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acf305-exam-2012-13 LANCASTER UNIVERSITY 2013 EXAMINATIONS PART II (SECOND AND FINAL YEAR) ACCOUNTING AND FINANCE

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Question;LANCASTER UNIVERSITY2013 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) ANDONE SUB-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 an answer booklet.QUESTION 1: MULTIPLE CHOICE PART (30 marks in total):ANSWER ALL SUB-QUESTIONS.Required:1)Identify the one false statement about the UK balance of payments (BOP):(A) The sale of computers of a UK company to a Swedish company is recorded in the merchandiseaccount of the current account.(B) The source side of a deal tells us where the money in an international transaction was obtained.(C) The balance of payments has two categories: the current account and the capital and financialaccount.(D) The following transaction will not be recorded in the UK BOP: AstraZeneca AG, the Germansubsidiary of a UK pharmaceutical firm, buys drugs from Merck Inc., a US pharmaceutical firm.(E) Securities bought internationally are a use of funds.(3 marks)1Please turn over2)Identify the one false statement about purchasing power parity (PPP):(A) Absolute PPP may not hold when the consumption bundles of different countries are not thesame.(B) Absolute PPP may not hold when the prices for individual goods are sticky.(C) Absolute PPP holds when commodity price parity holds for every individual good.(D) Absolute PPP holds if the real exchange rate equals 1.(E) Absolute PPP holds if relative PPP holds.(3 marks)3)Assume that you have bought forward EUR (=FC) 2,000 at a forward rate of GBP/EUR 0.80, with deliverydate in six months. In addition, you will need to repay a loan of NZD (=FC) 5,000 in six months. What willbe the combined future payoff of your two cash flows in GBP (=HC)? (Note: FC is foreign currency andHC is home currency.)(A)(B)(C)(D)(E)5,000*(future spot rate(EUR/GBP) ? 0.80) ? 2,000*(future spot rate(GBP/NZD).5,000*(future spot rate(GBP/EUR) ? 0.80) + 2,000*(future spot rate(NZD/GBP).2,000*(future spot rate(GBP/EUR) ? 0.80) + 5,000*(future spot rate(GBP/NZD).2,000*(future spot rate(GBP/EUR) ? 0.80) ? 5,000*(future spot rate(GBP/NZD).2.000*(future spot rate(EUR/GBP) ? 0.80) + 5,000*(future spot rate(NZD/GBP).(3 marks)4)Identify the one false statement about the mechanisms used by banks that partially solve the problem ofdefault risk under a forward contract:(A)(B)(C)(D)(E)Margin requirements.Restricted use.Short lives.Right to offset.Credit agreements.(3 marks)5)Identify the one false statement about hedging with futures:(A) The expiration dates of the futures contract rarely match those for the currency inflows/outflowsthat the contract is meant to hedge.(B) The choice of underlying assets in the futures market is limited, and the currency one wishes tohedge may not have a futures contract.(C) Hedging with futures involves higher transaction costs than hedging with forwards.(D) A currency-mismatch can be hedged via a cross-hedge.(E) A maturity-mismatch can be hedged via a delta hedge.(3 marks)2Please turn over6)Identify the one true statement about swaps:(A) In practice, swap rates are much higher than risk-free rates in order to compensate banks fordefault risk.(B) A fixed-for-floating swap is insensitive to changes in the interest rate.(C) A fixed-for-fixed currency swap is insensitive to changes in the foreign interest rate.(D) A fixed-for-fixed currency swap is insensitive to changes in the respective exchange rate.(E) Swaps allow a company to borrow in the market where it can obtain the lowest spread.(3 marks)7)Identify the one false statement about a currency option with a strike price of EUR/EGP 8.00:(A) The underlying is the exchange rate between the euro and the Egyptian pound.(B) A put on the EUR/EGP exchange rate can be used to hedge a future cash outflow in EGP.(C) You will lose money at expiration if the option is a call, you are short the call and the EUR/EGPspot rate is 8.50.(D) The option is said to be in the money if it is a call and the EUR/EGP spot rate is 8.50.(E) Combining a short put and a long call replicates the payoff of a forward purchase.(3 marks)8)Identify the one false statement about accounting exposure:(A) Accounting exposure arises because the outcome of translating the accounting numbers of foreign subsidiaries from FC to HC depends on the exchange rate at the date of consolidation,which is uncertain.(B) Accounting exposure is not an economic exposure.(C) Accounting exposure cannot be hedged.(D) Examples of accounting translation methods are: current/noncurrent method, monetary/nonmonetary method and temporal method.(E) The HC value of total assets of a foreign subsidiary is higher under the current-rate or closingrate method than under all other methods if the FC had appreciated.(3 marks)9)Identify the one true statement about the expected exposure of the GBP value of assets to a change inthe GBP/USD exchange rate:(A)(B)(C)(D)(E)US government bonds have zero exposure.UK government bonds have negative exposure.Shares in an American importer have negative exposure.Shares in a British importer have negative exposure.Shares in a British exporter have negative exposure.