1. The realized dollar returns for a U.S. resident investing in a foreign market will depend on the return in the foreign market as well as on the exchange rate fluctuations between the dollar and the foreign currency. Calculate the variance of the monthly rate of return in dollar terms, if the variance of the foreign market's return (in terms of its own currency) is 1.14, the variance between the U.S. dollar and the foreign currency is 17.64, the covariance is 2.34, and the contribution of the cross-product term is 0.04.
2. USE THE FOLLOWING INFORMATION TO ANSWER THE NEXT FIVE QUESTIONS
A U.S. firm holds an asset in Great Britain and faces the following scenario:
State 1 State 2 State 3
Probability 25% 50% 25%
Spot rate $2.20/£ $2.00/£ $1.80/£
P* £2,000 £2,500 £3,000
P $4,400 $5,000 $5,400
where,
P* = Pound sterling price of the asset held by the U.S. firm
P = dollar price of the same asset
(a) What is the expected value of the investment in U.S. dollars?
(b) What is the variance of the exchange rate?
(c) What is the "exposure coefficient" (i.e. the regression coefficient beta)?
(d) What is the volatility of the dollar value of the British asset [i.e. Var(P)]?
(e) Var(e) represents the residual part of the dollar value variability that is independent of exchange rate movements. What is the Var(e)?
3. Emerald Energy is an oil exploration and production company that trades on the London stock market. Over the past year, the stock has enjoyed a 20 percent return in pound terms, but over the same period, the exchange rate has fallen from $2.00 = £1 to $1.80 = £1. Calculate the investor's annual percentage rate of return in terms of the U.S. dollars.
4. Zeda, Inc., a U.S. MNC, is considering making a fixed direct investment in Denmark. The Danish government has offered Zeda a concessionary loan of DKK 15,000,000 at a rate of 4 percent per annum. The normal borrowing rate is 6 percent in dollars and 5.5 percent in Danish krone. The loan schedule calls for the principal to be repaid in three equal annual installments. What is the present value of the benefit of the concessionary loan? The current spot rate is DKK5.60/$1.00 and the expected inflation rate is 3% in the U.S. and 2.5% in Denmark.
(a) Fill in the answers in the table below.
(b) The dollar value of the concessionary loan is:
(c) The dollar present value of the concessionary loan payments is:
(d) The present value of the benefit of the concessionary loan is:
5. Given the following information for a levered and unlevered firm, calculate the difference in the cash flow available to investors. Assume the corporate tax rate is 40%.
Levered Unlevered
Revenue $250 $250
Operating cost -$100 -$100
Interest expense -$20 $0
6. Your company is considering building a plant which produces coin-operated cappuccino machines in Japan. The project costs ¥ 1,000,000 (year 0) and is expected to generate a cash flow of ¥ 500,000, ¥ 600,000, and ¥ 400,000 in the next three following years (years 1, 2, and 3; no cash flow is generated after year 3). Your company's required dollar rate of return on projects of similar risk is 10%. Inflation in the US and Japan is expected to be 3% and 2%, and the current spot rate is ¥ 125/$.
Assume that the international parity relations hold. Calculate the NPV of the project in dollars.
7. USE THE FOLLOWING INFORMATION TO ANSWER THE NEXT TWO QUESTIONS
i = rdebt = 7% Ku= rasset = 15% Kl=requity = 24.9%
K = rWACC = 11.20%
Tax rate = 40%
The 5-year project requires equipment that costs $200,000. If undertaken, the shareholders will contribute $80,000 cash and borrow $120,000 with an interest-only loan with a maturity of 5 years and annual interest payments. The equipment will be depreciated straight-line to zero over the 5-year life of the project.
(a) When using the APV methodology, what is the NPV of the depreciation tax shield?
(b) When using the APV methodology, what is the NPV of the interest tax shield?
8. XYZ Corporation, located in the United States, has an accounts payable obligation of ¥750 million payable in one year to a bank in Tokyo. The current spot rate is
¥116/$1.00 and the one year forward rate is ¥109/$1.00. The annual interest rate is 3 percent in Japan and 6 percent in the United States. XYZ can also buy a one-year call option on yen at the strike price of $0.0086 per yen for a premium of 0.012 cent per yen. Assume that the forward rate is the best predictor of the future spot rate. What is the future dollar cost of meeting this obligation using the option market hedge