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Question;acf305-exam-2011-12LANCASTER UNIVERSITY2012 EXAMINATIONSPART II(SECOND AND FINAL YEAR)ACCOUNTING AND FINANCEAcF 305INTERNATIONAL FINANCIAL MANAGEMENT(2 hours + 15 minutes reading time)Answer ALL SUB-QUESTIONS OF QUESTION 1 (THE MULTIPLE CHOICE PART) AND ONESUB-QUESTION (EITHER SUB-QUESTION A OR B) OF QUESTIONS 2 TO 8.Question 1 carries 30 marks and questions 2 to 8 each carry 10 marks.Answer Question 1 using the MCQ sheet and Questions 2 to 8 in a booklet.QUESTION 1: MULTIPLE CHOICE PART (30 marks in total):Answer all sub-questions.Required:1) Identify the one true statement about an exchange-rate regime with fixed exchange ratesrelative to gold:(A)(B)(C)(D)It will lead to central banks running out of gold reserves.It is unable to maintain a low level of inflation.It will lead to continuously increasing prices of gold.It suffers from the Triffin Dilemma, i.e. the necessity of choosing between economic growth and maintaining a credible gold backing of the currency.(E) None of the above.(3 marks)2) Identify the one false statement about bid and ask rates when you want to buy foreigncurrency from a bank in the spot market:(A)(B)(C)(D)(E)The bank sells at the ask rate.You buy at the ask rate.The spread depends on the liquidity.The spread depends on the maturity.The spread depends on the transaction volume.(3 marks)Please turn over13) Identify the one false statement about forwards:(A) Forward markets are not organised exchanges, but over-the-counter markets.(B) The general formula for the delivery date of a forward is: day [t + 2 plus nmonths]. The delivery date differs from the general formula in certain circumstances.(C) A 90-day forward contract signed on Thursday, 29 March 2012, is normally settled on Friday, 29 June 2012.(D) The outright rate for a forward is its actual rate.(E) The GBP trades at a premium if the swap rates of GBP/EUR forwards are positive.(3 marks)4) Identify the one false statement about hedging contractual exposure:(A) Perfect hedging means that the contractual exposure is hedged in the cheapestway possible.(B) Options are imperfect hedges in the sense that they do not entirely eliminate uncertainty about future cash flows.(C) For a hedge with a forward, there is reverse risk due to credit risk.(D) Hedging of pooled cash flows can introduce interest risk.(E) A duration-matched hedge is an example of a value hedge.(3 marks)5) Identify the one true statement about FX forwards and futures.(A)(B)(C)(D)(E)Forwards do not have default risk.Forwards are less liquid than futures.Forwards are more profitable than futures.Forwards can require a margin call.None of the above.(3 marks)6) Identify the one false statement about swaps:(A) A fixed-for-fixed currency swap allows a company to borrow in the market whereit can obtain the lowest spread.(B) In a fixed-for-fixed currency swap, the bank?s risks in case of default are limitedbecause of the right-of-offset clause.(C) A fixed-for-floating interest-rate swap allows a company to swap fixed interestpayments of one currency into variable interest payments of another currency.(D) In a fixed-for-floating interest-rate swap, interest rates used in the swap contractare (near) risk-free rates.(E) Coupon swap is an alternative name for an interest-rate swap.(3 marks)Please turn over27) Identify the one true statement about all currency options with a strike price of GBP/NZD0.55 when the current spot rate is GBP/NZD 0.50:(A)(B)(C)(D)(E)The option is said to be deep out of the money.The option is said to be out of the money.The option is said to be at the money.The option is said to be in the money.None of the above.(3 marks)8) Identify the one false statement about corporate hedging of exchange risk:(A) Adding a zero-initial-value financial instrument for hedging purposes can increase the value of the firm.(B) There is an agency conflict between shareholders and managers if managersdecide not to implement effective hedging strategies.(C) If a company has always been profitable, no risk of bankruptcy exists and corporate taxes are linear, hedging will not reduce expected taxes.(D) Hedging can reduce the costs of bankruptcy and financial distress.(E) It is possible to hedge non-linear exposure with financial instruments.(3 marks)9) Identify the one false statement about the expected exposure of the USD value of assetsto a change in the USD/EUR exchange rate:(A)(B)(C)(D)(E)US government bonds have zero exposure.European government bonds have positive exposure.Shares in an American importer have positive exposure.Shares in a European importer have positive exposure.Shares in an American exporter have positive exposure.