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Fnce 425: International Finance Question Paper
Fnce 425: International Finance
Course:Bachelor Of Commerce
Institution: Kabarak University question papers
Exam Year:2009
COURSE CODE: FNCE 425
COURSE TITLE: INTERNATIONAL FINANCE
STREAM: Y4S2
INSTRUCTIONS:
1. Attempt question ONE and any other TWO questions.
2. Question one carries 30 Marks and the rest 20 marks each.
3. Show all your workings clearly.
QUESTION ONE
a) “Like the traffic lights in the city, the international monetary system is taken for
granted until it begins to malfunction and to disrupt people’s daily lives,” Robert
Solomon.
Required:
Explain the relevance of the quotation and use fundamental exchange rate
relationships to demonstrate the working of international financial markets.
(15mks)
b) i) Briefly explain four types of restrictions faced by multi-national
corporations (MNCS) when investing in foreign markets. (4mks)
ii) Global exchange Ltd is a company based in Kenya in considering
investing in a project in a foreign country. The project will be located in
Plutonia, a country whose currency is the Peso (P). The Kenyan currency
is the shilling (sh.). The details of the project are presented below:
1. The initial capital outlay will be 10 million pesos. An additional 5 million
pesos will be required at commencement of the project which will
however be recovered on completion of the project.
2. The project will last for four years and is expected to generate annual
profits before tax of 13 million pesos.
3. The cost capital of the project will be depreciated on a straight line basis
over the duration of the project. Depreciation expense is allowed for tax
purposes in Plutonia.
4. A double taxation agreement exists between Kenya and Plutonia. Global
exchange Ltd. Intends to repatriate all the project net cash inflows to
Kenya at each year end.
5. The current exchange rate between the two currencies is: 1 peso = 50
shillings. The shilling is expected to depreciate against the peso by 10%
per annum.
6. The corporation tax rate in Plutonia is 50%.
7. The required rate of return on investments is 20%.
Required:
Using the net present value (NPV) approach, determine whether the project
should be undertaken. (11mks)
QUESTION TWO
a) Explain why firms attempt to forecast exchange rates. (4mks)
b) Ulaya Ltd is a Kenyan multinational corporation with obligations denominated in
US dollars. The finance manager is interested in forecasting the exchange rate
between the Kenya shillings (Ksh.) and the USA dollar (US $). He believes that
the interest rate differential can be used in a linear regression function as follows:
Y = a + bX where: Y is the direct quote.
X is the interest rate differential.
a and b are constants.
The following historical data have been collected for the last seven months of the
year 2008.
Month Interest rate differential Direct quote (Ksh/US$)
June 10 74
July 13 77
August 9 70
September 15 80
October 16 79
November 11 78
December 10 77
Required:
i) Determine the forecasting equation using the cost squares method.
(10mks)
ii) Compute the direct quote for a period when the interest rate is 19% in
Kenya and 6% in the USA (2mks)
iii) Using the coefficient of determination (r2
), explain the reliability of the
function established in (i) above. (4mks)
QUESTION THREE
a) The cost of capital for a multinational corporation (MNC) depends on the country
of operation elaborate on this statement. (6mks)
b) Outline the factors to be considered by a multinational corporation (MNC) before
deciding on whether to use debt finance or equity finance. (4mks)
c) First international company Ltd. a Kenyan based international company is
evaluating an investment in Germany. First international company is thinking of
opening a plant in Germany. The project will cost DM 4 million and is expected
to produce cash inflows of DM 4 million in year 1 and DM 3 million in years 2
and 3.
Assume that the current spot rate is shs.50/DM1 and the current risk free rate in
Kenya is 11.3% compared to that in Germany of 6%. The appropriate discount
rate for the project is estimated to be 15% which is Kenyan cost of capital for the
Germany.
Required:
Should First International company Ltd. Undertake the project? Explain.
(10mks)
QUESTION FOUR
a) Briefly describe the types of risks that a multinational company faces in its
foreign operations. (8mks)
b) The following are expected interest rates and inflation rates in Canada and Britain
over the next six months.
Country Interest rate inflation rate
Canada 9% 4%
Britain 7% 2%
The current exchange rate between the Canadian dollar (C$) and the British
pound (£) in 2C$ = 1£
Required:
Determine the six month forward exchange rate between the two currencies using
the following approaches:
i) Interest rate Parity (IRP) approach (6mks)
ii) Purchasing Power Parity (IPP) approach (6mks)
QUESTION FIVE
a) In respect of a multinational company with dealings in different currencies,
distinguish the following risks:
i) Translation exposure (3mks)
ii) Economic exposure (3mks)
b) The cross border listings of securities on the three East African bourses is
motivated partly by the advantages of being part of an integrated international
financial market, explain the advantages and dangers to an East African investor
of being part of the integrated global market. (14mks)
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