International Financial Management Final Review International Financial Management 171207 Final Review

Final December 14, 2017 From 2:00 to 3:30 PM 40% of your final score Chapter 8, 9, 13, 15, 16, 17, 18 BRING YOUR FINANCIAL CALCULATOR Please use at least 4 decimal places (ex. 2.3829) One (i) letter-sized (ii) two-sided (iii) hand-written cheat sheet is allowed The total score is 100 points Multiple choice: 10 problems, 40 points Short answer question: 6 problems, 60 points Bonus extra: 2 problems, 10 points 171207 Final Review

Problem 1 IBM purchased computer chips from NEC, a Japanese electronics concern, and was billed ¥250 million payable in three months. Currently, the spot exchange rate is ¥105/$ and the three-month forward rate is ¥100/$. The three-month money market interest rate is 8 percent per annum in the U.S. and 7 percent per annum in Japan. The management of IBM decided to use the money market hedge to deal with this yen account payable. Explain the process of a money market hedge and compute the dollar cost of meeting the yen obligation. Conduct the cash flow analysis of the money market hedge. 171207 Final Review

Answer 1 Let’s first compute the PV of ¥250 million, i.e., So if the above yen amount is invested today at the Japanese interest rate for three months, the maturity value will be exactly equal to ¥25 million which is the amount of payable. To buy the above yen amount today, it will cost: $2,340,002.34 = ¥245,700,245.70/105. The dollar cost of meeting this yen obligation is $2,340,002.34 as of today. 171207 Final Review

Answer 1 (cont.) Write down all the cash flows in detail __________________________________________________________________ Transaction CF0 CF1 1. Buy yens spot −$2,340,002.34 with dollars ¥245,700,245.70 2. Invest in Japan − ¥245,700,245.70 ¥250,000,000 3. Pay yens − ¥250,000,000 Net cash flow − $2,340,002.34 171207 Final Review

Problem 2 Boeing just signed a contract to sell a Boeing 737 aircraft to Air France. Air France will be billed €20 million which is payable in one year. The current spot exchange rate is $1.05/€ and the one-year forward rate is $1.10/€. The annual interest rate is 6.0% in the U.S. and 5.0% in France. Boeing is concerned with the volatile exchange rate between the dollar and the euro and would like to hedge exchange exposure. It is considering two hedging alternatives: sell the euro proceeds from the sale forward or borrow euros from Credit Lyonnaise against the euro receivable. Which alternative would you recommend? Why? Other things being equal, at what forward exchange rate would Boeing be indifferent between the two hedging methods? 171207 Final Review

Answer 2 In the case of forward hedge, the future dollar proceeds will be (20,000,000)(1.10) = $22,000,000. In the case of money market hedge (MMH), the firm has to first borrow the PV of its euro receivable, i.e., 20,000,000/1.05 =€19,047,619. Then the firm should exchange this euro amount into dollars at the current spot rate to receive: (€19,047,619)($1.05/€) = $20,000,000, which can be invested at the dollar interest rate for one year to yield: $20,000,000(1.06) = $21,200,000. Clearly, the firm can receive $800,000 more by using forward hedging. 171207 Final Review

Answer 2 (cont.) According to IRP, F = S(1+i$)/(1+iF). Thus the “indifferent” forward rate will be: F = 1.05(1.06)/1.05 = $1.06/€. Note: IRP means 1+ i $ What you can get by depositing in the US = F $ € S $ € 1+ i € What you can get by depositing in the foreign country € here 171207 Final Review

Problem 3 A "primary" stock market is A big internationally-important market like the NYSE Where brokers and market makers trade A market where corporations issue new shares to initial investors The market that provides market participants with marketability and share valuation 171207 Final Review

171207 Final Review

Problem 4 The more concentrated a national stock market is The greater opportunity a global investor has to include shares from that county in an internationally diversified portfolio The less opportunity a global investor has to include shares from that county in an internationally diversified portfolio The broader the investor base across a number of different shares and industries None of the above 171207 Final Review

171207 Final Review

Problem 5 Suppose that the US capital markets are integrated with the rest of the world and that the world beta measure of Dell stock is 0.7, that is, β Dell W =0.7. If we assume that the risk-free rate is 6 percent and the expected return on the world market portfolio is 12 percent, that is, R f =6% and R W =12%, the expected return on Dell stock can be computed as 4.2% 8.4% 10.2% 14.4% 171207 Final Review

R i = R f + β i Local R Local − R f Answer 5 If the capital markets around the world are segmented, then the expected return can be computed using typical CAPM with the local market index, i.e. R i = R f + β i Local R Local − R f On the other hand, if the capital markets are integrated globally, then the expected return should be computed using CAPM with the world (or global) market index, i.e. R i = R f + β i World R World − R f Since the problem is assuming the capital markets are integrated, the expected return of Dell can be computed as R Dell = R f + β Dell World R World − R f =6%+0.7 12%−6% =10.2% 171207 Final Review

Problem 6 Choose a wrong description: In most cases, cross-listings are beneficial for MNCs, because after cross-listing Liquidity (or trading volume) in the market improves The corporations can attract more external investors and hence raise more capital Cost of capital for most firms increases Their information disclosure is enhanced and correspondingly their corporate governance is improved 171207 Final Review

Slides from Chapter 17 171207 Final Review

Slides from Chapter 13 171207 Final Review

Problem 7 MNCs may undertake overseas investment projects in a foreign country, despite the fact that local firms may enjoy inherent advantages. This implies that MNCs are making a mistake in this case and will have to eventually withdraw MNCs should have significant advantages over local firms such as comparative advantages due to intangible assets The local firms will not have to compete due to their inherent advantages over the foreigners The government and citizens of the host countries always welcome MNCs and their investment 171207 Final Review

171207 Final Review

Problem 8 A U.S. firm holds a real estate in Italy and faces the following scenario: Where P* is the price of the real estate denominated by Euro and P is the same price denominated by US Dollar Compute Var[S], i.e. the variance of S Compute Cov[P,S], i.e. the covariance between P and S Compute the measure of economic exposure b, which is Cov P,S Var S State 1 State 2 State 3 Probability 1/3 S (Spot Rate) $1.2/€ $1.1/€ $1.0/€ P* €3,000 €2,700 €2,400 P (=P*×Spot Rate) $3,600 $2,920 $2,400 171207 Final Review

Answer 8 Variance of S Covariance between P and S First, calculate the mean of S, i.e. E[S] 1 3 1.2+ 1 3 1.1+ 1 3 1.0=1.1 Then, the mean of squared deviations 1 3 1.2−1.1 2 + 1 3 1.1−1.1 2 + 1 3 1.0−1.1 2 =0.0067 Covariance between P and S First, calculate the mean of P, i.e. E[P] 1 3 3600+ 1 3 2920+ 1 3 2400=2973 Then, the mean of the multiplication of two deviations 1 3 3600−2973 1.2−1.1 + 1 3 2920−2973 1.1−1.1 + 1 3 2400−2973 1.0−1.1 =40 Sensitivity measure “b” Cov P,S Var S = 40 0.0067 =€5970.15 171207 Final Review

Q&As Thanks for Listening 171207 Final Review