International Financial Management
14th Edition
ISBN: 9780357130698
Author: Madura
Publisher: Cengage
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The chapter demonstrated that a firm borrowing in a foreign currency could potentially end up paying a very different effective rate of interest than what it expected. Using the same baseline values of a debt principal of SF1.5 million, a one year period, an initial spot rate of SF1.5000/$, a 5.000% cost of debt, and a 34% tax rate, what is the effective cost of debt for one year for a U.S. dollar-based company if the exchange rate at the end of the period was: a. SF1.5000/$ b. SF1.4400/$ c. SF1.3860/$ d. SF1.6240/%
Suppose that California Co., a U.S. based MNC, seeks to capitalize a difference in interest rates between euros and British pounds via the use of a carry trade. In particular, after 1 month, funds invested in euros will yield a 0.50% percent return, while funds invested in pounds will yield a return of 2.00% percent.
Currently the spot rate of the British pound is $1.00 while the spot rate of the euro is $0.80. In other words, the pound is worth 1.25 euros. California Co. expects these spot rates to remain constant over the next month.
After repaying their euro loan, California Co. has 211,200 pounds remaining. Assume that the exchange rate is still $1.00 per pound.
These pounds are equivalent to $
, which represents a profit of $
over the initial $200,000 that California Co. used from their own funds.
PIMCO gives the following example of an Inflation Linked Bond (ILB), called a Treasury Inflation Protected Security (TIPS) in the US.
"How do ILBs work?
An ILB’s explicit link to a nationally-recognized inflation measure means that any increase in price levels directly translates into higher principal values. As a hypothetical example, consider a $1,000 20-year U.S. TIPS with a 2.5% coupon (1.25% on semiannual basis), and an inflation rate of 4%. The principal on the TIPS note will adjust upward on a daily basis to account for the 4% inflation rate. At maturity, the principal value will be $2,208 (4% per year, compounded semiannually). Additionally, while the coupon rate remains fixed at 2.5%, the dollar value of each interest payment will rise, as the coupon will be paid on the inflation-adjusted principal value. The first semiannual coupon of 1.25% paid on the inflation-adjusted principal of $1,020 is $12.75, while the final semiannual interest payment will be 1.25% of $2,208, which…
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- In December 2001, Argentina announced it would nothonor its sovereign (government-issued) debt. Manyinvestors were left holding Argentinean bonds pricedat a fraction of their previous value. A few years later,Argentina announced it would pay back 25% of the face value of its debt. Comment on the effects of information asymmetries on government bond markets. Doyou think investors are currently willing to buy bondsissued by the government of Argentina?arrow_forwardAs a US multinational you decide to borrow long-term debt of 1 million JPY at 10% for one year. The exchange rate on the date you borrowed the debt is 100 JPY/$ and the exchange rate on the date you repaid the debt is 120 JPY/$. The Japanese inflation rate during the year is 6% and the US inflation rate is 4%. What is the nominal cost of borrowing the JPY debt in US$ terms? a) -8.33% b) -11.83% c) -12.33% d) +11.83%arrow_forwardAssume that Stevens Point Co. has net receivables of 150,000 Singapore dollars in 90 days. The spot rate of the S$ is $.52, and the Singapore interest rate is 2% over 90 days. Suggest how the U.S. firm could implement a money market hedge. Be precise.arrow_forward
- Suppose the interest rate on investments in GBP is 12% in London and the interest rate for comparable investments in USD in New York is 7%. Suppose further, that the spot rate is USD 1.95 /GBP and that the one-year forward rate is USD 1.87 /GBP a) Is the covered interest parity violated? Is there an arbitrage opportunity? b) If yes, how high is it if you were able to borrow USD 1 million from a US-based bank?arrow_forwardAssume the following information:U.S. investors have $1,000,000 to invest: 1-year deposit rate offered by U.S. banks = 10% 1-year deposit rate offered on British pounds = 13.5% 1-year forward rate of Swiss francs = $1.26 Spot rate of Swiss franc = $1.30 Given this information: A. interest rate parity exists and covered interest arbitrage by U.S. investors results in a yield above what is possible domestically. B. interest rate parity doesn't exist and covered interest arbitrage by U.S. investors results in a yield below what is possible domestically. C. interest rate parity exists and covered interest arbitrage by U.S. investors results in the same yield as investing domestically. D. interest rate parity doesn't exist and covered interest arbitrage by U.S. investors results in a yield above what is possible domestically.arrow_forward
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