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International Finance Question Paper
International Finance
Course:Bachelor Of Commerce
Institution: Kabarak University question papers
Exam Year:2008
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.
3. Show all your workings clearly.
QUESTION ONE
(a) “Like the traffic lights in a 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) Second International Company Ltd, a Kenyan based international company is
evaluating an investment in Germany. Second International Company is thinking
of opening a plant in Germany. The project will cost DM 4 million and is
expected to produce cash flows of DM 4 million in year 1; and DM 3 million in
years 2 and 3.
Assume that the current spot rate is sh. 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
company.
Required:
Should Second International Company Ltd undertake the project? Explain.
(10 marks)
(C) The following are expected interest rates and inflation rates in Canada and Britain
over the nest six months.
Country Interest rate Inflation rate
Canada 9% 4%
Britain 7% 2%
The current exchange rate between the Canadian dollar C8 and the British pound
(£); in 2C8 = 1 £
Required:
Determine the six month forward exchange rate between the two currencies using
the following approaches:
(i) Interest rate parity (IRP) approach (2½ marks)
(ii) Purchasing power parity (PPP) approach (2½ marks)
QUESTION TWO
(a) Explain why multinational firms attempt to forecast exchange rates.
(4 marks)
(b) Ulaya Ltd is a Kenyan multinational corporation with obligations denominated in
British pounds (£). The finance manager is interested in forecasting the exchange
rate between the Kenyan Shillings (Kshs) and the British pound (£). She believes
that the interest rate differential can be used in a linear regression functions 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 first seven months of the
year.
Month Interest rate differential (%) Direct quote (Kshs.)
January 10 71
February 13 77
March 9 70
April 15 80
May 16 79
June 11 78
July 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 20% in
Kenya and 7% in the Great Britain. (4 marks)
QUESTION THREE
Ravine Company Ltd a company based in Kenya is considering investing in a project in a
foreign company. The project will be located in Plutonia, a country whose currency is
the peso (P). The Kenyan currency is the shilling (Shs.).
The details of the project are presented below:-
1. The initial capital outlay avail 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 (4) years and is expected to generate annual
profits before tax of 13 million pesos.
3. The capital cost 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. Ravine
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. (20 marks)
QUESTION FOUR
(a) Explain how a multinational company can reduce its exposure to:-
(i) Foreign exchange rate (8 marks)
(ii) Country risk (4 marks)
(b) A Kenyan company has a liability of US & 200,000 on account of credit
purchases from a USA supplier. This liability is payable after 30 days. The
relevant 30 days money market rates ate 2 % for lending and 2.5% for
borrowing.
Assume that the spot rate = shs.66 to the dollar.
Required:
Design and illustrate an appropriate money market hedge for the Kenyan
company. (8 marks)
QUESTION FIVE
(a) Describe the factors that determine the exchange rate between a domestic and a
foreign currency. (10 marks)
(b) Your company has purchased the following data which provides scores of the
political risk for a number of countries in which the company is considering
investing in a new subsidiary.
TOTAL ACCESS
TO
CAPITAL
ECONOMIC
PER
FORMANCE
DEBT
DEFAULT
CREDIT
RATING
GOV’T
STABILITY
REMITTANCE
RESISTANCE
WEIGHING 100 15 25 10 10 25 15
UGANDA 37 0 13 4 5 5 0
U. S. A. 52 4 5 0 9 6 4
CANADA 36 5 2 2 3 9 5
BRITAIN 30 0 9 3 2 15 0
JAPAN 39 2 5 4 3 11 2
Countries have been rated from zero (0) up to the maximum weighting factor for
each factor. A high score for each factor as well as overall, reflect low political
risk. A proposal has been put before the company’s board of directors to invest in
U. S. A.
Required:
Prepare a brief report for the company’s board of directors discussing whether or
not the above data should form the basis for:-
(i) Measurement of political risk (5 marks)
(ii) The decision about which country to invest in. (5 marks)
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