1. Effective Yield. Fort Collins, Inc., has $1 million in cash available for 30 days. It can earn 1% on a 30 day investment in the U. S. Alternatively, if it converts the dollars to Mexican pesos, it can earn 1 1/2% on a Mexican deposit

ANSWER: If Fort Collins Inc. invests in a Mexican deposit, it will convert $1 million to 8,333,333 pesos, which will accumulate to 8,458,333 pesos after one month (due to the 1 1/2% interest rate). If the spot rate of the peso is $.10 after one month, the pesos will be converted to $845,833, which is less than the amount of dollars the firm started with. Thus, the Fort Collins Inc. should invest its cash in the U.S.

ANSWER: Central banks can use their currency reserves to buy up a specific currency in the foreign exchange market in order to place upward pressure on that currency. Central banks can also attempt to force currency depreciation by flooding the market with that specific currency (selling that currency in the foreign exchange market in exchange for other currencies).

Abrupt movements in a currency’s value may cause more volatile business cycles, and may cause more concern in financial markets (and therefore more volatility in these markets). Central bank intervention used to smooth exchange rate movements may stabilize the economy and financial markets.
3. Capital Budgeting Analysis.

A project in South Korea requires an initial investment of 2 billion South Korean won. The project is expected to generate net cash flows to the subsidiary of 3 billion and 4 billion won in the two years of operation, respectively. The project has no salvage value. The current value of the won is 1,100 won per U.S. dollar, and the value of the won is expected to remain constant over the next two years.

1. 
   What is the NPV of this project if the required rate of return is 13 percent?
   

or 3.44 million U.S.dollars

2. 
   Repeat the question, expect assume that the value of the won is expected to be 1,200 won per U.S. dollar after two years. Future assume that the funds are blocked and that the parent company will only be able to remit them back to the United States in two years. How does this affect the NPV of the project?
   

ANSWER: J.C. Penney has name recognition, which could result in customer trust, and therefore a stronger demand for its products. It also has marketing expertise that it applies to each store. It also has economies of scale, because it could buy its products in bulk and distribute the products to the stores that need those products.

ANSWER: Its risk may decrease because it has a strategy that allows it to utilize its expertise, while relying on foreign expertise for part of the business that requires knowledge about foreign cultures. Also, it has created more international diversification by spreading its store throughout more foreign markets, so that its overall performance is not as heavily influenced by U.S. economic conditions.

Its risk could have increased if it selected local partners in the foreign countries that do not properly apply their knowledge of the local culture when making decisions about the types of products that the store should carry.
c. J.C. Penney has been more cautious about entering China. Explain the potential obstacles associated with entering China.

ANSWER: Obstacles include high inflation in China, difficulties in converting foreign currency, difficulties in efficiently distributing products across stores, and the lack of disposable income for many China residents.

ANSWER: International cash management can be segmented into two functions: optimizing cash flow movements, and investing excess cash. Cash inflows can be optimized by techniques such as accelerating cash inflows, minimizing currency conversion costs, managing blocked funds and managing inter subsidiary cash transfers. Investing excess cash involves assessment of effective yield and decision to invest funds in domestic or foreign short-term securities.

In managing blocked funds, the MNC may use transfer pricing in a manner that will increase the expenses incurred by the subsidiary. In this way, the profit of the subsidiary will be reduced
6. Comparing International Projects.

Savannah, Inc., a manufacturer of clothing, wants to increase its market share by acquiring a target producing a popular clothing line in Europe. This clothing line is well established. Forecasts indicate a relatively stable euro over the life of the project. Marquette, Inc., wants to increase its market share in the personal computer market by acquiring a target in Thailand that currently produces radios and converting the operations to produce PCs. Forecasts indicate a depreciation of the baht over the life of the project. Funds resulting from both projects will be remitted to the respective U.S. parent on a regular basis. Which target do you think will result in a higher net present value? Why?

ANSWER online: The European target will likely result in a higher NPV. First, the euro has generally been more stable than the Thai baht. The Thai baht is expected to depreciate, which would result in a reduction in dollar cash flows remitted to Marquette, which would reduce the net present value associated with that project. Second, Savannah will likely continue the operations of the acquired European target, while Marquette will substantially change the target's existing operations. Consequently, there is much greater uncertainty regarding the Thailand project, which would result in a higher required rate of return. A higher required rate of return will reduce the net present value associated with a project.

The project of Savannah, Inc. will result in a higher net present value.

1. Exchange rate. Forecasts indicate that euro will be quite stable while baht will depreciate against dollar during the life of projects. It can be inferred that Savannah, Inc. will receive more cash flow in dollar than Marquette, Inc.

