Question 1: Letters of Credit.
Ocean traders of North America is a firm based in Mobile, Alabama, that specializes in seafood exports and commonly uses letters of credit (L/Cs) to ensure payment. It recently experienced a problem, however. Ocean Traders has an irrevocable L/C issued by a Russian bank to ensure that it would receive payment upon shipment of 16,00 tons of fish to a Russian firm. This bank backed out of its obligation, however, stating that it was not authorized to guarantee commercial transactions.
a. Explain how an irrevocable L/C would normally facilitate the business transaction between the Russian importer and Ocean Traders of North America (the U.S. exporter).
b. Explain how the cancellation of the L/C could create a trade crisis between the U.S. and Russian firms.
c. Why do you think situations like this (cancellation of the L/C) are rare in industrialized countries?
d. Can you think of any alternative strategy that the U.S. exporter could have used to protect itself better when dealing with a Russian importer?
Question 2: Break-Even Financing.
Akron Co. needs dollars. Assume that the local one-year loan rate is 15 percent, while a one-year lone rate on Euros is 7 percent. By how much must a Euro appreciate to cause the loan in Euros to be more costly than a U.S. dollar loan?
Question 3: Effective Yield.
Fort Collins Inc., has $1 million in cash available for 30 days. It can earn 1 percent on a 30 day investment in the United States. Alternatively, if it converts the dollars to Mexican pesos, it can earn 1 ½ percent on a Mexican deposit. The spot rate 30 days from now is expected to be $.10. should Fort Collins invest its cash in the United States or in Mexico? Substantiate your answer.
Question 4: Investing in a Portfolio.
Pittsburgh Co. plans to invest its excess cash in Mexican pesos for one year. The one-year Mexican interest rate is 19 percent. The probability of the peso’s percentage change in value during the next year is as shown below
What is the expected value of the effective yield based on this information? Given that the U.S. interest rate for one year is 7 percent, what is the probability that a one-year investment in pesos will generate a lower effective yield than could be generated if Pittsburgh Co. simply invested domestically?