint.

6) Multinational firms should invest only if they can earn a risk-adjusted return greater than locally based competitors can earn on the same project.

Essay

1) The authors highlight a strong theoretical argument in favor of analyzing any foreign project from the viewpoint of the parent. Provide at least three reasons why the parent’s viewpoint is superior to the local viewpoint and give an example of when the local viewpoint fails to maximize the value of the firm.

2) Explain how political risk and exchange rate risk increase the uncertainty of international projects for the purpose of capital budgeting.

18.3 Illustrative Case: Cemex Enters Indonesia

Multiple Choice

1) Which of the following is NOT an example of political risk?
A) Expropriation of cash flows by a foreign government.
B) The U.S. government restricts trade with a foreign country where your firm has investments.
C) The foreign government nationalizes all foreign-owned assets.
D) All of the above are examples of political risk.

2) Real option analysis allows managers to analyze all of the following EXCEPT:
A) the option to defer.
B) the option to abandon.
C) the option to alter capacity.
D) All of the above may be analyzed using real option analysis.

3) Given a current spot rate of 8.10 Norwegian krone per U.S. dollar, expected inflation rates of 6% in Norway and 3% per annum in the U.S., use the formula for relative purchasing power parity to estimate the one-year spot rate of krone per dollar.
A) 7.87 krone per dollar
B) 8.10 krone per dollar
C) 8.34 krone per dollar
D) There is not enough information to answer this question.

4) When evaluating capital budgeting projects, which of the following would NOT necessarily be an indicator of an acceptable project?
A) an NPV > $0
B) an IRR > the project’s required rate of return
C) an IRR > $0
D) All of the above are correct indicators.

5) Given a current spot rate of 8.10 Norwegian krone per U.S. dollar, expected inflation rates of 3% in Norway and 6% per annum in the U.S., use the formula for relative purchasing power parity to estimate the one-year spot rate of krone per dollar.
A) 7.87 krone per dollar
B) 8.10 krone per dollar
C) 8.34 krone per dollar
D) There is not enough information to answer this question.

6) When determining a firm’s weighted average cost of capital (wacc) which of the following terms is NOT necessary?
A) the firm’s tax rate
B) the firm’s cost of debt
C) the firm’s cost of equity
D) All of the above are necessary.

7) When determining a firm’s weighted average cost of capital (WACC) which of the following terms is NOT necessary?
A) the firm’s weight of equity financing
B) the risk-free rate of return
C) the firm’s weight of debt financing
D) All of the above are necessary to determine a firm’s WACC.

Instruction 18.1:
Use the information to answer the following question(s).

The Velo Rapid Revolutions Inc., a company that produces bicycles, elliptical trainers, scooters and other wheeled non-motorized recreational equipment is considering an expansion of their product line to Europe. The expansion would require a purchase of equipment with a price of euro 1,200,000 and additional installation of euro 300,000 (assume that the installation costs cannot be expensed, but rather, must be depreciated over the life of the asset). Because this would be a new product, they will not be replacing existing equipment. The new product line is expected to increase revenues by euro 600,000 per year over current levels for the next 5 years, however; expenses will also increase by euro 200,000 per year. (Note: Assume the after-tax operating cash flows in years 1-5 are equal, and that the terminal value of the project in year 5 may change total after-tax cash flows for that year.) The equipment is multipurpose and the firm anticipates that they will sell it at the end of the five years for euro 500,000. The firm’s required rate of return is 12% and they are in the 40% tax bracket. Depreciation is straight-line to a value of euro 0 over the 5-year life of the equipment, and the initial investment (at year 0) also requires an increase in NWC of euro 100,000 (to be recovered at the sale of the equipment at the end of five years). The current spot rate is $0.95/euro , and the expected inflation rate in the U.S. is 4% per year and 3% per year in Europe.

