MT480-01: Corporate Finance
Unit Nine: Assignment
Complete the following exercises and problems from the textbook. Some problems ask multiple questions; be sure to answer every part of the exercise or problem unless otherwise noted * Chapter 28: Practice Questions 2, 10, 11, and 13
* Chapter 34: Practice Questions 2, 3, and 7
2.Table 28.1 shows the 90-day forward rate on the South African rand.
a. Is the dollar at a forward discount or premium on the rand?
The dollar is selling at a forward premium on the rand.
b. What is the annual percentage discount or premium?
4 x [(6.4662/6.5917) – 1] = -0.0762 = -7.62%
c. If you have no other information about the two currencies, what is your best guess about the spot rate on the rand three months hence?
Using the Expectations Theory:
$1 = 6.5917 rand
d. Suppose that you expect to receive 100,000 rand in three months. How many dollars is this likely to be worth?
100,000 rand = $(100,000 / 6.5917) = $15,170.59
10.In March 2004, an American investor buys 1,000 shares in a Mexican company at a price of 500 pesos each. The share does not pay any dividend. A year later she sells the shares for 550 pesos each. The exchange rates when she buys the stock are shown in Table 28.1. Suppose that the exchange rate at the time of sale is peso $12.0/$.
a. How many dollars does she invest?
Pesos invested = 1,000 × 500 pesos = 500,000 pesos
Dollars invested = $500,000/10.9815 = $45,531.12
b. What is her total return in pesos? In dollars?
Total return in pesos = [(550 - 500) x (1000)] / (500 ×1000) = 0.10 = 10.0%
Dollars received = (550 × 1000)/12.0 = $45,833.33
c. Do you think that she has made an exchange rate profit or loss? Explain.
Although there was a loss on the exchange rate, there has been a return on the investment of 10%.
11.Table 28.4 shows the annual interest rate (annually compounded) and exchange rates against the dollar for different currencies. Are there any arbitrage opportunities? If so, how would you secure a positive cash flow today, while zeroing out all future cash flows?
TABLE 28.4Interest Rate (%) Spot Exchange Rate 1-Year Forward Exchange Rate*
United States (dollar) 3 --
Costaguana (pulga) 23 10,000 11,942
Westonia (ruple) 5 2.6 2.65
Gloccamorra (pint) 8 17.1 18.2
Anglosaxophonia (wasp) 4.1 2.3 2.28
Using the Interest Rate Theory, you can determine whether arbitrage opportunities exist by seeing if the relationships between the U.S. and others.
Ratio of Interest RatesRatio of Forward Rate to Spot Rate
There are arbitrage opportunities for Anglosaxophonia and Gloccamorra, because interest rate parity does not hold. This is because there would be risk-free profit involved.
13.Carpet Baggers, Inc., is proposing to construct a new bagging plant in a country in Europe. The two prime candidates are Germany and Switzerland. The forecasted cash flows from the proposed plants are as follows:
C0 C1 C2 C3 C4 C5 C6 IRR (%)
Germany (millions of Euros) -60 +10+15+15+20+20+2018.8
Switzerland (millions of Swiss francs) -120 +20+30+30+35+35+3512.8
The spot exchange rate for euros is $1.3/k, while the rate for Swiss francs is SFr 1.5/$. The interest rate is 5 percent in the United States, 4 percent in Switzerland, and 6 percent in the euro countries. The financial manager has suggested that, if the cash flows were stated in dollars, a return in excess of 10 percent would be acceptable.
Should the company go ahead with either project? If it must choose between them, which should it take?
1 + euro return = (1 + dollar return) x (1 + r euro) / (1 + r $) = 1.1 x 1.06 / 1.05 = 1.11 Euro return on the...