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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:2010

INSTRUCTIONS:
i. The paper contains FOUR questions
ii. Answer ALL the questions
iii. All the questions carry EQUAL marks
iv. Marks are allocated at the end of each question

QUESTION ONE
(a) If interest rate parity exists, would a forward hedge be more favorable, equally
favorable, or less favorable than a money market hedge on euro payables? (2Marks)
(b) Explain how the September 11, 2001 terrorist attack on the U.S. could adversely
affect MNCs that are subject to transaction exposure. Based on your expectations,
would U.S. exporters or importers be more adversely affected? (3 Marks)
(c) Assume the following information:
Bank X Bank Y
Bid price of New Zealand dollar $.401 $.398
Ask price of New Zealand dollar $.404 $.400

Required:
Given this information, is locational arbitrage possible? If so, explain the steps involved
in locational arbitrage, and compute the profit from this arbitrage if you had $1,000,000
to use. (5 Marks)

(d) Write the explanatory notes on the following:
(i) London Inter Bank Offer Rate (LIBOR) (3 Marks)
(ii) Multilateral netting (3 Marks)
(iii)Currency futures (3 Marks)
(iv) Bid-ask spread (3 Marks)
(v) Distinction between American option and European option (3 Marks)

(Total Marks: 25)
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QUESTION TWO
(a) Explain why firms attempt to forecast exchange rates (4 Marks)
(b) Outline reasons why government may intervene in the foreign exchange market
(6 Marks)
(c) Rafiki Company Ltd expects to need S$1milion in one year. The existing spot rate of
the Singapore dollar is $.60. The one-year forward rate of the Singapore dollar is
$.62. Carbondale created a probability distribution for the future spot rate in one year
as follows:

3
Future Spot Rate Probability
$.61 20%
.63 50
.67 30

Assume that one-year put options on Singapore dollars are available, with an exercise
price of $.63 and a premium of $.04 per unit. One-year call options on Singapore
dollars are available with an exercise price of $.60 and a premium of $.03 per unit.
Assume the following money market rates:
U.S. Singapore
Deposit rate 8% 5%
Borrowing rate 9 6
Required:
Given this information, determine whether a forward hedge, money market hedge, or
a currency options hedge would be most appropriate. Then compare the most
appropriate hedge to an unhedged strategy, and decide whether Carbondale should
hedge its payables position. (15 Marks)

(Total Marks: 25)
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QUESTION THREE
(a) Why might a firm use a “local” capital structure at a particular subsidiary that differs
substantially from its “global” capital structure? ( 5 Marks)

(b) Mole Ltd. A Kenyan company intends to invest in a capital project that will be
located in Durban South Africa. This idea of investing came about when the CEO of
the company went to South Africa a week before the official start of the world cup.
The project is expected to commence on January 2011. The local currency is the rand
(R).

The following are available on the project:

1) The project would cost R10million. This amount would be incurred on January
2011,
2) An additional R6million would be required on 1st January 2011to finance working
capital requirements. This amount would be recovered at the end of the project’s
economic life,
3) The project will have a zero salvage value at the end of the economic life.
4) The sales revenue for each year are projected as follows:
4

Year
2011 ` 2012 2013 2014
Sales revenue (Rands) 7.5million 15million 22.5million 7.5million
5) Variable operating costs are estimated to be 20percent of sales revenue per
annum,
6) Fixed operating costs are estimated to be R500,000 per annum,
7) The expected exchange rates between the Rand (R) and the Kenya shilling (Ksh.)
are as follows:
Ksh/R
1st January 2011 10.00
31st December 2011 9.75
31st December 2012 8.25
31st December 2013 7.80
31st December 2014 6.50

Assume that the cash flows relating to sales revenue and operating costs occur at the end
of the year. Ignore taxation.

Required:
(a) Net present value (NPV) of the project in Kenya Shillings (14 Marks)
(b) Is the project beneficial to the shareholders of Rafiki Ltd? Explain. ( 2 Marks)
(c) Other than political risks and currency risks, identify the risks which the project is
likely to face by virtue of being located in a foreign country (4 Marks)
(Total Marks: 25)
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QUESTION FOUR

(a) With reference to the determination of the foreign currency exchange rates, briefly
explain the following:
(i) Interest rate parity (3 Marks)
(ii) Purchasing power parity (3 Marks)
(b) The current exchange rate between the Swiss francs (SFr) and the United States dollar
(US$) is SFr1 =US$0.63. Assume that the one year interest and inflation rates in
Switzerland and the United States are as follows:
Switzerland United States
Interest rate 4% 13%
Inflation rate 8% 8%

5

Required:
The expected exchange rate in one year’s time between the SFr and the US$ under the
following conditions:

(i) Interest rate parity (4 Marks)
(ii) Purchasing power parity (4 Marks)
(c) Generally, Eurocurrency deposit rates are higher than domestic deposit rates. Explain
the possible reasons for the above condition (6 Marks)
(d) Compare and contrast transaction exposure and economic exposure. (5 Marks)
(Total Marks: 25)

Fnce 425: International Finance Question Paper

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