8) Refer to Instruction 18.1. What is the initial investment for the Velo Rapid Revolutions project?
A) $1,500,000
B) €1,600,000
C) $1,600,000
D) €1,500,000

9) Refer to Instruction 18.1. What are the annual after-tax cash flows for the Velo Rapid Revolutions project?
A) €400,000
B) €240,000
C) €120,000
D) €360,000

10) Refer to Instruction 18.1. What is the NPV of the European expansion if Velo Rapid Revolutions first computes the NPV in euros and then converts that figure to dollars using the current spot rate?
A) $1,520,000
B) $1,684,210
C) -$75,310
D) -$71,544

11) Refer to Instruction 18.1. In euros, what is the NPV of the Velo Rapid Revolutions expansion?
A) €1,524,690
B) $1,611,317
C) -€75,310
D) -€111,317

12) Refer to Instruction 18.1. What is the IRR of the Velo Rapid Revolutions expansion?
A) 14.4%
B) 10.3%
C) 12.0%
D) 8.6%

13) If a firm undertakes a project with ordinary cash flows and estimates that the firm has a positive NPV, then the IRR will be:
A) less than the cost of capital.
B) greater than the cost of capital.
C) greater than the cost of the project.
D) cannot be determined from this information

14) When estimating a firm’s cost of equity capital using the CAPM, you need to estimate:
A) the risk-free rate of return.
B) the expected return on the market portfolio.
C) the firm’s beta.
D) all of the above

15) ________ is the risk that a foreign government will place restrictions such as limiting the amount of funds that can be remitted to the parent firm, or even expropriation of cash flows earned in that country.
A) Exchange risk
B) Foreign risk
C) Political risk
D) Unnecessary risk

16) Generally speaking, a firm wants to receive cash flows from a currency that is ________ relative to their own, and pay out in currencies that are ________ relative to their home currency.
A) appreciating; depreciating
B) depreciating; depreciating
C) appreciating; appreciating
D) depreciating; appreciating

17) When assessing the additional risk that can occur from investing abroad firms may choose to account for risk via:
A) adjusting the cash flows.
B) adjusting the discount rates.
C) adjusting both cash flows and discount rates.
D) adjusting all of the above.

True/False

1) When a multinational firm invests abroad, it is common to develop two capital budgets: one from the project viewpoint, and one from the parent viewpoint.

2) When estimating a capital budget, it is common to separate cash flows into: 1) the initial investment, 2) incremental cash flows over the life of the project, and 3) a terminal value.

3) Because international capital budgeting is so difficult, time consuming, expensive, and uncertain, firms generally forego any type of additional sensitivity analysis after completing a base-case scenario.

4) A criticism of adjusting the discount rate to account for political risk is that adjusting the discount rate for political risk penalizes early cash flows too heavily while not penalizing distant cash flows enough.

18.4 Project Financing

Multiple Choice

1) Which of the following is NOT a factor critical to the success of project financing?
A) separability of the project from its investors
B) long-lived and capital intensive singular projects
C) cash flow predictability from third part commitments
D) All of the above are critical factors for project financing.

2) Which of the following is NOT a characteristic of international long-term capital project financing?
A) The projects are large in scale.
B) The projects are long in life.
C) The projects are generally high in risk.
D) The projects may be all of the above.

3) Which of the following is NOT a reason given for international mergers and acquisitions?
A) gaining access to strategic proprietary assets
B) gaining market power and dominance
C) diversifying and spreading their risks wider
D) All of the above are commonly cited reasons for international mergers and acquisitions.

4) The process of acquiring an enterprise anywhere in the world has three common elements EXCEPT:
A) identification and valuation of the target.
B) execution of the acquisition offer and purchase—the tender.
C) management of the post-acquisition transition.
D) All of the above are common elements in acquiring an enterprise anywhere in the world.

True/False

1) Project financing is the arrangement of financing for very large individual long-term capital projects.

