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FIN 565 Week 7 Homework

1. Question: Banker’s Acceptances a. Describe how foreign trade would be affected if banks did not providetrade- related services. b. How can a banker’s acceptance be beneficial to an exporter, an importer, anda bank? 2. Question: 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 had an irrevocable L/C issued by a Russian bank to ensure that it would receive payment upon shipment of 16,000 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 betweentheRussianimporterandOceanTradersofNorthAmerica(theU.S.exporter). b. Explain how the cancellation of the L/C could create a trade crisis between the U.S.and Russianfirms. c. Why do you think situations like this (the cancellation of the L/C) are rarein industrializedcountries? d. Can you think of any alternative strategy that the U.S. exporter could have used toprotect itself better when dealing with a Russianimporter? 3. Question: IRP Application to Short-Term Financing Connecticut Co. plans to finance its U.S. operations. It can borrow euros on a short-term basis at a lower interest rate than if it borrowed dollars. a. If interest rate parity does not hold, what strategy should Connecticut Cder when it needs short-term financing? b. Assume that Connecticut Co. needs dollars. It borrows euros at a lower interest rate than that for dollars. If interest rate parity exists and if the forward rate of the euro is a reliable predictor of the future spot rate, what does this suggest about the feasibility of such a strategy? c. If Connecticut Co. expects the current spot rate to be a more reliable predictor of the future spot rate, what does this suggest about the feasibility of such astrategy? 4. Question: IRP Application to Short-term Financing Seabreeze Co. needs to finance some dollar- denominated expenses for one year. It can borrow euros cheaper than dollars. Interest rate parity exists. The one-year forward rate of the euro contains a premium of 4 percent. If it believes the euro will appreciate by 6 percent over the next year, would its expected financing expense be lower if it borrowed dollars or euros? 5. Question: Investing in a Portfolio Pittsburgh Co. plans to invest its excess cash in Mexican pesos forone 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 shown next: 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?

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