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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
a) Attempt question ONE and any other TWO questions.
b) Question ONE carries 30 marks and the rest 20 marks each.
c) 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 any 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 is considering investing in a
project in a foreign country. The project will be located in Plutonia, a country whose
currently 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 general 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 agreements 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% the project would be exempted from
tax in Kenya.
7. The required rate of return on investments is 20%.
Required
Using the net present value (NPV) approach, determine the project should be undertaken.
(11mks)
(Total: 30 marks)
QUESTION TWO
(a) Explain why the 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 Kenyan shillings (Ksh) and the USA dollar (US$). He believes that the interest
rate differential can be used in a linear regression function as follows:
Y = a + bX where: Y is the direct quote
X is the interest rate differential
a and b are constants
The following historical data have been collected for the last seven months of the year
2008.
Month Interest rate differential Direct quote
(Kshs/US$)
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 least squares method. (10mks)
(ii) Compute the direct quote for a period when the interest rate is 21% in Kenya and
7% 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
inflow 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/DM 1 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) In respect of a multinational company with dealings in different currencies,
distinguish the following risks:
(i) Translation exposure (4mks)
(ii) Economic exposure (4mks)
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 (g)
is 2 C $ = 1g
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 (PPP) approach (6mks)
QUESTION FIVE
(a) Explain the major risks faced by multinational firms on their foreign investments.
(10mks)
(b) Describe five techniques that a multinational firm might adopt to minimize exposure
to the risks identified in (a) above. (10mks)
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