Question 1

If interest rate parity exists, the attempt to finance with a foreign currency while covering the position to avoid exchange rate risk will result in an effective financing rate that is ____ the domestic interest rate.

Accepted Answer

Interest rate parity states that the forward exchange rate will incorporate the interest rate differential between two currencies. Therefore, the effective financing rate in the foreign currency will be similar to the domestic interest rate, after accounting for the expected changes in the exchange rate.

Question 2

Which of the following statement is false?

Accepted Answer

If the forward rate is expected to underestimate the future spot rate, uncovered foreign financing would result in higher financing costs, not lower, because the future spot rate would be higher than anticipated.

Question 3

If interest rate parity exists, and the forward rate is an accurate estimator of the future spot rate, the foreign financing rate will be ____ the home financing rate.

Accepted Answer

If interest rate parity exists and the forward rate is an accurate estimator of the future spot rate, then foreign and home financing rates will be similar. This is because interest rate parity ensures that there are no arbitrage opportunities between foreign and domestic currencies, and the forward rate provides an unbiased estimate of the future spot rate. Therefore, the foreign and home financing rates will be similar.

Question 4

The degree of volatility of financing with a currency portfolio depends on only the standard deviations of effective financing rates of the individual currencies within the portfolio.

Accepted Answer

The degree of volatility also depends on the correlations between the returns of the currencies in the portfolio, not just their individual standard deviations.

Question 5

Assume the U.S. one-year interest rate is 9%, while the Chilean one-year interest rate is 13%. If the Chilean peso ____ by ____%, a U.S.-based MNC would incur the same financing cost in dollars versus Chilean pesos over a one year period.

Accepted Answer

To calculate the equal financing cost in dollars, we need to use the interest rate parity formula:

(1 + US interest rate) / (1 + Chilean interest rate) = (1 + % change in USD/CLP exchange rate)

Substituting the given values, we get:

(1 + 0.09) / (1 + 0.13) = (1 + % change in USD/CLP exchange rate)

Solving for % change in USD/CLP exchange rate:

% change in USD/CLP exchange rate = -3.54%

This means that if the Chilean peso depreciates by 3.54% against the US dollar, a US-based MNC would incur the same financing cost in dollars versus Chilean pesos over a one year period. Therefore, the correct choice is A.

Question 6

Foreign financing costs in a single foreign currency ____ financing costs in dollars, and the variance of foreign financing costs over time is ____ than the variance of financing in dollars.

Accepted Answer

Foreign financing costs in a single foreign currency can be lower or higher than financing costs in dollars, depending on the exchange rate fluctuations. However, the variance of foreign financing costs over time is generally higher than the variance of financing in dollars, as currency exchange rates can be highly volatile. Therefore, choice B is the most accurate.

Question 7

Kushter Inc. would like to finance in euros. European interest rates are currently 4%, and the euro is expected to depreciate by 2% over the next year. What is Kushter's effective financing rate next year?

Accepted Answer

The effective financing rate is the interest rate plus the expected depreciation of the currency. In this case, the interest rate is 4% and the expected depreciation is 2%, so the effective financing rate is 4% + 2% = 6%.

Question 8

Assume the U.S. financing rate is 10 percent and that the financing rate in Germany is 9 percent. An MNC would be indifferent between financing in dollars and financing in euros next year if the euro is expected to ____.

Accepted Answer

The MNC would be indifferent if the cost of financing in both currencies is the same. With a 10% U.S. rate and a 9% German rate, the euro must appreciate by approximately 0.92% to equalize the effective cost of financing.

Question 9

If movements of two currencies with low interest rates are highly negatively correlated, then financing in a portfolio of currencies would not be very beneficial. That is, financing with such a portfolio would not be very different from financing with a single foreign currency.

Accepted Answer

The answer of If movements of two currencies with low...

Question 10

Which of the following is probably not a scenario under which a U.S.-based MNC would consider short-term foreign financing?

Accepted Answer

A U.S.-based MNC would avoid borrowing in a foreign currency that is expected to appreciate, as this would increase the cost of repaying the loan when converted back to U.S. dollars.

Question 11

A large firm may finance in a foreign currency to offset a net payable position in that foreign country.

Accepted Answer

The answer of A large firm may finance in a...

Question 12

A negative effective financing rate indicates that an MNC:

Accepted Answer

A negative effective financing rate means that the MNC paid back fewer dollars than it borrowed. This can occur when the foreign currency appreciates significantly against the dollar during the loan period, resulting in the MNC needing to convert fewer dollars to repay the loan. While it may seem like a benefit, it also indicates potential currency risk for the MNC in the future.

Question 13

An MNC's parent or subsidiary in need for funds commonly determines whether there are any available internal funds before searching for outside funding.

Accepted Answer

MNCs typically prioritize internal funding sources before seeking external funding to maintain control of their financial operations and minimize costs such as interest payments.

Question 14

If interest rate parity does not hold, and the forward ____ is ____ the interest rate differential, then foreign financing with a simultaneous hedge of that position in the forward market results in higher financing costs than those of domestic financing

Accepted Answer

The answer of If interest rate parity does not hold,...

Question 15

Countries with a ____ rate of inflation tend to have a ____ interest rate.

Accepted Answer

Countries with a high rate of inflation typically have high interest rates. This is because central banks often raise interest rates to combat inflation by reducing spending and borrowing.

Quiz 20: Short-Term Financing