Chapter 31:

Questions and Problems 4: Using Spot and Forward Exchange Rates

Suppose the spot exchange rate for the Canadian dollar is Can$1.05 and the Six-month forward rate is Can$1.03.

a. Which is worth more, a U.S. dollar or a Canadian dollar?

b. Assuming absolute PPP holds, what is the cost in the United States of an Elkhead beer if the price in Canada is Can$2.19? Why might the beer actually sell at a different price in the United States?

c. Is the U.S. dollar selling at a premium or a discount relative to the Canadian dollar?

d. Which currency is expected to appreciate in value?

e. Which country do you think has higher interest rates - the United States or Canada? Explain.

Questions and Problems 7: Interest Rates and Arbitrage

The treasurer of a major U.S. firm has $30 million to invest for three months. The annual interest rate in the United States is 21 percent per month. The interest rate in Great Britain is 57 percent per month. The spot exchange rate is £.64, and the three-month forward rate is £.65. Ignoring transaction costs, in which country would the treasurer want to invest the company's funds? Why?

Questions and Problems 8. Inflation and Exchange Rates

Suppose the current exchange rate for the Polish zloty is Z 3.14. The expected exchange rate in three years is Z 3.23. What is the difference in the annual inflation rates for the United States and Poland over this period? Assume that the anticipated rate is constant for both countries. What relationship are you relying on in answering?

Questions and Problems 15. Capital Budgeting

You are evaluating a proposed expansion of an existing subsidiary located in Switzerland. The cost of the expansion would be SF 25 million. The cash flows from the project would be SF 6.9 million per year for the next five years. The dollar required return is 12 percent per year, and the current exchange rate is SF 1.17. The going rate on Eurodollars is 6 percent per year. It is 5 percent per year on Swiss francs.

a. What do you project will happen to exchange rates over the next four years?

b. Based on your answer in (a), convert the projected franc flows into dollar flows and calculate the NPV.

c. What is the required return on franc flows? Based on your answer, calculate the NPV in francs and then convert to dollars.