2) Currency risk is a concern for any international merger and acquisition activity. For instance, the initial bid, if denominated in a foreign currency, creates a contingent foreign currency exposure for the bidder.

3) Currency risk is a concern for any international merger and acquisition activity. For instance, once the bidder has successfully won the acquisition, the exposure evolves from a transaction exposure to a contingent exposure.

4) The drivers of international merger and acquisitions are only MACRO in scope.

5) As opposed to greenfield investment, a cross-border acquisition is typically quicker.

ECO 410 Week 11 Quiz Solution

Chapter 19 Working Capital Management

19.1 Trident Brazil’s Operating Cycle

Multiple Choice

1) Working capital management involves the management of:
A) current and long-term assets.
B) current assets and current liabilities.
C) current liabilities and long-term assets.
D) current liabilities and long-term debt and equity.

2) The cash conversion cycle:
A) is a subset of the operating cycle.
B) occurs in the latter stages of the operating cycle.
C) is a subset of the accounts receivable period.
D) all of the above.

3) The proper order of events for the operating cycle is:
A) input serving period, accounts receivable period, inventory period, quotation period.
B) quotation period, accounts receivable period, inventory period, input servicing period.
C) quotation period, input servicing period, inventory period, accounts receivable period.
D) accounts receivable period, input servicing period, quotation period, inventory period.

4) TrinityApps Corporation (US) has bid a price on a project for a Korean firm, but the Korean firm has not yet placed an order. This portion of the operating cycle is best described as the:
A) quotation period.
B) input sourcing period.
C) cash conversion cycle.
D) accounts payable cycle.

5) The period in the cash cycle where the customer places the order, and the firm determines what materials for manufacture are NOT in inventory is called the ________ period.
A) quotation
B) input sourcing
C) accounts payable
D) accounts receivable

6) The accounts payable period of the operating cycle:
A) is equal to the inventory period.
B) may run concurrently but shorter than the inventory period.
C) may run concurrently but longer than the inventory period.
D) Any one of the above may be true.

True/False

1) Typically, the inventory period and the accounts payable period at least partially overlap in the firms operating cycle.

2) Typically, the inventory period and the accounts receivable period at least partially overlap in the firms operating cycle.

3) The operating cycle begins with the quotation period and ends with the accounts payable period.

19.2 Trident’s Repositioning Decisions

Multiple Choice

1) Of the following, which would NOT be a significant decision-making factor in a multinational firm’s repositioning decision-making?
A) the subsidiary’s tax environment (high or low)
B) the stability of the local currency
C) the ability to move capital in and out of the subsidiary’s country
D) All of the above are significant factors.

True/False

1) In a country with a relatively high tax rate, it make sense the the MNE to reposition cash flows TO that country.

2) The MNE would prefer to leave capital with a firm in a country with high growth prospects over the alternative of leaving capital with a firm in a country with low growth prospects (other factors equal).

19.3 Constraints on Repositioning Funds

Multiple Choice

1) Each of the following is listed by your authors as a constraint on repositioning funds by an MNE EXCEPT:
A) political constraints.
B) tax constraints.
C) transaction costs.
D) All of the above are listed by your authors.

True/False

1) Local liquidity needs sometimes impact a firm’s worldwide optimal cash position.

2) The constraints on repositioning of funds that occur when exchanging one currency for another are considered to be primarily political constraints.

3) Political constraints can block the transfer of funds either overtly or covertly. OVERT blockage occurs when dividends or other forms of fund remittances are severely limited, heavily taxed, or excessively delayed by the need for bureaucratic approval.

