International Financial Management

Question 1 (20 marks)
Gaggle is a U.S. based firm with operations across Europe. The firm expects to pay €20mil in 90
days. As the head of the risk management department, you need to hedge against the € exposure.
The European prevailing interest rate is 2% p.a., while that of the U.S. is 3% p.a.. The current spot
rate of the € is $1.2. The 90-day forward price is $1.15/€. The 90-day European call option on the
$ with the exercise price of €0.85 is selling at 3% premium. The 90-day European put option on the
$ with the exercise price of €0.87 is selling at 2% premium.
A) What is the dollar cost of using a forward hedge? Make sure you state your position in the
forward contract. (4 marks)
B) What is the cost if you decided to use money markets to hedge against the $XX of payable
in 90 days?
(6 marks)
C) What is the cost of an option hedge at the time the payment is due assuming you exercise
the option when the payment is due. (6 marks)
D) Based on the answers in (a), (b), and (c), which hedging methods should your firm choose?
(4 marks)
Semester One Final Examinations, 2021 FINM7406 International Financial Management
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Question 2 (15 marks)
You work for a large bank which provides funding for a number of firms across Europe.
Gauging the funding demand from clients, you have identified some interest-rate swap opportunities
that could potentially lower their borrowing costs. The following table provides information about
the funding costs for two of your clients ABC and TLP:
Fixed-Rate Variable-Rate
ABC 12% LIBOR + 2%
TLP 13.5% LIBOR + 2.5%
While ABC prefers to borrow in the variable-rate market, TLP’s preference is to borrow in the
fixed-rate market. You propose an interest-rate swap deal to your clients. ABC is particularly
unimpressed with your proposal. They argue that an interest rate swap with TLP is a disaster and
only benefits TPL because ABC can borrow at both fixed and variable debt at more attractive
rates than TLP.
A) Explain to ABC why they might benefit from the swap. Make sure that your explanation
includes the discussion about the absolute and comparative advantages and the potential
savings from the interest rate swap deal? (5 marks)
B) Now show both clients that the interest rate swap will work by completing the diagram
below with the following assumptions: 1) ABC will have 50% of the potential savings, and
TLP will receive the rest 2) To maintain long-term relationship with both clients, the bank
will not receive any commission from the current swap. Not that you can have multiple
correct answers. (10 marks)
™ LIBOR (floating rate) must be used in the transaction between ABC and TLP companies i.e.
either transaction (iii) or (iv).
ABC TLP
Borrows
(i)_
Borrows
(ii)_

(iii)
(iv)

