Foundations of Finance, 7e (Keown/Martin/Petty)

Chapter 17 International Business Finance

17.1 Learning Objective 1

1) Compared with other developed countries, the U.S. is particularly reliant on foreign trade for
self-subsistence.
Answer: FALSE
Keywords: Foreign Trade, Self-subsistence
AACSB: Reflective thinking skills

2) Investments in capital markets in foreign countries are motivated by the desire to earn higher
returns and reduce risk through international diversification.
Answer: TRUE
Keywords: Foreign Investment, International Diversification
AACSB: Reflective thinking skills

3) Problems of multinationals include

A) cash management and positioning of funds.
B) managing receivables.
C) global control.
D) all of the above.
Answer: D
Keywords: Multinationals
AACSB: Reflective thinking skills

17.2 Learning Objective 2

1) The Eurodollar market is larger than any financial market in the United States.
Answer: TRUE
Keywords: Financial Markets, Eurodollar Market
AACSB: Reflective thinking skills

2) Most major countries in the world have agreed on fixed exchange rates in order to facilitate
international trade.
Answer: FALSE
Keywords: Fixed Exchange Rates
AACSB: Reflective thinking skills

3) The bid-asked spread is much lower for currencies that are infrequently traded in order to
compensate banks for providing the service.
Answer: FALSE
Keywords: Bid-Asked Spread
AACSB: Reflective thinking skills

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4) A cross rate is the computation of an exchange rate for a currency from the exchange rates of
two other currencies.
Answer: TRUE
Keywords: Cross Rate
AACSB: Reflective thinking skills

5) The forward exchange rate quoted today should be equal to the spot rate in the future.
Answer: FALSE
Keywords: Forward Exchange Rate, Spot Rate
AACSB: Reflective thinking skills

6) Short-term daily fluctuations in exchange rates are caused by supply and demand conditions in
the foreign exchange market.
Answer: TRUE
Keywords: Exchange Rates
AACSB: Reflective thinking skills

7) An indirect quote indicates the number of units of foreign currency that can be bought for one
unit of the home currency.
Answer: TRUE
Keywords: Indirect Quote
AACSB: Reflective thinking skills

8) Arbitrage is the process of buying in one market and selling in another market in order to
make a riskless profit.
Answer: TRUE
Keywords: Arbitrage
AACSB: Reflective thinking skills

9) Spot exchange markets provide the potential for arbitrage opportunities.

Answer: TRUE
Keywords: Spot Exchange Market, Arbitrage
AACSB: Reflective thinking skills

10) The difference between the asked price and the bid price is known as the spread.
Answer: TRUE
Keywords: Bid-Asked Spread
AACSB: Reflective thinking skills

11) A narrow spread indicates efficiency in the spot exchange market.

Answer: TRUE
Keywords: Bid-Asked Spread
AACSB: Reflective thinking skills

12) Forward contracts are usually quoted for periods greater than 1 year.
Answer: FALSE
Keywords: Forward Contracts
AACSB: Reflective thinking skills
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13) Forward rates, like spot rates, are quoted in both direct and indirect form.
Answer: TRUE
Keywords: Forward Rates, Spot Rates, Direct Quote, Indirect Quote
AACSB: Reflective thinking skills

14) Forward contracts benefit only the customer due to a reduction in uncertainty.
Answer: FALSE
Keywords: Forward Contracts
AACSB: Reflective thinking skills

15) The efficiency of foreign currency markets is assured, in large measure, by the process of
arbitrageurs.
Answer: TRUE
Keywords: Arbitrage, Foreign Currency Markets
AACSB: Reflective thinking skills

16) A quote of .7645 euros per dollar in New York is an example of a direct quote.
Answer: FALSE
Keywords: Direct Quote, Indirect Quote
AACSB: Reflective thinking skills

17) The bid rate is the rate at which the bank buys the foreign currency from the customer by
paying in home currency.
Answer: TRUE
Keywords: Bid Rate
AACSB: Reflective thinking skills

18) Foreign currency forward rates aid traders by reducing uncertainty regarding future market
fluctuations.
Answer: TRUE
Keywords: Forward Rates
AACSB: Reflective thinking skills

19) In order to profit from an expected near-term increase in the relative value of the British
pound versus the U.S. dollar, an investor would be wise to maintain a short position in pounds,
then sell when the pound rises in relative value.
Answer: FALSE
Keywords: Relative Value, Foreign Exchange
AACSB: Analytic skills

20) Covered interest arbitrage can be taken advantage of when premiums in forward rates are not
exactly equal to the interest rate differential between two countries.
Answer: TRUE
Keywords: Covered Interest Arbitrage
AACSB: Reflective thinking skills

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21) The value of the Euro floats against other major international currencies, but has a fixed
value when compared to the currencies of the countries in the European Union, such as the
French Franc and the German Mark.
Answer: FALSE
Keywords: Euro, Floating Exchange Rates
AACSB: Reflective thinking skills

22) A direct quote of $1.9887 dollars to buy one U.K. pound corresponds to an indirect quote of .
9887 pounds per one dollar.
Answer: FALSE
Keywords: Direct Quote, Indirect Quote
AACSB: Analytic skills

23) Triangular arbitrage eliminates exchange rate differentials across three markets for three
currencies.
Answer: TRUE
Keywords: Triangular Arbitrage
AACSB: Reflective thinking skills