19.4 Conduits for Moving Funds by Unbundling Them

Multiple Choice

1) ________ allows a multinational firm to recover funds from subsidiaries without piquing host country sensitivities over large dividend drains.
A) Unbundling funds
B) Bundling funds
C) Coordinating funds
D) none of the above

2) Unbundling of funds by an MNE may be a useful practice for which of the following reasons?
A) An increase in the funds flow (charges) in any of the before-tax categories reduces the taxable profits of the foreign subsidiary if the host-country tax authorities acknowledge the charge as a legitimate expense.
B) An item-by-item matching of remittance to input, such as royalties for intellectual property, and fees for patents and advice, is equitable to the host country and foreign investor alike.
C) Unbundling facilitates allocation of overhead from a parent”s international division, so-called shared services, to each operating subsidiary in accordance with a predetermined formula.
D) All of the reasons listed above

True/False

1) If all investment inputs are unbundled, part of what might have been classified as residual profits may turn out to be tax-deductible expenses related to a specific purchased benefit.

2) The before-tax/after-tax distinction is quite significant to a parent company attempting to repatriate funds in the most tax-efficient method if it is attempting to manage its own foreign tax credit/deficits between foreign units.

19.5 International Dividend Remittances

Multiple Choice

1) In anticipation of a foreign exchange loss, an MNE may speed up the transfer of funds out of the company via dividends. When undertaking such an activity the MNE must be concerned with all of the following EXCEPT:
A) interest rate differences between the two countries.
B) the negative impact on host country relations.
C) defection on the part of executives in the home headquarters.
D) MNEs must be concerned with all of the above.

True/False

1) Political risk may motivate parent firms to require foreign subsidiaries to remit all locally generated funds above that required to internally finance growth in sales and planned capital expansions.

19.6 Net Working Capital

Multiple Choice

1) One possible definition of net working capital (NWC) provided by your authors is:
A) NWC = A/R + inventory – A/P.
B) NWC = cash + A/P – inventory.
C) NWC = A/P + A/R – short-term loans.
D) NWC = A/R + inventory – long-term debt.

2) Which of the following actions will result in an increase in NWC?
A) an increase in A/P that exceeds an increase in A/R
B) a reduction in inventory
C) a reduction in A/P plus a smaller reduction in A/R
D) an increase in A/P and a smaller reduction in inventory

3) Which of the following statements is true?
A) A/R provide part of the funding for inventory.
B) A/P provide part of the funding for A/R and inventory.
C) Inventory pays for A/R and A/P.
D) None of the above is true.

TABLE 19.1
Use the information to answer following question(s).

TrinityApps Corporation Balance Sheet December 31, 20xx

4) Refer to Table 19.1. The NWC for TrinityApps is:
A) $80,000
B) $680,000
C) $35,000
D) $45,000

5) Refer to Table 19.1. If TrinityApps increases inventory by $10,000 and A/P also by $10,000, the net change in NWC is:
A) $20,000
B) $10,000
C) $0
D) none of the above

6) Refer to Table 19.1. NWC currently makes up what percentage of total firm value for TrinityApps?
A) 6.6%
B) 5.1%
C) 11.8%
D) 9.2%

Instruction 19.1:
Use the information to answer the following question(s).

Sunny Manufacturing Systems Inc. is supplied with plastic chips for their plastic injection molding manufacturing process. Their supplier, Sun Chemical, Inc. offers financing terms of a 2% discount if the accounts payable are paid in 10 days or less with the full balance due in 45 days. Short-term financing available to Sunny Manufacturing is available at an annual rate of 9.6%. Sunny Manufacturing has just purchased $400,000 of plastic chips from Sun Chemical.

7) Refer to Instruction 19.1. What is the amount of money Sunny Manufacturing will save on accounts payable if they accept the discount?
A) $400,000
B) $8,000
C) $33,333
D) $20,000

8) Refer to Instruction 19.1. What is the effective annual interest cost of supplier financing offered by Sun Chemical?
A) 7.3%
B) 9.5%
C) 10.4%
D) 22.9%

9) Refer to Instruction 19.1. Should Sunny Manufacturing take the discount offered by Sun Chemical?
A) Yes, Sunny Manufacturing will get to use their raw materials 35 days earlier than if they waited to pay at the end of the 45 days.
B) No, Sunny Manufacturing will not have to pay any interest if they just pay in 45 days.
C) Yes, Sunny Manufacturing’s short term borrowing rate of 9.6% is less than Sun’s offered cost of carry of 22.9%.
D) No, it costs Sunny Manufacturing 22.9% to accept the discount and they are better off paying the full amount in 45 days.

