Chapter 7 Essay Q’s 1. ABC Corporation, a Canadian firm, wants to float a bond issue in the United Kingdom. Which choices does the company have? Discuss the main characteristics of each option. What do you recommend? Answer: ABC Corporation can issue foreign bonds (Bulldogs) or Eurobonds. Foreign bonds are bonds issued by a foreign borrower in a national market, in the national currency, and subject to the national securities regulations. Eurobonds are bonds sold in countries other the country that issued the denominating currency.
Foreign bonds tend to be registered bonds and subject to the local regulations while Eurobonds tend to be bearer bonds. Generally, foreign bonds are more costly than Eurobonds. Therefore, Eurobonds are likely the better option. page: 157-158 2. A- Canada Inc. has issued a dual-currency bond that pays $555. 10 at maturity per SF1,000 of par value. The company’s cash flows are exclusively in Canadian dollars. a) What is the implicit $/SF exchange rate at maturity? b) Will the company be better or worse off if the actual exchange rate at maturity is $0. 6123/SF? Answer: a) $555. 10/SF 1,000 = $ 0. 5551 b) The company will be better off.
Page: 175, problem 3 3. ZZZ Corp. wants to issue zero-coupon bonds with a 10-year maturity. The implied yield to maturity on these bonds is 5% and ZZZ Corp. wants to raise $10,000,000. (Assume no transaction costs). How much money will ZZZ Corp. have to pay at maturity of the bond? Answer: 10,000,000 (1. 05)10 = $16,288,946. 27 4. Assume Bank of Montreal has two zero-coupon bonds outstanding, each for a face value $100,000,000. Bond A matures in 10 years and sells at a discount of 35% off face value and bond B matures in 20 years and sells at a discount of 60% off face value. Calculate the implied yield to maturity of each bond.
Answer: Bond A: 650,000,000(1 + i)10 = 100,000,000 i = 4. 4% Bond B: 400,000,000(1 + i)20 = 100,000,000 i = 4. 67% 5. What happens to the present value of the bonds in 4. , if the implied yield to maturity increases by 1%? Answer: Bond A: 100,000,000/(1. 054)10 = 59,100,872. 35 The present value of the bond decreases by 65,000,000 59,100,872. 35 = 5,899,127. 65 Bond B: 100,000,000/(1. 0567)20 = 33,186,836. 18 The present value of the bond decreases by 40,000,000 33,186,836. 18 = 6,813,163. 82 Chapter 8 [Question] 1. Assume that Nestle shares are trading at SF 300 in Zurich and $ 51 in New York. Each share equals 4 ADRs.
The current exchange rate is SF1. 5/$. In the absence of transaction costs, can you make an arbitrage profit? Answer: Yes. Buy one share in Zurich for SF 300 or $ 200 (300/1. 5), exchange to ADRs and sell the ADRs for 4*51 = $204; profit $4 [Question] 2. Assume that Nestle shares are trading at SF 300 in Zurich and $ 51 in New York. Each share equals 4 ADRs. The current exchange rate is SF1. 5/$. If transaction costs are $1 per ADR, can you make an arbitrage profit? Answer: No, transaction costs = potential profit Potential profit in the absence of transaction costs: Buy one share in Zurich for SF 300 or $ 200 (300/1. ), exchange to ADRs and sell the ADRs for 4*51 = $204; profit $4 [Question] 3. What factors go into the decision to cross-list on a foreign exchange? Answer: When deciding whether to cross-list shares on a foreign exchange, the firm has to consider the expected benefits and costs. The benefits may be: to establish a broader investor base for its stock, to establish name recognition in foreign capital markets, thus paving the way for the firm to source new equity and debt capital from investors in different markets, and to expose the firm’s name to a broader investor and consumer groups.