24) The asked rate is also known as the selling rate or the offer rate.
Answer: TRUE
Keywords: Asked Rate, Selling Rate, Offer Rate
AACSB: Reflective thinking skills

25) The existence of a forward-spot differential creates an arbitrage opportunity that will
eliminate the differential almost immediately.
Answer: FALSE
Keywords: Forward-Spot Differential, Arbitrage
AACSB: Reflective thinking skills

26) A direct quote of $1.6255 dollars to buy one U.K. pound corresponds to an indirect quote of .
6152 pounds per one dollar.
Answer: TRUE
Keywords: Direct Quote, Indirect Quote
AACSB: Reflective thinking skills

27) International expansion often occurs because it is generally easier for firms to expand the
market for their products rather than to develop new products.
Answer: TRUE
Keywords: International Markets
AACSB: Reflective thinking skills

28) A U.S. corporation investing in a foreign corporation by purchasing stock on a foreign stock
exchange is an example of direct foreign investment.
Answer: FALSE
Keywords: Direct Foreign Investment, Portfolio Investment
AACSB: Reflective thinking skills

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29) Commercial centers for foreign exchange exist only in New York and London in order to
make it possible for arbitrage to work.
Answer: FALSE
Keywords: Foreign Exchange Market, Arbitrage
AACSB: Reflective thinking skills

30) A direct quote is always denominated in U.S. dollars, since the dollar is the medium of
exchange in international business.
Answer: FALSE
Keywords: Direct Quote
AACSB: Reflective thinking skills

31) An exchange rate of $1.6 per British Pound is an example of a direct quote in the United
States.
Answer: TRUE
Keywords: Direct Quote
AACSB: Reflective thinking skills

32) A direct quote of $1.6 per British Pound in the United States is equivalent to a direct quote of
.625 British Pounds per U.S. dollar in Great Britain.
Answer: TRUE
Keywords: Direct Quote
AACSB: Reflective thinking skills

33) Three types of arbitrage are simple arbitrage, rectangular arbitrage, and covered-expense
arbitrage.
Answer: FALSE
Keywords: Simple Arbitrage, Triangular Arbitrage, Convered-Interest Arbitrage
AACSB: Reflective thinking skills

34) The forward-spot differential is the difference between the forward rate and the expected
future spot rate.
Answer: FALSE
Keywords: Forward-Spot Differential
AACSB: Reflective thinking skills

35) Due to the dominance of Chinese companies in international trade, the Chinese yuan is the
most frequently traded currency.
Answer: FALSE
Keywords: Foreign Currency Markets
AACSB: Dynamics of the global economy

36) The U.S. dollar is the most frequently traded currency in foreign currency markets,
accounting for over 40% of total trading.
Answer: TRUE
Keywords: Foreign Currency Markets
AACSB: Reflective thinking skills

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37) Exchange rate risk exists in international trade contracts denominated in a foreign currency,
but not in foreign portfolio investments, because the returns on investment securities are adjusted
automatically for differences in exchange rates.
Answer: FALSE
Keywords: Exchange Rate Risk, International Trade Contracts, Foreign Portfolio Investments
AACSB: Reflective thinking skills

38) If a U.S. company enters into a purchase agreement with a European company and the
contract is denominated in euros, then direct exchange rate risk exists for both companies.
Answer: FALSE
Keywords: Exchange Rate Risk
AACSB: Analytic skills

39) A wide bid/ask spread could indicate which of the following?

A) the presence of arbitrageurs
B) large volume transactions are taking place
C) frequent trading of a currency
D) an inefficient market
Answer: D
Keywords: Bid/Ask Spread, Efficient Markets
AACSB: Reflective thinking skills

40) The Euro increased dramatically in value against the U.S. dollar between 2000 and 2009.
The result has been that
A) U.S. exports are more competitive in Europe.
B) U.S. goods cost more in Europe.
C) U.S. travelers are finding it less expensive to travel in Europe.
D) European exports to the United States are more competitive.
Answer: A
Keywords: Euro, Exchange Rates
AACSB: Analytic skills

41) A British-made component costs 45 U.K. pounds. A company in the United States needs to
buy these components and the current indirect quote indicates that one dollar will buy .6250
pounds. Ignoring transactions costs, how much will one component cost in U.S. dollars?
A) $28.13
B) $45.63
C) $57.14
D) $72.00
Answer: D
Keywords: Indirect Quote
AACSB: Analytic skills

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42) The direct quote in New York is .015 dollar per Pakistani Rupee. The direct quote in
Pakistan is 60 rupees per dollar. This imbalance in rates can be correct by arbitrage. A trader will
________ rupees in New York and ________ rupees in Pakistan, causing the direct quote in New
York to ________.
A) buy, sell, increase
B) buy, sell, decrease
C) sell, buy, decrease
D) sell, buy, increase
Answer: A
Keywords: Direct Quote, Indirect Quote, Arbitrage, Foreign Exchange
AACSB: Analytic skills

43) Suppose the current exchange rates are 1.52 dollars per euro, and 99.8 yen per dollar. What
is the current exchange rate between yen and euros?
A) 65.658 yen per euro
B) 133.371 yen per euro
C) 151.696 yen per euro
D) 179.357 yen per euro
Answer: C
Keywords: Cross Rate
AACSB: Analytic skills

