TUTORIAL International Financial Markets TRUE-FALSE The most common type of foreign exchange transaction is for immediate exchange at the so-called forward rate a False Correct The spot rate is for immediate exchange; the forward rate is for exchange in the future A purchaser of a currency put option buys the right to sell a specific currency at a specific price within a specific period of time a True Correct A currency put option is the right to sell a currency; a currency call option is the right to buy a currency In December 1987, 12 major industrialized countries met in Buenos Aires and agreed on standardized guidelines for bank capital classification This agreement was called the "Brazil Accord." a False Correct It is the Basel Accord Furthermore, Buenos Aires is in Argentina Loan rates float in accordance with the movement of some market interest rate, such as the Lisbon Intrabank Offer Rate (LIBOR) It is the rate commonly charged for loans between Eurobanks a False Correct It is the London Interbank Offer Rate The adoption of the euro discouraged MNCs based in Europe to issue stock a False Correct The adoption of the euro encouraged MNCs based in Europe to issue stock Investors throughout Europe were more willing to invest in stocks if they did not have to worry about exchange rate effects MULTIPLE CHOICE Which of the following is not a motive for investing in foreign markets? a expectations of a weaker foreign currency Correct Expectations of a stronger foreign currency would be a motive for investing in foreign markets b international diversification Incorrect International diversification applies to an investor's asset portfolio c economic conditions Incorrect Economic conditions are a motive for investors seeking more favorable performance than they can receive in their home country d all of the above are motives for investing in foreign markets Incorrect Answer a is the correct answer 2 The Eurodollar market grew substantially in the 1960s and 1970s for which of the following reasons? a higher reserve requirements for Eurobanks Incorrect The Eurobanks charged lower spreads on loans and deposits because of less regulation and because there were no reserve requirements on Eurobanks b U.S regulations in 1968 which limited foreign lending by U.S banks Correct This was a reason for growth in the Eurodollar market Foreign subsidiaries of U.S.-based MNCs could obtain U.S dollars from banks in Europe In addition, ceilings were placed on the interest rates of dollar deposits in the United States c higher spreads that Eurobanks could charge on loans and deposits Incorrect The Eurobanks charged lower spreads on loans and deposits because of less regulation and because there were no reserve requirements on Eurobanks d all of the above Incorrect Answers a and c are incorrect e both a and c Incorrect Answers a and c are incorrect Multinational corporations sometimes borrow in the Eurocredit market These loans are denominated in dollars and many other currencies The common maturity for Eurocredit loans is: a one year Incorrect Commonly, these loans have a maturity of more than one year b three years Incorrect Commonly, these loans have a maturity of more than three years c five years Correct Commonly, these loans have a maturity of five years d ten years Incorrect Commonly, these loans have a maturity of less than ten years e thirty years Incorrect Commonly, these loans have a maturity of less than thirty years A long-term bond that is issued by a borrower foreign to the country where the bond is placed is called a: a foreign bond Correct A foreign bond is a long-term bond that is issued by a borrower foreign to the country where the bond is placed For example, a U.S corporation may issue a bond denominated in Japanese yen, which is sold to investors in Japan b Eurobond Incorrect A Eurobond is sold in countries other than the country represented by the currency denominating it For example, a Eurobond denominated in U.S dollars is sold in Japan c Eurocredit bond Incorrect There are loans, not bonds, in the Eurocredit market Furthermore, maturities in the Eurocredit market are not long-term 5 A stock offering by foreign corporations in the U.S is called a (an): a American depository receipt (ADR) Incorrect An American depository receipt (ADR) is a certificate representing bundles of stock b Yankee stock offering Correct Foreign governments or corporations will often use Yankee stock offerings due to the liquidity of the new-issues market in the U.S c floating rate note (FRN) Incorrect Floating rate notes (FRNs) are a type of Eurobond that have a variable interest rate provision REVIEW QUESTIONS What is the role of the government in the international finance scene? • • • • Setting the exchange rate policy of the country Dealing with balance of payment problems Regulation of international financial markets Setting policy on MNCs: foreign investment guidelines, international tax and regulation • Supervision of international banking operations within their jurisdition What is the difference between a euromarket and a normal market? If an American company issues sterling bonds in Britain, is this a eurobond issue? What if the sterling bonds are issued in France? Why did the euromarkets develop and why they still exist? PROBLEMS Chapter 3: Question 16 and 22 on page 84-85 of Madura 16 International Diversification Explain how the Asian crisis would have affected the returns to a U.S firm investing in the Asian stock markets as a means of international diversification [See the chapter appendix.] ANSWER: The returns to the U.S firm would have been reduced substantially as a result of the Asian crisis because of both declines in the Asian stock markets and because of currency depreciation For example, the Indonesian stock market declined by about 27% from June 1997 to June 1998 Furthermore, the Indonesian rupiah declined again the U.S dollar by 84% 22 International Financial Markets Recently, Wal-Mart established two retail outlets in the city of Shanzen, China, which has a population of 3.7 million These outlets are massive and contain products purchased locally as well as imports As Wal-Mart generates earnings beyond what it needs in Shanzen, it may remit those earnings back to the United States Wal-Mart is likely to build additional outlets in Shanzen or in other Chinese cities in the future a Explain how the Wal-Mart outlets in China would use the spot market in foreign exchange ANSWER: The Wal-Mart stores in China need other currencies to buy products from other countries, and must convert the Chinese currency (yuan) into the other currencies in the spot market to purchase these products They also could use the spot market to convert excess earnings denominated in yuan into dollars, which would be remitted to the U.S parent b Explain how Wal-Mart might utilize the international money market when it is establishing other Wal-Mart stores in Asia ANSWER: Wal-Mart may need to maintain some deposits in the Eurocurrency market that can be used (when needed) to support the growth of Wal-Mart stores in various foreign markets When some Wal-Mart stores in foreign markets need funds, they borrow from banks in the Eurocurrency market Thus, the Eurocurrency market serves as a deposit or lending source for Wal-Mart and other MNCs on a short-term basis c Explain how Wal-Mart could use the international bond market to finance the establishment of new outlets in foreign markets ANSWER: Wal-Mart could issue bonds in the Eurobond market to generate funds needed to establish new outlets The bonds may be denominated in the currency that is needed; then, once the stores are established, some of the cash flows generated by those stores could be used to pay interest on the bonds Small Business Dilemma Use of the Foreign Exchange Markets by the Sports Exports Company Explain how the Sports Exports Company could utilize the spot market to facilitate the exchange of currencies Be specific ANSWER: The Sports Exports Company would have an account with a commercial bank As it receives payment in pounds each month, it would deposit the check at a bank that provides foreign exchange services Each month, the bank would cash the check, and then convert the British pounds received into dollars for the Sports Exports Company at the prevailing spot rate Explain how the Sports Exports Company is exposed to exchange rate risk and how it could use the forward market to hedge this risk ANSWER: The Sports Exports Company is exposed to exchange rate risk, because the value of the British pound will change over time If the pound depreciates over time, the payment in pounds will convert to fewer dollars The Sports Exports Company could engage in a forward contract in which it would sell pounds forward in exchange for dollars For example, if it anticipated receiving a payment in pounds 30 days from now, it could negotiate a forward contract in which it would sell pounds in exchange for dollars at a specific forward rate This would lock in the forward rate at which the pounds would be converted into dollars in 30 days, thereby removing any concern that the pound could depreciate against the dollar over that 30-day period This hedges exchange rate risk over the short run, but does not effectively hedge against exchange rate risk over the long run ... jurisdition What is the difference between a euromarket and a normal market? If an American company issues sterling bonds in Britain, is this a eurobond issue? What if the sterling bonds are... For example, if it anticipated receiving a payment in pounds 30 days from now, it could negotiate a forward contract in which it would sell pounds in exchange for dollars at a specific forward... euromarkets develop and why they still exist? PROBLEMS Chapter 3: Question 16 and 22 on page 84-85 of Madura 16 International Diversification Explain how the Asian crisis would have affected the