The costs include: listing fees, reconciliation of the accounting standards of two countries, compliance with the regulations of the foreign exchange, and investor relations. page: 187. [Question] 4. Assume that Accor shares are trading at A$2. 5 in Sydney and $28 in New York. Each ADR equals 20 shares. The current exchange rate is A$1. 5/$. In the absence of transaction costs, can you make an arbitrage profit? Answer: Yes. Buy one ADR in New York for $28 (or A$42), exchange to shares and sell the shares for A$50; profit A$8 [Question] 5. Assume that Accor shares are trading at A$2. 5 in Sydney and $28 in New York.
Each ADR equals 20 shares. The current exchange rate is A$1. 5/$. At what transaction cost per share would there be no profit opportunity? Answer: A$8/20 = A$0. 4 Buy one ADR in New York for $28 (or A$42), exchange to shares and sell the shares for A$50; profit A$8 less transaction cost of 20*. 4 = A$8; profit = 0 Chapter 9 – I don’t believe there will be anything from here tho Chapter 10 [Question] 1. The following information is given: Both parties want to engage in an interest rate swap. Assume that S Bank will arrange for an interest rate swap between X Company and Y Company for 0. % . Also, assume that X Company gets 2/3 of the interest savings available. a) Which company has a better credit rating? b) What is the quality spread differential? c) What is X Company’s preferred type of debt? What rate of interest does it pay on this debt after the swap? d) What is Y Company’s preferred type of debt? What rate of interest does it pay on this debt after the swap? e) Illustrate the cash flows from this swap. Assume that X Company pays LIBOR to S Bank. Answer: a) X Company b) QSD = 2 1. 3 = 0. 7 c) Floating LIBOR . 4 d) Fixed 6. 8% e) [Question] 2.
The following information is given. ABC Inc. and XYZ Inc. have agreed to swap their debt payments so that each firm gets its preferred debt terms. They can arrange an interest rate swap through Big Bank. Big bank charges 0. 15% for its services. The remaining savings from the interest rate swap are equally shared by A and B. QSD: 1% . 25% = . 75%; after bank fees: . 75% . 15% = . 60% savings available a) Does ABC Inc. prefer fixed or floating rate debt? What rate does it pay on its preferred debt? b) Does XYZ Inc. prefer fixed or floating rate debt? What rate does it pay on its preferred debt? ) What are the total interest savings available in this interest rate swap? d) Which company has a better credit rating? Answer: a) ABC Inc. prefers floating and pays LIBOR + . 2 b) Interest Savings: 0. 6%. QSD bank fees = (6 5) (LIBOR + . 75 LIBOR + 0. 50) 0. 15 c) XYZ Inc. prefers fixed and pays 5. 7% d) Company ABC has a better credit rating [Question] 3. The following information is given. Boeing and Airbus have agreed to swap their debt payments so that each firm gets its preferred debt terms. Each firm will save the same amount in percentage terms. ) Does Boeing prefer fixed or floating rate debt? What rate does it pay on its preferred debt? b) Does Airbus prefer fixed or floating rate debt? What rate does it pay on its preferred debt? c) What are the total interest savings available in this interest rate swap? d) Which company has the advantage in fixed rate debt? Answer: a) Boeing prefers floating and pays LIBOR + 0. 05%. b) Airbus prefers fixed and pays 5. 5%. c) Interest Savings 0. 4%. d) Boeing has the advantage in fixed dollar debt. [Question] 4. ABC Corporation has entered into a 10-year interest rate swap with a swap bank. ABC Corp. ays the swap bank a fixed-rate of 6 percent annually on a notional amount of EUR100,000,000 and receives LIBOR - ? percent. What is the price of the swap on the seventh reset date, assuming that the fixed-rate at which ABC can borrow has decreased to 5%. Answer: PV of a hypothetical bond issue of EUR100,000,000 with three remaining 6 percent coupon payments at the new fixed rate of 5 percent is EUR100,000,000/1. 