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Lancaster Universty ACf305 final exam




Question;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 rates relative to gold;(A);It will lead to central banks running out of;gold reserves.;(B);It is unable to maintain a low level of;inflation.;(C);It will lead to continuously increasing;prices of gold.;(D) It;suffers from the Triffin Dilemma, i.e. the necessity of choosing between;eco-nomic 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 foreign currency from a bank in the spot market;(A);The bank sells at the ask rate.;(B);You buy at the ask rate.;(C);The spread depends on the liquidity.;(D) The spread;depends on the maturity.;(E);The spread depends on the;transaction volume.;(3 marks);Please turn over;1;3);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 n months]. The;delivery date differs from the general formula in certain circum-stances.;(C);A 90-day forward contract;signed on Thursday, 29 March 2012, is normally set-tled 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 posi-tive.;(3 marks);4);Identify the one false;statement about hedging contractual exposure;(A);Perfect hedging means that the contractual;exposure is hedged in the cheapest way possible.;(B);Options are imperfect hedges;in the sense that they do not entirely eliminate un-certainty 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);Forwards do not have default risk.;(B);Forwards are less liquid than futures.;(C);Forwards are more profitable;than futures.;(D) Forwards;can require a margin call.;(E);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 where it can obtain the lowest spread.;(B);In a fixed-for-fixed currency;swap, the bank?s risks in case of default are limited because of the;right-of-offset clause.;(C);A fixed-for-floating interest-rate swap;allows a company to swap fixed interest payments 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 contract;are (near) risk-free rates.;(E);Coupon swap is an alternative;name for an interest-rate swap.;(3 marks);Please turn over;2;7);Identify the one true statement;about all currency options with a strike price of GBP/NZD;0.55 when the;current spot rate is GBP/NZD 0.50;(A);The option is said to be deep out of the;money.;(B);The option is said to be out of the money.;(C);The option is said to be at the money.;(D) The option;is said to be in the money.;(E);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 in-crease the value of the firm.;(B);There is an agency conflict between;shareholders and managers if managers decide not to implement effective hedging;strategies.;(C);If a company has always been profitable, no;risk of bankruptcy exists and corpo-rate 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 assets to a change in;the USD/EUR exchange rate;(A);US government bonds have zero exposure.;(B);European government bonds have positive;exposure.;(C);Shares in an American importer have positive;exposure.;(D) Shares in;a European importer have positive exposure.;(E);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 are part 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 expropria-tion.;(D);The term ?incremental cash;flows? refers to the cash flows generated at the level of the foreign;subsidiary.;(E) Usually;you should assume that the international investment has a positive ter-minal;value.;(3 marks);(TOTAL: 30 MARKS);Please turn over;3;QUESTION;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 the;source 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 gets its fee paid into its London bank;account.;ii);GlaxoSmithKline S.A., the;French subsidiary of a UK pharmaceutical firm, buys drugs from Pfizer Inc., a;US pharmaceutical firm, and pays for these by transferring money into the New;York bank account of Pfizer.;iii);Ericsson, a Swedish firm, sells network;equipment to Vodafone plc, a UK telecom-munications 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 Turkish citizen to travel to;the UK and give him a Turkish massage.;(10 marks);OR;b) 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 not need to provide descriptions;of the exchange-rate regimes).;iii);How do some governments;intervene in the exchange markets?;(10 marks);Please turn over;4;QUESTION;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-ask spreads show only the;last three decimal places. When the ask seems to be smaller than the bid, add;1,000.;Country;Code;Midpoint;Spread;Denmark;DKK;12.5994;816-172;Norway;NOK;11.5327;256-398;Turkey;TRY;2.7655;623-687;Required;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 shopping around if the TRY/NOK;spot rate is 0.2398-0.2401?;(10 marks);OR;b);The following table shows;Big Mac prices and exchange rates from the Economist, 26 May 2006.;Currency;(HC);Local price;HC/USD;Egypt;EGP;9.5;5.77;United;States;USD;3.1;1.00;Switzerland;CHF;6.3;1.21;Required;i);Calculate the USD price of a Big Mac in Egypt;and Switzerland using the exchange rates provided in the table above.;ii);Calculate the implied;purchasing power parity rates in HC/USD for Egypt and Swit-zerland.;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 over;5;QUESTION 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. sim-ple interest rate on;a three-month deposit is 6% in the UK and 4% in Europe. Note: t is today;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);OR;b);Given the following data;are there any arbitrage opportunities? If so, how would you make a risk-free;profit?;Required;HC/FC;St;Ft,T;rt,T;r*t,T;i);JPY/GBP;292.07;299.28;4.9%;3.1%;ii);THB/NZD;22.17;22.43;3.8%;2.6%;iii);USD/EUR;1.18;1.18;4.2%;2.5%;(10 marks);Please turn over;6;QUESTION 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/CAD and;EUR/AUD are strongly correlated because both Canada?s and Australia?s economies;have a strong exposure to prices of commodities. Therefore she decides to hedge;the risk with a EUR/AUD future. Additionally, she considers a EUR/USD future.;The regres-sion output is, with t-statistics in parentheses and R2;= 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 