...Chapter Exchange Rate Determination and Forecasting QUESTIONS 1. What is the difference between the ex ante and the ex post real interest rate? 10 Answer: The ex post interest rate corrects the nominal interest rate with the realized or ex post rate of inflation; whereas the ex-ante (or expected) real interest rate corrects the nominal interest rate for expected inflation. As a lender, you care about the real return on your investment, which is the return that measures your increase in purchasing power between two periods of time. If you invest $1, you sacrifice $1 1+i real goods now, where P(t) is the price level. In 1 year, you get back , where i is the P(t) P(t+1) nominal rate of interest. We calculate the real return by dividing the real amount you get back by the real amount that you invest. Thus, if rep is the ex post real rate of return and ex post real interest rate, we have 1 + r ep ⎛ 1+i ⎞ ⎜ P(t+1) ⎟ ⎠ = (1 + i ) = ⎝ ⎛ 1 ⎞ ⎛ P(t+1) ⎞ ⎜ P(t) ⎟ ⎜ P(t) ⎟ ⎝ ⎠ ⎝ ⎠ Notice that the real rate of interest depends on the realization of the rate of inflation because P(t + 1)/P(t) = 1 + π(t + 1), where π(t + 1) is the rate of inflation between time t and t + 1. For simplicity, we drop the time notation and simply write 1 + r ep = If we subtract 1 from each side, we have (1 + i) (1 + π) r ep = which is often approximated as (1 + i) (1 + π) i-π = (1 + π) (1 + π) (1 + π) rep = i – π The approximation involves ignoring the term (1 + π) in the denominator...
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...Answer: Foreign Direct Investment: FDI occurs when a frim invest directly in facilities to produce or market product in a foreign country. The Theories of FDI: Theroies of FDI may be classified under the following------ 1. Production or product Cycle Theory of Vernon 2. The theory of Exchange Rate on Imperfect Capital Market 3. The Internalisation Theory 4. The Eclectic Paradigm of Dunning Production or product Cycle Theory of Vernon Production or product theory developed by Vernob in 1966 was used to explain certain types of FDI. He believes that there are four stage of production cycle— * Innivation * Growth * Maturity * Decline. Vernon’s production life-cycle suggest that frims undertake FDI at particular stage in the life cycle of products they have developed or produced. However, Vernon’s theory does not adresss the issue of whether FDI is more efficient than exporting or licensing for expanding abroad. The theory of Exchange Rate on Imperfect Capital Market: This is another theory which tried to explain FDI. Initially the foreign exchange risk has been analyzed from the perspective of international trade. However, currency risk rate theory cannot explain simultaneous foreign direct investment between countries with different currencies. The sustainers argue that such investments are made in different times, but there are enough cases that contradict these claims. The Internalisation Theory This theory tries to explain the...
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...spot rate of the Malaysian ringgit is $.30 and the six month forward rate of the ringgit is $.32, what is the forward premium or discount on an annual basis? A. premium; about 14.5% B. discount; about 14.5% * C. premium; about 13.3% D. discount; about 13.3% E. premium; about 16.7% Solution: use Equation (5-4) [(.32 - .30)/.30] x (360/180) = 13.3% 18. If the spot rate of the Israel shekel is $.32 and the six month forward rate is $.30, what is the forward premium or discount on an annual basis? A. discount; 11.5% B. premium; 11.5% C. premium; 12.5% * D. discount; 12.5% E. premium; 22.5% Solution: use Equation (5-4) [(.30 - .32)/.32] x (360/180) = -12.5% 19. If the Canadian dollar is equal to $.86 and the Brazilian real is equal to $.28, what is the value of the Brazilian real in terms of Canadian dollars? * A. about .3256 reals B. about .3568 reals C. about 1.2 reals D. about 1.5 reals E. about .5600 reals Solution: cross rate .28/.86 = .3256 20. If the Japanese yen was worth $.0035 six months ago and is worth $.0045 today, how much has the yen appreciated or depreciated? * A. appreciated; about 29% B. appreciated; about 25% C. depreciated; about 20% D. depreciated; about 18% E. appreciated; about 15% Solution: use Equation (5-1) (.0045 - .0035)/.0035 = 29% 21. Assume: (1) the US annual interest rate = 10%;...
