finance

1) Australian MNCs commonly invest in foreign securities.

a. Assume that the dollar is presently weak and is expected to strengthen over time. How will
these expectations affect the tendency of Australian investors to invest in foreign securities?

b. Explain how low Australian interest rates can affect the tendency of Australia-based MNCs to
invest abroad.

c. In general terms, what is the attraction of foreign investments to Australian investors?

2) Exchange rate effects on trade.

a. Explain why a stronger dollar could enlarge the Australian balance of trade deficit. Explain
why a weaker dollar could affect the Australian balance of trade deficit.

b. It is sometimes suggested that a floating exchange rate will adjust to reduce or eliminate any
current account deficit. Explain why this adjustment would occur.

c. Why does the exchange rate not always adjust to a current account deficit?

3) Factors affecting exchange rates. India tends to have much higher inflation than Australia
and also much higher interest rates than Australia. Inflation and interest rates are much more
volatile in India than in industrialised countries. The value of the Indian rupee is typically more
volatile than the currencies of industrialised countries from an Australian perspective; it has
typically depreciated from one year to the next, but the degree of depreciation has varied
substantially. The bid/ask spread tends to be wider for the rupee than for currencies of
industrialised countries.

a. Identify the most obvious economic reason for the persistent depreciation of the rupee.

b. High interest rates are commonly expected to strengthen a country’s currency because they
can encourage foreign investment in securities in that country, which results in the exchange of
other currencies for that currency. Yet, the rupee’s value has declined against the Australian
dollar over most years even though Indian interest rates are typically much higher than
Australian interest rates. Thus, it appears that the high Indian interest rates do not attract
substantial Australian investment in Indian securities. Why do you think Australian investors do
not try to capitalise on the high interest rates in India?

c. Why do you think the bid/ask spread is higher for rupees than for currencies of industrialised
countries? How does this affect an Australian company that does substantial business in India?

4) Decision to expand internationally

Aussie Blades, Pty Ltd is an Australia-based company that has been incorporated in Australia
for three years. It is a relatively small company, with total assets of only A$200 million. The

company produces a single type of product: rollerblades. Due to the booming rollerblade
market in Australia at the time of the company’s establishment, Aussie Blades has been quite
successful. For example, in its first year of operation, it reported a net income of A$3.5 million.
Recently, however, the demand for Aussie Blades’ ‘Speedos’, the company’s primary product
in Australia, has been slowly tapering off, and Aussie Blades has not been performing well.
Last year, it reported a return on assets of only 7 per cent. In response to the company’s
annual report for its most recent year of operations, Aussie Blades’ shareholders have been
pressuring the company to improve its performance; its stock price has fallen from a high of
A$20 per share three years ago to A$12 last year. Aussie Blades produces high-quality roller
blades and employs a unique production process, but the prices it charges are among the top 5
per cent in the industry.

In light of these circumstances, Ben Holt, the company’s chief financial officer (CFO), is
contemplating his alternatives for Aussie Blades’ future. There are no other cost-cutting
measures that Aussie Blades can implement in Australia without affecting the quality of its
product. Also, production of alternative products would require major modifications to the
existing plant set-up. Furthermore, and because of these limitations, expansion within Australia
at this time seems pointless.

Holt is considering the following: If Aussie Blades cannot penetrate the Australian market
further or reduce costs here, why not import some parts from overseas and/ or expand the
company’s sales to foreign countries? Similar strategies have proved successful for numerous
companies that expanded into Asia in recent years to increase their profit margins. The CFO’s
initial focus is on Thailand. Thailand has recently experienced weak economic conditions, and
Aussie Blades could purchase components there at a low cost. Holt is aware that many of
Aussie Blades’ competitors have begun importing production components from Thailand.