(3 marks)10) Identify the one false statement about international NPV calculations:(A) The valuation can be done in either FC or HC if the home and host country arepart of one integrated financial market.(B) Political risks include transfer risk.(C) It may not be possible to perfectly hedge against the political risk of expropriation.(D) The term ?incremental cash flows? refers to the cash flows generated at the levelof the foreign subsidiary.(E) Usually you should assume that the international investment has a positive terminal value.(3 marks)(TOTAL: 30 MARKS)Please turn over3QUESTION 2 (10 marks in total):ANSWER EITHER SUB-QUESTION A) OR SUB-QUESTION B).a) How would each of the transactions below show up in the UK Balance of Payments, i.e.what is the source of funds, what is the use of funds and in which sub-balances would thesource and the use be credited or debited?Note that the sub-accounts of the balance of payments are shown in the Appendix.Required:i) A UK investment bank advises a Russian company in a merger transaction, and getsits fee paid into its London bank account.ii) GlaxoSmithKline S.A., the French subsidiary of a UK pharmaceutical firm, buys drugsfrom Pfizer Inc., a US pharmaceutical firm, and pays for these by transferring moneyinto the New York bank account of Pfizer.iii) Ericsson, a Swedish firm, sells network equipment to Vodafone plc, a UK telecommunications firm, and receives a trade bill, payable in 90 days.iv) A UK investor sells shares of a Turkish firm and uses the receipts to pay for a Turkishcitizen to travel to the UK and give him a Turkish massage.(10 marks)ORb) Different currencies trade under different exchange-rate regimes.Required:i) Describe what fixed against a single currency means and give one example.ii) Name two other exchange-rate regimes and give an example for each (you do notneed to provide descriptions of the exchange-rate regimes).iii) How do some governments intervene in the exchange markets?(10 marks)Please turn over4QUESTION 3 (10 marks in total):ANSWER EITHER SUB-QUESTION A) OR SUB-QUESTION B).a) The following table shows spot rates against the GBP, i.e. XXX/GBP. Note: Bid-askspreads show only the last three decimal places. When the ask seems to be smaller thanthe bid, add 1,000.CountryDenmarkNorwayTurkeyCodeDKKNOKTRYMidpoint12.599411.53272.7655Spread816-172256-398623-687Required:i) What are the bid-ask quotes for DKK/GBP and TRY/GBP?ii) What is the bid-ask quote for GBP/NOK?iii) What is the synthetic TRY/NOK rate? Is there an opportunity of arbitrage or shoppingaround if the TRY/NOK spot rate is 0.2398-0.2401?(10 marks)ORb) The following table shows Big Mac prices and exchange rates from the Economist, 26May 2006.EgyptUnited StatesSwitzerlandCurrency (HC)EGPUSDCHFLocal price9.53.16.3HC/USD5.771.001.21Required:i) Calculate the USD price of a Big Mac in Egypt and Switzerland using the exchangerates provided in the table above.ii) Calculate the implied purchasing power parity rates in HC/USD for Egypt and Switzerland.iii) Calculate the real exchange rates in HC/USD for Egypt and Switzerland.iv) According to the Big Mac prices, which currency is undervalued compared to USD?(10 marks)Please turn over5QUESTION 4 (10 marks in total):ANSWER EITHER SUB-QUESTION A) OR SUB-QUESTION B).a) You are given the following data: the spot exchange rate is GBP/EUR 0.85, the p.a. simple interest rate on a three-month deposit is 6% in the UK and 4% in Europe. Note: t istoday and T is the end of the investment period.Required:Compute:i) The time-T EUR value of a time-t EUR 100 investment.ii) The time-t GBP value of a time-T GBP 100 loan.iii) The EUR/GBP forward rate for a three-month forward contract.iv) The time-t EUR value of a time-t GBP 100 spot sale.v) The time-t GBP value of the proceeds of a time-T EUR 100 loan.(10 marks)ORb) Given the following data, are there any arbitrage opportunities? If so, how would youmake a risk-free profit?Required:i)ii)iii)HC/FCJPY/GBPTHB/NZDUSD/EURSt292.0722.171.18Ft,T299.2822.431.18rt,T4.9%3.8%4.2%r*t,T3.1%2.6%2.5%(10 marks)Please turn over6QUESTION 5 (10 marks in total):ANSWER EITHER SUB-QUESTION A) OR SUB-QUESTION B).a) A French exporter wants to hedge an inflow of CAD 50m with futures contracts. However,no future on EUR/CAD is available. After doing some research, she finds that EUR/CADand EUR/AUD are strongly correlated because both Canada?s and Australia?s economieshave a strong exposure to prices of commodities. Therefore she decides to hedge therisk with a EUR/AUD future. Additionally, she considers a EUR/USD future. The regres2sion output is, with t-statistics in parentheses and R = 0.72, as follows.?S[EUR/CAD] = a + 0.59?f[EUR/AUS] + 0.21?f[EUR/USD].