10) Days working capital is equal to:
A) days payables + days receivables – days inventory.
B) days inventory + days receivables – days payables.
C) days payables + days inventory + days receivables.
D) none of the above

11) Amundsen of Norway receives raw materials from their corporate parent in the U.S. with payment terms of net 60 days. Most of their sales are to firms in Norway where normal payment terms are net 30 days. This causes a problem for the subsidiary with working capital management because:
A) accounts receivable are so much longer than accounts payable.
B) accounts payable are so much longer than accounts receivable.
C) accounts receivable and accounts payable are equal.
D) This doesn’t really cause a problem; in fact it is to the benefit of the Norwegian subsidiary.

True/False

1) In principle, the firm tries to minimize its NWC balance.

2) Other things equal, managers prefer a lower “days working capital” to a higher one.

3) The authors present empirical evidence that shows the days sales basis for working capital to be 30 days GREATER in the U.S. compared to a similar industry in Europe.

Essay

1) What is a free-trade zone? Identify three techniques and provide examples of how firms and countries can benefit from having free trade zones.

19.7 International Cash Management

Multiple Choice

1) Other things equal, a firm would rather have ________ in a depreciating currency, and ________ in an appreciating currency.
A) accounts receivable; accounts payable
B) accounts receivable; accounts receivable
C) accounts payable; accounts receivable
D) none of the above

2) Which of the following is NOT a precautionary motive for holding cash?
A) Anticipated funds to be remitted from several Middle East countries are in question due to unrest in the region.
B) The firm has several short-term obligations in unhedged foreign currency-denominated contracts.
C) The firm must pay ordinary wages in two days.
D) All are precautionary motives.

3) Increases to cash flows can be anticipated if which of the following occurs?
A) A receivables contract is denominated in an appreciating foreign currency.
B) Sales are less than anticipated.
C) Days in accounts receivable increase by 15 days.
D) none of the above

4) A centralized depository benefits the firm primarily by:
A) reducing the cost of repatriating funds.
B) positioning profits where taxes are lowest.
C) reducing the total amount of capital employed within the total firm.
D) earning a higher rate of return than in domestic banking deposits.

5) The Clearing House Interbank Payment System (CHIPS) is:
A) the largest publicly operated payments system in the world.
B) owned and operated by the world’s seven largest central banks.
C) a computerized network that connects banks globally.
D) none of the above

6) An organizational structure employed by an MNE to reduce its use of bank lending for the support of operations is:
A) a centralized depository.
B) a reinvoicing center.
C) a cost center.
D) a syndicated bank.

7) ________ is the process that cancels via offset all, or part, of the debt owed by one entity to another related entity.
A) Syndicated banking
B) Centralized depositing
C) Multilateral netting
D) Debt cancellation

True/False

1) In an inflationary economy, demand for credit usually exceeds supply.

2) For disbursement purposes, it is to the benefit of the firm to minimize float.

3) Regarding wire transfers, CHIPS actually clears transactions whereas SWIFT does not.

4) A significant problem with centralized cash depositories is that they are isolated from the rest of the firm and tend to be at an information disadvantage.

5) A reason for holding all precautionary balances in a central pool is that the total pool, if centralized, can be reduced in size without any loss in the level of protection.

6) A disadvantage of a centralized cash management system is that managers will not be able to get the lowest average rate available for the firm. Instead, it misses out on the really low borrowing rates.

Essay

1) Central depositories are used for international cash management. What is a central depository? Identify and provide examples of at least three advantages to MNEs of having a central depository.