Not only would Aussie Blades be able to reduce costs by importing rubber and/or plastic from
Thailand due to the low costs of these inputs, it might also be able to augment weak Australian
sales by exporting to Thailand, an economy still in its infancy and just beginning to appreciate
leisure products such as roller blades. While several of Aussie Blades’ competitors import
components from Thailand, few are exporting to the country. Long- term decisions would also
eventually have to be made; maybe Aussie Blades, Pty Ltd could establish a subsidiary in
Thailand and gradually shift its focus away from Australia if its Australian sales do not rebound.
Establishing a subsidiary in Thailand would also make sense for Aussie Blades due to its
superior production process. Holt is reasonably sure that Thai companies could not duplicate
the high-quality production process employed by Aussie Blades. Furthermore, if the company’s
initial approach of exporting works well, establishing a subsidiary in Thailand would preserve
Aussie Blades’ sales before Thai competitors are able to penetrate the Thai market.

As a financial analyst for Aussie Blades, Pty Ltd, you are assigned to analyse international
opportunities and risk resulting from international business. Your initial assessment should
focus on the barriers and opportunities that international trade may offer. Holt has never been
involved in international business in any form and is unfamiliar with any constraints that may
inhibit his plan to export to and import from a foreign country. Holt has presented you with a list
of initial questions you should answer.

a. What are the advantages Aussie Blades could gain from importing from and/or
exporting to a foreign country such as Thailand?

b. What are some of the disadvantages Aussie Blades could face as a result of foreign
trade in the short run? What about in the long run?

c. Which theories of international business described in this chapter apply to Aussie

Blades, Pty Ltd in the short run? Which apply in the long run?

d. What long-range plans other than the establishment of a subsidiary in Thailand are an
option for Aussie Blades and may be more suitable for the company?

e. If a subsidiary is established in Thailand and the Thai baht weakens over the next five
years, will the value of Aussie Blades be favourably affected, unfavourably affected or
not affected? Briefly explain.

5) Blades follows a policy of invoicing in Thai baht (Thailand’s currency). Holt felt that this strategy
would give Aussie Blades a competitive advantage since Thai importers can plan more easily
when they do not have to worry about paying differing amounts due to currency fluctuations.
Furthermore, Aussie Blades’ primary customer in Thailand (a retail store) has committed itself
to purchasing a certain amount of Speedos annually if Aussie Blades will invoice in baht for a
period of three years. Aussie Blades’ purchases of components from Thai exporters are
currently invoiced in Thai baht.

Holt is rather content with current arrangements and believes the lack of competitors in
Thailand, the quality of Aussie Blades’ products, and its approach to pricing will ensure Aussie
Blades’ position in the Thai rollerblade market in the future. Holt also feels that Thai importers
will prefer Aussie Blades over its competitors because Aussie Blades invoices in Thai baht.

You, as Aussie Blades’ financial analyst, have doubts as to Aussie Blades’ ‘guaranteed’ future
success. Although you believe Aussie Blades’ strategy for its Thai sales and imports is sound,
you are concerned about current expectations for the Thai economy. Current forecasts indicate
a high level of anticipated inflation, a decreasing level of national income, and the continuing
depreciation of the Thai baht. In your opinion, all of these future developments could affect
Aussie Blades financially, given the company’s current arrangements with its suppliers and with
the Thai importers. Both Thai consumers and companies might adjust their spending habits
should certain developments occur.

In the past, you have had difficulty convincing Holt that problems could arise in Thailand.
Consequently, you have developed a list of questions for yourself, which you plan to present to
the company’s CFO after you have answered them. Your questions are listed here:

a. How could a higher level of inflation in Thailand affect Aussie Blades (assume
Australian inflation remains constant)?

b. How could a decreasing level of national income in Thailand affect Aussie Blades?

c. How could the continuing depreciation of the Thai baht affect Aussie Blades? How
would it affect Aussie Blades relative to Australian exporters invoicing their rollerblades
in Australian dollars?

d. How could competition from cheaper imports of rollerblades into Thailand by Chinese
companies affect Aussie Blades?

e. How could the imposition of tariffs on luxury goods (rollerblades are considered a
luxury in Thailand) affect Aussie Blades?

6) Assessment of prevailing spot and forward rates by the Sports Exports Company.

