Introduction to Corporate Finance

17: International Investment Decisions

IMPORTANT EQUATIONS

17.1

− 360

×

FS

SN

17.2

()

()

(1 )

(1 )

=

+

+

F

S

R

R

n

for/dom

for/dom

for

n

dom

n

KEY TERMS

appreciate, 608

cross exchange rate, 610

currency board arrangement, 603

depreciate, 608

direct quote, 608

exchange rate, 602

fixed exchange rate, 603

floating exchange rate, 603

forward discount, 609

forward exchange rate, 609

forward premium, 609

hedging, 613

indirect quote, 608

interest rate parity, 618

managed floating rate system, 603

multinational corporations

(MNCs), 602

spot exchange rate, 609

triangular arbitrage, 610

SELF-TEST PROBLEMS

Answers to Self-test problems and the Concept review questions throughout the chapter appear on

CourseMate with SmartFinance Tools at http://login.cengagebrain.com.

ST17-1 Suppose the spot exchange rate equals ¥100/$, and the six-month forward rate equals

¥101/$. An investor can purchase a Treasury bill that matures in six months and earns

an annual rate of return of 3%. What would be the annual return on a similar Japanese

investment?

■ Companies that are exposed to a variety

of currencies can experience extra volatility

in profitability caused by exchange rate

volatility. Hedging this exchange rate risk can

reduce the impact of this.

■ Exchange rate risk hedging can be done

with a currency hedge trading strategy, or

by using a natural hedge. A natural hedge

can be created by matching revenues and

expenses, or assets and liabilities in the same

currency.

■ When a company analyses a capital

investment in a foreign currency, it can either

discount the foreign currency cash flows using

a foreign cost of capital, or it can calculate the

domestic currency equivalent of those cash

flows using forward rates, and discount them

at the domestic cost of capital.

LO17.2