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...distribute tennis rackets in Germany. The project life is expected to be two years (at which time, an end to protectionist sentiment in the U.S. will lead to an end to trade restrictions). The required investment in the project is a. DM 25,000,000 in plant and equipment, b. DM 5,000,000 in working capital. The projected after-tax cash flows from the project are DM 20,000,000 for the next two years, in addition to DM5,000,000 from the liquidation of working capital in two years. The spot exchange rate (S$/DM) is $0.6500/DM1 . The interest rate in the U.S. (RUS ) is 6 percent per year while the German interest rate (RDM ) 11 percent per year. Assuming that the firm has a WACC of 12%, showing all calculations indicate whether the project should be accepted. Solution Predicted Exchange Rates If the real rate of interest is the same in all countries (due to the international mobility of capital) the International Fisher Effect implies that differences in nominal interest rates will signal differences in the expected rates of inflation across countries. Given that RUS is 6 percent per year and that the German interest rate RDM is 11 percent per year, we would expect the expected rate of inflation in Germany to be roughly 5 percent greater than the expected rate of inflation in the US. Relative Purchasing Power Parity implies that the expected changes in exchange rates should reflect differences the expected rates of inflation in the two countries in question...
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...skilled labors and proper infrastructure, high unemployment rate, low standard of living, continuous disequilibria in the economy, defective administrative and inappropriate tax structure. However, this country has a good prospect of doing better because of having huge natural and other resources which fascinated many investors to invest in Bangladesh. In spite of going through all these hardships and troubles, this country is trying to overcome these lacking through the development of different macro aggregates. The macro aggregates that affect the development of the economy of Bangladesh are National Income, Inflation, Exchange Rate, Export, Import, Remittance, Money Supply and Government Expenditure. For this research paper, four macro aggregates have been selected and then comparison and demonstration have been done about how these four factors influence the economy of Bangladesh in the reference period (April 2013 to June 2013). The four macro aggregates are: 1. Exchange Rate 2. Export 3. Inflation 4. Remittance Among all other indicators, these four would be the most relevant and constructive ones in terms of explaining Bangladesh’s economy. 1.1 OBJECTIVE The term project has the following objectives: * To have extensive knowledge of Exchange Rate, Export, Inflation and Remittance growth trend in the reference period and how the trends vary. * Reasons behind Exchange Rate, Export, Inflation and Remittance growth trend fluctuation...
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...Problem set 1 (*optional items) Questions and problems on global firms and governance, international monetary systems, forex markets, and parities. Global firms and governance: 1. How would you define and measure multinational corporations? A firm is called a MNC if it has controlling real assets or operating facilities in multiple countries. Operationally, it can be measured by the extent of “foreign content,” proxied by foreign sales ratios, foreign asset ratios, and foreign employee ratios, or their averages, augmented by the number of countries in which the firm has operations. 2. Define greenfield investment versus foreign direct investment. FDI involves corporate investments in real assets located aboard and includes both greenfield investment and international mergers and acquisitions. The greenfield investment involves construction of plants and equipment or R&D facilities from the scratch. 3. ESM13, chapter 2, question 8. Labor Unions. In Germany and Scandinavia, among others, labor unions have representation on boards of directors or supervisory boards. How might such union representation be viewed under the shareholder wealth maximization model compared to the corporate wealth maximization model? Labor union representation that may be required by statute is an example of governmental direction toward the corporate stakeholder model (or corporate wealth maximization model), in that such a requirement is...
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...available to help you accurately forecast exchange rates. Identify the implications of exchange-rate changes on the company’s marketing, production and financial decisions. The CFO of the company that exports export supply components to German manufacture should consider the variety of factors including exchange rates while estimating the budget for the coming year. Since the business of the company involved in exporting the supply material to Germany on contract basis in future, the company CFO need to forecast exchange rates as part of their pricing decision, choice of the currency (whether deal with dollars, or Euros) and hedging strategies to establish accurate budget for the project. In the process, the CFO can forecast exchange rates by using either of two approaches: fundamental forecasting or technical forecasting (Daniels, Radebaugh & Sullivan, 2011). Fundamental forecasting predicts the future exchange rates on the basis of trends in the economic variables. The managers in the company can make use of econometric model by feeding the data to get the more subjective analysis. Technical forecasting uses the past trends in the exchange rates to determine the future trends in the rates. It presumes that the current exchange rates reflect all the facts in the market and future rates will follow the same patterns under similar circumstances. The researchers say that forecasting is imprecise and the past movements of the exchange rates cannot be used to predict future movements...