As the Sports Exports Company exports Australian Rules footballs to the United Kingdom, it
receives British pounds. The cheque (denominated in pounds) for last month’s exports just
arrived. Jim Logan (owner of the Sports Exports Company) normally deposits the cheque with
his local bank and requests that the bank convert it to Australian dollars at the prevailing spot
rate (assuming that he did not use a forward contract to hedge this payment). Logan’s local
bank provides foreign exchange services for many of its business customers who need to buy
or sell widely traded currencies. Today, however, Logan decided to check the quotations of the
spot rate at other banks before converting the payment into Australian dollars.

a. Do you think Logan will be able to find a bank that provides him with a more favourable
spot rate than his local bank? Explain.

b. Do you think that Logan’s bank is likely to provide more reasonable quotations for the
spot rate of the British pound if it is the only bank in town that provides foreign
exchange services? Explain.

c. Logan is considering using a forward contract to hedge the anticipated receivables in
pounds next month. His local bank quoted him a spot rate of A$1.65 and a one-month
forward rate of A$1.6435. Before he decides to sell pounds one month forward, he
wants to be sure that the forward rate is reasonable, given the prevailing spot rate. A
one-month Treasury security in Australia currently offers a yield (not annualised) of 1
per cent, while a one-month Treasury security in the United Kingdom offers a yield of
1.4 per cent. Do you believe that the one-month forward rate is reasonable given the
spot rate of A$1.65?

d. The pound is being sold in question (3) at a discount in the forward market. If Logan
anticipates that the value of the pound will continue to decrease against the Australian
dollar (that is, the future spot rate will be lower than the forward rate) in the next few
months, what strategy should Logan take to make a profit from the pound? Explain
your answer

7) Developing a multinational sporting goods corporation

Last month, Jim Logan completed his undergraduate degree in finance and decided to pursue
his dream of managing his own sporting goods business. Logan had worked in a sporting
goods shop while going to university, and he had noticed that many customers wanted to
purchase a low-priced Australian Rules football. However, the sporting goods store where he
worked, like many others, sold only top-of-the-line footballs. From his experience, Logan was
aware that top-of-the-line footballs had a high mark-up and that a low-cost football could
possibly penetrate the Australian market. He also knew how to produce footballs. His goal was
to create a company that would produce low-priced footballs and sell them on a wholesale
basis to various sporting goods stores in Australia. Unfortunately, many sporting goods stores

began to sell low-priced footballs just before Logan was about to start his business. The
company that began to produce the low-cost footballs already provided many other products to
sporting goods stores in Australia and therefore had already established a business
relationship with these stores. Logan did not believe that he could compete with this company
in the Australian market.

Rather than pursue a different business, Logan decided to implement his idea on a global
basis. While Australian Rules football obviously has not been a traditional sport in foreign
countries, it has become more popular in some foreign countries in recent years. Furthermore,
the expansion of cable networks in foreign countries would allow for much more exposure to
Australian football games in those countries in the future. To the extent that this would increase
the popularity of football (Australian style) as a hobby in the foreign countries, it would result in
a demand for footballs in foreign countries. Logan asked many of his foreign friends from his
university days if they recalled seeing Australian footballs sold in their home countries. Most of
them said they rarely noticed footballs being sold in sporting goods stores but that they
expected the demand for footballs to increase in their home countries. Consequently, Logan
decided to start a business producing low-priced footballs and exporting them to sporting goods
distributors in foreign countries. Those distributors would then sell the footballs at the retail
level. Logan planned to expand his product line over time once he identified other sports
products that he might sell to foreign sporting goods stores. He decided to call his business
‘Sports Exports Company’. To avoid any rent and labour expenses, Logan planned to produce
the footballs in his garage and to perform the work himself. Thus, his main business expenses
were the cost of the materials used to produce footballs and the expenses associated with
finding distributors in foreign countries who would attempt to sell the footballs to sporting goods
stores.

a. Is Sports Exports Company a multinational corporation?

b. Why are the agency costs lower for Sports Exports Company than for most MNCs?

c. Does Sports Exports Company have any comparative advantage over potential
competitors in foreign countries that could produce and sell footballs there?

d. How would Jim Logan decide which foreign markets he would attempt to enter? Should
he initially focus on one or many foreign markets?

e. Sports Exports Company has no immediate plans to conduct foreign direct investment.
However, it might consider other, less costly methods of establishing its business in
foreign markets. What methods might Sports Exports Company use to increase its
presence in foreign markets by working with one or more foreign companies?

f. How should Jim Logan choose foreign markets to avoid foreign currency exposure?