44) Alpha Corp. enters into a 30-day forward exchange contract to buy 113,540,000 yen for
$100,000. Which of the following statements is true concerning this transaction?
A) Alpha will pay $100,000 and receive 113,540,000 yen 30 days from now.
B) Alpha will pay $100,000 today and receive 113,540,000 yen 30 days from now.
C) The spot exchange rate in 30 days will be 113.54 yen per dollar.
D) Alpha will receive 113,540,000 yen today and pay $100,000 30 days from now.
Answer: A
Keywords: Forward Exchange Contract
AACSB: Analytic skills

45) The spot exchange rate is 1.57 dollars per pound. The 30-day forward exchange rate is .6211
pounds per dollar. Therefore, pounds in the forward market are selling at a ________ to the
current spot rate.
A) .958 discount
B) .958 premium
C) .04 discount
D) .04 premium
Answer: D
Keywords: Spot Rate, Forward Exchange Rate, Premium
AACSB: Analytic skills

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46) The spot exchange rate is 1.57 dollars per pound. The 30-day forward exchange rate is .6211
pounds per dollar. The percent-per-year discount on the 30-day pound is
A) 32.77%.
B) 30.57%.
C) 48.00%.
D) 45.93%.
Answer: B
Keywords: Percent-per-year Premium, Forward Exchange Rate
AACSB: Analytic skills

47) The 30-day forward exchange rate is .01073033 dollars per yen. If this forward rate
represents a per year discount of 2.5% from the current spot rate, what is the current spot
exchange rate?
A) .01073033 dollars per yen
B) .01257754 dollars per yen
C) .01329684 dollars per yen
D) .01093833 dollars per yen
Answer: A
Keywords: Forward Exchange Rate, Spot Rate, Percent-per-year discount
AACSB: Analytic skills

48) A Spot transaction occurs when

A) one currency is deposited in a foreign bank.
B) one currency is immediately exchanged for another currency.
C) one currency is exchanged for another currency at a specified price.
D) one currency is exchanged for another currency in 30, 60, or 90 days.
Answer: B
Keywords: Spot Transaction
AACSB: Reflective thinking skills

49) Buying and selling in more than one market to make a riskless profit is called
A) profit-maximization.
B) arbitrage.
C) international trading.
D) Cannot be determined from the above information.
Answer: B
Keywords: Arbitrage
AACSB: Reflective thinking skills

50) Which of the following is true?

A) The forward rate is the same as the spot rate that will prevail in the future.
B) The future spot rate is equal to the forward rate less the current spot rate.
C) The actual spot rate that will prevail in the future is not known today.
D) The future spot rate is the current spot rate increased by the inflation rate.
Answer: C
Keywords: Forward Rate, Spot Rate
AACSB: Reflective thinking skills

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51) Forward rates are all of the following except:
A) quoted in both direct and indirect form.
B) quoted at a premium or discount.
C) beneficial to risk-reduction.
D) equal to future spot rates.
Answer: D
Keywords: Forward Rates
AACSB: Reflective thinking skills

52) Which of the following is true regarding the correct price of the forward contract?
A) If the quote is less than the computed price, the forward contract is undervalued.
B) If the quote is greater than the computed price, the forward contract is overvalued.
C) Both A and B.
D) Neither A nor B.
Answer: C
Keywords: Forward Contracts
AACSB: Reflective thinking skills

53) Prior to 1973 the exchange rates between the major currencies of the world were
A) on a floating exchange rate system.
B) on an arbitrage exchange rate system.
C) on a fixed exchange rate system.
D) on a spot exchange rate system.
Answer: C
Keywords: Fixed Exchange Rates
AACSB: Reflective thinking skills

54) Since 1973 the exchange rates between the major currencies of the world are
A) on a floating exchange rate system.
B) on an arbitrage exchange rate system.
C) on a fixed exchange rate system.
D) on a spot exchange rate system.
Answer: A
Keywords: Floating Exchange Rate System
AACSB: Reflective thinking skills

55) If you are an importer of goods and you need to make payment for the purchase of inventory
before the close of business today, which of the below is the correct term for the exchange rate
that you will use?
A) indirect rate
B) spot rate
C) direct rate
D) forward rate
Answer: B
Keywords: Spot Rate
AACSB: Reflective thinking skills

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56) If you are an importer of goods and you will make payment for the purchase of inventory on
90-day terms, which of the below is the correct term for the exchange rate that you will use?
A) indirect rate
B) spot rate
C) direct rate
D) forward rate
Answer: D
Keywords: Forward Rates
AACSB: Reflective thinking skills

57) U.S. Wineries purchased 75,000 cases of French wine at a cost of 6,500,000 Euros. If the
current exchange rate is 0.6712 Euros to the U.S. dollar, what is the purchase price of the wine in
U.S. dollars?
A) $9,684,148
B) $9,328,651
C) $8,350,012
D) $ 7,707,685
Answer: A
Keywords: Exchange Rates
AACSB: Analytic skills

58) Assume that the British pound is worth 1.6750 U.S. dollars. If a new Jaguar costs $120,000,
what is the cost in British pounds?
A) 201,000
B) 60,633
C) 71,642
D) 119,998
Answer: C
Keywords: Exchange Rates
AACSB: Analytic skills