(14.57)(7.22)Required:i) Why does it make sense to consider a EUR/USD future although the USD does nothave a strong commodities exposure?ii) How will you hedge if you use both contracts, and if an AUD contract is for AUD 5mand a USD contract for USD 2m?iii) Should you use both contracts if you base your decision solely on the t-statistics?Note that a t-statistic above (below) 1.96 (?1.96) indicates statistical significance.iv) If the French exporter does not exclusively focus on futures, is there a way to hedgethe CAD 50m cash inflow perfectly? If yes, how?(10 marks)ORb) One year ago, a US firm swapped USD 150m with a swap rate of 4% for GBP 75m with aswap rate of 5%. Both assets had 2 years to maturity at that time. Currently, the USDswap rate is 5%, the GBP swap rate is 6% and the spot rate is USD/GBP 2.2.Required:i)ii)iii)iv)Calculate the current value of the USD leg of the swap (in USD).Calculate the current value of the GBP leg of the swap (in GBP).Calculate the value of the swap in USD.Has the US firm benefitted from the swap? Why?(10 marks)Please turn over7QUESTION 6 (10 marks in total):ANSWER EITHER SUB-QUESTION A) OR SUB-QUESTION B).a) Both forwards and options can be used for hedging purposes. Consider a US companywhich wants to hedge a future JPY cash inflow.Required:i) Draw a diagram which shows the payoff at expiration from selling a USD/JPY forward. Label the axes.ii) Draw a diagram which shows the payoff at expiration from buying a USD/JPY put option. Label the axes.iii) When does the US firm benefit from buying a put but not from selling a forward?iv) What is the disadvantage of buying a put instead of selling a forward?(10 marks)ORb) Options can be used for hedging purposes. For this question, consider that you are theCFO of a German firm.Required:i) Draw a diagram which shows the payoff at expiration of a EUR/JPY call option, aloan denominated in JPY and the combined payoff. Label the axes. The option expires on the day when the loan has to be repaid.ii) What is the benefit of the hedge from i)?iii) What is the advantage of a hedge with an option compared to a hedge with a forward?(10 marks)Please turn over8QUESTION 7 (10 marks in total):ANSWER EITHER SUB-QUESTION A) OR SUB-QUESTION B).a) A firm can be affected by different types of exposure to exchange rates. Your answers tothe following questions should concentrate on the main aspects.Required:i)ii)iii)iv)What is contractual exposure?What is operating exposure?What is accounting exposure?What is the main difference between contractual and operating exposure on the oneside and accounting exposure on the other?(10 marks)ORb) Forwards can be used to hedge operating exposure. Consider the Italian firm Fiat. If theEUR is strong against the USD, exporting becomes more difficult and the value of thefirm decreases. Additionally, the value of the firm depends on the general state of theeconomy in Italy (bad or good).State of the economyValue (joint probability) if EUR/USD=0.95Value (joint probability) if EUR/USD=0.75Bad5.7bn (30%)4.8bn (25%)Good6.7bn (10%)6.2bn (35%)Required:i) Calculate the currency exposure.ii) What is the optimal forward hedge?iii) Calculate the value of the hedged firm in each currency state if the forward rate isEUR/USD 0.83.(10 marks)Please turn over9QUESTION 8 (10 marks in total):ANSWER EITHER SUB-QUESTION A) OR SUB-QUESTION B).a) Consider the following information regarding the returns of Google and Ford.Expected returnGoogleFord0.140.09CovariancesGoogleFord0.850.310.310.56Required:You hold a portfolio of Google and Ford in which Google has a weight of 60%.i) Calculate the expected return.ii) Calculate the variance.iii) Draw a diagram which shows the efficient portfolios and the tangency portfolio of asingle-country CAPM. Label the axes. You do not need to make any calculations forthis question.iv) Explain the two key differences between the standard CAPM and the internationalCAPM.(10 marks)ORb) There are three steps which should be followed in international NPV calculations. Youranswers to the following questions should concentrate on the main aspects.Required:i)ii)iii)iv)What should be done in the branch stage?What should be done in the unbundling stage?What should be done in the external financing stage?Why is it useful to have a separate branch stage?(10 marks)Please turn over10Appendix: Sub-Accounts of the Balance of PaymentsEND OF PAPER


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