19.8 Financing Working Capital

Multiple Choice

1) A precautionary cash balance:
A) is used to replace spoiled or damaged inventory.
B) is held to facilitate cash disbursements when receipts slow down.
C) is used for normal day-to-day operations.
D) is held for the benefit of a sister affiliate.

2) An in-house bank:
A) is a separate bank chartered to operate within a business firm.
B) is in fact a set of functions performed by the firm’s existing treasury department.
C) assesses the credit standing of the bank’s customers.
D) provides banking services for employees.

3) A foreign banking office that is separately incorporated in the host country is:
A) a correspondent bank.
B) a representative office.
C) a bank subsidiary.
D) an Edge Act corporation.

True/False

1) An Edge Act corporation is a subsidiary of a U.S. bank located outside of the U.S. and incorporated to engage in international banking and financing operations.

2) Because they are direct payments, dividends are among the most efficient way for foreign subsidiaries to remit funds back to the parent.

3) Even though dividends are cash payments, firms typically must consider both cash flow and net income when making dividend distribution decisions.

Chapter 20 International Trade Finance

20.1 The Trade Relationship

Multiple Choice

1) The exporter-importer relationship to a corporation of a foreign importer that has not previously conducted business with the firm would be an:
A) unaffiliated known.
B) affiliated party.
C) unaffiliated unknown.
D) any of the above

2) Which of the following relationships between importing and exporting parties would require the least detailed contract to conduct business?
A) affiliated party
B) unaffiliated unknown party
C) known unaffiliated party
D) domestic supplier

3) Polaris Corporation has made an agreement to ship goods to a foreign firm with whom they have not entered into a contract for three years. However, the firms have communicated regularly since the last sale three years ago. This is an example of an:
A) unaffiliated known party transaction.
B) unaffiliated unknown party transaction.
C) affiliated party transaction.
D) none of the above

True/False

1) Today, international trade is dominated by transactions between unaffiliated parties (known or unknown).

2) Because most international transactions are between affiliated parties, international transaction contracts are less complex, but the management of the total value of the MNE is more complex.

3) An advantage of trading with an affiliated party for an MNE, compared to an unaffiliated party, could be reduced contracting costs and less to even no need to protect against nonpayment.

20.2 The Trade Dilemma

Multiple Choice

1) Which of the following is NOT a financial instrument that may be included in an international trade transaction?
A) Letter of Credit
B) Sight Draft
C) Order bill of lading
D) Federal funds transaction

True/False

1) The fundamental dilemma of foreign trade is being unwilling to trust a stranger in a foreign land.

20.3 Benefits of the System

Multiple Choice

1) The combination of a letter of credit, a sight draft, and an order bill of lading protect both parties in international transactions from which of the following?
A) the risk of noncompletion
B) the risk of foreign exchange risk (when combined with a various hedging techniques)
C) the risk that financing will not be available due to foreign exchange risk
D) All of these risks are reduced when using these trade implements.

True/False

1) If a foreign exchange transaction calls for payment in the importer’s currency, the exporter has the foreign exchange risk.

2) If a foreign exchange transaction calls for payment in the exporter’s currency, the importer has the foreign exchange risk.

3) In the case of international trade, the risk of nonpayment is essentially eliminated with the use of a letter of credit issued through a trustworthy bank.

20.4 Key Documents

Multiple Choice

1) Which of the following is NOT true regarding a letter of credit?
A) The importer and exporter agree on a transaction.
B) The importer applies to its local bank for the issuance of a letter of credit.
C) The exporter applies to its local bank for the issuance of a letter of credit.
D) The importer’s bank cuts a sales contract based on its assessment of the creditworthiness of the importer.