59) If the exchange rate quotes in two different countries were out of line with each other, an
enterprising trader could make a profit by buying in the market where the currency was cheaper
and simultaneously selling it in the market where the currency was more expensive. Such a
person would be known as a:
A) spot trader.
B) arbitrageur.
C) cross trader.
D) capitalist.
Answer: B
Keywords: Arbitrageur
AACSB: Reflective thinking skills

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60) Why do currency exchange rates throughout the world trade within a very narrow range on
any given day?
A) because of purchasing power parity
B) because of the international translation effect
C) because of arbitrage
D) because of the law of one price
Answer: C
Keywords: Arbitrage
AACSB: Reflective thinking skills

61) You purchased 500,000 Swiss Francs in London at an exchange rate of 0.6705 to the dollar
and simultaneously sold the francs in New York at an exchange rate of 0.6692 to the dollar.
What is the name for such a transaction?
A) trend trading
B) arbitrage
C) currency swapping
D) exchange rate hedging
Answer: B
Keywords: Arbitrage
AACSB: Reflective thinking skills

62) A forward exchange contract

A) gives the owner the right, but not the obligation, to buy a foreign currency at a fixed exchange
rate for a fixed period of time.
B) gives the owner the right to purchase a foreign currency at some point in the future and any
gains or losses are credited/debited to the account at the close of business each day.
C) requires delivery, at a specified future date, of one currency for a specified amount of another
currency.
D) requires delivery, within two working days, of one currency for a specified amount of another
currency.
Answer: C
Keywords: Forward Exchange Contract
AACSB: Reflective thinking skills

63) The current direct quote in New York is .01075 dollars per yen. Suppose the current direct
quote in Tokyo is 91 yen per dollar. What is the appropriate indirect quote in New York? What
will arbitrageurs do to eliminate the differential rates in these markets?
Answer: Indirect Quote in New York = 1/.01075 = 93.023 yen per dollar.

Arbitrageurs will buy yen in New York where the price is .01075 dollars per yen and sell yen in
Tokyo where the price is .01099 dollars per yen. The increase in demand in New York will
increase the price while the selling pressure in Tokyo will lower the price.
Keywords: Arbitrage, Direct Quote, Indirect Quote
AACSB: Analytic skills

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64) What is arbitrage? Assume that the dollar is quoted $1 = £0.625 in New York and the pound
sterling is quoted as £1 = $1.63 in London. Is there an arbitrage opportunity? If so, what would
an astute trader do? What will happen to the quotes as trades are made at current prices?
Answer: Arbitrage is the simultaneous purchase and sale of an asset in more than one market
resulting in a riskless profit. There is an arbitrage opportunity because the price of a pound in
New York is $1.60 and the price of a pound in London is $1.63. Given the current quotes, an
astute investor will buy pounds in New York while simultaneously buying dollars in London.
Example: A $10,000 investment in New York will buy £6,256 ($10,000 × 0.6256).
Simultaneously buying dollars in London yields $10,197.28 (£6,256 × $1.63), a 1.65% gain.
Since the transactions are entered simultaneously, no risk is involved. The sale of dollars in New
York for pounds and the sale of pounds in London for dollars will force the rates back to
equilibrium.
Keywords: Arbitrage
AACSB: Reflective thinking skills

17.3 Learning Objective 3

1) Interest rate parity theory states that the forward premium or discount should be equal and
opposite in sign to the difference in the national interest rates for securities of the same maturity.
Answer: TRUE
Keywords: Interest Rate Parity Theory
AACSB: Reflective thinking skills

2) Interest Rate Parity theory states that interest rates must be the same in all countries using
floating exchange rates or else international markets will not be in equilibrium.
Answer: FALSE
Keywords: Interest Rate Parity
AACSB: Reflective thinking skills

3) Suppose the 360-day forward exchange rate is 1.936 dollars per British Pound, and the current
spot rate is 1.900 dollars per British Pound. If the 360-day interest rate in the United States is 5%
and the 360-day interest rate in Great Britain is 3%, is the market in equilibrium according to the
interest rate parity theory?
A) Yes, because the forward premium on the pound (2%) is exactly offset by the lower interest
rate in Great Britain.
B) No, because the higher interest rate in the United States (2%) implies that the forward
exchange rate should be 2% lower than the current spot rate.
C) No, because the forward premium on the pound is 2% while the interest rate in the U.S is
67% higher than the interest rate in Great Britain.
D) Cannot be determined without knowing the amount of money being exchanged.
Answer: A
Keywords: Interest Rate Parity Theory
AACSB: Analytic skills

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4) Money-market hedges and forward market hedges rely on the
A) interest rate parity theory.
B) purchasing power parity theory.
C) law of large numbers.
D) capital asset pricing model.
Answer: A
Keywords: Interest Rate Parity Theory, Money-market Hedge, Forward Market Hedge
AACSB: Reflective thinking skills

5) One theory that is useful states that the forward premium or discount should be equal and
opposite in sign to the difference in the national interest rates for securities of the same maturity.
This theory is known as
A) the forward rate theory.
B) the interest rate parity theory.
C) the exchange rate theory.
D) the covered interest arbitrage theory.
Answer: B
Keywords: Interest Rate Parity
AACSB: Reflective thinking skills

6) Except for the effects of small transaction costs, the forward premium or discount should be
equal and opposite in size to the difference in the national interest rates for securities of the same
maturity. What is the name of this theory?
A) the purchasing power parity theory
B) the Bobby Fisher effect
C) interest rate parity theory
D) the law of one price
Answer: C
Keywords: Interest Rate Parity
AACSB: Reflective thinking skills

