Question: Assume that you believe exchange rate movements

> Consider a period in which the U.S. dollar weakens against the euro. How will this affect the reported earnings of a U.S.-based MNC with European subsidiaries? Consider a period in which the U.S. dollar strengthens against most foreign currencies. How wi

> Compare and contrast transaction exposure and economic exposure. Why would an MNC consider examining only its “net” cash flows in each currency when assessing its transaction exposure?

> Lexington Co. is a U.S.- based MNC with subsidiaries in most major countries. Each subsidiary is responsible for forecasting the future exchange rate of its local currency relative to the U.S. dollar. Comment on this policy. How might Lexington Co. ensur

> Syracuse Corp. believes that future real interest rate movements will affect exchange rates, and it has applied regression analysis to historical data to assess this relationship. It will use regression coefficients derived from this analysis along with

> You are hired as a consultant to assess a firm’s ability to forecast. The firm has developed a point forecast for two different currencies presented in the following table. The firm asks you to determine which currency was forecasted wi

> Explain how to assess performance in forecasting exchange rates. Explain how to detect a bias in forecasting exchange rates.

> Recall that Blades has tentatively decided to establish a subsidiary in Thailand to manufacture roller blades. The new plant will be utilized to produce Speedos, Blades’ primary product. Once the subsidiary has been established in Thailand, it will conti

> Explain the mixed technique for forecasting exchange rates.

> Explain the market-based approach to forecasting exchange rates. What is the rationale for using market-based forecasts? If the euro appreciates substantially against the dollar during a specific period, would market-based forecasts have overestimated or

> The prevailing one-year risk-free interest rate in Argentina is higher than the interest rate in the United States and will continue to be higher over time. Sycamore Co. believes the international Fisher effect can be used to derive the best forecast of

> Assume that interest rate parity exists. The one-year risk-free interest rate in the United States is 3 percent versus 16 percent in Singapore. You believe in purchasing power parity, and you also believe that Singapore will experience a 2 percent inflat

> Assume that interest rate parity exists and it will continue to exist in the future. Kentucky Co. wants to forecast the value of the Japanese yen in one month. The Japanese interest rate is lower than the U.S. interest rate. Kentucky Co. will use either

> Assume that interest rate parity exists. One year ago, the spot rate of the euro was $1.40, whereas the spot rate of the Japanese yen was $0.01. At that time, the one-year interest rate of the euro and the Japanese yen was 3 percent, compared to 7 percen

> Explain the fundamental approach to forecasting exchange rates. What are some limitations of using a fundamental technique to forecast these rates?

> Assume that interest rate parity exists. Today the one-year U.S. interest rate is equal to 8 percent, whereas Mexico’s one-year interest rate is equal to 10 percent. Today the two-year annualized U.S. interest rate is equal to 11 percent, whereas the two

> Assume that interest rate parity exists, and that it will continue to exist in the future. Assume that interest rates of the United States and the United Kingdom vary substantially in many periods. You expect that interest rates at the beginning of each

> Purdue Co. (based in the United States) exports cable wire to Australian manufacturers. It invoices its product in U.S. dollars and will not change its price over the next year. There is intense competition between Purdue and the local cable wire produce

> The Sports Exports Company produces footballs in the United States and exports them to the United Kingdom. It also has an ongoing joint venture with a British firm that produces some sporting goods for a fee. The Sports Exports Company is considering the

> New York Co. has agreed to pay 10 million Australian dollars (A$) in two years for equipment that it is importing from Australia. The spot rate of the Australian dollar is $0.60. The annualized U.S. interest rate is 4 percent, regardless of the debt matu

> For all parts of this question, assume that interest rate parity exists, that the prevailing one-year U.S. nominal interest rate is low, and that you expect U.S. inflation to be low this year. a. Assume that the country Dinland engages in much trade wit

> Bolivia currently has a nominal one-year risk-free interest rate of 40 percent, which is primarily due to the high level of expected inflation. The U.S. nominal one-year risk-free interest rate is 8 percent. The spot rate of Bolivia’s currency (called th

> The value of each Latin American currency relative to the dollar is dictated by supply and demand conditions between that currency and the dollar. The values of Latin American currencies have generally declined substantially against the dollar over time.

> The treasurer of Glencoe, Inc., detected a forecast bias when using the 30-day forward rate of the euro to forecast future spot rates of the euro over various periods. He believes he can use this information to determine whether imports ordered every wee

> The September 11, 2001, terrorist attacks on the United States were quickly followed by lower interest rates in the United States. How would this affect a fundamental forecast of foreign currencies? How would this affect the forward rate forecast of fore

> You must determine whether there is a forecast bias in the forward rate. You apply regression analysis to test the relationship between the actual spot rate and the forward rate forecast (F ): The regression results are as follows Based on these results

> Explain the technical approach to forecasting exchange rates. What are some limitations of using technical forecasting to predict these rates?

