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The rise of globalization is due to the many companies that have become multinational corporations for various reasons-for example, to access better technology, to enter new markets, to obtain more raw materials, to find funding resources, to minimize production costs, or to diversify business risk. This multimarket presence exposes companies to different kinds of risk as well-for example, political risk and exchange rate risk. The relationship between interest rates and exchange rates can be represented through the concept of interest rate parity. Consider the following: An American investor is considering investing $1,000 in default-free 90-day Japanese bonds that promise a 5% annual nominal return. The spot exchange rate is ¥104.79 per dollar. • The 90-day forward exchange rate is ¥103.55 per dollar. The investor's annualized return on these bonds-if he or she can lock in the dollar return by selling the foreign currency in the forward market-will be Which of the following statements is implied by interest rate parity theory? Interest rates in all countries should be the same. An investment in one's home country should have the same return as a similar investment in a foreign country. O Interest rates in all countries with the same political risk should be the same. A product bought in one country should have the same price in other countries, adjusted for exchange rate. Relative inflation rates affect interest rates, exchange rates, the overall economic health of a country, and the operations and profitability of multinational companies. Consider the following statement: Countries with lower inflation rates will have lower interest rates. Based on your understanding of the relationship between relative inflation rates and exchange rates, identify whether the preceding statement is valid or invalid. The statement is valid, because the nominal interest rate is the sum of the real interest rate plus inflation, so lower inflation rates would result in lower interest rates. The statement is invalid, because the nominal interest rate is independent of the inflation rate. If companies borrow from countries with low interest rates, the potential gains from the interest savings will likely be by the losses from currency appreciation. The currency of a country with a higher inflation rate than the U.S. inflation rate will over time against the dollar. The rise of globalization is due to the many companies that have become multinational corporations for various reasons-for example, to access better technology, to enter new markets, to obtain more raw materials, to find funding resources, to minimize production costs, or to diversify business risk. This multimarket presence exposes companies to different kinds of risk as well-for example, political risk and exchange rate risk. The relationship between interest rates and exchange rates can be represented through the concept of interest rate parity. Consider the following: An American investor is considering investing $1,000 in default-free 90-day Japanese bonds that promise a 5% annual nominal return. The spot exchange rate is ¥104.79 per dollar. • The 90-day forward exchange rate is ¥103.55 per dollar. The investor's annualized return on these bonds-if he or she can lock in the dollar return by selling the foreign currency in the forward market-will be Which of the following statements is implied by interest rate parity theory? Interest rates in all countries should be the same. An investment in one's home country should have the same return as a similar investment in a foreign country. O Interest rates in all countries with the same political risk should be the same. A product bought in one country should have the same price in other countries, adjusted for exchange rate. Relative inflation rates affect interest rates, exchange rates, the overall economic health of a country, and the operations and profitability of multinational companies. Consider the following statement: Countries with lower inflation rates will have lower interest rates. Based on your understanding of the relationship between relative inflation rates and exchange rates, identify whether the preceding statement is valid or invalid. The statement is valid, because the nominal interest rate is the sum of the real interest rate plus inflation, so lower inflation rates would result in lower interest rates. The statement is invalid, because the nominal interest rate is independent of the inflation rate. If companies borrow from countries with low interest rates, the potential gains from the interest savings will likely be by the losses from currency appreciation. The currency of a country with a higher inflation rate than the U.S. inflation rate will over time against the dollar.
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Financial Accounting Tools for business decision making
ISBN: 978-0470534779
6th Edition
Authors: Paul D. Kimmel, Jerry J. Weygandt, Donald E. Kieso
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