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7) The spot exchange rate in New York is 1.600 dollars per British pound. The 360-day forward
exchange rate is 1.680 dollars per pound. The one-year interest rate in Great Britain is 2% while
the one-year interest rate in the United States is 4%.
a. If the interest rate in Great Britain remains at 2%, what should the interest rate be in the
United States according to the interest rate parity theory?
b. An American investor with $40,000 decides to take advantage of the differences in rates.
Ignoring transaction costs, how can the American investor exploit the disequilibrium? Compare
the amount of money the investor will have at the end of the year if he or she invests in one-year
U.S. securities versus one-year British securities.
Answer:
a. 7%. The forward rate is a premium of 5% over the spot rate. The interest rate parity theory
suggests that the difference in interest rates should be of the same magnitude as the difference in
exchange rates, but in the opposite direction.

b. If the investor buys U.S. securities, he or she will have ($40,000 × 1.04) = $41,600 at the end
of the year. If the investor buys pounds, invests the pounds, and then sells the pounds via the
forward contract, he or she will end up with ($40,000/$1.600) × 1.02 × 1.68 = $42,840 at the end
of the year.
Keywords: Interest Rate Parity Theory
AACSB: Analytic skills

17.4 Learning Objective 4

1) Purchasing power parity suggests that interest rates in different countries will adjust so that
each currency will have the same purchasing power.
Answer: FALSE
Keywords: Purchasing Power Parity
AACSB: Reflective thinking skills

2) Argentina experienced a period of extremely high inflation relative to its trading partners and
Argentina's currency decreased in value. This is an example of purchasing power parity theory.
Answer: TRUE
Keywords: Purchasing Power Parity Theory
AACSB: Reflective thinking skills

3) Exceptions to purchase power parity exist if arbitrage opportunities are limited by

characteristics such as perishability or high transportation costs.
Answer: TRUE
Keywords: Purchasing Power Parity, Arbitrage
AACSB: Reflective thinking skills

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4) Suppose the current spot rate in New York is .0107 dollars per yen. Inflation for the coming
year in the United States is expected to be 5%, while inflation for the coming year is Japan is
expected to be only 2%. Using the purchasing power parity theory, what is the expected spot rate
at the end of the year should be
A) .0110147 dollars per yen.
B) .0108159 dollars per yen.
C) .0138373 dollars per yen.
D) .0107988 dollars per yen.
Answer: A
Keywords: Purchasing Power Parity Theory
AACSB: Analytic skills

5) A bottle of French wine costs $25 euros in Paris. According to the purchasing power parity
theory, what would the bottle sell for in New York if it costs the New York company $2 per
bottle to transport the wine to the United States? Assume the exchange rate is $1.50 per euro.
A) $40.50
B) $28.50
C) $27.00
D) $39.50
Answer: D
Keywords: Purchasing Power Parity Theory, Law of One Price
AACSB: Analytic skills

6) The law of one price suggests that all of the following will have the same price in different
countries except:
A) oil.
B) grain.
C) fresh vegetables.
D) silver.
Answer: C
Keywords: Law of One Price, Purchasing Power Parity Theory
AACSB: Reflective thinking skills

7) A corporate investment manager needs to invest $1,000,000 for the next 6 months. The
current nominal rate of interest in the United States is 5%, while the nominal rate of interest in
Brazil is 8%. Which of the following statements is most correct?
A) The manager should invest the funds in Brazil and make an extra $30,000 for the year.
B) The manager may decide to invest the funds in the United States due to the international
Fisher effect, which suggests inflation in Brazil may make the extra interest income worth less in
one year.
C) The manager is indifferent between investing the funds in the United States or Brazil because
real returns will always be the same in the end.
D) The manager cannot invest in Brazil because his company is investing dollars.
Answer: B
Keywords: International Fisher Effect
AACSB: Reflective thinking skills

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8) Exchange rate changes tend to reflect international differences in inflation rates. What is the
name of this theory?
A) the purchasing power parity theory
B) the IMF effect
C) interest rate parity theory
D) the law of one price
Answer: A
Keywords: Purchasing Power Parity Theory
AACSB: Reflective thinking skills

9) Which of the following parity conditions is (are) correct?

A) The interest-rate parity theory states that the forward premium/discount should be equal and
opposite in size to the national interest rate differential.
B) The purchasing-power parity theory states that in the long run exchange rate changes tend to
reflect international differences in inflation rates.
C) The international Fisher effect states that national interest rate differentials are the result of
inflation differentials.
D) All of the above are correct.
Answer: D
Keywords: Interest Rate Parity, Purchasing Power Parity, International Fisher Effect
AACSB: Reflective thinking skills

17.5 Learning Objective 5

1) Exchange rate fluctuations increase the variability of returns for investment portfolios that
include foreign securities.
Answer: TRUE
Keywords: Exchange Rate Fluctuations, Exchange Rate Risk
AACSB: Analytic skills

2) A U.S.-based multinational corporation with 200,000,000 yen of net exposed assets in Japan
will realize exchange rate gains if the yen appreciates in value relative to the dollar.
Answer: TRUE
Keywords: Net Exposed Assets
AACSB: Analytic skills

3) The objective of a prudent financial manager is to eliminate all foreign exchange risk.
Answer: FALSE
Keywords: Foreign Exchange Risk
AACSB: Reflective thinking skills

