International Financial Management

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Question 1 (2.5 Marks)
How do you replicate (i.e., reproduce) a short forward contract with a combination of two types of options at the same exercise price?
A) Long Call + Short Put
B) Long Call + Short Call
C) Long Put + Short Call
D) Long Put + Short Put
E) Long Call + Long Put
Question 2 (2.5 Marks)
Assume that Zhang Corporation will need to sell 200,000 British pounds in 90 days. A call option exists on British pounds with an exercise price of $1.68, a 90-day expiration date, and a premium of $.04. A put option exists on British pounds, with an exercise price of $1.69, a 90-day expiration date, and a premium of $0.03. Zhang Corporation plans to purchase options to cover its future payables. It will exercise the option in 90 days (if at all). It expects the spot rate of the pound to be $1.76 in 90 days. Determine the amount of dollars it will receive for the receivables, including the amount paid for the option premium (ignore time value of money).
A) $331,000-$333,000
B) $335,000-$337,000
C) $338,000-$340,000
D) $345,000-$347,000
E) $359,000-$361,000
Semester Two Final Examinations, 2019 FINM7406 International Financial Management
Page 3 of 6
Question 3 (5 Marks)
ABC Learning centre Australian Company (A) needs to borrow RMB487 million ($100 million at the current exchange rate of RMB/$ = 4.87) for ten years to establish a childcare centre in China. Huawei – a Chinese telecommunications firm (C) needs to borrow $100 million for ten years to set up an Australian division. The two face the following borrowing costs (annual coupon payments):
Consider the following arrangement. A and C should borrow the full principal amount of either RMB487 million (or $100 million equivalent) based on their comparative advantage. Each company then agrees to pay the repayment obligation of the other. In addition, A will pay C RMB29.22mil at the end of each year, and C will pay A $4.5 mil at the end of each year. [Assume: Forward rates for the next ten years will be the same as the current spot rate of RMB/$=4.87.]
Question: With this swap arrangement, what are the interest rate (%) savings for A relative to the interest rate without this swap arrangement? Please only show the workings for A. [You don’t need to show the workings for C.]
Question 4 (5 Marks)
Money Corp. frequently uses a forward hedge to hedge its Malaysian ringgit (MYR) receivables. For the next month, Money has identified its net exposure to the ringgit as being MYR1,500,000. The 30-day forward rate is $0.23. Furthermore, Money’s financial centre has indicated that the possible values of the Malaysian ringgit at the end of next month are $0.20 and $0.25, with probabilities of 30% and 70%, respectively. Based on this information, what is the expected real cost of hedging receivables?
r($)
r(RMB)
A = ABC Learning
4.50%
6.30%
C = Huawei
4.20%
5.00%
Semester Two Final Examinations, 2019 FINM7406 International Financial Management
Page 4 of 6
Question 5 (5 Marks)
Assume the following information:
U.S. deposit rate for 1 year = 11%
U.S. borrowing rate for 1 year = 12%
New Zealand deposit rate for 1 year = 8%
New Zealand borrowing rate for 1 year = 10%
New Zealand dollar forward rate for 1 year = $0.40
New Zealand dollar spot rate = $0.39
Also assume that a U.S. exporter denominates its New Zealand exports in NZ$ and expects to receive NZ$600,000 in 1 year. You are a consultant for this firm.
Using the information above,
a) what will be the approximate value of these exports in 1 year in U.S. dollars given that the firm executes a money market hedge? [3 marks]
b) explain what this U.S. exporter needs to do at the end of one year. [2 marks]
Question 6 (5 Marks)
Calculate the euro-based return an Italian investor would have realized by investing €10,000 into a £50 British stock. One year after investment, the stock pays a £1 dividend, and sells for £54, the exchange rate has changed from €1.25 per pound to €1.30 per pound, although he sold £8,800 forward at the forward rate of €1.28 per pound.
Semester Two Final Examinations, 2019 FINM7406 International Financial Management
Page 5 of 6
Question 7 Economic Exposure (10 Marks)
Consider a British firm (BF), that operates in Australia. BF produces all its output (pens) in Australia and all of its costs of production are at local Australian dollar prices. It sells some fraction of its output to Australia and some fraction to New Zealand. See the following information below.
Australia
New Zealand
Sales
700,000
Pens
300,000
Pens
Price per pen
AUD
1
NZD
1.2
Cost of manufacturing a pen
AUD
0.6
Nominal exchange rate relative to the GBP
AUD/GBP
1
NZD/GBP
1.2
Required:
a) Calculate the GBP profits of BF’s operation. [2 marks]
b) Following a currency crisis in Australia the AUD has devalued to 5 AUD to the GBP. The NZD exchange rate against GBP does not change. Recalculate the profits for BF’s operation. Is the increase or decrease in profit consistent with your expectation? Please briefly explain. [2 marks]
c) Do you agree with the following statement? Why or why not? Please provide a brief example.
“Only firms that have foreign operations are exposed to foreign exchange risk.”
[3 marks]
d) Where are the sources of economic exposures? Please briefly mention any of the three sources. [3 marks]
Semester Two Final Examinations, 2019 FINM7406 International Financial Management
Page 6 of 6
Question 8 (15 Marks)
Alphabet Inc., a U.S. MNC, is contemplating making a foreign capital expenditure in Malaysia. The initial cost of the project is Malaysian Ringgit (MYR) 95mil.
The annual cash flows over the three-year economic life of the project in MYR are estimated to be 25mil, 45mil, and 60mil.
The parent firm’s cost of debt is 7%; equity beta is 1.1; US market return is 8%; US government bond yield is 2%; company tax rate is 20%. Debt to equity ratio is 1.
Long-run inflation is forecasted to be 2 percent per annum in the U.S. and 3 percent in Malaysia. The current spot foreign exchange rate is MYR/USD = 3.
Please show all your workings:
a) What is the weighted average cost of capital (WACC) in dollars? [1 mark]
b) Determine the NPV for the project in USD using local currency (MYR) approach. (Hint: you will need to use Fisher Effect to obtain the MYR equivalent Dollar WACC.) [5 marks]
c) Determine the NPV for the project in USD using period-by-period conversion approach. (Hint: This question requires you to convert your MYR cash flows into USD using Purchasing Power Parity forecasted exchange rate.) [5 marks]
d) Do you think the NPV in dollars would be higher or lower (comparing with Part C), if the actual pattern of MYR/USD exchange rates in the next three years is: S(0) = 3, S(1) = 2.9, S(2) = 2.8 and S(3) = 2.6? Explain why? [Please note you should not show the full calculation but explain your intuition here.]
[2 marks]
e) If Alphabet Inc. does not know the project discount rate for this project in Malaysia, what would you advise Alphabet Inc to do in order to estimate the cost of capital for this project in Malaysia? (Hint: Use less than 200 words to answer this question.) [2 marks]

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