> Assume that the following regression model was applied to historical quarterly data: Assume that the regression coefficients were estimated as follows: Also assume that the inflation differential in the most recent period was 3 percent. The real intere

> Assume that the forward rate is an unbiased but not necessarily accurate forecast of the future exchange rate of the yen over the next several years. Based on this information, do you think Raven Co. should hedge its remittance of expected Japanese yen p

> Recently, Ben Holt, Blades’ chief financial officer, has assessed whether it would be more beneficial for Blades to establish a subsidiary in Thailand to manufacture roller blades or to acquire an existing manufacturer, Skates’n’Stuff, which has offered

> You believe that the Singapore dollar’s exchange rate movements are mostly attributable to purchasing power parity. Today the nominal annual interest rate in Singapore is 18 percent, compared to 3 percent in the United States. You expect that annual infl

> Assume that you obtain a quote for a one-year forward rate on the Mexican peso. Assume that Mexico’s one-year interest rate is 40 percent, whereas the U.S. one-year interest rate is 7 percent. Over the next year, the peso depreciates by 12 percent. Do yo

> Cooper, Inc., a U.S.- based MNC, periodically obtains euros to purchase German products. It assesses U.S. and German trade patterns and inflation rates to develop a fundamental forecast for the euro. How could Cooper potentially improve its method of fun

> Royce Co. is a U.S. firm with future receivables one year from now denominated in Canadian dollars and British pounds. Its pound receivables are known with certainty, but its estimated Canadian dollar receivables are subject to a 2 percent error in eithe

> When some countries in Eastern Europe initially allowed their currencies to fluctuate against the dollar, would the fundamental technique based on historical relationships have been useful for forecasting future exchange rates of these currencies? Explai

> The director of currency forecasting at Champaign-Urbana Corp. says, “The most critical task of forecasting exchange rates is not to derive a point estimate of a future exchange rate, but rather to assess how wrong our estimate might be.” What does this

> Assume that foreign exchange markets were found to be weak-form efficient. What does this suggest about utilizing technical analysis to speculate in euros? If MNCs believe that foreign exchange markets are semi strong-form efficient, why would they devel

> Assume that the four-year annualized interest rate in the United States is 9 percent and the four-year annualized interest rate in Singapore is 6 percent. Assume interest rate parity holds for a four-year horizon. Assume that the spot rate of the Singapo

> Explain corporate motives for forecasting exchange rates.

> One assumption made in developing the IFE is that all investors in all countries have the same real interest rate. What does this mean?

> The Sports Exports Company has been successful in producing footballs in the United States and exporting them to the United Kingdom. Recently, Jim Logan, the owner of the Sports Exports Company, has considered restructuring his company by expanding throu

> During the Asian crisis, direct intervention did not prevent depreciation of currencies. Offer your explanation for why the interventions did not work.

> Compare and contrast interest rate parity (discussed in Chapter 7), PPP, and the IFE.

> Assume U.S. interest rates are generally higher than foreign interest rates. What does this suggest about the future strength or weakness of the dollar based on the IFE? Should U.S. investors invest in foreign securities if they believe in the IFE? Shoul

> Explain the international Fisher effect (IFE). What is the rationale for the existence of the IFE? What are the implications of the IFE for firms with excess cash that consistently invest in foreign Treasury bills? Explain why the IFE may not hold.

> Explain why PPP does not hold.

> The United States has expected inflation of 2 percent, whereas Country A, Country B, and Country C have expected inflation of 7 percent. Country A engages in much international trade with the United States. The products that are traded between Country A

> Investors based in the United States can earn 11 percent interest on a oneyear bank deposit in Argentina (with no default risk) or 2 percent on a one-year bank deposit in the United States (with no default risk). Assess the following statement: “Accordin

> You believe that the future value of the Australian dollar will be determined by purchasing power parity. You expect that inflation in Australia will be 6 percent next year, whereas inflation in the United States will be 2 percent next year. Today the sp

> The one-year Treasury (risk-free) interest rate in the United States is presently 6 percent, whereas the one-year Treasury interest rate in Switzerland is 13 percent. The spot rate of the Swiss franc is $0.80. Assume that you believe in the international

> Assume that you believe purchasing power parity exists. You expect that inflation in Canada during the next year will be 3 percent and inflation in the United States will be 8 percent. Today the spot rate of the Canadian dollar is $0.90 and the one-year