4) A multinational with a large number of receivables runs the risk of transaction exposure.
Answer: TRUE
Keywords: Transaction Exposure
AACSB: Reflective thinking skills

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5) Translation exposure can be reduced by the use of a money-market hedge or a forward-market
hedge.
Answer: FALSE
Keywords: Translation Exposure, Money-Market Hedge, Forward-Market Hedge
AACSB: Reflective thinking skills

6) All of the following exchange rate exposures involve direct cash flow effects except:
A) net exposed assets.
B) transactions exposure.
C) economic exposure.
D) translation exposure.
Answer: D
Keywords: Translation Exposure, Economic Exposure, Transactions Exposure, Net Exposed
Assets
AACSB: Reflective thinking skills

7) A U.S. Company has a 20,000 euro loan in Germany that must be paid in 30 days. Assume the
30-day money market rates in the U.S. and France are both 3% for lending and 4% for
borrowing. The current exchange rate is 1.55 dollars per euro. If the company wants to complete
a money-market hedge, then the company will
A) sell euros on the spot market and invest the dollars in the U.S. money market.
B) buy euros on the spot market and invest the euros in the German money market.
C) buy dollars on the spot market and invest them in the German money market.
D) buy dollars on the spot market and invest them in the U.S. money market.
Answer: B
Keywords: Money-market Hedge
AACSB: Analytic skills

8) A U.S. Company has a 40,000 euro loan in Germany that must be paid in 30 days. Assume the
30-day money market rates in the U.S. and Germany are both 2% for lending and 3.5% for
borrowing. The current exchange rate is 1.55 dollars per euro. If the company wants to complete
a money-market hedge, how many euros will be invested in the German money market?
A) 25,806.45
B) 38,647.34
C) 39,215.69
D) 44,245.01
Answer: C
Keywords: Money-market Hedge
AACSB: Analytic skills

17
Copyright © 2011 Pearson Education, Inc.
9) A U.S. Company has a 40,000 euro loan in Germany that must be paid in 30 days. Assume the
30-day money market rates in the U.S. and Germany are both 2% for lending and 3.5% for
borrowing. The current exchange rate is 1.55 dollars per euro. If the company wants to complete
a money-market hedge, how many dollars will be needed to purchase euros in the spot market?
A) $36,213.60
B) $40,000.00
C) $59,903.38
D) $60,784.32
Answer: D
Keywords: Money-market Hedge
AACSB: Analytic skills

10) Elimination of all foreign exchange risk

A) should be the objective of a prudent financial manager.
B) should be analyzed on a cost-benefit basis.
C) both A and B.
D) neither A nor B.
Answer: B
Keywords: Foreign Exchange Risk
AACSB: Reflective thinking skills

11) Billings, Inc., a U.S.-based multinational, has just sold equipment to a French company for
$1 million. The French company will pay for the order in 60 days. Billings is now exposed to
which kind of risk
A) hedging risk.
B) transaction risk.
C) business risk.
D) forward exchange risk.
Answer: B
Keywords: Transaction Risk
AACSB: Reflective thinking skills

12) Translation exposure is typically dealt with in the following manner

A) money-market hedge.
B) forward-market hedge.
C) currency-futures contract.
D) no hedging is done since any losses are paper losses only.
Answer: D
Keywords: Translation Exposure
AACSB: Reflective thinking skills

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Copyright © 2011 Pearson Education, Inc.
13) Firms generally do not hedge against which type of exposure
A) transaction.
B) translation.
C) economic.
D) financial.
Answer: B
Keywords: Translation Exposure, Hedging
AACSB: Reflective thinking skills

14) If the exposed position in a foreign currency is offset by borrowing or lending, it is referred
to as a
A) forward-market hedge.
B) spot hedge.
C) money-market hedge.
D) interest-rate hedge.
Answer: C
Keywords: Money-market Hedge
AACSB: Reflective thinking skills

15) Which of the following refers to the overall impact of exchange rate changes on the value of
a firm?
A) transaction exposure
B) economic exposure
C) translation exposure
D) interest rate parity exposure
Answer: B
Keywords: Economic Exposure, Exchange Rate Risk
AACSB: Reflective thinking skills

16) If a firm had plant and equipment expropriated without compensation, this would be referred
to as
A) financial risk.
B) business risk.
C) political risk.
D) exchange rate risk.
Answer: C
Keywords: Political Risk
AACSB: Reflective thinking skills

17) A foreign currency option differs from a forward exchange contract is all of the following
ways except:
A) it is used to hedge for foreign exchange risk.
B) it permits delivery of the currency anytime before maturity.
C) it is traded in standard amounts.
D) it is traded with standard maturity dates.
Answer: A
Keywords: Foreign Currency Option, Forward Exchange Contract
AACSB: Reflective thinking skills
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Copyright © 2011 Pearson Education, Inc.
17.6 Learning Objective 6

1) If a foreign currency is expected to depreciate with respect to the home currency, the holder of
a net liability in foreign currency will profit.
Answer: TRUE
Keywords: Net Liability in Foreign Currency
AACSB: Analytic skills

2) A company holding a net asset position in a depreciating currency should lead, and a company
holding a net asset position in an appreciating currency should lag.
Answer: TRUE
Keywords: Leading, Lagging
AACSB: Analytic skills

