Economics

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International Financial Management
Theory Questions
1) Compare and Contrast the theories of interest rate parity, purchasing power parity and international fisher effect. Interest Rate Parity(IRP)- Suggests a relationship between the interest rate differential of two countries and the forward premium/discount. Purchasing Power Parity(PPP)- Suggests a relationship between the inflation rate differential of two countries and the percentage change in the spot rate overtime. International Fisher Effect(IFE)-Suggests a relationship between the interest rate between two countries and the percentage change in the spot rate overtime. IFE is based on nominal interest rate differentials, which are influenced by expected inflation. Therefore, IFE is closely related to PPP

2) Compare and Contrast the following hedging techniques used by MNC’s – leading and lagging , cross hedging, currency diversification

Leading and Lagging- this involves adjusting the timing of a payment request or disbursement to reflect expectations about future currency movements.

Cross-Hedging- this is a common method of reducing transaction exposure when the currency cannot be hedged

Currency Diversification- this can limit the potential effect of any single currency’s movements on the value of an MNC.

3) Compare MNC capital budgeting to domestic capital budgeting. Talk about economic exposure. MNC capital budgeting, like domestic capital budgeting, focuses on the cash flows of prospective long-term investment projects. They use the same NPV discounted cash flow model.

However MNC is more complex because of the following factors: * Terminal Values
* Financing versus operating cash flows
* Foreign currency fluctuations
* Long-term inflation rates
* Subsidized Financing
* Political Risk
* Parent versus project cash flows

Economic exposure- is any exposure of an MNC’s cash flows to exchange rate movements. MNC’s can measure their economic...
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