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...TRADE ON EXCHANGE RATE OF INDIA Introduction India in the 21st century is one of the fastest growing countries of the world. Oil being the bloodline of the growing economy, is a necessary commodity and has a very inelastic demand, steadily growing with time. In 2011, India was the fourth largest energy consumer in the world after the United States, China, and Russia. India's economy grew at an annual rate of approximately 7 percent since 2000 and proved relatively resilient to the 2008 global financial crisis. India was the 10th largest economy in the world in 2011, as measured by nominal gross domestic product (GDP). In the International Energy Outlook 2011, EIA projects India and China to account for the biggest share of Asian energy demand growth through 2035. India is heavily dependent on crude oil imported from the Middle East and imports more than 70% of its domestic demand. Due to a stagnation of domestic production, the import of crude has gone up from 11.68 million tons (mt) in 1970–1971 to 196 mt in 2007–2008. Oil import bill for India in 2007–2008 was $144.93 billion. With the high demand of oil and other petroleum, and their fluctuating price in the global markets, we are at a very high risk of foreign exchange risk. With so much purchase of energy imports, it might lead to exchange rate movements. And the volatility in the exchange rates (caused by the oil price volatility) may have severe effects on the economy, especially on infrastructural projects and FDI....
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...economic considerations, choice of a specific project within a particular product-market posture calls for evaluation of its economic feasibility. For this purpose, capital budgeting exercise has to be done. A firm should deploy funds in a project if the marginal revenue obtained there from exceeds the marginal cost. For an MNC, capital budgeting involves economic analysis of the firm's direct investment opportunities. Whatever be the motive for Direct Foreign Investment (DFI), an MNC's very survival and sustainable competitive position depends on its ability to identify and choose the most profitable investment opportunity. Capital budgeting technique provides the mechanism to identify opportunities and evaluate their economic viability. This is why MNCs evaluate international projects by using capital budgeting techniques. Proper use of capital budgeting techniques can help the firm in identifying the international projects worthy of implementation from those that are not. 13.2 FUNDAMENTALS OF EVALUATING FOREIGN PROJECTS Once a firm has compiled a list of prospective investments, it uses capital budgeting techniques to select from among them that combination of projects that maximizes the firm's value to shareholders. The theoretical framework involved in evaluation of domestic projects is the same as for foreign projects and various considerations influencing choice of a project within the country are the, same as those for projects overseas. However, there are a host of factors...
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...1) Explain why the Consumption and Production distortions are indeed a loss to society, and what is wrong with the logic that leads to the apparent paradox. The two deadweight triangles associated with the graphical analysis of a tariff are the Consumption distortion and Production distortion losses. It is easy to understand why the Consumption distortion constitutes a loss for society. After all it raises the prices of goods to consumers, and even causes some consumers to drop out of the market altogether. It seems paradoxical that the Production distortion is considered an equivalent burden on society. After all, in this case, profits increase, and additional production (with its associated employment) comes on line. This would seem to be an offset rather than an addition to the burden or loss borne by society. Explain why the Production distortion is indeed a loss to society, and what is wrong with the logic that leads to the apparent paradox. [4] Answer: The Production distortion is a loss to society because it constitutes a loss to consumer surplus, which is not recouped by any other group in society. The actual triangle here represents an inefficient shift of society’s resources to produce a good, which it could not sell profitably at world prices. The basic point here is that the country ends up producing more than it should at the free trade equilibrium 2) The U.S. producer Boeing, and the European Airbus are contemplating...
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...c.|product cycle theory.| d.|none of the above.| ____ 2. A product cycle is the process by which a firm provides a specialized sales or service strategy, support assistance, and possibly an initial investment in the franchise in exchange for periodic fees. a.|true.| b.|false.| ____ 3. Which of the following is not a provision or result of the Single European Act of 1987? a.|increased regulatory uniformity among European countries.| b.|the phasing in of a common currency for all European countries by 1992.| c.|the removal of many taxes on goods traded between European countries.| d.|firms' ability to achieve economies of scale.| e.|all of the above.| ____ 4. Which of the following is not mentioned in the text as an additional risk resulting from international business? a.|exchange rate fluctuations.| b.|political risk.| c.|interest rate risk.| d.|exposure to foreign economies.| ____ 5. Due to the larger opportunity set of funding sources around the world from which an MNC can choose, an MNC may be able to obtain capital at a lower cost than a purely domestic firm. a.|true.| b.|false.| ____ 6. Although MNCs may need to convert currencies occasionally, they do not face any exchange rate risk, as exchange rates are stable over time. a.|true.| b.|false.| ____ 7. If the home currency begins to appreciate against other currencies, this should ____________ the current account balance, other things equal (assume that substitutes are readily...