Semester One Final Examinations, 2021 FINM7406 International Financial Management
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Question 3 (15 marks)
Seeking Beta is an investment asset manager based in China. Recognizing Australia as a
potential market for diversification, the fund invested RMB100 mil to buy Australian shares two
years ago. The exchange rate was RMB7.00/AUD. The Australian equity market performed well
since then from 5000 to 7000 points. The current exchange rate is RMB5.00/AUD. The fund exited
the position to capitalise that gain. They sold the Australian shares at 7000 points.
A) Determine the percentage return from this investment in Australian dollars. Show all
workings. (4 marks)
B) Compute the rate of return on your investment in RMB terms. Show all workings.
(6 marks)
C) What are channels that contribute to your investment risk? (Hint: Think about the
variance of your investment) (5 marks)
Semester One Final Examinations, 2021 FINM7406 International Financial Management
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Question 4 (15 marks)
ABC Ltd. considers to issue $100mil debts to fund a potential acquisition of DEF Ltd..
ABC decides to hire Macquarie Bank as their lead underwriter. Macquarie Bank proposes three
options.
a. ABC can raise the capital in the Australian domestic bond market. The coupon rate is 5% p.a..
The coupon is paid semi-annually. The bond will mature in 3 years. The underwriting fees is
0.85% of the issue size.
b. Alternatively, ABC can tap into the Eurobond market. The Euro-bonds also have three years
to maturity. The annual coupon payment is slightly higher at 5.25% p.a. Macquarie has a
reputation in this market so the underwriting fees is lower at 0.65%.
c. Finally, ABC can issue two-year Dim-Sum bonds in China with a coupon rate of 5.5% paid
annually. The underwriting fee is 0.75%.
Based on All-in cost method, which bond should ABC Ltd. choose? (15 marks)
Semester One Final Examinations, 2021 FINM7406 International Financial Management
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Question 5 (25 marks)
Textla Ltd. (TXLA), an Australian firm, wishes to expand its electric car operations to East
Asia as fierce competition has significantly affect demands across Europe. They plan to enter the
East Asia markets through Malaysia. The plant expansion cost is RM 80mil which must be
immediately expended. Moreover, TXLA would have to fund additional working capital of RM
5mil at the time of the expansion. Further investment in net working capital would be RM 5mil,
RM 8mil, and RM 10mil in year 1, 2, and 3 respectively. TXLA will depreciate the plant at a rate
of RM 4mil per year (starting in year 1) and will have to fund additional capital expenditures of RM
8mil per year to maintain and improve the plant. Although the project is assumed to have an infinite
life, cash-flows are only projected up to three years and the terminal value of the project is computed
based on the year 3 free cash-flow (FCF) assuming a growth rate that equals the Malaysian longrun GDP growth rate. The Earnings before Interests, Taxes, Depreciation and Amortisation
(EBITDA) are projected to be $35mil, $45mil, and $55mil for year 1, year 2, and year 3,
respectively.
All taxes are paid in Malaysia in the year the income is earned. Tax treaties are in effect so
that TXLA will have no tax obligations to the Australian Tax Office (ATO). The following
information applies to the valuation.
Malaysia Australia
Price Inflation 2.00% 3.00%
Annual return on government bonds 2.00% 4.00%
Corporate tax rate 30.00% 40.00%
Equity market risk premium AUD 5.00%
Spot rate-S(AUD/RM) 0.2
Before tax cost of debt 6.00%
Debt-to-value ratio (D/V) 0.3
Systematic risk (beta) 1.2
Malaysian long-run GDP growth rate 3.00%
WACC 12.80%
Required:
A) Calculate the cost of capital, in Australia, for the project. (4 marks)
B) Calculate the forward exchange rates, F1(AUD/RM) through F3(AUD/RM), for the years 1,
2, and 3 based on the spot rate and the interest rates given in the question. (round to 5
decimal places) (3 marks)
C) Calculate the Free of Cash Flows of the project in RM from year 1 to year 3.
(7 marks)
Semester One Final Examinations, 2021 FINM7406 International Financial Management
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D) What is the terminal value as of year 3? Use a perpetuity formula, the Free Cash Flows in
RM for year 3, and the Malaysian growth rate assumption given in the question. Assume
the appropriate discount rate is WACC. (3 marks)
E) Calculate the AUD value of FCF for the years 0, 1, 2 and 3 and the terminal value using the
forward rates calculated in (b). (5 marks)
F) What is the NPV of the project from TXLA’s perceptive (in AUD)? Should TXLA expand
into the Asian market? (3 marks)

