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Fnce 425: International Finance Y4s2 Question Paper
Fnce 425: International Finance Y4s2
Course:Bachelor Of Commerce
Institution: Kabarak University question papers
Exam Year:2010
COURSE CODE: FNCE: 425
COURSE TITLE: INTERNATIONAL FINANCE
STREAM: Y4S2
DAY: FRIDAY
TIME: 2:00 – 4:00 P.M.
DATE: 19/03/2010
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.
(15 marks)
(b) (i) First International Company Ltd, a Kenyan based 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 (10 marks)
(ii) The following are expected interest rates and inflation rates in Canada and Britain
over the next six months.
Country Interest rate Inflation rate
Canada 10 % 4 %
Britain 6 % 2 %
The current exchange rate between the Canadian dollar (C $) and the British pound (£) is
2 C $ = 1£
Required:
Determine the six month forward exchange rate between the two currencies using the
following approaches:
(i) Interest rate Parity (IRP) approach (2 marks)
(ii) Purchasing Power Parity (PPP) approach (3marks)
QUESTION TWO
(a) Explain why the firms attempt to forecast exchange rates (6 marks)
(b) KABU 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
2009.
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
(12 marks)
(ii) Compute the direct quote for a period when the interest rate is 21% in Kenya and 7%
in the USA (2 marks)
QUESTION THREE
(a) The cost of capital for a multinational corporation (MNC) depends on the country of
operation. Elaborate on this statement. (6 marks)
(b) 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%.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
(14 marks)
QUESTION FOUR
In respect of a multinational company with dealings in different currencies, distinguish
the following risks:
(i) Translation exposure (4 marks)
(ii) Transaction exposure (4 marks)
(b) The purpose of long-term foreign exchange management is not to cover a given
foreign exchange exposure by dealings on the forward markets, but to minimize
and, if possible, eliminate such exposures before they become critical and
therefore costly to cover. (Source: Havard Business Review – March/April 1977)
Comment on the above statement and suggest what actions the financial manager
should take in both the long and short term in order to reduce risks from foreign
currency transactions.
(12 marks)
QUESTION FIVE
(a) Globalisation has resulted in several organizations engaging in corporate alliances
and the establishment of several trading blocks. The advent of e-commerce has
enabled companies to greatly expand their markets.
Required:
Identify and elaborate on five factors that complicate financial management in
multi-national firms. (10 marks)
(b) Highspeed Electronics Limited has taken delivery of 50,000 electronic devices
from an American company. The seller is in a strong bargaining position and has
priced the devices in American dollars at $12.00 each.
Highspeed Electronics Limited has been granted three months credit. Assume
that interest rates in America are 3% per quarter (three months). Highspeed
electronics Limited has all its money tied up in its operations but it could borrow
in dollars at 3% per quarter if necessary.
Foreign exchange rates
US$ = Sh. 1
Spot 0.013
Three month forward 0.0154
A three month dollar call option for US$ 600,000 is available at a premium of
US$15,000.
Required:
(i) Using suitable computations, illustrate two hedging strategies available to
High speed Electronics Limited.
(8 marks)
(ii) Distinguish between a currency option and a currency swap.
(2 marks)
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