1. Given the following unlikely exchange rates, is covered interest arbitrage worthwhile for Mexican investors who can borrow, say, 100 pesos? If so, the forward rate below is wrong. Applying the formula Ft = S0 [(1 + if) t/365 /(1 + ih) t/365] what should it be? 2. Deriving Forecasts of the Future Spot Rate. As of today, assume the following information is available: UK Mexico Spot rate of Mexican peso 180-day forward rate of Mexican peso = 14.00 euros = 13.72 euros 180-day Mexican interest rate = 6% 180-day euro interest rate = 5% Real rate of interest required by investors Nominal interest rate Spot rate One-year forward rate 2% 2% 11% 15% — £0.05 — £0.049 a. Use the forward rate to forecast the percentage change in the Mexican peso over the next year. b. Use the differential in expected inflation to forecast the percentage change in the Mexican peso over the next year. c. Use the spot rate to forecast the percentage change in the Mexican peso over the next year. 3. Assume that Citadel plc purchases some goods in Chile that are denominated in Chilean pesos. It also sells goods denominated in British pounds to some firms in Chile. At the end of each month, it has a large net payables position in Chilean pesos. How can it use an invoicing strategy to reduce this transaction exposure? List any limitations on the effectiveness of this strategy. 4. Vizor Pharmaceuticals, a U.S.-based multinational pharmaceutical company, is evaluating an export sale of its cholesterol-reduction drug with a prospective Indonesian distributor. The purchase would be for 1,650 million Indonesian rupiah (Rp), which at the current spot exchange rate of Rp9,450/$, translates into nearly $175,000. Although not a big sale by company standards, company policy dictates that sales must be settled for at least a minimum gross margin, in this case, a cash settlement of $168,000. The current 90-day forward rate is Rp9,950/$. Although this rate appeared unattractive, Vizor had to contact several major banks before even finding a forward quote on the rupiah. The consensus of currency forecasters at the moment, however, is that the rupiah will hold relatively steady, possibly falling to Rp9,400/$ over the coming 90 to 120 days. Analyze the prospective sale and make a hedging recommendation. 5. Assume that Loras (UK) Ltd. imported goods from New Zealand and needs 100,000 New Zealand dollars 180 days from now. It is trying to determine whether to hedge this position. Loras has developed the following probability distribution for the New Zealand dollar and note that we are working for convenience with direct exchange rates (and that Loras is worried about a strengthening NZ$): Possible Value of New Zealand Dollar in 180 Days £0.40 £0.45 £0.48 £0.50 £0.53 Probability 5% 10% 30% 30% 20% £0.55 The 180-day forward rate of the New Zealand dollar is £.52. The spot rate of the New Zealand dollar is £.49. Develop a table showing a feasibility analysis for hedging. That is, determine the possible differences between the costs of hedging versus no hedging. What is the probability that hedging will be more costly to the firm than not hedging? Determine the expected value of the additional cost of hedging. 6. Mattel is a U.S.-based company whose sales are roughly two-thirds in dollars (Asia and the Americas) and one- third in euros (Europe). In September Mattel delivers a large shipment of toys (primarily Barbies and Hot Wheels) to a major distributor in Antwerp. The receivable, €30 million, is due in 90 days, standard terms for the toy industry in Europe. Mattel’s treasury team has collected the following currency and market quotes. Current spot rate is $1.4158/€. Mattel can borrow at 5% per year and invest funds at its weighted average cost of capital (WACC) of 9.6% per year. Assume 360 days in a year. a. Advise Mattel on how to achieve a guaranteed outcome using a money market hedge b. Explain in words how such a strategy removes transaction risk c. How could Mattel hedge using the forward market if the forward rate is Current spot rate is $1.4195/€.? d. If the company’s foreign exchange advisors believe the euro will be at about $1.4200/€ in 90 days, which strategy is preferable?. e. Mattel’s management does not use currency options in currency risk management activities. How could Mattel do so and should it act now or wait until nearer the 90 day date? f. Which of these solutions would be preferable if Mattel was not yet sure about whether it had this future receivable? 7. Enid Ltd. (UK) produces furniture and has no international business. Its major competitors import most of their furniture from Brazil and then sell it out of retail stores in the United Kingdom. How will Enid be affected if Brazil’s currency (the real) strengthens over time? What type of risk is this? 8. Laurette SA is a French wholesale company that imports expensive high-quality luggage and sells it to retail stores around Europe. Its main competitors also import high-quality luggage and sell it to retail stores. None of these competitors hedge their exposure to exchange rate movements. The treasurer of Laurette told the board of directors that the firm’s performance would be more volatile over time if it hedged its exchange rate exposure and less volatile if it did not? In terms of competition, how could a firm’s cash flows be more stable as a result of such high exposure to exchange rate fluctuations? 9. a. How can a Multi National Enterprise (MNE) restructure its operations to reduce its economic exposure? b. Are there any disadvantages? c. How can an MNE diversify financing? 10. a. If the balance of payments (BOP) were viewed as a financial statement, would it be a balance sheet of the country’s wealth, an income statement of the country’s earnings, or a cash flow statement of money into and out of the country? Outline the BOP accounting for the countries involved in the following cases: b. Cathay Pacific Airlines buys jet fuel at Los Angeles International Airport so it can fly the return segment of a flight back to Hong Kong. It pays using a $ bank account in New York. c. Cathay Pacific pays using a HK$ bank account in Hong Kong. Its bank sells HK$ to a U.S. investment bank and buys the necessary US$ to pay for the fuel. d. Cathay Pacific pays using a HK$ bank account in Hong Kong. Its bank sells HK$ to a U.S. company (which is buying a subsidiary in Hong Kong) and buys the necessary US$ to pay for the fuel. 11. With reference to the identity of the balance on a country’s current account BCA X – M (S – I) + (T – G), assume X refers to exports, M to imports, S to private saving, I to investment, T to taxes and G to government spending. a. outline the causes of the current account deficit. b. outline the implications for the capital account c. outline the policy choices facing a government which wishes to eliminate a current account deficit. 12. Assume U.S. interest rates are above U.K. rates,caused not by inflation but by“crowding out”due to U.S.budget deficits. How might this affect trade between the two countries? Explain
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