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introduction to corporate finance

Questions and Answers of Introduction To Corporate Finance

2. Purchasing power parity and the Argentine currency board (A-beginner). In April 1991 Argentina established a currency board whereby for all practical purposes the Argentine peso was pegged to the
1. Hyperinflation in Turkey (beginner). Turkey experienced hyperinflation in the late 1990s and early 2000s. The exchange rate stood at Turkish lira (TRY) 650,000= US$1 on January 1, 2000. With
15. What does it mean for forward rates to be an “unbiased” predictors of future spot exchange rates?
14. Is the carry trade consistent with uncovered or covered interest rate parity?
13. What are the risks involved in the carry trade?
12. What is the carry trade?
11. Why were large deviations from covered interest rate parity observed during the subprime crisis?
10. What are the main reasons accounting for the fact that covered interest rate parity may not hold as a perfect equality?
9. Why do currencies yielding low interest rates tend to sell at a forward premium?
8. What are the risks involved in uncovered interest arbitrage? Can they be eliminated?
7. What is the relationship between interest rates and inflation?
6. Under what conditions would you expect PPP to be a reliable model for forecasting future spot exchange rates?
5. What is the difference between covered and uncovered interest rate parity?
4. Under what circumstances would you expect PPP to be a reliable explanation of exchange rate changes?
3. How do you gauge whether a currency is under- or overvalued?
2. What is the meaning of Purchasing Power Parity?
Q: If the nominal annual interest rate is 40% in Argentina and the expected rate of inflation is 36% for the coming year, what is the real interest rate?
Q: Since December 2006 the Thai baht nominal exchange rate has hovered between 36 and 28 when the PPP rate held steady at 35. Has the THB been over- or undervalued during the last decade?
Q: In 2005 the Chinese-controlled nominal exchange rate stood at RMB 8.5 =US$ 1 when the PPP rate consensus was 7. Was the RMB over- or undervalued and by how much?
■ How forward rates can be used as unbiased forecasts of future spot exchange rates
■ How differentials of nominal interest rates are good predictors of expected inflation rates differentials
■ How nominal interest rates are equal to a real interest rate (assuming no inflation) + inflation rate expectation
■ Why PPP explanatory power is greatest when one of the countries involved suffers from a high rate of inflation
■ How PPP exchange rates can be used as benchmark equilibrium exchange rates against which to gauge whether nominal exchange rates are under- or overvalued
■ Why, over the longer term, inflation rate differentials between two countries explain the change in the exchange rate between these two countries’ currencies
■ What is The meaning of the “Law of One Price” and how its importance as a lynchpin of international finance
5. Portray in a simple diagram the different funding options as a function of the sixmonth BRL/US$ spot rate. Comment on the significance of different intersection points. Is interest rate parity
4. What are the real costs of six-month financing in either currency? On an early Monday morning, Dr. Guadalupe Philips was reviewing pro forma cash-flow statements in preparation for an upcoming
3. How could the different funding options be structured? Can all risks be hedged?How? On an early Monday morning, Dr. Guadalupe Philips was reviewing pro forma cash-flow statements in preparation
2. Why are borrowing rates slightly lower in offshore money markets for dollars or reals? What is/are the risk(s) involved for Rede Globo to raise short-term financing from these markets? On an early
1. What would be the rationale for Rede Globo to consider dollar financing? What are the risks involved? On an early Monday morning, Dr. Guadalupe Philips was reviewing pro forma cash-flow statements
17. Forward premium/discount (advanced). Log in to FXStreet exchange services at www.fxstreet.com/rates-charts/forward-rates and identify the currency which is at the deepest 180-day discount
16. Forward Speculation (intermediate). Log in to www.oanda.com. Are the Swiss franc and Japanese yen at a 90-day premium or discount to the US dollar? Are these currencies forecast to appreciate or
15. Interest rate arbitrage with bid-ask spreads (advanced). Consider the configuration of bid-ask spot and 90-day forward US$/£ exchange rate on June 12, 2013, keeping in mind that the lower rate
14. Covered interest rate arbitrage with a two-tier exchange market (advanced).Monsieur Dassault, the treasurer of Renault-Finance S.A. – the Geneva-based international finance subsidiary of the
13. Covered interest rate arbitrage with transaction costs (advanced). Assume that U.S.-based potential arbitrageurs do not hold cash, but hold dollardenominated securities. Covered investment in
12. Yen carry trade with investment in U.S. dollars/Icelandic króna (advanced).Louise is an associatewith Charlemagne, a hedge fund domiciled in Luxembourg, who is considering the following
11. Carry trade at a macro hedge fund (intermediate). Ms. Ivanhoe is the chief strategist of Caran d’Ache, the Fribourg-based (Switzerland) macro hedge fund.Newly issued one-year Greek government