1576 = EUR86,385,625. 54 PV of the three coupon payments is: (6,000,000/1. 05) + (6,000,000/1. 1025) + (6,000,000/1. 1576) = EUR 16,339,488. 18 PV of the Bond and its coupon is = 102,725,113. 1 Therefore, the price of the swap = 100,000,000 102,725,113. 61 = 2,725,113. 61 [Question] 5. Canada Corporation enters into a 2-year interest rate swap with Bank A in which it agrees to pay the swap bank a fixed-rate of 5 percent annually on a notional amount of US$1,000,000 and receive LIBOR – 1 percent. Determine the price of the swap on the first reset date, assuming that the fixed-rate at which Canada Corporation can borrow has stayed unchanged. Answer: PV of a hypothetical bond issue of US$ 1,000,000 with one remaining 5 percent coupon payments at the fixed rate of 5 percent is US$1,000,000
Therefore, the price of the swap = 1,000,000 1,000,000 = 0 Chapter 11 [Question] 1. A US investor bought shares in ABC Inc. on the Frankfurt Stock Exchange 2 years ago for EUR 10,000. The exchange rate at that time was EUR 1. 20/USD. Currently, the shares are worth EUR 11,000 and the exchange rate is EUR 0. 80/$. Calculate the investor’s annual percentage rate of return in terms of the U. S. dollars. Answer: The annual percentage rate of return is: 28. 45%. 2-year rate of return = (11,000/0. 8 10,000/1. 2)/(10,000/1. 2) = 0. 65 (1 + r)2 = 1. 65 r = 0. 2845 [Question] 2. A US investor bought shares in ABC Inc. n the Frankfurt Stock Exchange 2 years ago for EUR 10,000. The exchange rate at that time was EUR 1. 20/USD. Currently, the shares are worth EUR 11,000 and the exchange rate is EUR 0. 80/$. The investor had sold EUR 10,000 (the principal investment amount at the same time that the stock was purchased) forward at the forward exchange rate of EUR 1. 15/$. What is the dollar rate of return? Assume that the unhedged portion of the investment is exchanged at the current exchange rate. Answer: The annual dollar rate of return is 9. 25%. 2-year rate of return = (10,000/1. 15 + 1,000/0. 8 10,000/1. )/(10,000/1. 2) = 0. 1935 (1 + r)2 = 1. 1935 r = 0. 0925 [Question] 3. In May 2003 when the exchange rate was Yen 110/$, Nissan Motor Company invested ? 1,100,000,000 in pure-discount U. S. bonds and liquidated the investment one year later when the exchange rate was Yen 105/$. The Yen rate of return earned on this investment was 10%. a) Calculate the dollar amount that the bonds were sold at. b) Calculate the dollar rate of return of this investment. Answer: a) The dollar amount that the bonds were sold at is: $11,523,809. 0. 1 = (X*105 1,100,000,000)/1 ,100,000,000) b) The dollar rate of return is:15. 4%. (11,523,809 10,000,000)/10,000,000 = . 1524 [Question] 4. A Canadian investor buys shares in DaimlerChrysler on the New York Stock Exchange when the stock’s price and the exchange rate were US$ 40 and US$0. 70/C$ respectively. One year later the investor sells the shares for US$ 41 and the exchange rate is US$0. 80/$. a) Calculate the investor’s annual percentage rate of return in terms of the U. S. dollars. b) Calculate the investor’s annual percentage rate of return in Canadian dollars. Answer: a) Rate of return: (41 40)/40*100 = 2. 5% b) Purchase price in Canadian dollars = 40/. 70 = 57. 4 Selling price in Canadian dollars = 41/. 80 = 51. 25 Therefore, the Canadian dollar rate of return is: R(C$) = [(51. 25 57. 14)/51. 25] 100 = 10. 313% Chapter 12 1. How can operating exposure be managed? Answer: The object of managing operating exposure is to stabilize cash flows when exchange rates are fluctuating. There are a number of ways in which operating exposure can be managed: (1) selecting low cost production sites (2) using a flexible sourcing policy (3) diversification of the market (4) product differentiation and R&D efforts (5) financial hedging page: 302-304 [Question] 2.
