Problems 575
Questions
Define each of the following terms:
a.Multinational corporation
b.Exchange rate; fixed exchange rate system; floating exchange rates
c.Trade deficit; devaluation; revaluation
d.Exchange rate risk; convertible currency; pegged exchange rates
e.Interest rate parity; purchasing power parity
f.Spot rate; forward exchange rate; discount on forward rate; premium on forward rate
g.Repatriation of earnings; political risk
h.Eurodollar; Eurobond; international bond; foreign bond
i.The euro
Under the fixed exchange rate system, what was the currency against which all other currency
values were defined? Why?
Exchange rates fluctuate under both the fixed exchange rate and floating exchange rate systems.
What, then, is the difference between the two systems?
If the Swiss franc depreciates against the U.S. dollar, can a dollar buy more or fewer Swiss francs
as a result?
If the United States imports more goods from abroad than it exports, foreigners will tend to
have a surplus of U.S. dollars. What will this do to the value of the dollar with respect to foreign
currencies? What is the corresponding effect on foreign investments in the United States?
Why do U.S. corporations build manufacturing plants abroad when they could build them at
home?
Should firms require higher rates of return on foreign projects than on identical projects located
at home? Explain.
What is a Eurodollar? If a French citizen deposits $10,000 in Chase Manhattan Bank in New
York, have Eurodollars been created? What if the deposit is made in Barclay’s Bank in London?
Chase Manhattan’s Paris branch? Does the existence of the Eurodollar market make the Federal
Reserve’s job of controlling U.S. interest rates easier or more difficult? Explain.
Does interest rate parity imply that interest rates are the same in all countries?
Why might purchasing power parity fail to hold?
Self-Test Problem (Solution Appears in Appendix A)
Suppose the exchange rate between U.S. dollars and EMU euros is Euro 0.98 $1.00, and the
exchange rate between the U.S. dollar and the Canadian dollar is $1.00 C$1.50. What is the
cross rate of euros to Canadian dollars?
Problems
A currency trader observes that in the spot exchange market, 1 U.S. dollar can be exchanged for
9 Mexican pesos or for 111.23 Japanese yen. What is the cross-exchange rate between the yen
and the peso; that is, how many yen would you receive for every peso exchanged?
Six-month T-bills have a nominal rate of 7 percent, while default-free Japanese bonds that ma-
ture in 6 months have a nominal rate of 5.5 percent. In the spot exchange market, 1 yen equals
$0.009. If interest rate parity holds, what is the 6-month forward exchange rate?
15–2
INTEREST RATE PARITY
15–1
CROSS RATES
ST–1
CROSS RATES
15–10
15–9
15–8
15–7
15–6
15–5
15–4
15–3
15–2
15–1
Multinational Financial Management 569