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... 9:30-10:30 And by appointment Note that I am always willing to schedule additional office hours by appointment. I check email frequently, so that is also a good way to communicate. If I do not respond to your email message, that means I did not receive it. Please send it again. Email: butcher@ups.edu Required Course Materials Text: Madura, International Financial Management, Abridged 10th Edition, South-Western, 2011 Book: Lewis Michael, Boomerang: Travels in the New Third World, Norton, 2011 Calculator: A calculator is required. A financial calculator would be preferable, as it would have functions for bond valuation, net present valuation (NPV), internal rate of return (IRR), present value (PV), and future value (FV). A suitable calculator, the HP10-B, is available in the bookstore for about $30. Harvard Business School Cases https://cb.hbsp.harvard.edu/cbmp/access/17920074 The above is the URL for Harvard Business School so that you can obtain discounted student pricing for the cases: Group Ariel S.S.: Parity Conditions and Cross-Border Valuation (Note that there is no need to purchase the audio version of this case.) Pixonix Inc. Addressing Currency Exposure Recommended: 1. Subscription to the Wall Street Journal. Several class sessions will utilize information from the Wall Street Journal. See syllabus for the dates...
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...Business Economics GM545 Project Part 2 Fall Session A 2011 Mohamed Bah t.bahafsl@yahoo.com _______________________________ DeVry University Keller Graduate School of Management New Jersey North Brunswick An economic system should provide two social needs for the people it serves first an adequate production of goods and second an equitable distribution of those goods. National Income is the science of how to measure an economy’s overall economic performance. It mainly focuses on the overall level of production of goods and services. The Gross Domestic Product (GDP) per person tells us the income and expenditure of the average person in the economy, though it is not intended to be a measure of happiness or quality of life, It is good to measure the material well-being of the whole economy, because the more real GDP we have mean that we have higher standard of living by being able to consume more goods and services. In addition, we do have some factors or issues not in GDP that lead to the well being of the economy such as leisure, quality environment, volunteer work, and child rearing. Having measured these factors or issues above the national income accounting is faced with these limitations: • Measurement problem exist, • GDP measure economic activities not welfare, and • Subcategories are often interdependent. Finally, due to these limitations we faced these measurement errors: • Illegal drug sales • Work...
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...Classnote Prof. Gordon Bodnar Techniques for Managing Exchange Rate Exposure A firm's economic exposure to the exchange rate is the impact on net cash flow effects of a change in the exchange rate. It consists of the combination of transaction exposure and operating exposure. Having determined whether the firm should hedge its exposure, this note will discuss the various things that a firm can do to reduce its economic exposure. Our discussion will consider two different approaches to handling these exposures: real operating hedges and financial hedges. Transaction Exposure Financial Techniques of Managing Transaction Exposure Transaction exposure hedging should have been discussed in some detail in the previous international finance course; however, we will briefly go over the standard financial methods available for hedging this exposure. The main distinction between transaction exposure and operating exposure is the ease with which one can identify the size of a transaction exposure. This, combined with the fact that it has a well-defined time interval associated with it makes it extremely suitable for hedging with financial instruments. Among the more standard methods for hedging transaction exposure are: i) Forward Contracts - When a firm has an agreement to pay (receive) a fixed amount of foreign currency at some date in the future, in most currencies it can obtain a contract today that specifies a price at which it can buy (sell) the foreign currency at the specified...
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...either make $30 million or lose $10 million every year with equal probability. The companies' profits are perfectly negatively correlated. What are the expected after-tax profits of Thither in any year, assuming a corporate tax rate of 35% and no tax loss carry back or carry forward? A) $19.5 million B) $6.5 million C) $4.75 million D) -$6.5 million 2) Consider two firms, Thither and Yon. Both companies will either make $30 million or lose $10 million every year with equal probability. The companies' profits are perfectly negatively correlated. What are the expected after-tax profits of the combined company (Thither and Yon) in any year, assuming a corporate tax rate of 35% and no tax loss carry back or carry forward? A) $19.5 million B) $6.5 million C) $4.75 million D) -$6.5 million 3) Consider two firms, Bob Company and Cat Enterprises, both with earnings of $10 per share and 5 million shares outstanding. Cat is a mature company with few growth opportunities and a stock price of $25 per share. Bob is a new firm with much higher growth opportunities and a stock price of $40 per share. Assume Bob acquires Cat using its own stock and the takeover adds no value. In a perfect capital market, how many shares must Bob offer Cat's shareholders in exchange for their shares? A) 1 share of new company after takeover for each share of Cat Enterprises. B) 0.625 shares of new company after takeover for each share of Cat Enterprises. C) 1.6 shares of new company after takeover for...
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