Banff Inc. is headquartered in Calgary and produces high-end living room furniture. The firm has a subsidiary in Germany. The wooden frames of the sofas are made in Calgary by an independent contractor and then shipped to Germany. The German subsidiary then upholsters the sofas using Belgium fabrics. Each frame costs the subsidiary C$1,500. The materials and labour for the upholstery amount to euro 2,000 per sofa. Fixed overhead costs are euro 1,500,000 for the subsidiary. Banff Inc. expects to be able to sell 3,000 Sofas for 5,000 euros each. The firm can depreciate 1,000,000 euros per year.
The German income tax rate is 40%. The current exchange rate is C$1. 5/euro. How would the operating cash flows (expressed in Canadian dollars) change if the exchange rate is C$1. 6/euro, all else equal? Answer: The operating income would increase by C$340,000. [Question] 3. Banff Inc. is headquartered in Calgary and produces high-end living room furniture. The firm has a subsidiary in Germany. The wooden frames of the sofas are made in Calgary by an independent contractor and then shipped to Germany. The German subsidiary then upholsters the sofas using Belgium fabrics.
Each frame costs the subsidiary C$1,500. The materials and labour for the upholstery amount to euro 2,000 per sofa. Fixed overhead costs are euro 1,500,000 for the subsidiary. Banff Inc. expects to be able to sell 3,000 Sofas for 5,000 euros each. The firm can depreciate 1,000,000 euros per year. The German income tax rate is 40%. The current exchange rate is C$1. 5/euro. How would the operating cash flows (expressed in Canadian dollars) change if the exchange rate is C$1. 4/euro, all else equal? Answer: The operating income would decrease by C$ 340,000. [Question] 4. Banff Inc. s headquartered in Calgary and produces high-end living room furniture. The firm has a subsidiary in Germany. The wooden frames of the sofas are made in Calgary by an independent contractor and then shipped to Germany. The German subsidiary then upholsters the sofas using Belgium fabrics. Each frame costs the subsidiary C$1,500. The materials and labour for the upholstery amount to euro 2,000 per sofa. Fixed overhead costs are euro 1,500,000 for the subsidiary. Banff Inc. expects to be able to sell 3,000 Sofas for 5,000 euros each. The firm can depreciate 1,000,000 euros per year.
The German income tax rate is 40%. The current exchange rate is C$1. 5/euro. How would the operating cash flows (expressed in Canadian dollars) change if the exchange rate is C$1. 4/euro, the German inflation rate is 3% but the firm will not be able to raise the price for its products and due to new competition from the Russian market (with a more favorable exchange rate) unit sales drop to 2,500? Answer: The operating income would decrease by C$ 1,276,000. [Question] 5. ABC Inc. , a Canadian paper manufacturer, has a subsidiary in the United States which sources its wood from Canada.
