IBUS 401 - Chapter 3 Exam UPDATED
ACTUAL QUESTIONS AND CORRECT
ANSWERS
1. Motives for Investing in Foreign Money Markets. Explain why an MNC may invest funds in a
financial market outside its own country.
ANSWER: - CORRECT ANSWER The MNC may be able to earn a higher interest rate on
funds invested in a financial market outside of its own country. In addition, the exchange rate of the
currency involved may be expected to appreciate.
2. Motives for Providing Credit in Foreign Markets. Explain why some financial institutions prefer to
provide credit in financial markets outside their own country.
ANSWER: - CORRECT ANSWER Financial institutions may believe that they can earn a
higher return by providing credit in foreign financial markets if interest rate levels are higher and if
the economic conditions are strong so that the risk of default on credit provided is low. The
institutions may also want to diversity their credit so that they are not too exposed to the economic
conditions in any single country.
3. Exchange Rate Effects on Investing. Explain how the appreciation of the Australian dollar against
the U.S. dollar would affect the return to a U.S. firm that invested in an Australian money market
security.
ANSWER: - CORRECT ANSWER If the Australian dollar appreciates over the investment
period, this implies that the U.S. firm purchased the Australian dollars to make its investment at a
lower exchange rate than the rate at which it will convert A$ to U.S. dollars when the investment
period is over. Thus, it benefits from the appreciation. Its return will be higher as a result of this
appreciation.
4. Exchange Rate Effects on Borrowing. Explain how the appreciation of the Japanese yen against the
U.S. dollar would affect the return to a U.S. firm that borrowed Japanese yen and used the proceeds
for a U.S. project.
ANSWER: - CORRECT ANSWER If the Japanese yen appreciates over the borrowing period,
this implies that the U.S. firm converted yen to U.S. dollars at a lower exchange rate than the rate at
, which it paid for yen at the time it would repay the loan. Thus, it is adversely affected by the
appreciation. Its cost of borrowing will be higher as a result of this appreciation.
5. Bank Services. List some of the important characteristics of bank foreign exchange services that
MNCs should consider.
ANSWER: - CORRECT ANSWER The important characteristics are (1) competitiveness of
the quote, (2) the firm's relationship with the bank, (3) speed of execution, (4) advice about current
market conditions, and (5) forecasting advice.
6. Bid/ask Spread. Utah Bank's bid price for Canadian dollars is $.7938 and its ask price is $.81. What
is the bid/ask percentage spread?
ANSWER: - CORRECT ANSWER ($.81 - $.7938)/$.81 = .02 or 2%
7. Bid/ask Spread. Compute the bid/ask percentage spread for Mexican peso retail transactions in
which the ask rate is $.11 and the bid rate is $.10.
ANSWER: - CORRECT ANSWER [($.11 - $.10)/$.11] = .091, or 9.1%.
8. Forward Contract. The Wolfpack Corporation is a U.S. exporter that invoices its exports to the
United Kingdom in British pounds. If it expects that the pound will appreciate against the dollar in the
future, should it hedge its exports with a forward contract? Explain.
ANSWER: - CORRECT ANSWER The forward contract can hedge future receivables or
payables in foreign currencies to insulate the firm against exchange rate risk. Yet, in this case, the
Wolfpack Corporation should not hedge because it would benefit from appreciation of the pound
when it converts the pounds to dollars.
9. Euro. Explain the foreign exchange situation for countries that use the euro when they engage in
international trade among themselves.
ANSWER: - CORRECT ANSWER There is no foreign exchange. Euros are used as the
medium of exchange.
ACTUAL QUESTIONS AND CORRECT
ANSWERS
1. Motives for Investing in Foreign Money Markets. Explain why an MNC may invest funds in a
financial market outside its own country.
ANSWER: - CORRECT ANSWER The MNC may be able to earn a higher interest rate on
funds invested in a financial market outside of its own country. In addition, the exchange rate of the
currency involved may be expected to appreciate.
2. Motives for Providing Credit in Foreign Markets. Explain why some financial institutions prefer to
provide credit in financial markets outside their own country.
ANSWER: - CORRECT ANSWER Financial institutions may believe that they can earn a
higher return by providing credit in foreign financial markets if interest rate levels are higher and if
the economic conditions are strong so that the risk of default on credit provided is low. The
institutions may also want to diversity their credit so that they are not too exposed to the economic
conditions in any single country.
3. Exchange Rate Effects on Investing. Explain how the appreciation of the Australian dollar against
the U.S. dollar would affect the return to a U.S. firm that invested in an Australian money market
security.
ANSWER: - CORRECT ANSWER If the Australian dollar appreciates over the investment
period, this implies that the U.S. firm purchased the Australian dollars to make its investment at a
lower exchange rate than the rate at which it will convert A$ to U.S. dollars when the investment
period is over. Thus, it benefits from the appreciation. Its return will be higher as a result of this
appreciation.
4. Exchange Rate Effects on Borrowing. Explain how the appreciation of the Japanese yen against the
U.S. dollar would affect the return to a U.S. firm that borrowed Japanese yen and used the proceeds
for a U.S. project.
ANSWER: - CORRECT ANSWER If the Japanese yen appreciates over the borrowing period,
this implies that the U.S. firm converted yen to U.S. dollars at a lower exchange rate than the rate at
, which it paid for yen at the time it would repay the loan. Thus, it is adversely affected by the
appreciation. Its cost of borrowing will be higher as a result of this appreciation.
5. Bank Services. List some of the important characteristics of bank foreign exchange services that
MNCs should consider.
ANSWER: - CORRECT ANSWER The important characteristics are (1) competitiveness of
the quote, (2) the firm's relationship with the bank, (3) speed of execution, (4) advice about current
market conditions, and (5) forecasting advice.
6. Bid/ask Spread. Utah Bank's bid price for Canadian dollars is $.7938 and its ask price is $.81. What
is the bid/ask percentage spread?
ANSWER: - CORRECT ANSWER ($.81 - $.7938)/$.81 = .02 or 2%
7. Bid/ask Spread. Compute the bid/ask percentage spread for Mexican peso retail transactions in
which the ask rate is $.11 and the bid rate is $.10.
ANSWER: - CORRECT ANSWER [($.11 - $.10)/$.11] = .091, or 9.1%.
8. Forward Contract. The Wolfpack Corporation is a U.S. exporter that invoices its exports to the
United Kingdom in British pounds. If it expects that the pound will appreciate against the dollar in the
future, should it hedge its exports with a forward contract? Explain.
ANSWER: - CORRECT ANSWER The forward contract can hedge future receivables or
payables in foreign currencies to insulate the firm against exchange rate risk. Yet, in this case, the
Wolfpack Corporation should not hedge because it would benefit from appreciation of the pound
when it converts the pounds to dollars.
9. Euro. Explain the foreign exchange situation for countries that use the euro when they engage in
international trade among themselves.
ANSWER: - CORRECT ANSWER There is no foreign exchange. Euros are used as the
medium of exchange.