10. Yen carry trade at the Conan Doyle Galaxy Fund (intermediate). Dr. Watson is the chief trader at the currency arbitrage desk of the U.S.-based Conan Doyle Galaxy Fund. He is considering arbitrage
9. Fuji Life Insurance Co. global money management (intermediate/advanced).Hiko Yamamoto, the deputy treasurer of Fuji Life Insurance Co. (FLI), was reviewing one-year investment opportunities for
8. Speculating on the collapse of Argentina’s currency board (intermediate).Dr. Lawrence Krohn is the New York–based lead currency strategist for Latin American currencies at Standard Bank. On
7. Selecting a construction loan (intermediate). Italthai, the Bangkok-based construction company, has recently been awarded a baht (THB) 2,500 million contract for the renovation of Phuket
6. Carry trade (intermediate). Felipe Lemos is a currency strategist with the Miami-based hedge fund Kawa. With the annual interest rate at 8.5 percent for real-denominated deposits with AAA-rated
5. Covered interest rate arbitrage (intermediate). As a trader for the London-based money market Commonwealth Fund, you see the following quotes:a. From Barclays Bank, one-year sterling
4. Covered interest rate arbitrage with withholding tax (intermediate). On September 1, 2018, the treasurer of Volvo, the Swedish automotive manufacturer, is faced with the following investment
3. Interest rate parity for asset managers and hedge fund arbitrageurs (beginner).You have been given the following information:where:i$ = Annual interest rate on three-month U.S. dollar commercial
2. Indian rupee forward contracts (beginner). The Indian rupee (INR) is currently trading at INR 50 = US$1. With 90-day Indian-rupee and U.S. dollar treasury bills currently yielding 10 percent and 2
1. DuPont’s cash balance (beginner). The treasurer of E.I. DuPont de Nemours has a $500 million cash balance to invest over the next six months. She has been instructed to play it safe and to avoid
10. What is the difference between the carry trade and speculation through forward contracts?
9. Is the carry trade consistent with covered interest rate parity?
8. What are the risks involved in the carry trade?
7. What is the carry trade?
6. Why were large deviations from covered interest rate parity observed during the subprime crisis?
5. What are the main reasons accounting for the fact that covered interest rate parity may not hold as perfect equality?
4. Why do currencies yielding low interest rates tend to sell at a forward premium?
3. What are the risks involved in covered interest arbitrage? Can they be eliminated?
2. What is covered interest rate parity?
1. What is interest rate arbitrage?
Q: Honda Motors is seeking one-year forward quotes on the yen-rupee (INR).The contract is not actively traded, but interest rates are 1 percent in Japan and 9 percent in India. If the spot yen-rupee
Q: Alternatively, the currency trader could borrow AUD and invest in ¥ with forward protection: Would the round-trip covered interest rate arbitrage be profitable?
■ What the carry trade is and when it can be profitable
■ Why interest rate parity may not hold exactly and what sources of friction may account for small deviations from parity
■ Explain Interest rate parity or how interest rate arbitrage keeps nominal interest rates at par when they are corrected for the cost of hedging exchange rate risk
■ How forward exchange rates are determined by interest rate differentials
■ How corporate treasurers can compare the cost of financing sourced from different currencies
■ What is the Interest rate arbitrage or how money managers can compare the yields on shortterm investments of the same credit risk class but denominated in different currencies such as the U.S.
6. Do you believe that trading rooms within large commercial banks should be forbidden to engage in directional trades? Under what conditions would you allow trading rooms to engage in directional
5. What are the control systems that Banco Mercantil should institute to prevent the recurrence of such a speculative scheme? On March 19, 2001, in the heyday of the Argentine currency board of fixed
4. Why were forward exchange rates trading at significant discounts or premiums from the spot price when the latter was fixed at ARS 1 = US$1 and backed by a currency board? On March 19, 2001, in the
3. Given that the Argentine peso did not devalue until January 2002, explain what would have been the end result of the Chilean trader’s speculative scheme if the bank had let it ride until
2. Why would an outright speculative position be easily found out and exposed by the BMI’s branch back office? How was the currency trader able to hide his trades? On March 19, 2001, in the heyday
1. How would the Chilean trader speculate on the Argentine peso? Spell out his exchange rate forecast and how and when he would earn a profit. On March 19, 2001, in the heyday of the Argentine
1. 17. Forward premium/discount (intermediate). Log in to FXStreet exchange services www.fxstreet.com/rates-charts/forward-rates and identify the three currencies which are at the deepest discount
1. 16. Trilateral arbitrage (advanced). Log in to www.oanda.com and select three currencies:Using the bilateral exchange rates between the three currencies, can you identify arbitrage opportunities?