The US dollar depreciates rapidly. Discuss the likely competitive and conversion effects of the depreciation of the US dollar. Answer: The depreciation of the US dollar may alter the firm’s competitive position in the US market place. First of all, the input costs of the subsidiary in terms of US dollars are increasing. If the competitors source their raw materials in the United States, the competitive position of ABC Inc. ’s subsidiary will be eroded. The conversion effect implies in this case that the US dollar operating cash flows will be translated into a lower Canadian dollar value. page: 297-298
Chapter 13 1. Sonnenschein A. G. , a German retailer of solar panels just bought panels for US $ 100,000 to be paid in 120 days. As the financial manager, you are responsible for making a recommendation on the best hedging choice available to Sonnenschein A. G. You check with your banker and find out the following: The spot bid and ask rates are USD 1. 1001/EUR and USD 1. 0953/EUR respectively and the 120-day forward rates are EUR 0. 8850/USD and EUR 0. 8950/USD. Determine the net payables if Sonnenschein uses a forward hedge to manage its payables. Answer: US$ 100,000*0. 8950 = EUR 89,500 Question] 2. Pile-of-Bones Inc. , headquartered in Regina, just bought snowblowers for US $ 100,000 to be paid in 90 days. As the financial manager, you are responsible for making a recommendation on the best hedging choice available to Pile-of-Bones Inc. You check with your banker and find out the following: The current spot rate is C$ 1. 35/US$ and the 90-day forward rate is C$1. 36/US$. The interest rates are 5% in the United States and 6% in Canada. a) What are the net payables if Pile-of-Bones uses a forward hedge? b) What are the net payables if Pile-of-Bones uses a money market hedge? ) Which type of hedge should Pile-of-Bones use? Answer: a) 100,000*1. 36 = 136,000 b) 100,000/(1 + . 05/4) = 98,765. 43 98,765. 43*1. 35 = 133,333. 33 133,333. 33*(1 + . 025) = 136,666. 67 c) Pile-of-Bones should use forward hedge. [Question] 3. Soleil Inc. , a French manufacturer of sunscreen, has agreed to sell sunscreen to a Danish retailer for 2 million Danish kroner to be received in 180 days. The current spot rate is DKR5. 02/EUR and the 180-day forward rate is DKR5. 23/EUR. The current interest rates are 5% in Denmark and 4% in France. Should the firm use a forward hedge or a money market hedge?
Explain. Answer: The net proceeds from a forward hedge are: 2,000,000/5. 23 = 382,409. 17 The net proceeds from a money market hedge are: 2,000,000/(1. 05) = 1,903,761. 90 1,903,761. 90/5. 02 = 379,434. 64 379,434. 64*1. 04 = EUR394,612. 02 Since the net proceeds from the money market hedge are higher than from a forward market hedge, Soleil should use the money market hedge. [Question] 4. Quebec Inc. , manufactures prefabricated houses in Quebec and sells them all over the world in local currencies. The firm has just received an order from China for renminbi 8,280,000 to be paid at delivery in 1 year.
The Chinese renminbi is pegged to the US dollar at an exchange rate of 8. 28 per dollar. Does Quebec Inc have a transaction exposure? Explain. Answer: Quebec Inc is exposed to exchange rate risk. First of all, the Chinese government may choose to change the exchange rate at which the renminbi is pegged or drop the peg altogether within the next year. Even if the government does not intervene, Quebec Inc. is exposed to the US dollar-Canadian dollar exchange rate since the renminbi is pegged to the US Dollar and not the Canadian dollar. [Question] 5. Fashion Shoes Inc. anufactures its shoes in Milano, Italy. The company just received an order from the United States for USD 1 million to be received in one year. The current spot rate is EUR 1 /USD and the 1 year forward rate is EUR 1. 01/USD. The current interest rates are 4% in the United States and 5% in Italy. A call option on the US dollar is available with a strike price of EUR 1. 01/USD and a premium of EUR 0. 03 and a put option is available with a strike price of EUR 1/USD and a premium of EUR 0. 025/USD. Determine the net proceeds from a forward hedge and an options hedge. Which option should Fashion Shoes use?
Answer: Forward hedge: USD 1,000,000*1. 01 = EUR 1,010,000 Option hedge: Use the put option on the USD. Net proceeds from the options hedge: Strike price: USD 1,000,000*1 = EUR 1,000,000 Less premium in year 1 euros: 1,000,000*0. 025(1 + . 05) = 26,250 net proceeds: 1,000,000 26,250 = 973,750. The choice of the hedging strategy depends on exchange rate expectations. The option will provide a minimum of EUR 973,750 but if the dollar strengthens (i. e. the spot rate in one year is greater than EUR1. 03625/USD) the option will provide higher cash flows than the forward hedge.