8) Identifying factors that will affect the foreign demand at the Sports Exports Company Jim Logan
planned to pursue his dream of establishing his own business (called the Sports Exports
Company) of exporting Australian footballs to one or more foreign markets. He has decided to
initially pursue the market in the United Kingdom because British citizens appear to have some
interest in football as a possible hobby, and no other company has capitalised on this idea in
the United Kingdom. (The sporting goods shops in the United Kingdom do not sell footballs but
might be willing to do so.) Logan has contacted one sporting goods distributor that has agreed

to purchase footballs on a monthly basis and distribute (sell) them to sporting goods stores
throughout the United Kingdom. The distributor’s demand for footballs is ultimately influenced
by the demand for footballs by British citizens who shop in British sporting goods stores. The
Sports Exports Company will receive British pounds when it sells the footballs to the distributor
and will then convert the pounds into Australian dollars. Logan recognises that products (such
as the footballs his company will produce) exported from Australian companies to foreign
countries can be affected by various factors.

Identify the factors that affect the current account balance between Australia and the United
Kingdom. Explain how each factor may possibly affect British demand for the footballs that are
produced by the Sports Exports Company.

9) Use of the foreign exchange markets by the Sports Exports Company

Each month, the Sports Exports Company (an Australian company) receives an order for
Australian Rules footballs from a British sporting goods distributor. The monthly payment for
the footballs is denominated in British pounds, as requested by the British distributor. Jim
Logan, owner of the Sports Exports Company, must convert the pounds received into
Australian dollars.
a. Explain how the Sports Exports Company could utilise the spot market to facilitate the

exchange of currencies. Be specific.

b. Explain how the Sports Exports Company is exposed to exchange rate risk and how it
could use the forward market to hedge this risk.

c. Is it wise for Jim to export footballs in Asian countries in order to reduce exchange rate
risk? Explain.

10) Jim Logan, owner of the Sports Exports Company, is concerned about the value of the British
pound over time because his company receives pounds as payment for Australian Rules
footballs exported to the United Kingdom. He recently read that the Bank of England (the
central bank of the United Kingdom) is likely to intervene directly in the foreign exchange
market by buying a massive amount of British pounds to prevent a significant drop in the value
of British pounds in response to Brexit-related turmoil.

a. Forecast whether the British pound will weaken or strengthen based on the information
provided.

b. How would the performance of the Sports Exports Company be affected by the Bank of
England’s policy of massive buying of British pounds in the foreign exchange market
(assuming that it does not hedge its exchange rate risk)?

11) Because the Sports Exports Company (an Australian company) receives payments in British
pounds every month and converts those pounds into Australian dollars, it needs to closely
monitor the value of the British pound in the future. Jim Logan, owner of the Sports Exports
Company, expects that inflation will rise substantially in the United Kingdom while inflation in
Australia will remain low. He also expects that the interest rates in both countries will rise by
about the same amount.

a. Given Jim’s expectations, forecast whether the pound will appreciate or depreciate against
the Australian dollar over time.

b. Given Jim’s expectations, will the Sports Exports Company be favourably or unfavourably
affected by the future changes in the value of the pound?

c. If Jim expects that interest and inflation in the United Kingdom will rise at the same rate,
and that the interest rate and inflation in Australia will remain low for at least one year, what
strategy should Jim take to avoid the loss due to the exchange rate exposure? Explain.

12) Use of currency futures and options by the Sports Exports Company

The Sports Exports Company receives British pounds each month as payment for the footballs
that it exports. It anticipates that the pound will depreciate over time against the Australian
dollar.

a. How can the Sports Exports Company use currency futures contracts to hedge against
exchange rate risk? Are there any limitations of using currency futures contracts that
would prevent the Sports Exports Company from locking in a specific exchange rate at
which it can sell all the pounds it expects to receive in each of the upcoming months?

b. How can the Sports Exports Company use currency options to hedge against
exchange rate risk?

