050354 April 2011 Dr. C. Raymond
050 354 International Financial Management
MIDTERM EXAMINATION
Directions. Answer all question in your answer book. Each of the four Parts of the exam counts As 25%
of your total score.
PART A. Transaction Exposure. A USA company is expecting to earn UK £5 million in one year as a result
of selling one of its subsidiaries. The company is worried that the UK £ will fall in value over the next few
months, so it is thinking about hedging. The current spot rate is S($/£) = 1.50 and the one-year forward
rate is F($/£) = 1.40. There is also a one-year put option available to sell UK £ at a price of $0.02/£.
1. Draw a diagram such as the one shown below, and draw payout functions for (a) no hedge, (b)
forward hedge, and (c) put option hedge.
2. Why might the put option hedge be preferred to the forward hedge?
3. Why would a forward hedge be preferred to a currency hedge using currency futures?
$ proceeds
Future S($/£)
PART B. Economic Exposure. In a short essay, explain what economic exposure is, and the different
ways it might be reduced. Can “domestic” businesses face economic exposure as do multinational
companies (MNCs)? If so, please explain.
PART C. Exchange rates.
1. If the spot rate S($/£) = 2.00, what is the spot rate S(£/$)?
2. If the spot rate S($/£) = 2.00 and the spot rate S($/€) = 1.5, what is the spot rate S(£/€)?
3. If the spot rate S($/€) = 1.5, and if the US interest rate is i$ = 6.00% and the euro rate is i€ =
10.00%, what is the no-arbitrage forward rate F($/€)?
4. What relationship are you using to get the forward rate in (3) above?
5. If the USA inflation rate is now expected to rise (relative to the eurozone inflation rate), what
other changes would you expect to happen to the spot rate, the forward rate, and or interest
rates between the USA and the eurozone?
6. What relationship(s) are you using to get your answer to (5) above?
050354 April 2011 Dr. C. Raymond
PART D. Agree, Disagree, Explain. State whether you agree or disagree with the following
statements and VERY BRIEFLY explain why or why not.
1. Options are not risky because they are cheap to buy and they have limited downside.
2. MNCs should always borrow money from the countries with the lowest interest rate.
3. MNCs are always better off when their home currency gets stronger.
4. Currency (FX) bid-ask spreads are always largest for the US$.
5. If the Bank of Thailand were to once again fix the baht to the US$, there would be no need for
Thai businesses to worry about foreign exchange exposure.