3) The objective of hedging strategy is to have a zero net asset position in a foreign currency.
Answer: TRUE
Keywords: Hedging Strategy, Net Asset Position
AACSB: Reflective thinking skills

4) A multinational corporation can move funds from a subsidiary in one country to a subsidiary
in another country so foreign exchange exposure and the tax liability of the multinational
corporation as a whole are minimized.
Answer: TRUE
Keywords: Multinational Working-Capital Management, Positioning of Fun
AACSB: Reflective thinking skills

5) A multinational corporation is involved in a country whose currency is likely to decline in

value. The corporation should
A) lead if the corporation has a net liability (short) position.
B) lag if the corporation has a net asset (long) position.
C) lead regardless of whether the corporation has a net asset or net liability position.
D) lag if the corporation has a net liability (short) position.
Answer: D
Keywords: Lagging, Leading, Net Asset Position, Net Liability Position
AACSB: Analytic skills

6) The transfer of funds among subsidiaries and the parent company of a multinational
corporation is achieved by which of the following methods?
A) money-market hedge
B) royalties
C) forward-market hedge
D) leading and lagging
Answer: B
Keywords: Royalties, Multination Corporation, Cash Management
AACSB: Reflective thinking skills

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Copyright © 2011 Pearson Education, Inc.
7) The rate that a subsidiary or parent of the MNC charges other divisions of the firm for its
products is called
A) a forward price.
B) an intrafirm transaction rate.
C) a transfer price.
D) an exchange rate.
Answer: C
Keywords: Transfer Price
AACSB: Reflective thinking skills

8) Leading and lagging

A) are important risk-reduction techniques.
B) are useful when hedging is not available.
C) can be successfully applied for an MNC.
D) all of the above.
Answer: D
Keywords: Leading, Lagging
AACSB: Reflective thinking skills

17.7 Learning Objective 7

1) Only purely domestic firms that buy all of their inputs and sell all of their outputs in their
home countries are unaffected by events in international financial markets.
Answer: FALSE
Keywords: Purely Domestic Firms, International Financial Markets
AACSB: Reflective thinking skills

2) The cost of debt used in the international investment decision is the lesser of the parent's or the
subsidiary's cost of debt.
Answer: FALSE
Keywords: Cost of Debt
AACSB: Reflective thinking skills

3) A major source of long-term capital overseas is in the Eurocurrency market.

Answer: FALSE
Keywords: Eurocurrency Market
AACSB: Reflective thinking skills

4) A currency swap is the exchange of principal and interest in one currency for the same in
another currency for an agreed period of time.
Answer: TRUE
Keywords: Currency Swap
AACSB: Reflective thinking skills

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Copyright © 2011 Pearson Education, Inc.
5) Which of the following is a reason for international investment?
A) to reduce portfolio risk
B) to increase P/E ratio
C) to gain an advantage in a foreign country
D) to gain access to foreign currency
Answer: A
Keywords: International Investment, Portfolio Risk
AACSB: Reflective thinking skills

6) An important (additional) consideration for a direct foreign investment is

A) political risk.
B) maximizing the firm's profits.
C) attaining a high international P/E ratio.
D) maintaining the domestic cost of capital.
Answer: A
Keywords: Direct Foreign Investment
AACSB: Reflective thinking skills

7) All of the following are examples of political risk for a U.S. company investing in a foreign
country except:
A) expropriation of plant and equipment.
B) the problem of blocked funds.
C) substantial changes in foreign country tax laws.
D) government requirements that ownership must be limited to U.S. citizens.
Answer: D
Keywords: Direct Foreign Investment
AACSB: Reflective thinking skills

17.8 Learning Objective 8

1) Exchange rate risk is the risk that exchange rates will be lower in the future than they are
today.
Answer: FALSE
Keywords: Exchange Rate Risk
AACSB: Reflective thinking skills

2) Exchange rate risk exists for a party to a contract if the contract is denominated in a foreign
currency.
Answer: TRUE
Keywords: Exchange Rate Risk
AACSB: Reflective thinking skills

3) Exchange-rate risk arises from the fact that the spot exchange rate on a future date is unknown
today.
Answer: TRUE
Keywords: Exchange Rate Risk
AACSB: Reflective thinking skills

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4) Exchange rate risk exists in International Trade Contracts, Foreign Portfolio Investments, and
in Direct Foreign Investments.
Answer: TRUE
Keywords: Exchange Rate Risk
AACSB: Reflective thinking skills

5) With international investing, unlike domestic investing, exchange rate risk could cause a
marginally-positive-NPV project to be rejected due to the additional risk.
Answer: TRUE
Keywords: Exchange Rate Risk
AACSB: Reflective thinking skills

6) In an international trade contract involving one buyer and one seller, both parties may be
exposed to exchange rate risk if the contract is denominated in a third currency.
Answer: TRUE
Keywords: International Trade Contract, Exchange Rate Risk
AACSB: Analytic skills

7) Exchange rate fluctuations do not increase the riskiness of foreign portfolio investments
because changes in exchange rates are compensated for by changes in interest rates and
investment returns.
Answer: FALSE
Keywords: Exchange Rate Risk, Foreign Portfolio Investments
AACSB: Analytic skills