(3 marks)3Please turn over10)Identify the one false statement about international NPV calculations:(A) A three-step process can be used for valuing international projects: branch stage, unbundlingstage and external financing stage.(B) In the branch stage, the foreign subsidiary is treated as a legally separate company.(C) In the unbundling stage, the costs and benefits of intragroup financial arrangements are analysed.(D) In the external financing stage, it has to be decided whether the parent or the subsidiary shouldborrow.(E) Political risks include transfer risk and the risk of expropriation.(3 marks)(Total 30 Marks)4Please turn overQUESTION 2 (10 marks in total):ANSWER EITHER SUB-QUESTION A) OR SUB-QUESTION B).a) The following questions are about money and banking.Required:i)ii)iii)iv)How was trade conducted before the development of paper (fiat) money?Was there any role for exchange rates before the development of paper money? Explain.In the current monetary system, how do central banks influence the money supply?Why are monetary policies of central banks important for exchange rates? Hint: Consider the covered interest parity formula.(10 marks)ORb) Over time, different currencies traded under different exchange-rate regimes.Required:i) How did the exchange-rate regime work which involved gold?ii) Describe one exchange-rate regime which is currently used and give an example of a currency otherthan the US dollar traded under this regime.iii) Under which different exchange rate-regimes had the US dollar traded since 1900?iv) State one reason why the US dollar is the most important currency in the world today?(10 marks)5Please turn overQUESTION 3 (10 marks in total):ANSWER EITHER SUB-QUESTION A) OR SUB-QUESTION B).a) Assume that a Big Mac costs AUD 3.4 in Australia and USD 3.2 in the United States. You are also given the following official exchange rates: USD/EUR 1.20 and AUD/EUR 1.32.Required:i)ii)iii)iv)Calculate the USD price of a Big Mac in Australia using the information provided above.Calculate the implied purchasing power parity (PPP) rate in USD/AUD.Calculate the real exchange rate in AUD/USD.According to the Big Mac prices, is the AUD overvalued or undervalued compared to the USD? Explain.(10 marks)ORb) Assume that you observe the following data regarding the NZD/GBP exchange rate:- Spot rate: 2.32?2.34- 6-month forward rate: 2.365?2.394- 6-month NZD interest rate (simple, p.a.): 5.15?5.35%- 6-month GBP interest rate (simple, p.a.): 2.65?2.85%Required:i) Which of the two values shown as spot rate is the bid rate, and which one is the ask rate? Explain.ii) Calculate the synthetic 6-month forward rate (both the bid and ask rate).iii) Is there any opportunity for arbitrage or shopping around using the synthetic forward rate? Explain.(10 marks)6Please turn overQUESTION 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 INR/GBP 58, the p.a. simple interest rateon a nine-month deposit is 9% in India and 3% in the UK. Note: t is today and T is the end of the investment period.Required:Compute:i) The INR/GBP forward rate for a nine-month forward contract.ii) The INR/GBP swap rate for a nine-month period.iii) The time-T INR value of a time-t INR 10,000 investment.iv) The time-t GBP value of a time-t INR 5,000 spot sale.v) The time-t INR value of the proceeds of a time-T GBP 500 loan.(10 marks)ORb) The following questions are about spot exchange quotes in the wholesale market, where differentbanks provide different bid and ask quotes for various exchange rates.Required:i) What does the law of one price for spot exchange quotes state?ii) What does arbitrage mean? Give an example of an arbitrage opportunity in the spot exchange market.iii) What does shopping around mean? Give an example of an opportunity for shopping around in thespot exchange market.iv) Why is arbitrage and shopping around important in the spot exchange market?(10 marks)7Please turn overQUESTION 5 (10 marks in total):ANSWER EITHER SUB-QUESTION A) OR SUB-QUESTION B).a) You work for a Spanish firm and are asked to hedge an outflow of MXN (Mexican peso) 400m with futures contracts. However, no future on EUR/MXN is available. After doing some research, you find thatEUR/MXN and EUR/USD are correlated because Mexico and the United States share a border andtherefore there is a high volume of trade between the two countries. Therefore you decide to hedge therisk with EUR/USD futures contracts. Additionally, you consider a EUR/AUD future. In order to determine your hedging positions, you estimate a multiple regression model. The regression output is, with2t-statistics in parentheses and R = 0.67, as follows.?S [EUR/MXN] = a + 0.46?f [EUR/USD]? 0.02?f [EUR/AUD].(9.32)(?0.05)Required:i) If a USD contract is for USD 10m and an AUD contract for AUD 5m, how will you hedge if you useboth contracts?ii) Should you use both contracts? Explain.iii) Now assume that the Spanish firm hedges the outflow of MXN perfectly using forwards. Draw a diagram which shows the payoff of the outflow of MXN and the forward position which hedges the exposure. Label the axes.