2) A/An ________ letter of credit is intended to serve as a means of arranging payment, but not as a guarantee of payment.
A) irrevocable
B) revocable
C) confirmed
D) unconfirmed

3) A/An ________ letter of credit is an obligation only of the issuing bank whereas other banks honor a/an ________ letter of credit.
A) irrevocable; unconfirmed
B) revocable; confirmed
C) confirmed; irrevocable
D) unconfirmed; confirmed

4) A letter of credit that is confirmed in the ________ country has the additional advantage of eliminating the problem of ________.
A) exporter’s; portfolio risk
B) importer’s; blocked foreign exchange
C) exporter’s; blocked foreign exchange
D) none of the above

5) The draft is the instrument normally used in international commerce to:
A) transfer product.
B) prove ownership.
C) transfer title.
D) initiate the sale.

6) The ________ is the instrument normally used to actually effect payment in international commerce.
A) banker’s acceptance
B) bill of exchange
C) bill of lading
D) letter of credit

7) The person or company initiating the draft or bill of exchange is known as the:
A) maker.
B) drawer.
C) originator.
D) any of the above

8) The person or company to whom the draft or bill of exchange is addressed is the:
A) drawee.
B) drawer.
C) maker.
D) originator.

9) Drafts that have been accepted by banks become:
A) clean drafts.
B) nonmarketable.
C) banker’s acceptances.
D) none of the above

10) Which of the following purposes is NOT served by the bill of lading?
A) It acts as a receipt.
B) It acts as a contract.
C) It acts as a document of title.
D) It acts as all of the above.

11) The ________ is issued to the exporter by a common carrier transporting the merchandise.
A) bill of lading
B) draft
C) banker’s acceptance
D) line of credit

12) A straight bill of lading is most likely to be used under which of the following circumstances?
A) when the merchandise has not been paid for in advance
B) when the transaction is being financed by a bank
C) when the shipment is to an affiliate
D) none of the above

13) To become a negotiable instrument, a draft must conform to the following requirements EXCEPT:
A) it must be in writing and signed by the maker or drawer.
B) it must be payable to order or to bearer.
C) it must be written in English.
D) it must be payable on demand or at a fixed or determinable future date.

True/False

1) A letter of credit is an agreement by the bank to pay against documents rather than the actual merchandise.

2) The primary advantage of a letter of credit is that it reduces risk.

3) The major advantage of a letter of credit to the exporter is that the exporter does not receive any funds until the documents have arrived at a local port or airfield.

4) To constitute a true letter of credit transaction, the issuing bank must receive a fee or other valid business consideration for issuing the L/C.

5) To constitute a true letter of credit transaction, the bank’s L/C must contain a specified expiration date or a definite maturity.

6) To constitute a true letter of credit transaction, the bank’s commitment must be open-ended and cannot have a stated maximum amount of money.

7) A revocable L/C is intended to serve as a means of arranging payment but not as a guarantee of payment.

8) A sight draft is payable on presentation to the drawee; a time draft allows a delay in payment.

9) A draft is sometimes called a revocable letter of credit.

10) A time draft is payable on presentation to the drawee; the drawee must pay at once or dishonor the draft. A sight draft, allows a delay in payment.

11) The bill of lading is issued to the exporter by a common carrier transporting the merchandise. It serves three purposes: a receipt, a contract, and a document of title.

Essay

1) Explain what a letter of credit (L/C) is, who the principle parties are, what the principle advantage is, and how the L/C facilitates international trade.

20.5 Example: Documentation in a Typical Trade Transaction

Multiple Choice

1) In a typical international trade transaction, the order of activity would be which of the following?
A) The foreign buyer places an order; The domestic manufacturer ships to the buyer; The manufacturer’s bank presents a draft and documents to the buyer’s bank for acceptance; The buyer’s bank submits payment to the manufacturer’s bank.
B) The domestic manufacturer ships to the buyer; The buyer’s bank submits payment to the manufacturer’s bank; The foreign buyer places an order; The domestic manufacturer ships to the buyer; The manufacturer’s bank presents a draft and documents to the buyer’s bank for acceptance.
C) The foreign buyer places an order; The manufacturer’s bank presents a draft and documents to the buyer’s bank for acceptance; The domestic manufacturer ships to the buyer; The buyer’s bank submits payment to the manufacturer’s bank.
D) The domestic manufacturer ships to the buyer; The manufacturer’s bank presents a draft and documents to the buyer’s bank for acceptance; The foreign buyer places an order; The buyer’s bank submits payment to the manufacturer’s bank.

