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Fnce 425: International Finance 2010 Question Paper
Fnce 425: International Finance 2010
Course:Bachelor Of Commerce
Institution: Kabarak University question papers
Exam Year:2010
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) 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 multinational
firms. (10 marks)
(b) (i) 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.
(15 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 9 % 4 %
Britain 5 % 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 (3 marks)
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) In respect of a multinational company with dealings in different currencies, distinguish
the following risks:
(i) Translation exposure (4 marks)
(ii) Operating 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: Harvard Business Review – March/April 1977)
Required:
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 FOUR
a) A Kenyan company has agreed to sell goods to an importer in Zedland at an invoiced
price of Z 150,000 (Zed (Z) is the currency of Zedland). Of this amount, Z 60,000 will
be payable on shipment, Z 45,000 one month after shipment and Z 45,000 three months
after shipment.
The quoted foreign exchange rates (Z per KSh.) at the date of shipment as as follows:
Spot 1.690 - 1.692
One month 1.687 - 1.690
Three months 1.680 - 1.684
The company decides to enter into appropriate forward exchange contracts through a
bank in order to hedge these transactions.
Required:
(i) State the advantages of hedging in this way. (2 marks)
(ii) Calculate the amount in Kenya Shillings that the Kenyan Company would
receive. (3 marks)
(iii) Comment with hindsight on the wisdom of hedging in this instance, assuming that
the spot rates at the dates of receipt of the two installments of Z 45,000 were as
follows:
First installment 1.69 - 1.69
Second installment 1.700 - 1.704 (3 marks)
b) Large companies with significant borrowings or overseas trade often use interest rate
swaps and currency swaps.
Required:
Explain how interest rate swaps and currency swaps may be used. (12 marks)
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