International Finance Exercise
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ScribdTranslationsInternational Finance Exercise
Uploaded by
ScribdTranslationsInternational Finance Exercise:
1. If the yield on one-year European government bonds is 3%, the yield on US Treasury bills
is 1%, and the euro/dollar spot rate is 0.7300, then interest rate parity would imply a
one-year forward rate of:
(1+3 % )
f= −1=1.98 %
(1+1 %)
2. The US dollar is expected to appreciate against the Brazilian real by 4% annually. If a
company can borrow reais at 9.3%, what is the maximum interest rate that the company
would be willing to pay to obtain a loan in US dollars, if its objective is to minimize the
expected cost of its financing?
To maintain purchasing power parity, if the dollar is expected to appreciate by 4% next
year, the maximum amount of interest the company could face is 13.30%.
3. Suppose a company located in Bolivia can borrow dollars at 8% or bolivianos (BOB) at
13%. If the boliviano is expected to depreciate from BOB 6.67 = USD $1 at the beginning
of the year to BOB 7.01 = USD $1 at the end of the year, what is the cost in dollars of a
loan denominated in bolivianos?
The dollar will appreciate against the bolivar, this means that each bolivar that the
company requests today will cost an additional $0.01. This is due to the depreciation of
the currency.
4. With a 0% inflation rate, the cash flows of a new project in the Philippines in year 2 are
expected to be 100 million Philippine pesos (PHP). If Philippine inflation were 6% per
year, the increase in cash flow would be only 5% per year (since depreciation would
remain constant). Assuming that the expected US inflation is 2% per year and that
purchasing power parity remains constant, what is the expected cash flow in dollars in
year 2? The spot exchange rate is 50 Philippine pesos = $1.00 USD
$5,455.88 million dollars.
5. American Airlines plans to collect £2.5m within 90 days. The CFO wants to hedge this
transaction by selling sterling forward. If the spot rate is pounds 1 = US $1.66 and the 90-
day forward rate is pounds $1 = US $1.50. What is the cost of coverage for American
Airlines?
$0.16 per pound, 2.66 million in total.
6. What determines the price of an option? What types exist? When can they be an
alternative coverage?
Options are derivatives that are defined by an underlying asset. When the value of the
underlying asset changes, the value of the option changes. There are 2 types of options,
call options and put options. Call options allow the holder to purchase the asset at a set
price within a specific time period. Put options allow the holder to sell the asset at a set
price within a specific time period.
Companies can use these hedges when they need an input and want to reduce the
uncertainty of whether or not they have it, both physically and in terms of the value of the
asset. For example, if your company is a pork company and needs a large quantity of pork
at the end of December, you could purchase an option to guarantee that you will have the
product.
7. What is a swap? What can it be used for by a company?
A swap is a type of derivative in which two parties exchange the cash flows or liabilities of
two different financial instruments. Companies can usually use a swap when they have
loans with variable interest rates and want to change them to a fixed rate or vice versa.
They can also use it to exchange loans at different exchange rates, etc.
8. List 3 advantages of a company issuing shares on foreign stock exchanges:
i. It allows you to raise capital in a foreign currency quickly and at a lower cost.
ii. Allows you to choose a country with a lower interest rate compared to the country of
origin.
iii. Reduces exchange rate risk.
9. The price indices in India and the US were at 100 at the beginning of the year and at 120
and 103 at the end of the same year, respectively. If the exchange rate at the end of the
year is US$1=60INR (Indian Rupee), what has been the change in the theoretical value of
the Rupee against the dollar during the year?
Using the PPP equation and calculating the respective inflation for each country.
(1+20 % )
e= −1=0.1650
(1+3 % )
The theoretical variation was 0.1650.
Literature
James Chen. (Feb 19, 2020). Options. September 17, 2020, from Investopedia Website:
https://www.investopedia.com/terms/o/option.asp
James Chen. (February 4, 2020). Swaps. September 17, 2020, from Investopedia Website:
https://www.investopedia.com/terms/s/swap.asp
Paul Mizen, Frank Packer, Eli Remolona and Serafeim Tsoukas. (December 2012). Why do firms
issue issues abroad? Lessons from onshore and offshore corporate bond finance in Asian emerging
markets. BIS Working Papers, 401, 51.