True/False

1) Because of the risks involved in international trade, most transactions follow conventional methods and rarely require flexibility or creativity on the part of management.

Comment: Few international transactions are typical and often require flexibility or creativity on the part of management.

20.6 Government Programs to Help Finance Exports

Multiple Choice

1) The Export-Import Bank is an independent agency of the U.S. government established in 1934 to:
A) ship money abroad.
B) import agricultural products during the recession.
C) facilitate and stimulate foreign trade of the United States.
D) none of the above

2) In the United States, the Foreign Credit Insurance Corporation:
A) is a subsidiary of the Export-Import Bank.
B) provides letters of credit for U.S. importers.
C) provides letters of credit for U.S. exporters.
D) provides policies that protect U.S. exporters against default by foreign importers.

Instruction 20.1:
Use the information to answer the following question(s).

Cypress Systems Inc., of Florida, agrees to sell specialized hydroponic growing equipment to Landcaster’s of Australia. Because the two companies have never done business with each other, Cypress requires a banker’s acceptance as payment for the $1,000,000 order. The banker’s acceptance carries a 1.4% commission per annum and payment is to be received in 6 months. If Cypress Inc. chooses to discount or sell the bankers acceptance to its bank, the discount rate is 1.00% per annum.

3) Refer to Instruction 20.1. What is the size of the discount (not including the commission fee) Cypress must take for receiving the proceeds of the sale today rather than waiting for six months?
A) $7,000
B) $5,000
C) $12,000
D) $14.000

4) Refer to Instruction 20.1. What is the size of the commission Cypress will pay the bank for the banker’s acceptance?
A) $7,000
B) $5,000
C) $12,000
D) $14,000

5) Refer to Instruction 20.1. What is the total Cypress can expect to receive if the firm takes payment today?
A) $993,000
B) $995,000
C) $988,000
D) $996,000

6) Refer to Instruction 20.1. ________ is an unsecured promissory note.
A) A banker’s acceptance
B) An overdraft
C) A securitized loan
D) Commercial paper

7) Rogue Spices Inc. has a Canadian receivables contract for $200,000 due in 270 days. The firm has been approached by a factoring firm that offers to purchase the receivables at a 12% per annum discount plus a 1% charge for a nonrecourse clause. What is the annualized percentage all-in-cost of this factoring alternative?
A) 14.82%
B) 13.00%
C) 12.00%
D) 9.09%

True/False

1) The Foreign Credit Insurance Association is a branch of the U.S. federal government.

2) The Export-Import Bank (also called Eximbank) is an independent agency of the U.S. government, established in 1934 to stimulate and facilitate the foreign trade of the United States.

3) Essentially, the Eximbank lends dollars to borrowers inside the United States for the purchase of U.S. goods and services.

4) Banker’s acceptances can be used to finance only international trade receivables but not domestic trade receivables.

Essay

1) What is a banker’s acceptance? How are they initiated? Why are they desirable for the exporter?

20.7 Forfaiting: Medium- and Long-Term Financing

Multiple Choice

1) ________ is a specialized technique to eliminate the risk of nonpayment by importers in instances where the importing firm and/or its government is perceived by the exporter to be too risky for open account credit.
A) Forfeiting
B) Marketable Bank Shares
C) Forfaiting
D) Banker’s Acceptances

True/False

1) In effect, the forfaiter functions both as a money market firm and a specialist in packaging financial deals involving country risk.