c. We assume Jim Logan, owner of the Sports Exports Company, has locked in the
pound’s spot exchange rate using currency options (1 per cent premium) in anticipation
that the pound will either depreciate or appreciate by next payment against the
Australian dollar at least by 5 per cent. Do you think it was a wise decision for Jim to
lock in a currency options contract? Explain.

d. Are there any limitations of using currency options contracts that would prevent the
Sports Exports Company from locking in a specific exchange rate at which it can sell
all the pounds it expects to receive in each of the upcoming months?

e. Jim Logan is concerned that the pound may depreciate substantially over the next
month, but he also believes that the pound could appreciate substantially if specific
situations occur. Should Logan use currency futures or currency options to hedge the
exchange rate risk? Is there any disadvantage of selecting this method for hedging?

13) Assessment of exchange rate exposure by the Sports Exports Company

At the current time, the Sports Exports Company is willing to receive payments in British
pounds for the monthly exports it sends to the United Kingdom. Although all of its receivables
are denominated in pounds, it has no payables in pounds or in any other foreign currency. Jim
Logan, owner of the Sports Exports Company, wants to assess his company’s exposure to
exchange rate risk.

a. Would you describe the exposure of the Sports Exports Company to exchange rate
risk as transaction exposure? Economic exposure? Translation exposure?

b. Logan is considering a change in the pricing policy in which the importer must pay in
Australian dollars so that Logan will not have to worry about converting pounds to
Australian dollars every month. If implemented, would this policy eliminate the
transaction exposure of the Sports Exports Company? Would it eliminate Sports
Exports’ economic exposure? Explain.

c. If Logan decides to implement the policy described in the previous question, how
would the Sports Exports Company be affected (if at all) by appreciation of the pound?
By depreciation of the pound? Would these effects on Sports Exports differ if Logan
retained his original policy of pricing the exports in British pounds?

14) Hedging decisions by the Sports Exports Company

Jim Logan, owner of the Sports Exports Company, will be receiving 10,000 British pounds one
month from now as payment for exports produced and sent by his company. Logan is
concerned about his exposure because he believes that there are two possible scenarios: (1)
the pound will depreciate by 3 per cent over the next month, or (2) the pound will appreciate by
2 per cent over the next month. There is a 70 per cent chance that (1) will occur. There is a 30
per cent chance that (2) will occur. Logan notices that the prevailing spot rate of the pound is
A$1.65, and the one-month forward rate is A$1.645.

Logan can purchase a put option over the counter from a securities company that has an
exercise (strike) price of A$1.645, a premium of A$0.025 and an expiration date of one month
from now.

a. Determine the amount of Australian dollars received by the Sports Exports Company if the
receivables to be received in one month are not hedged under each of the two exchange
rate scenarios.

b. Determine the amount of Australian dollars received by the Sports Exports Company if a
put option is used to hedge receivables in one month under each of the two exchange rate
scenarios.

c. Determine the amount of Australian dollars received by the Sports Exports Company if a

forward hedge is used to hedge receivables in one month under each of the two exchange
rate scenarios

d. Summarise the results of Australian dollars received based on an unhedged strategy, a put
option strategy and a forward hedge strategy. Select the strategy that you prefer based on
the information provided.

e. What is the break-even strike price between the put option and forward rate hedging

strategy?

15) Multinational restructuring by the Sports Exports Company

The Sports Exports Company has been successful in producing footballs in Australia and
exporting them to the United Kingdom. Recently, Jim Logan (owner of the Sports Exports
Company) has considered restructuring his company by expanding throughout Europe. He

plans to export Australian Rules footballs and other sporting goods that were not already
popular in Europe to one large sporting goods distributor in Germany; the goods will then be
distributed to any retail sporting goods stores throughout Europe that are willing to purchase
these goods. This distributor will make payments in euros to the Sports Exports Company.

a. Are there any reasons why the business that has been so successful in the United
Kingdom might not be successful in other European countries?

b. If the business is diversified throughout Europe, will this substantially reduce the exposure
of the Sports Exports Company to exchange rate risk?

c. Now that several countries in Europe participate in a single currency system, will this affect
the performance of new expansion throughout Europe?