1. 15. Law of One Price (advanced). Shares of Yacimientos Petroliferos Fiscales(YPF) – Argentina’s integrated energy conglomerate listed on the New York Stock Exchange and the Argentine Bolsa –
1. 14. Band of fluctuations (advanced). Show that if two currencies i and j independently maintain their exchange rate within a band of fluctuations defined as +/−1 percent around a par value
1. 13. Trilateral arbitrage (advanced). Assuming that the pound is worth 1.1567 euros in Paris and 1.4393 Swiss francs in Zurich, can Britain-based arbitrageurs make profits, given that the Swiss
1. 12. Cross-rates with bid-ask spreads (advanced). Assume that the Thai baht (THB) is quoted as THB 30.2511-3987 per US$1 and that the Japanese yen (¥) is quoted as 76.2518-7985 per US$1. What is
1. 11. Transaction costs (advanced). Geneviève received as a graduation present a one-week cruise on the Baltic Sea that will take her from Kiel (Germany) to Copenhagen (Denmark), Stockholm
1. 10. Transaction costs (advanced). Assuming that transaction costs represent 1/16 of 1 percent of the amount transacted, what is the maximum/minimum dollar price of one Japanese yen that you would
1. 9. Forward speculation (intermediate). The chief currency strategist at the Copenhagen-based Viking hedge fund was reviewing the forecast that the fund’s chief economist had just released.
1. 8. Forward premiums/discounts with bids/asks (intermediate). Referring to the following spot and forward bid-ask rates for the US$/€ exchange rate, answer the questions that follow:a. Is the
1. 7. Forward premiums/discounts (intermediate). Referring to the forward quotes in theWall Street Journal (Exhibit 5.5) for the Japanese yen, determine whether the yen is at a premium or discount
1. 6. Cross-rates (intermediate). Referring to exchange rate quotations provided in the Wall Street Journal (Exhibit 5.5) for the Brazilian real and the Thai baht, compute the cross-rate price of one
1. 5. Cross-rates (intermediate). Siam Commercial Bank in Bangkok (Thailand)quotes the U.S. dollar at THB 31.25/US$ whereas Standard Chartered Bank of Singapore quotes the U.S. dollar at SGD
1. 4. Bilateral currency arbitrage (intermediate). If the dollar price of one Russian ruble (RUB) is US$0.03198 = RUB 1 in New York City and at the same time the Russian ruble price of one dollar is
1. 3. Currency quotations (beginner). Weyerhaeuser Inc. – the U.S. lumber multinational– is importing a shipment of pine trees from Canada. The invoice is for CAD 250 million. Wells Fargo’s
1. 2. Bid-ask prices (beginner). A currency trader at UBS in New York City quotes to a customer the Swissie-dollar as CHF 1.1975-85 = US$1. What is the bid price for the U.S. dollar? What is the bid
1.1. Currency quotations (beginner). Ford Motor Company has successfully negotiated the sale of Volvo Car Corporation for the cash amount of SEK 10 billion.Svenska Handelbank quotes the Swedish krona
1. 18. What is the implicit interest rate for a given currency?
1. 17. What is the difference between a forward and a non-deliverable forward contract? For which currencies are non-deliverable forward contracts usually traded?
1. 16. What is the meaning of a forward premium or discount?
1. 15. Would you expect the bid-ask percentage spread to be different for the Indonesian rupiah versus the U.S. dollar than for the Japanese yen?
1. 14. State the Law of One Price. Why does it hold in the foreign exchange market?
1.13. What is the bid-ask spread in foreign exchange?
1.12. What is meant by trilateral arbitrage in the foreign exchange market?
1.11. What is meant by bilateral arbitrage in the foreign exchange market?
1.10. Why is the price of Swiss franc for U.S. dollar in Zurich and New York City almost – but not quite – the same? What do you think explains the small difference in rates?
1.9. Why is foreign exchange considered an asset class?
1.8. Why is the foreign exchange market often referred to as “the market that never sleeps”?

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