管理系统

MOCK EXAMINATION PAPER-Resit

2014/2015

Module Number: ECS3350 Module Title: International Finance

Time allowed:

Total number of questions:

Instructions to candidates:

Answer ALL questions in Part A and answer any TWO questions in Part B. This is a closed book exam.

You must justify your answers, either numerically or in writing. A correct answer without explanation will gain limited marks.

Formulas

Use of non-programmable calculators is permitted 6 9

TWO Hours

Materials provided:

Equipment permitted:

Total number of pages:

No books, paper or electronic devices are permitted to be brought into the examination room other than those specified above. Candidates are warned that illegible scripts will not be marked.

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Part A: Compulsory Questions (attempt ALL questions)

exchange rate regimes?

(16 marks)

Question A1: What is balance of payment identity? How are they different under fixed and floating

The balance of payment identity means that combined balance on the current and capital accounts should be equal in size, but opposite in sign, to the change in the official reserves: BCA + BKA=-BRA.

Under the pure flexible exchange rate regime, central banks do not engage in official reserve transactions. Thus, the overall balance must balance, i.e., BCA=-BKA

Under the fixed exchange rate regime, a country can have an overall BOP surplus or deficit as the central bank will accommodate it via official reserve transactions.

Question A2: A speculator is considering the purchase of four three-month British pound put options with a striking price of $1.57 per £. The premium is $0.04 per pound. The standard size of each option contract is 10,000 pounds. Determine the future spot price at which the speculator will only break even.

(Please include currency symbols $, £ in your answer) St=E+C=$1.57+$0.04=$1.61 per pound

Question A3: Microsoft would like to borrow pounds, and Boots wants to borrow dollars. Because Microsoft is better known in the United States, it can borrow on dollars at 6% and pounds at 8%, whereas Boots can on its own borrow dollars at 6.5% and pounds at 7%. Suppose Microsoft wants to borrow £2 million for two years, Boots wants to borrow $3 million for two years, and the current ($/£) exchange rate is $1.50/£. What swap transaction would accomplish this objective? Assume the counterparties would exchange principal and interest payments with no rate adjustments.

Boots would borrow £2 million for tow years and Microsoft would borrow $3 million for two years. The two companies would then swap their proceeds and payment streams.

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(Please include currency symbols $, £ in your answer)

(4 marks)

(3 marks)

(3 marks)

Question A4: How is transaction exposure different from economic exposure?

(3 marks)

Transaction exposure is the sensitivity of realized domestic currency values of the firm’s contractual cash flow denominated in foreign currencies to unexpected changes in exchange rates. Unlike economic exposure, transaction exposure is well-defined and short-term.

Question A5: What is the capital budgeting framework and how would it be different for international capital budgeting of multinational firms?

(3 marks)

capital budgeting framework can by defined as the process of identifying, analysing , and

selecting investment projects whose returns(cash flows) are expected to extend beyond one year.

Part B: Optional Questions (Attempt any TWO questions)

Question B1: (22 marks)

(44 marks)

Discuss why or why not a country should join a currency union. 1. 2. 3. 4.

reducing costs of exchange reducing exchange-rate

preventing competitive devaluations preventing speculative attacks

Question B2: (22 marks)

The table below shows the information for exchange rates, interest rates and inflation rates in the US and Germany. Answer the following questions

Current spot rate:

$1.32/€ $1.30/€ 4%

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One-year forward rate: Interest rate in the US:

Interest rate in Germany: Inflation rate in the US: Inflation rate in Germany:

5% 3% 3.3%

(a) Find the 1-year forward exchange rate in $ per € that satisfies IRP from the perspective of a customer that borrowed $1000 traded for € at the spot and invested in Germany.

(b) There is one profitable arbitrage at these prices. How to conduct the covered interest arbitrage if you can either borrow $1000 in the US or €1000 in Germany?

(c) A fund manager uses the concepts of purchasing power parity (PPP) to forecast spot exchange rates using the financial information. Calculate the future euro spot rate in dollar after one year that would be forecast by relative PPP.

(d) What could be the reasons for the deviation of PPP? (Please include currency symbols $, € in your answer) Question B3: (22 marks)

Alcoa Chemical, a US company, has sold £2 million chemicals to CPL Co. Payment is due in 90 days.

Spot rate:

$1.62/£ $1.58/£ 3% 4%

premium $0.05 per pound premium $0.06 per pound

90-day forward rate

90-day U.S. dollar interest rate (annualized) 90-day Pound interest rate (annualized) 90-day call option on pound at $1.60/£ 90-day put option on pound at $1.60/£

(a) What is the hedged value of Alcoa's receivable using the forward market hedge?

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Alcoa can use a forward contract to lock in a value of £2,000,000*$1.58/£=$3,160,000 for its receivable (b) What is the hedged value of Alcoa's receivable using the money market hedge?

Alcoa would borrow the present value of the £2 million receivable, which equals

£2,000,000/(1+4%/4)= £1,980,198 at the 1% 90-day interest rate (4%/4).

This pound amount translates into a dollar amount of £1,980,198*$1.62/£=$3,207,921 at the current spot rate of $1.62/£. By investing there dollars at the 90-day rate of 3%/4=0.75 % , Alcoa will have ($0.06+0.75%)*$3,207,921=$216,535 at the end of 90 days.

(c) Which of the hedging alternatives analyzed in parts (a) and (b) would you recommend to Alcoa? Why?

The forward contract is the preferred alternative, because its hedging characteristics are identical to those of the others but it has a higher payoff. Alcoa would be speculating on the future spot price of the Pound if it bought the put option.

Since Alcoa has no comparative advantage in pricing options, it should drop this alternative.

(d) What alternative is available to Alcoa to use currency options to hedge its receivable? What is the hedged value of Alcoa's receivable using the option hedge?

Alcoa can buy a put option giving it the right but no the obligation to sell £2 million in 90 days at

a price of $1.60/£ and put premium of $0.06 per pound, Alcoa can also use a currency collar, which would involve buying the put option and selling a call option in the amount of £2 million and receiving a premium $0.05 per pound. With sale of the call option, of the Pound appreciates beyond $1.60/£, the holder of the call option will call the Pound away.

Thus, Alcoa will cap its upside potential at $1.60/£ plus the premium $0.05 per pound and be protected on the downside by the put option.

By buying the put option and selling the call option at a strike price of $1.60/£ and pocketing the premium $0.06 per pound of ($0.06/£)*($1.62/£)= $0.0972, Alcoa would create the equivalent of a forward contract at $1.58+ $0.0972=$1.6772. So ,forward contract is better .

(Please include currency symbols $, £ in your answer)

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Question B4: (22 marks)

Mill Company is evaluating the proposed acquisition of a new milling machine in Europe. The machine's base price is €80,000. The project has a life-time of 3 years. The cash flow of the project depends on whether the Euro zone will be in recession or experience an economic recovery. The probability of remaining in recession is 65%, the probability of recovery is 35%. The operating cash flows are as follows:

Year 1 €25,000 €30,000

Year 2 €25,000 €35,000

Year 3 €30,000 €38,000

Recession

Economic Recovery

The exchange rate at the time of investment is $1.50/€. The inflation rate in the U.S. ($) is 2 percent and in the euro zone 4 percent (€). The company's cost of capital is 10%. (a) Find the dollar cash flows of this project under each scenario.

(b) Find the dollar-denominated expected net present value (NPV) of this project. Should the firm invest

in the Euro zone?

(Please include currency symbols $, £ in your answer)

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