16) Multinational capital budgeting by the Sports Exports Company

Jim Logan, owner of the Sports Exports Company, has been pleased with his success in the
United Kingdom. He began his business by producing footballs and exporting them to the
United Kingdom. While Australian-style football is still not nearly as popular in the United
Kingdom as it is in Australia, his company controls the market in the United Kingdom. Logan is
considering an application of the same business in Mexico. He would produce the footballs in
Australia and export them to a distributor of sporting goods in Mexico, who would sell the
footballs to retail stores. The distributor likely would want to pay for the product each month in
Mexican peso. Logan would need to hire one full-time employee in Australia to produce the
footballs. He would also need to lease one warehouse.

a. Describe the capital budgeting steps that would be necessary to determine whether this
proposed project is feasible, as related to this specific situation.

b. Explain why there is uncertainty surrounding the cash flows of this project.

c. When Logan is considering the implementation of his project in one of several possible
countries, what type of tax characteristics should be assessed among the countries?

17) Currency denomination decision by the Sports Exports Company

The Sports Exports Company continues to focus on producing footballs in Australia and
exporting them to the United Kingdom. The exports are denominated in pounds, which has
continually exposed the company to exchange rate risk. It is now considering a new expansion
project where it would sell specialty golfing products in Australia. If it pursues this Australian
project, it will need to borrow funds.

a. Jim Logan, owner of the Sports Exports Company, needs to determine whether Australian
dollar- denominated debt or pound-denominated debt would be most appropriate for
financing this expansion, if he does expand. Assume that Australia and the United
Kingdom have equal interest rates. Logan is also concerned that pounds are steadily
weakening post-Brexit. What should be the currency of denomination for new borrowing, if
his goal is to minimise exchange rate risk?

b. Assume that Logan faces much lower Australian interest rates than UK rates, if he decides
to borrow. Also, assume that the Australian project will produce no revenues during the
next three years. Does he have to face a trade-off between paying lower interest rates and
hedging his pound receivables?

18) Potential effects if Switzerland adopted the euro Switzerland has its own currency, the

Swiss franc. Switzerland has considered adopting the euro as its currency. There have been
many arguments about whether it should do so. Use your knowledge and intuition to discuss
the likely effects if the Switzerland adopts the euro. For each of the 10 statements below, insert
either INCREASE or DECREASE and complete the statement by adding a clear short
explanation (perhaps one to three sentences) of why the UK’s adoption of the euro would have
that effect. To help you narrow your focus, follow these guidelines. Assume that the Swiss franc
is more volatile than the euro. Do not base your answer on whether the Swiss franc would have
been stronger than the euro in the future. Also, do not base your answer on an unusual change
in economic growth in Switzerland or in the euro zone if the euro is adopted.

a. The economic exposure of Swiss companies that are heavy exporters to the eurozone
would __________ because __________.

b. The translation exposure of companies based in the eurozone that have Swiss subsidiaries
would __________ because __________.

c. The economic exposure of Australian companies that conduct substantial business in
Switzerland and have no other international business would __________ because
__________.

d. The translation exposure of Australian companies with Swiss subsidiaries would
__________ because __________.

e. The economic exposure of Australian companies that export to Switzerland and whose
only other international business is importing from companies based in the eurozone would
__________ because __________.

f. The discount on the forward rate paid by Australian companies that periodically use the
forward market to hedge payables of Swiss imports would __________ because
__________.

g. The earnings of a foreign exchange department of a Swiss bank that executes foreign
exchange transactions desired by its European clients would __________ because
__________.

h. Assume that the British pound is more highly correlated with the Swiss franc than with the
euro. An Australian company has substantial monthly exports to Switzerland denominated
in the Swiss currency, and it also has substantial monthly imports of British supplies
denominated in British pounds. The economic exposure of this company would
__________ because __________.

i. Assume that the British pound is more highly correlated with the Swiss franc than with the
euro. An Australian company has substantial monthly exports to the United Kingdom
denominated in the British currency, and it also has substantial monthly exports to
Switzerland denominated in Swiss francs. The economic exposure of this company would
__________ because __________.

j. The Swiss Government’s reliance on monetary policy (as opposed to fiscal policy) as a
means of fine-tuning the economy would __________ because __________.