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Exam 21: Options and Corporate Finance

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Question 51

Multiple Choice

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In the spot market, $1 is currently equal to £0.6211.Assume the expected inflation rate in the U.K.is 2.6 percent while it is 4.3 percent in the U.S.What is the expected exchange rate four years from now if relative purchasing power parity exists?

A) £0.5799
B) £0.5822
C) £0.6105
D) £0.6623
E) £0.6644

F) None of the above
G) C) and D)

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Question 52

Multiple Choice

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Which of the following variables used in the covered interest arbitrage formula are correctly defined? I.R_FC: Foreign country nominal risk-free interest rate II.R_US: U.S.real risk-free interest rate III.F₁: 360-day forward rate IV.S₀: Current spot rate expressed in units of foreign currency per one U.S.dollar

A) I and II only
B) III and IV only
C) I, III, and IV only
D) II, III, and IV only
E) I, II, III, and IV

F) A) and E)
G) A) and B)

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Question 53

Multiple Choice

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On Friday evening, Bank A loans Bank B Eurodollars that must be repaid the following Monday morning.Which one of the following is most likely the interest rate that will be charged on this loan?

The expected inflation rate in Finland is 2.8 percent while it is 3.2 percent in the U.S.A risk-free asset in the U.S.is yielding 4.9 percent.What approximate real rate of return should you expect on a risk-free Finnish security?

You are analyzing a project with an initial cost of £130,000.The project is expected to return £20,000 the first year, £50,000 the second year and £90,000 the third and final year.There is no salvage value.The current spot rate is £0.6211.The nominal risk-free return is 5.5 percent in the U.K.and 6 percent in the U.S.The return relevant to the project is 14 percent in the U.S.Assume that uncovered interest rate parity exists.What is the net present value of this project in U.S.dollars?

What is the relationship between the value of the dollar and the value of the euro in relation to the rate of inflation in the United States?

Which one of the following supports the idea that real interest rates are equal across countries?

George and Pat just made an agreement to exchange currencies based on today's exchange rate.Settlement will occur tomorrow.Which one of the following is the exchange rate that applies to this agreement?

U.S.dollars deposited in a bank in Switzerland are called:

Which of the following conditions are required for absolute purchasing power parity to exist? I.goods must be identical II.goods must have equal economic value III.transaction costs must be zero IV.there can be no barriers to trade

A basic interest rate swap generally involves trading a:

Assume you can buy 52 British pounds with 100 Canadian dollars.How much profit can you earn on a triangle arbitrage given the following rates if you start out with 100 U.S.dollars?

Assume the spot rate for the British pound currently is £0.6211 per $1.Also assume the one-year forward rate is £0.6347 per $1.A risk-free asset in the U.S.is currently earning 3.4 percent.If interest rate parity holds, what rate can you earn on a one-year risk-free British security?

Lakonishok Equipment has an investment opportunity in Europe.The project costs €12 million and is expected to produce cash flows of €2.7 million in year 1, €3.1 million in year 2, and €2.8 million in year 3.The current spot exchange rate is $1.3/€.The current risk-free rate in the United States is 5 percent, compared to that in Europe of 3.5 percent.The appropriate discount rate for the project is estimated to be 18 percent, the U.S.cost of capital for the company.In addition, the subsidiary can be sold at the end of three years for an estimated €6.5 million.What is the NPV of the project?

The condition stating that the interest rate differential between two countries is equal to the percentage difference between the forward exchange rate and the spot exchange rate is called:

The market value of the Blackwell Corporation just declined by 5 percent.Analysts believe this decrease in value was caused by recent legislation passed by Congress.Which type of risk does this illustrate?

Describe the foreign currency and home currency approaches to capital budgeting for a foreign project.Which is better? Which approach would you recommend a U.S.firm use? Justify your answer.

Absolute purchasing power parity is most apt to exist for which one of the following items?