8) An American manufacturer with its corporate headquarters in New York City is purchasing
goods from a French supplier. Which of the following statements is true regarding the exchange
rate risk for this contract?
A) The American company will bear all of the exchange rate risk if the contract is denominated
in dollars.
B) The French company will bear all of the exchange rate risk if the contract is denominated in
dollars.
C) Both companies could bear exchange rate risk if the contract is denominated in British
Pounds.
D) Both B and C are correct.
Answer: D
Keywords: Exchange Rate Risk
AACSB: Reflective thinking skills

9) Exchange rate risk is highest for companies with

A) international trade contracts denominated in the foreign currency.
B) investment portfolios that contain foreign securities.
C) direct foreign investments in foreign subsidiaries.
D) international trade contracts denominated in the domestic currency.
Answer: C
Keywords: Exchange Rate Risk, Direct Foreign Investment
AACSB: Reflective thinking skills

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Copyright © 2011 Pearson Education, Inc.
10) A U.S.-based multinational corporation (MNC) currently has an investment portfolio that
includes Japanese securities valued at 10,000,000 yen. The company also owes its Japanese
suppliers 12,000,000 yen. Which of the following statements is most correct?
A) The MNC is not exposed to exchange rate risk because it holds both assets and liabilities
denominated in yen.
B) The MNC will be exposed to exchange rate losses if the yen declines in value relative to the
dollar.
C) The MNC will be exposed to exchange rate losses if the yen increases in value relative to the
dollar.
D) The MNC can avoid exchange rate risk by paying its Japanese liabilities with dollars.
Answer: C
Keywords: Exchange Rate Risk, Net Exposed Position
AACSB: Reflective thinking skills

11) A U.S.-based multinational corporation has 100% owned subsidiary in Argentina. The
subsidiary operates only domestically, that is, all transactions occur within Argentina. Therefore,
the U.S. multinational corporation
A) is exposed to translation risk only.
B) is not exposed to exchange rate risk because the subsidiary operates 100% domestically.
C) is exposed to both translation exposure and economic exposure.
D) is most concerned with transactions exposure.
Answer: C
Keywords: Translation Exposure, Economic Exposure, Multinational Corporation, Exchange
Rate Risk
AACSB: Analytic skills

12) Exchange rate risk

A) arises from the fact that the spot exchange rate on a future date is a random variable.
B) applies only to certain types of international businesses.
C) has been phased out due to recent international legislation.
D) has been reduced by the adoption of floating exchange rates.
Answer: A
Keywords: Exchange Rate Risk
AACSB: Reflective thinking skills

13) Exchange rate risk

A) exists when the contract is written in terms of the foreign currency.
B) exists also in direct foreign investments and foreign portfolio investments.
C) does not exist if the international trade contract is written in terms of the domestic currency.
D) all of the above.
Answer: D
Keywords: Exchange Rate Risk
AACSB: Reflective thinking skills

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Copyright © 2011 Pearson Education, Inc.
14) Suppose a U.S. importer purchases an Italian product today but will not pay for it for 90
days. The cost of the product today is 35,000 euros. The spot exchange rate today is .6233 euros
per dollar. How much is the cost today in dollars?
A) $58,062
B) $56,153
C) $65,683
D) $64,255
Answer: B
Keywords: International Trade Contract, Exchange Rate Risk
AACSB: Analytic skills

15) Suppose a U.S. importer purchases an Italian product today but will not pay for it for 90
days. The cost of the product today is 30,000 euros. The spot exchange rate today is .6233 euros
per dollar. If the U.S. importer does not hedge the position, which of the following spot exchange
rates in 90 days will yield the highest returns?
A) 0.6833 euros per dollar
B) 0.6499 euros per dollar
C) $1.4844 per euro
D) $1.5387 per euro
Answer: A
Keywords: International Trade Contract, Exchange Rate Risk
AACSB: Analytic skills

16) Suppose a U.S. importer purchases an Italian product today but will not pay for it for 90
days. The cost of the product today is 35,000 euros. The spot exchange rate today is .6233 euros
per dollar. The importer creates a forward-market hedge. The 90-day forward rate is .6100 euros
per dollar. The amount the U.S. importer will pay in 90 days is
A) $56,153.
B) $57,377.
C) $55,683.
D) $56,667.
Answer: B
Keywords: International Trade Contract, Exchange Rate Risk
AACSB: Analytic skills

17) In addition to those risks faced by domestic corporations, multinational corporations face
A) political risk.
B) exchange risk.
C) both A and B are correct.
D) All domestic and multinational corporations face similar risk profiles.
Answer: C
Keywords: Political Risk, Exchange Risk, Multinational Corporation
AACSB: Reflective thinking skills

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Copyright © 2011 Pearson Education, Inc.
18) Strategies to counter exchange rate risk include all of the following except:
A) futures contracts.
B) spot-market hedges.
C) forward-market hedges.
D) money-market hedges.
Answer: B
Keywords: Exchange Rate Risk, Futures Contracts, Forward-market Hedges, Money-market
Hedges
AACSB: Reflective thinking skills

19) What is direct foreign investment? What are the additional risks that a multinational
corporation must consider before undertaking direct investment in a foreign country?
Answer: Direct foreign investment is the purchase of plants and equipment in other countries.
In addition to business risk and financial risk, multinational corporations face political risk and
exchange risk when investing abroad.
Keywords: Direct Foreign Investment, Political Risk Exchange Rate Risk
AACSB: Reflective thinking skills

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Copyright © 2011 Pearson Education, Inc.