Consider the investment cash flows in Problem 13.1. The spot rate is . Risk-free bond yields of percent and percent mirror the 2.91 percent inflation differential:

. However, nominal required returns on the risky project are percent and percent because of a higher risk premium in yuan than in shekels:

.

a. Use interest rate parity to find forward exchange rates. What is the value of the hedged investment from the parent's perspective using these forward exchange rates to translate the expected yuan project cash flows into shekels? (Note that this is the same result as in Problem 13.1.)

b. What are expected spot rates based on required returns on the risky project and relative purchasing power parity

? What is the value of the unhedged investment from the parent's perspective using these expected future spot rates?

c. Should the firm accept the project? Should the firm hedge?

d. The Israeli parent corporation wants to finance a portion of the project with debt and faces borrowing costs of percent and percent. In which currency would it make more sense to borrow? If the parent decides to hedge the project's operating cash flows, should the hedge be done with currency forwards or foreign currency debt, all else constant?