Problem 1. How would a domestic company that exports likely be impacted by a weak home currency? How would it be impacted by a strong home currency?
Problem 2. A purely domestic company that neither exports nor imports does not need to worry about the exchange rate. Do you agree or disagree? Explain.
Problem 3. The one-year interest rate in Singapore is 11 percent. The one-year interest rate in the U.S. is 6 percent. The spot rate of the Singapore dollar (S$) is $.50 and the forward rate of the S$ is $.46. Assume zero transactions costs.
a. Does interest rate parity exist? Explain your answer.
b. Can a U.S. firm benefit from investing funds in Singapore using covered interest arbitrage? Explain.
Problem 4. Consider a period in which the U.S. dollar weakens against the euro. How will this affect the reported earnings of a U.S.-based MNC with European subsidiaries? Consider a period in which the U.S. dollar strengthens against most foreign currencies. How will this affect the reported earnings of a U.S.-based MNC with subsidiaries all over the world?
Problem 5. Decko Co. is a U.S. firm with a Chinese subsidiary that produces cell phones in China and sells them in Japan. This subsidiary pays its wages and its rent in Chinese yuan, which is presently tied to the dollar. The cell phones sold to Japan are denominated in Japanese yen. Assume that Decko Co. expects that the Chinese yuan will continue to stay fixed against the dollar. The subsidiary's main goal is to generate profits for itself and it reinvests the profits. It does not plan to remit any funds to the U.S. parent.
a. Assume that the Japanese yen strengthens against the U.S. dollar over time. How would this be expected to affect the profits earned by the Chinese subsidiary?
b. If Decko Co. had established its subsidiary in Tokyo, Japan instead of China, would its subsidiary's profits be more exposed or less exposed to exchange rate risk?
c. Why do you think that Decko Co. established the subsidiary in China instead of Japan? Assume no major country risk barriers.
d. If the Chinese subsidiary needs to borrow money to finance its expansion and wants to reduce its exchange rate risk, should it borrow U.S. dollars, Chinese yuan, or Japanese yen?
Problem 6. Relate the use of currency options to hedging net payables and receivables. That is, when should currency puts be purchased, and when should currency calls be purchased? Why would Cleveland, Inc., consider hedging net payables or net receivables with currency options rather than forward contracts? What are the disadvantages of hedging with currency options as opposed to forward contracts?
Problem 7. If the potential return is high enough, any degree of country risk can be tolerated. Do you agree with this statement? Why or why not? Do you think that a proper country risk analysis can replace a capital budgeting analysis of a project considered for a foreign country? Explain.
Problem 8. Explain some of the reasons why a U.S.-based corporation might issue debt denominated in a foreign currency.