2. Required return. Since Savannah plans to acquire a popular clothing line which has been successful in the Europe market, it is clear that the risk of this business will be relatively low. As a result, the required return will be quite low. On the other hand, the target which Marquette, Inc. wants to acquire has not established itself in Thailand, so the risk of project is high. Therefore, the required return will be higher than that of Savannah.

Because of these two reason, the former project has a higher net present value.
7. Aggregate Effects on Exchange Rates.

Assume that the United States invests heavily in government and corporate securities of Country K. In addition, residents of Country K invest heavily in the United States. Approximately $10 billion worth of investment transactions occur between these two countries each year. The total dollar value of trade transactions per year is about $8 million. This information is expected to also hold in the future. Because your firm exports goods to Country K, your job as international cash manager requires you to forecast the value of Country K’s currency (the “krank”) with respect to the dollar. Explain how each of the following conditions will affect the value of the krank, holding other things equal. Then, aggregate all of these impacts to develop an overall forecast of the krank’s movement against the dollar.

a. U.S. inflation has suddenly increased substantially, while Country K’s inflation remains low.

ANSWER: Increased U.S. demand for the krank. Decreased supply of kranks for sale. Upward pressure in the krank’s value.

ANSWER: Decreased U.S. demand for the krank. Increased supply of kranks for sale. Downward pressure on the krank’s value.

ANSWER: Increased U.S. demand for the krank. Upward pressure on the krank’s value.

ANSWER: The tariff will cause a decrease in the United States’ desire for Country K’s goods, and will therefore reduce the demand for kranks for sale. Downward pressure on the krank’s value.

ANSWER: Two of the scenarios described above place upward pressure on the value of the krank. However, these scenarios are related to trade, and trade flows are relatively minor between the U.S. and Country K. The interest rate scenario places downward pressure on the krank’s value. Since the interest rates affect capital flows and capital flows dominate trade flows between the U.S. and Country K, the interest rate scenario should overwhelm all other scenarios. Thus, when considering the importance of implications of all scenarios, the krank is expected to depreciate.

ANSWER: Futures prices on pounds rose in tandem with the value of the pound. However, when central banks intervened to support the dollar, the value of the pound declined, and so did values of futures contracts on pounds. So traders with long (buy) positions in these contracts experienced losses because the contract values declined.

ANSWER: Normally, this order would have been sold in pieces. This action could signal a desperate situation in which many investors sell futures contracts at any price, which places more downward pressure on currency future prices, and could cause a crisis.

ANSWER: The central bank intervention placed downward pressure on the pound and other European currencies. Thus, the values of futures contracts on these currencies declined. Traders that had short positions in futures would benefit because they could now close out their short positions by purchasing the same contracts that they had sold earlier. Since the prices of futures contracts declined, they would purchase the contracts for a lower price than the price at which they initially sold the contracts.

ANSWER: Central bank intervention sometimes has only a temporary effect on exchange rates. Thus, the European currencies could strengthen after a temporary effect caused by central bank intervention. Traders have to predict whether natural market forces will ultimately overwhelm any pressure induced as a result of central bank intervention.

ANSWER: Its exposure is high since all currencies move in tandem—no offsetting effect is likely. If one of these currencies depreciates substantially against the firm’s local currency, all others will as well, and this reduces the value of these net receivables. No! Thus, past correlations will not serve as perfect forecasts of future correlations.

Firms can not presume that past correlations will be perfectly accurate forecasts of future correlations. Yet, historical data may still be useful if the general ranking of correlations is somewhat stable.
10. Floating-Rate Bonds.

a. What factors should be considered by a U.S. firm that plans to issue a floating rate bond denominated in a foreign currency?

ANSWER: A U.S. firm should consider the interest rate for each possible currency as well as forecasts of the exchange rate relative to the firm’s home currency. The firm should also determine whether it has future cash inflows in any foreign currencies that could denominate the bond. Finally, the firm should fore¬cast the future path of the coupon rate.

ANSWER: The risk from issuing a floating rate bond is that the interest rate may rise over time. The risk from issuing a fixed rate bond is that the firm is obligated to pay that coupon rate even if interest rates decline. Some firms may feel that a fixed rate bond is less risky since at least they know with certainty the coupon rate they must pay in the future. This question is somewhat open ended.

ANSWER: An investing firm prefers a bond denominated in a cur¬rency that is expected to appreciate and with an interest rate that is high and expected to increase. A borrowing firm prefers a bond denominated in a currency that is expected to depreciate and with an interest rate that is low and expected to decrease.

ANSWER: Alaska’s cash flows would be favorably affected, because it has only cash outflows in pesos, and can periodically convert dollars to cover its expenses in pesos.