(10 marks)ORb) You borrow Canadian dollar (CAD) 10m at 5% for one year, and you swap the loan into South Africanrand (ZAR) at a spot rate of CAD/ZAR 0.20 and the one-year swap rates of 4% (CAD) and 8% (ZAR).Required:i) What are the payments on the loan, on the swap, and on the combination of them? Show your results in a table.ii) Is there a gain of using the swap if you could have borrowed ZAR at 9%? Explain.iii) State two benefits of swaps.(10 marks)8Please turn overQUESTION 6 (10 marks in total):ANSWER EITHER SUB-QUESTION A) OR SUB-QUESTION B).a) Assume that the exchange rate between the British pound (GBP) and the Chinese yuan (CNY) isCNY/GBP 10. Also assume that the per annum interest rate in China is 6%, and the per annum interestrate in Great Britain is 4%. A bank offers to sell you options on the British pound with a time-to-maturityof one year and a strike price of CNY/GBP 9 for GBP 1.Required:i) Draw a diagram which shows the payoff at expiration from buying the above CNY/GBP call option.Label the axes.ii) There are arbitrage conditions imposing limits on the prices of options. What is the intuition underlying the arbitrage condition between the value of a call option and the value of a long forward contract?iii) Does the bank?s offer violate this arbitrage condition? Should you therefore accept the offer orshould you reject it?iv) If you accept the offer, is there an arbitrage opportunity? How would you exercise it?(10 marks)ORb) Consider that an Italian firm has the following contract:- It has to sell USD in one year at a rate of EUR/USD 0.80 if the USD trades below 0.80.- It has to sell USD in one year at a rate of EUR/USD 0.90 if the USD trades above 0.90.- It has to sell USD in one year at the spot rate if the EUR/USD is between 0.80 and 0.90.Required:i) Show the payoff of the contract graphically.ii) Show that the contract can be viewed as a combination of European-style options.iii) What is the benefit of this contract as a hedging instrument?(10 marks)9Please turn overQUESTION 7 (10 marks in total):ANSWER EITHER SUB-QUESTION A) OR SUB-QUESTION B).a) Corporate hedging can create shareholder value in the presence of market imperfections, such as taxes, financial distress costs or agency costs.Required:i) How can corporate hedging create shareholder value in the presence of taxes?ii) How can corporate hedging create shareholder value in the presence of financial distress costs?iii) What are agency costs? How can corporate hedging create shareholder value in the presence ofagency costs?(10 marks)ORb) Forwards can be used to hedge operating exposure. Consider the US firm Ford. If the USD is weakagainst the JPY, exporting becomes easier and the value of the firm increases. Additionally, the valueof the firm in USD depends on the general state of the economy in the United States (bad or good).Ford?s management estimates different firm values in USD depending on the level of the USD/JPY exchange rate and states of the US economy, as shown in the table below. It estimates that it is equallylikely that the USD will be strong or weak against the JPY. It also estimates that it is equally likely thatthe US economy will be in a bad or good state.State of the economyValue if USD/JPY=80Value if USD/JPY=100Bad36bn29bnGood46bn39bnRequired:i) A weak USD against the JPY makes it easier for Ford to export to Japan. What is another benefit ofa weak USD against the JPY for Ford?ii) Calculate the currency exposure.iii) What is the optimal forward hedge?iv) Are the estimates of the firm value by Ford?s management reasonable? Explain.(10 marks)10Please turn overQUESTION 8 (10 marks in total):ANSWER EITHER SUB-QUESTION A) OR SUB-QUESTION B).a) You consider investing in shares of BMW AG, a German carmaker. As part of your research on thecompany, you determine BMW?s cost of capital using the international CAPM (InCAPM). You use theFTSE World as world market portfolio and include the US and UK exchange rates in your analysis. Youobtain the following regression result:E (~BMW? r0) = 1.20 E (~? r0) + 0.51 E (~US + r0?,US? r0)? 0.22 E (~UK + r0?,UK? r0)r? rw? s? s(4.38)(?0.86)(2.13)Required:i) Interpret the output of the regression analysis.ii) Describe the difference between the CAPM and the InCAPM.(10 marks)ORb) Assume that you are the CFO of a large French company. The company is interested in evaluating abusiness opportunity in Russia. You recall that domestic business opportunities can be evaluated usinga standard NPV rule.Required:i) What is the additional complexity in case of evaluating a business opportunity in a foreign countrysuch as Russia?ii) What are the two approaches in which foreign business opportunities can be evaluated using NPVanalysis?iii) Why is the mathematical result that E[x*y] is not equal to E[x]*E[y] (with x and y being two arbitraryrandom variables) important for international capital budgeting?iv) Which of the two approaches would you decide to use for evaluating a business opportunity in Russia? Explain.(10 marks)

 

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