Sample Solution

International Financial Management

Problem Set # 1
PART 1: FX-markets, International Parity conditions
1) You are interested in buying Swedish krona (SK). Your bank quotes “SK7.5050/$ Bid
and SK7.5150/$ Ask”. What would you pay in dollars if you bought SK 10,000,000 at
the current spot rate?
2) The following outright quotations are given for the Canadian dollar:
Bid (C$/$) Ask (C$/$)
Spot rate 1.2340 1.2350
One moth forward 1.2345 1.2365
Three moths forward 1.2367 1.2382
Six months forward 1.2382 1.2397
Assume you reside in the United States. Calculate forward quotes for the Canadian dollar
as an annual percentage premium or discount. Would a foreign exchange trader in
Canada get a different answer if asked to calculate the annual percentage premium or
discount on the U.S. dollar for each forward rate? Why?
3) Calculate appreciation or depreciation in each of the following:
a) If the dollar depreciates 10% against the yen, by what percentage rate does the
yen appreciate against the dollar?
b) If the dollar appreciates 1,000% against the ruble, by what percentage point
does the ruble depreciate against the dollar?
4) Suppose that at time t=0 the dollar per yen spot rate S0
$/¥ is 0.0100 $/¥ and that the yen
appreciates 25.86 percent during the next period.
a) What is the closing spot rate in dollars per yen, S1
$/¥?
b) By what percentage does the dollar depreciate against the yen?
5) Dow Chemical is to deliver chemicals to an Indian firm in one year and is supposed to
receive 40 million rupee (INR) at the time of delivery. The current exchange rate is 34.5
rupee per dollar (INR/$) and the one year-forward rate is 40 rupee per dollar (INR/$).
Dow’s one-year interest rates are 18% for rupee funds and 4% for dollar funds.
Suppose that Dow decides to hedge its exposure to the rupee. What are the alternatives
available to Dow based on the information given? Which hedge is optimal for Dow?
6) The peso is quoted in direct terms at 28.7356 ¥/Ps BID and 28.7715 ¥/Ps ASK in
Tokyo. The yen is quoted in direct terms at 0.03416 Ps/¥ BID and 0.03420 Ps/¥ ASK in
Mexico City.
a) Calculate the bid/ask spread as a percentage of the bid price from a Japanese
and from a Mexican perspective.
b) Is there an opportunity for profitable arbitrage? If so, describe the necessary
transactions using a ¥ 1 million starting amount.
7) The real rate of interest on bank loans and deposits is 2% in both the UK and the US.
Inflation in the US is 6%. In equilibrium, what is the UK inflation rate?
8) As a percentage of an arbitrary starting amount, about how large would transactions
costs have to be to make arbitrage between the exchange rates S0
SFr/$ = 1.7223 SFr/$,
S0
$/¥ = 0.009711 $/¥, and S0
¥/SFr = 61.740 ¥/SFr unprofitable?
9) You are free to invest in any currency. You can trade at the following prices:
Spot rate, Russian ruble per dollar 20 RUB/$
6 month forward rate for rubles 22 RUB/$
6-month Russian interest rate 18%
6-month U.S. interest rate 6%
a) Is covered interest arbitrage worthwhile? If so, explain the steps and compute the
profit.
b) Suppose that there is no forward market for the Russian ruble. Explain how an
investor can engage in “uncovered” interest arbitrage and whether this is a true
arbitrage or not.
10) Suppose that S0
$/₤ = 1.25$/₤, F1
$/₤ = 1.20$/₤, i₤ = 11.56% and i$ = 9.82%. You are to
receive 100,000₤ on a shipment of goods in one year. As a US-based firm you want to
avoid foreign exchange risk.
a) Form a forward market hedge. Identify which currency you are buying and
which currency you are selling forward. When will currency actually change
hands? Today? Or, in one year?
b) Form a money market hedge that replicates the payoff on the forward contract
by using the spot currency and the Euro-currency markets. Identify each contract
in the hedge. Does this hedge eliminate the foreign exchange risk?
c) Are the currency and Euro-currency markets in equilibrium? How would you
arbitrage the difference from the parity condition?
PART 2: FX options and FX futures
1) You want to hedge the Brazilian real (BRR) value of a 1 million Canadian dollar
(CAD) inflow using futures contracts. On Brazil’s exchange, there is a futures
contract for US$100,000 at 1.5 BRR/US$.
a) Your assistant runs a bunch of regressions:

  1. ΔS [BRR/CAD] = α1 + β1 Δf [US$/BRR]
  2. ΔS [BRR/CAD] = α2 + β2 Δf [BRR/US$]
  3. ΔS [CAD/BRR] = α3 + β3 Δf [BRR/US$]
  4. ΔS [CAD/BRR] = α4 + β4 Δf [US$/BRR]
    Which regression is relevant to you?
    b) If the relevant β is 0.83 how many contracts do you buy/sell?
    c) We assumed that there was a $ futures contract in Brazil, with a fixed number
    of US$ (100,000 units) and a variable BRR/US$ price. What f there is no
    Brazilian futures exchange? Then, you’d have to go to a US exchange, where
    the number of BRR per contract is fixed (at, say, 125,000) rather than the
    number of US$. How many US$/BRR contacts will you buy?
    2) A charitable organization has issued a bond that gives the holder the option to cash in
    the principal as either £10,000 or €20,000. This asset can be viewed as a £10,000
    bond plus a call on €20,000 with a strike price K=0.5£/€
    a) Can the bond also be viewed as a € bond plus an option?
    b) Explain how the two equivalent views are just an application of the Put-Call
    parity
    c) Suppose that you observe the following:
    The price of a call option on the European Euro (€) is 0.055 $/€. The price of a put
    option on the € is 0.045 $/€. Both options have 135 days left to expiration and a strike
    price of 0.85 $/€. The current spot rate is 0.89 $/€. The $-risk free rate is 3.5% and the
    €-risk free rate is 3.75%.
    i) Is there an arbitrage opportunity? Why?
    ii) Calculate the arbitrage profits and show the arbitrage transactions and
    corresponding cash flows at t=0 (now) and at t=T=135 days later.
    3) ABC Inc., a US importer of European products wishes to devise a hedge of a 32
    million Thai Bhat (Bt) outflow, expected in 3 months. ABC’s financial experts
    suggest that this exposure can be hedged using different combinations of Euro (EU),
    SF , ¥ and £ futures contracts. They presented the following results of their analysis
    to the CFO:
    i) ΔS
    $/Bt = 0.03 + 0.95Δf
    $/SF
  • 2.55Δf
    $/¥
    [t=1.34] [t=7.50] [t=2.73]
    R
    2=0.87
    ii) ΔS
    $/Bt = 0.03 + 0.47Δf
    $/EU
  • 1.55Δf
    $/£
    [t=1.31] [t=2.50] [t=1.41]
    R
    2=0.33
    Upon seeing the above, the CFO got confused and did not know what to do. All he
    remembered is that the size of the EU, SF , ¥ and £ futures contracts is 100,000 EU,
    125,000 SF, 12,500,000 ¥ and 62,500 £, respectively. Can you help him devise the
    hedge? How many contracts does ABC need to buy/sell?
    4) D-U Inc., an Australian manufacturer, is expecting an outflow of 83 million US-$
    within the next four months. Today’s spot exchange rate is 1.25 Australian dollars
    (A$) per US-$. D-U Inc. decides to hedge using options. The A$ interest rate is
    5.79%. They contact Citi which offers the following options on the US-$:
    a) American call on the US-$ with T=3 months, K=1.25 A$/US$, price
    C=0.12A$/US$
    b) American put on the US-$ with T=3 months, K=1.25 A$/US$, price P=0.10
    A$/US$
    c) American call on the US-$ with T=6 months, K=1.25 A$/US$, price C=0.14
    A$/US$
    d) American put on the US-$ with T=6 months, K=1.25 A$/US$, price P=0.115
    A$/US$
    Answer the following questions, assuming that these options have no resale value, and
    ignoring transactions costs.
    i) Which option should D-U Inc. choose?
    ii) Suppose that 3.5 months later (i.e., at the time when D-U Inc. will have to pay
    83 million US-$) the spot exchange rate is 1.36 A$/US-$. What should D-U
    Inc. do? How much will D-U inc. have to pay, in terms of A$ per US-$?
    iii) Now, suppose that at the time D-U Inc. will have to pay the 83 million US-$
    (i.e. 3.5 months later) the spot exchange rate is 1.19 A$/US-$. What should DU Inc. do? How much will D-U Inc. pay in terms of A$ per US-$?
    5) On October 20, you sold 10 futures contracts for 100,000 Canadian dollars (CAD)
    each at a rate of 0.75 US$/CAD. The subsequent settlement prices are shown below.
    October 21 22 23 24 27 28 29 30
    Futures rate 0.74 0.73 0.74 0.76 0.77 0.78 0.79 0.81
    a) What are the daily cash flows from marking to market?
    b) What is the total cash flow from marking to market (ignoring discounting)?
    c) If you deposit US$75,000 into your margin account, and your broker requires
    US$50,000 as maintenance margin, when will you receive a margin call and how
    much will you have to deposit?
    6) You hold a foreign exchange asset that you have hedged with a put. Show graphically
    how the put limits the potential losses created by low exchange rates, without
    eliminating the potential gains from high rates.
    7) You have covered a foreign exchange debt using a call. Show graphically how the
    call limits the potential losses created by high exchange rates, without eliminating the
    potential gains from low rates.

Sample Solution

INTERNATIONAL FINANCIAL MANAGEMENT

A Canadian importer has to deliver 30,000,000 GBP in 3 months’ time.
Assume that market situation as at today is as follows:
SPOT Rates (FOREX):
GBP/CAD = 1.8380 – 85.
Money Markets Interest Rates:
CAD 3 MONTHS: 3.25 % – 3.50 % per annum
GBP 3 MONTHS: 4.75 % – 5.25 % per annum
CAD 6 MONTHS: 3.75 % – 4.00 % per annum
GBP 6 MONTHS: 5.25 % – 5.50 % per annum

(a) Draw the currency balance.
(b) Calculate the forward exchange rate for three months. Explain your approach. Quickly discuss the advantage and inconvenient of currencies forward.
d) If you use currencies options, what strategies could you propose? Draw all the required profiles. Remember the objective is to hedge!

Sample Solution

International financial management

1-Why is it important to study international financial management?

2-How is international financial management different from domestic financial management?

3-Discuss the major trends that have prevailed in international business during the last two decades.

8-In 1995, a working group of French chief executive officers was set up by the Confederation of French Industry (CNPF) and the French Association of Pri- vate Companies (AFEP) to study the French corporate governance structure. The group reported the following, among other things: “The board of directors should not simply aim at maximizing share values as in the U.K. and the U.S. Rather, its goal should be to serve the company, whose interests should be clearly distin- guished from those of its shareholders, employees, creditors, suppliers, and clients but still equated with their general common interest, which is to safeguard the prosperity and continuity of the company.” Evaluate the above recommendation of the working group.

Sample Solution