not have a strong commodities exposure?;ii);How will you hedge if you use;both contracts, and if an AUD contract is for AUD 5m and 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 hedge the CAD 50m cash;inflow perfectly? If yes, how?;(10 marks);OR;b);One year ago, a US firm;swapped USD 150m with a swap rate of 4% for GBP 75m with a swap rate of 5%. Both;assets had 2 years to maturity at that time. Currently, the USD swap rate is;5%, the GBP swap rate is 6% and the spot rate is USD/GBP 2.2.;Required;i);Calculate the current value of the USD leg of;the swap (in USD).;ii);Calculate the current value of the GBP leg of;the swap (in GBP).;iii);Calculate the value of the;swap in USD.;iv);Has the US firm benefitted;from the swap? Why?;(10 marks);Please turn over;7;QUESTION 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 company which wants to hedge a;future JPY cash inflow.;Required;i);Draw a diagram which shows the payoff at;expiration from selling a USD/JPY for-ward. Label the axes.;ii);Draw a diagram which shows the payoff at;expiration from buying a USD/JPY put op-tion. 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);OR;b);Options can be used for;hedging purposes. For this question, consider that you are the CFO of a German;firm.;Required;i);Draw a diagram which shows;the payoff at expiration of a EUR/JPY call option, a loan denominated in JPY;and the combined payoff. Label the axes. The option ex-pires 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 for-ward?;(10 marks);Please turn over;8;QUESTION 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 to the following;questions should concentrate on the main aspects.;Required;i);What is contractual exposure?;ii);What is operating exposure?;iii);What is accounting exposure?;iv);What is the main difference;between contractual and operating exposure on the one side and accounting;exposure on the other?;(10 marks);OR;b);Forwards can be used to;hedge operating exposure. Consider the Italian firm Fiat. If the EUR is strong;against the USD, exporting becomes more difficult and the value of the firm;decreases. Additionally, the value of the firm depends on the general state of;the economy in Italy (bad or good).;State of;the economy;Bad;Good;Value;(joint probability) if EUR/USD=0.95;5.7bn;(30%);6.7bn (10%);Value (joint;probability) if EUR/USD=0.75;4.8bn (25%);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 is EUR/USD 0.83.;(10 marks);Please turn over;9;QUESTION 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 return;Covariances;Google;Ford;Google;0.14;0.85;0.31;Ford;0.09;0.31;0.56;Required;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 a single-country CAPM.;Label the axes. You do not need to make any calculations for this question.;iv);Explain the two key;differences between the standard CAPM and the international CAPM.;(10 marks);OR;b);There are three steps which;should be followed in international NPV calculations. Your answers to the;following questions should concentrate on the main aspects.;Required;i);What should be done in the branch stage?;ii);What should be done in the unbundling stage?;iii);What should be done in the external financing;stage?;iv);Why is it useful to have a;separate branch stage?;(10 marks);Please turn over;10;Appendix;Sub-Accounts of the Balance of Payments;2013 examinations;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 merchandise account 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 financial account.;(D) The;following transaction will not be recorded in the UK BOP: AstraZeneca AG, the;German subsidiary 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);1 Please;turn over;2);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 the same.;(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 delivery date;in six months. In addition, you will need to repay a loan of NZD (=FC) 5,000 in;six months. What will be the combined future payoff of your two cash flows in;GBP (=HC)? (Note: FC is foreign currency and HC is home currency.);(A);5,000*(future spot rate(EUR/GBP) ? 0.80) ?;2,000*(future spot rate(GBP/NZD).;(B);5,000*(future spot;rate(GBP/EUR) ? 0.80) + 2,000*(future spot rate(NZD/GBP).;(C);2,000*(future spot rate(GBP/EUR) ? 0.80) +;5,000*(future spot rate(GBP/NZD).;(D);2,000*(future spot rate(GBP/EUR) ? 0.80) ?;5,000*(future spot rate(GBP/NZD).;(E);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;of default risk under a forward contract;(A);Margin requirements.;(B);Restricted use.;(C);Short lives.;(D) Right to;offset.;(E);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/outflows that the contract is meant;to hedge.;(B);The choice of underlying;assets in the futures market is limited, and the currency one wishes to hedge;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);2 Please;turn over;6);Identify the one true statement;about swaps;(A);In practice, swap rates are much higher than;risk-free rates in order to compensate banks for default 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/EGP spot 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 for-eign 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;mone-tary/nonmonetary method and temporal method.;(E);The HC value of total assets;of a foreign subsidiary is higher under the current-rate or closing-rate 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 in;the GBP/USD exchange rate;(A);US government bonds have zero exposure.;(B);UK government bonds have;negative exposure.;(C);Shares in an American importer have negative;exposure.;(D) Shares in;a British importer have negative exposure.;(E);Shares in a British exporter;have negative exposure.;(3 marks);3 Please turn;over;10);Identify the one false;statement about international NPV calculations;(A);A three-step process can be used for valuing;international projects: branch stage, unbundling stage 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 ana-lysed.;(D) In the;external financing stage, it has to be decided whether the parent or the;subsidiary should borrow.;(E);Political