INTERNATIONAL FINANCIAL MARKETS

Chapter three

QUESTIONS AND APPLICATIONS

1. Motives For Investing in Foreign Money.
The MNC may be able to earn a higher interest rate on funds invested in a financial
market outside of its own country. In addition, the exchange rate of the currency
involved may be expected to appreciate.
2. Motives For Providing Credit in Foreign Markets
Financial institutions may believe that they can earn a higher return by providing
credit in foreign financial markets if interest rate levels are higher and if the
economic conditions are strong so that the risk of default on credit provided is low.
The institutions may also want to diversity their credit so that they are not too
exposed to the economic conditions in any single country.
3. Exchange Rate Effects on Investing
Explain how the appreciation of the Australian dollar against the U.S dollar would
affect the return to a U.S firm that invested in an Australian money market security.
If the Australian dollar appreciates over the investment period, this implies that the
U.S firm purchased the Australian dollars to make its investment at a lower
exchange rate than the rate at which it will convert to U.S dollars when the
investment period is over. Thus, it benefits from the appreciation. Its return will be
higher as a result of this appreciation.
4. Exchange Rate Effects on Borrowing
If the Japanese yen appreciates over the borrowing period, this implies that the
U.S. firm converted yen to U.S. dollars at a lower exchange rate than the rate at
which it paid for yen at the time it would repay the loan. Thus, it is adversely
affected by the appreciation. Its cost of borrowing will be higher as a result of this
appreciation.
5. Bank Services
The important characteristics are:

competitiveness of the quote

the firms relationship with the bank
speed of execution
advice about current market conditions
forecasting advice.

6. Bid/Ask Spread
($.8100 $.7938)/$.8100 = .002 = 2%
7. Bid/Ask Spread.
($.11 $.10)/$.11] = .091 = 9.1%.
8. Forward Contract
The forward contract can hedge future receivables or payables in foreign
currencies to insulate the firm against exchange rate risk. Yet, in this case, the
Wolfpack Corporation should not hedge because it would benefit from appreciation
of the pound when it converts the pounds to dollars.
9. Euro
There is no foreign exchange. Euros are used as the medium of exchange.
10. Indirect Exchange Rate
1/1.25 = .8 euros.
11. Cross Exchange Rate
0.17/0.008 = 21,25 zloty : 1 yen
12. Sydicated Loans
A large MNC may want to obtain a large loan that no single bank wants to
accommodate by itself. Thus, a bank may create a syndicate whereby several
other banks also participate in the loan.
13. Loan Rates
Banks set the loan rate based on the prevailing LIBOR, and allow the loan rate to
float in accordance with changes in LIBOR.
14. International Markets
The function of the international money market is to efficiently facilitate the flow of
international funds from firms or governments with excess funds to those in need of
funds. Growth of the European money market was largely due to:

Regulations in the U.S. that limited foreign lending by U.S. banks;

Regulated ceilings placed on interest rates of dollar deposits in the U.S. that
encouraged deposits to be placed in the Eurocurrency market where
ceilings were nonexistent.

The international money market focuses on short-term deposits and loans, while
the international credit market is used to tap medium-term loans, and the

international bond market is used to obtain long-term funds (by issuing long-term
bonds).
15. Evolution of Floating Rates
Country governments had difficulty in maintaining fixed exchange rates. In 1971,
the bands were widened. Yet, the difficulty of controlling exchange rates even
within these wider bands continued. As of 1973, the bands were eliminated so that
rates could respond to market forces without limits .
16. International Diversification
Explain how the Asian crisis would have affected the returns to a U.S. firm
investing in the Asian stock markets as a means of international diversification.
The returns to the U.S. firm would have been reduced substantially as a result of
the Asian crisis because of both declines in the Asian stock markets and because
of currency depreciation. For example, the Indonesian stock market declined by
about 27% from June 1997 to June 1998. Furthermore, the Indonesian rupiah
declined against the U.S. dollar by 84%.
17. Eurocredit Loans
a. Large corporations and some government agencies commonly request
Eurocredit loans.
b. With a Eurocredit loan, no single bank would be totally exposed to the risk
that the borrower may fail to repay the loan. The risk is spread among all
lending banks within the syndicate.
c. LIBOR (London interbank offer rate) is the rate of interest at which banks in
Europe lend to each other. It is used as a base from which loan rates on
other loans are determined in the Eurocredit market.
18. Foreign Exchange
Exchange with the tourist. If you exchange the C$ for pesos at the foreign
exchange desk, the cross-rate is
$.60/$10 = 6.
Thus, the C$200 would be exchanged for
200 x 6 = 1,200 pesos.
If you exchange Canadian dollars for pesos with the tourist, you will receive 1,300
pesos.
19. Foreign Stock Markets
Firms may issue stock in foreign markets when they are concerned that their home
market may be unable to absorb the entire issue. In addition, these firms may have

foreign currency inflows in the foreign country that can be used to pay dividends on
foreign-issued stock. They may also desire to enhance their global image. Since
the euro can be used in several countries, firms may need a large amount of euros
if they are expanding across Europe.
20. Financing With Stock
21. Effects of September 11
The attack was expected to cause a weaker economy, which would result in lower
U.S. interest rates. Given the lower interest rates, and the weak stock prices, the
amount of funds invested by foreign investors in U.S. securities would be reduced.
22. International Financial Markets
a. The Wal-Mart stores in China need other currencies to buy products from
other countries, and must convert the Chinese currency (yuan) into the other
currencies in the spot market to purchase these products. They also could
use the spot market to convert excess earnings denominated in yuan into
dollars, which would be remitted to the U.S. parent.
b. Wal-Mart may need to maintain some deposits in the Eurocurrency market
that can be used (when needed) to support the growth of Wal-Mart stores in
various foreign markets. When some Wal-Mart stores in foreign markets
need funds, they borrow from banks in the Eurocurrency market. Thus, the
Eurocurrency market serves as a deposit or lending source for Wal-Mart and
other MNCs on a short-term basis.
c. Wal-Mart could issue bonds in the Eurobond market to generate funds
needed to establish new outlets. The bonds may be denominated in the
currency that is needed; then, once the stores are established, some of the
cash flows generated by those stores could be used to pay interest on the
bonds.
23. Interest Rates
Interest rates in each country are based on the supply of funds and demand for
funds for a given currency. However, the supply and demand conditions for the
euro are dictated by all participating countries in aggregate, and do not vary among
participating countries. Yet, the government interest rate in one country that uses
the euro could be slightly higher than others that use the euro if it is subject to
default risk. The higher interest rate would reflect a risk premium.
24. Interpreting Exchange Rate Quotations
Value of AP = $.333
Value of C$ in AP = 2
Value of C$ in $ = $.666

So you need $66,666 to purchase C$100,000.

25. Pricing ADRs
Expected value of Swiss stock in 1 year = SF80 x (1 - .03) = SF77.6.
Expected value of Swiss franc in 1 year = $.70 (1 - .08) = $0.644
Expected value of ADR in 1 year = 2 x SF77.6 x ($0.644 per franc) = $99.95.