The rise of globalization is due to the many companies that have become multinational corporations for various reasons—for example, to access better technology, to enter new markets, to obtain more raw materials, to find funding resources, to minimize production costs, or to diversify business risk. This multimarket presence
The rise of globalization is due to the many companies that have become multinational corporations for various reasons—for example, to access better technology, to enter new markets, to obtain more raw materials, to find funding resources, to minimize production costs, or to diversify business risk. This multimarket presence
Chapter4: Exchange Rate Determination
Section: Chapter Questions
Problem 13QA
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The rise of globalization is due to the many companies that have become multinational corporations for various reasons—for example, to access better technology, to enter new markets, to obtain more raw materials, to find funding resources, to minimize production costs, or to diversify business risk. This multimarket presence exposes companies to different kinds of risk as well—for example, political risk and exchange rate risk.
The relationship between interest rates and exchange rates can be represented through the concept of interest rate parity. Consider the following:
Suppose you observe the following spot and forward exchange rates between the U.S. dollar ($) and the Canadian dollar (C$):
|
|
Spot Exchange Rate
|
One-Year Forward
|
|---|---|---|
|
Exchange Rate
|
||
| Canadian dollar (U.S. dollar/Canadian dollar) | 0.8798 | 0.8935 |
The current one-year interest rate on U.S. Treasury securities is 8.03%. If interest rate parity holds, what is the expected yield on one-year Canadian securities of equal risk?
a. 5.73%
b. 6.37%
c. 6.69%
d. 7.01%
Interest rate parity recognizes that when you invest in a country other than your home country, two factors affect your investment—returns on the investment itself and changes in the exchange rate. Which of the following would cause the overall return on your investment to be lower than the investment’s stated return?
a. currency in which the investment is denominated appreciates relative to your home currency.
b. Your home currency appreciates relative to the currency in which the investment is denominated.
c. Your home currency depreciates relative to the currency in which the investment is denominated.
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