> Recall that Ben Holt, Blades’ chief financial officer (CFO), has suggested to the board of directors that Blades proceed with the establishment of a subsidiary in Thailand. Due to the high growth potential of the roller blades market in Thailand, his ana

> 1 million euros in one year from selling exports. It did not hedge this future transaction. Boston believes that the future value of the euro will be determined by purchasing power parity (PPP). It expects that inflation in countries using the euro will

> Assume the value of the Hong Kong dollar (HK$) is tied to the U.S. dollar and will remain tied to the U.S. dollar. Assume that interest rate parity exists. Today, an Australian dollar (A$) is worth $0.50 and HK$3.9. The one-year interest rate on the Aust

> Inflation differentials between the United States and other industrialized countries have typically been a few percentage points in any given year. Yet, in many years annual exchange rates between the corresponding currencies have changed by 10 percent o

> The nominal (quoted) U.S. one-year interest rate is 6 percent, whereas the nominal one-year interest rate in Canada is 5 percent. Assume you believe in purchasing power parity. You believe that the real one-year interest rate is 2 percent in the United S

> The United States and the country of Rueland have the same real interest rate of 3 percent. The expected inflation over the next year is 6 percent in the United States versus 21 percent in Rueland. Interest rate parity exists. The one-year currency futur

> Today, a U.S. dollar can be exchanged for three New Zealand dollars. The one-year CD (deposit) rate in New Zealand is 7 percent, and the one-year CD rate in the United States is 6 percent. Interest rate parity exists between the United States and New Zea

> The Argentine one-year CD (deposit) rate is 13 percent, while the Mexican one-year CD rate is 11 percent and the U.S. one-year CD rate is 6 percent. All CDs have zero default risk. Interest rate parity holds, and you believe that the international Fisher

> Today’s spot rate of the Mexican peso is $0.10. Assume that purchasing power parity holds. The U.S. inflation rate over this year is expected to be 7 percent, whereas Mexican inflation over this year is expected to be 3 percent. Wake Forest Co. plans to

> The U.S. three month interest rate (unannualized) is 1 percent. The Canadian three-month interest rate (unannualized) is 4 percent. Interest rate parity exists. The expected inflation over this period is 5 percent in the United States and 2 percent in Ca

> You believe that interest rate parity and the international Fisher effect hold. Assume that the U.S. interest rate is presently much higher than the New Zealand interest rate. You have receivables of 1 million New Zealand dollars that you will receive in

> Jim Logan, owner of the Sports Exports Company, has been pleased with his success in the United Kingdom. He began his business by producing footballs and exporting them to the United Kingdom. Although American-style football is still not nearly as popula

> Assume that locational arbitrage ensures that spot exchange rates are properly aligned. Also assume that you believe in purchasing power parity. The spot rate of the British pound is $1.80. The spot rate of the Swiss franc is £0.3. You expect the one-yea

> Assume that Mexico has a one-year interest rate that is higher than the U.S. one-year interest rate. Assume that you believe in the international Fisher effect and interest rate parity. Assume zero transaction costs. Ed is based in the United States and

> Assume that the inflation rates of the countries that use the euro are very low, whereas other European countries that have their own currencies experience high inflation. Explain how and why the euro’s value could be expected to change against these cur

> Explain how you could determine whether PPP exists. Describe a limitation in testing whether PPP holds.

> Would PPP be more likely to hold between the United States and Hungary if trade barriers were completely removed and if Hungary’s currency were allowed to float without any government intervention? Would the IFE be more likely to hold between the United

> Describe a statistical test for the IFE.

> How could you use regression analysis to determine whether the relationship specified by PPP exists, on average? Specify the model, and describe how you would assess the regression results to determine if there is a significant difference from the relati

> The one-year risk-free interest rate in Mexico is 10 percent. The one-year risk-free rate in the United States is 2 percent. Assume that interest rate parity exists. The spot rate of the Mexican peso is $0.14. a. What is the forward rate premium? b. Wh

> Assume the following information is available for the United States and the eurozone: a. Does IRP hold? b. According to PPP, what is the expected spot rate of the euro in one year? c. According to the IFE, what is the expected spot rate of the euro in

> Beth Miller does not believe that the IFE holds. Current one-year interest rates in Europe are 5 percent, whereas one-year interest rates in the United States are 3 percent. Beth converts $100,000 to euros and invests them in Germany. One year later, she

> Because Ben Holt, Blades’ chief financial officer, believes the growth potential for the roller blades market in Thailand is very high, he has decided to invest in Thailand. This investment would involve establishing a subsidiary in Bangkok consisting of

> Given the conversion of several European currencies to the euro, explain what would cause the euro’s value to change against the dollar according to the IFE.