risks include;transfer risk and the risk of expropriation.;(3 marks) (Total 30 Marks);4 Please turn;over;QUESTION;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);How was trade conducted before the;development of paper (fiat) money?;ii);Was there any role for exchange rates before;the development of paper money? Explain.;iii);In the current monetary system, how do;central banks influence the money supply?;iv);Why are monetary policies of;central banks important for exchange rates? Hint: Consider the cov-ered;interest parity formula.;(10 marks);OR;b)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 other than 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);5 Please turn;over;QUESTION 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 giv-en the;following official exchange rates: USD/EUR 1.20 and AUD/EUR 1.32.;Required;i);Calculate the USD price of a Big Mac in;Australia using the information provided above.;ii);Calculate the implied purchasing power parity;(PPP) rate in USD/AUD.;iii);Calculate the real exchange;rate in AUD/USD.;iv);According to the Big Mac;prices, is the AUD overvalued or undervalued compared to the USD? Ex-plain.;(10 marks);OR;b);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);6 Please;turn over;QUESTION 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 rate on a;nine-month deposit is 9% in India and 3% in the UK. Note: t is today and;T is the end of the in-vestment 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);OR;b);The following questions are;about spot exchange quotes in the wholesale market, where different banks;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 mar-ket.;iii);What does shopping around;mean? Give an example of an opportunity for shopping around in the spot;exchange market.;iv);Why is arbitrage and shopping;around important in the spot exchange market?;(10 marks);7 Please;turn over;QUESTION 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 fu-tures;contracts. However, no future on EUR/MXN is available. After doing some;research, you find that EUR/MXN and EUR/USD are correlated because Mexico and;the United States share a border and therefore there is a high volume of trade;between the two countries. Therefore you decide to hedge the risk with EUR/USD;futures contracts. Additionally, you consider a EUR/AUD future. In order to;deter-mine your hedging positions, you estimate a multiple regression model.;The regression output is, with t-statistics in parentheses and R2;= 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 use both;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 dia-gram which;shows the payoff of the outflow of MXN and the forward position which hedges;the ex-posure. Label the axes.;(10 marks);OR;b);You borrow Canadian dollar;(CAD) 10m at 5% for one year, and you swap the loan into South African rand;(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 re-sults 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);8 Please;turn over;QUESTION 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) is CNY/GBP 10.;Also assume that the per annum interest rate in China is 6%, and the per annum;interest rate in Great Britain is 4%. A bank offers to sell you options on the;British pound with a time-to-maturity of 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 underly-ing the;arbitrage condition between the value of a call option and the value of a long;forward con-tract?;iii);Does the bank?s offer violate;this arbitrage condition? Should you therefore accept the offer or should you;reject it?;iv);If you accept the offer, is;there an arbitrage opportunity? How would you exercise it?;(10 marks);OR;b);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);9 Please;turn over;QUESTION 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 tax-es;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 of agency costs?;(10 marks);OR;b);Forwards can be used to;hedge operating exposure. Consider the US firm Ford. If the USD is weak against;the JPY, exporting becomes easier and the value of the firm increases.;Additionally, the value of 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 ex-change;rate and states of the US economy, as shown in the table below. It estimates;that it is equally likely that the USD will be strong or weak against the JPY.;It also estimates that it is equally likely that the US economy will be in a;bad or good state.;State of;the economy;Bad;Good;Value if;USD/JPY=80;36bn;46bn;Value if;USD/JPY=100;29bn;39bn;Required;i);A weak USD against the JPY;makes it easier for Ford to export to Japan. What is another benefit of a 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);10 Please turn;over;QUESTION 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 the company;you determine BMW?s cost of capital using the international CAPM (InCAPM). You;use the FTSE World as world market portfolio and include the US and UK exchange;rates in your analysis. You obtain the following regression result;~;?r;~;?r;~;+r;?;?r;~;+r;?;?r);E(r;=1.20 E(r;+ 0.51 E(s;US;?0.22 E(s;UK;BMW;0;w;0;0,US;0;0,UK;0;(4.38);(2.13);(?0.86);Required;i);Interpret the output of the regression;analysis.;ii);Describe the difference;between the CAPM and the InCAPM.;(10 marks);OR;b);Assume that you are the CFO;of a large French company. The company is interested in evaluating a business;opportunity in Russia. You recall that domestic business opportunities can be;evaluated using a standard NPV rule.;Required;i);What is the additional complexity in case of;evaluating a business opportunity in a foreign country such as Russia?;ii);What are the two approaches in which foreign;business opportunities can be evaluated using NPV analysis?;iii);Why is the mathematical;result that E[x*y] is not equal to E[x]*E[y] (with x and y being two arbitrary;random variables) important for international capital budgeting?;iv);Which of the two approaches;would you decide to use for evaluating a business opportunity in Rus-sia?;Explain.


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