> Brazil commonly has a much higher nominal interest rate than the United States. Yet, some large institutional investors do not invest in Brazilian money market securities, even when they believe the securities have no credit (default) risk. Use the IFE t

> Russia commonly experiences a high rate of inflation. a. Explain why the high Russian inflation typically places severe downward pressure on the value of the Russian ruble. b. In some periods, the Russian government intervenes in the foreign exchange m

> As of today, assume the following information is available: a. Use the forward rate to forecast the percentage change in the Mexican peso over the next year. b. Use the differential in expected inflation to forecast the percentage change in the Mexican

> Explain the rationale underlying PPP theory.

> Assume that the spot exchange rate of the Singapore dollar is $0.70. The one-year interest rate is 11 percent in the United States and 7 percent in Singapore. What will the spot rate be in one year according to the IFE? Which force causes the spot rate t

> Assume that the spot exchange rate of the British pound is $1.73. How will this spot rate adjust according to PPP if the United Kingdom experiences an inflation rate of 7 percent while the United States experiences an inflation rate of 2 percent?

> How is it possible for PPP to hold if the IFE does not?

> Assume that the inflation rate in Brazil is expected to increase substantially. How will this affect Brazil’s nominal interest rates and the value of its currency (the real)? If the IFE holds, how will the nominal return to U.S. investors who invest in B

> IFE Shouldn’t the IFE discourage investors from attempting to capitalize on higher foreign interest rates? Why do some investors continue to invest overseas, even when they have no other transactions overseas?

> Jim Logan’s business, the Sports Exports Company, continues to grow. His primary product is the footballs he produces and exports to a distributor in the United Kingdom. However, his recent joint venture with a British firm has also been successful. Unde

> Assume that the nominal interest rate in Mexico is 48 percent and the interest rate in the United States is 8 percent for one-year securities that are free from default risk. What does the IFE suggest about the differential in expected inflation in these

> Japan has typically had lower inflation than the United States has. How would one expect this to affect the Japanese yen’s value? Why does this expected relationship not always occur?

> The currencies of some Latin American countries, such as Brazil and Venezuela, frequently weaken against most other currencies. What concept in this chapter explains this occurrence? Why don’t all U.S.-based MNCs use forward contracts to hedge their futu

> Assume that several European countries that use the euro as their currency experience higher inflation than the United States does, while two other European countries that use the euro as their currency experience lower inflation than the United States d

> investors in the United States and Canada require the same real interest rate, and the nominal rate of interest is 2 percent higher in Canada, what does this imply about expectations of U.S. inflation and Canadian inflation? What do these inflationary ex

> Explain the theory of purchasing power parity (PPP). Based on this theory, what is a general forecast of the values of currencies in countries with high inflation?

> Explain the concept of interest rate parity. Provide the rationale for its possible existence

> The terrorist attacks on the United States on September 11, 2001, led to expectations of a weaker U.S. economy. Explain how such expectations could have affected U.S. interest rates and, therefore, the forward rate premium (or discount) on various foreig

> Assume the following information Given this information, is covered interest arbitrage worthwhile for Mexican investors who have pesos to invest? Explain your answer.

> Assume the following information: Given this information, what would be the yield (percentage return) to a U.S. investor who used covered interest arbitrage? (Assume the investor invests $1 million.) What market forces would occur to eliminate any furth

> For the last year, Blades, Inc., has been exporting its products to Thailand to supplement its declining U.S. sales. Under the existing arrangement, Blades sells 180,000 pairs of roller blades annually to Entertainment Products, a Thai retailer, for a fi

> Assume that the one-year interest rate in Canada is 4 percent. The one-year U.S. interest rate is 8 percent. The spot rate of the Canadian dollar (C$) is $0.94. The forward rate of the Canadian dollar is $0.98. a. Is covered interest arbitrage feasible f

> Assume that interest rate parity holds and will continue to hold in the future. At the beginning of the month, the spot rate of the British pound is $1.60, while the one-year forward rate is $1.50. Assume that U.S. annual interest rate remains steady ove

> Today, the annualized interest rate in the United States is 4 percent for any debt maturity. The annualized interest rate in Australia is 4 percent for debt maturities of three months or less, 5 percent for debt maturities between three months and six mo

> Assume that the one-year interest rate in the United Kingdom is 9 percent, whereas the one-year interest in the United States is 4 percent. The spot rate of the pound is $1.50. Assume that interest rate parity exists. The quoted one-year interest in the

> As of now, the nominal interest rate is 6 percent in the United States and 6 percent in Australia. The spot rate of the Australian dollar is $0.58, whereas the oneyear forward rate of the Australian dollar exhibits a discount of 2 percent. Assume that as