Tool Kit Chapter 17 9/17/2018

Tool Kit for Multinational Financial Management

17-1 Multinational, or Global, Corporations

The terms multinational corporations, transnational corporations, multinational enterprises, and global corporations are used to describe firms that operate in an
integrated fashion in a number of countries.

17-2 Multinational versus Domestic Financial Management

Figure 17-1 shows the growth in employment by U.S. multinational companies (MNCs). Notice the rapid growth between 1988 and 2000, the drop in employment during
2000 to through 2003, and the rise since then. Also notice that virtually all of the net new employees added after 2003 came from the international subsidiaries of these
companies. Part of this flat employment in the United States is due to productivity gains, with the same number of employees producing more goods and services. But
part is due to the growth in developing markets, which is likely to continue in the foreseeable future.

Figure 17-1
Employment by U.S. Multinational Corporations (Millions)

Millions
35

30 International
Employees

25

20
U.S. Employees

15

10
1989

1991

1993
1994

1996

1998

2003

2005
2006

2008

2010
2011

2013

2015
1988

1990

1992

1995

1997

1999
2000
2001
2002

2004

2007

2009

2012

2014

Year
17-3 Exchange Rates

An exchange rate specifies the number of units of a given currency that can be purchased with another currency.

17-3a Foreign Exchange Notation

The International Organization for Standardization (ISO) defined specific codes for currencies. For example, the U.S. dollar is USD, the Japanese yen is JPY, and the
euro is EUR.

The notation for foreign exchange quotes can be very confusing! The standard method of quoting can be illustrated by the U.S. dollar (USD) for euro (EUR) quote. If 1
euro costs $1.25, then the quote is denoted EUR/USD = 1.25. The number of units of the left hand currency (the "base currency") is always 1 and the number of units
of the right hand currency is always the quote. In this case, 1 euro is worth 1.25 dollars. This is not the same as you would expect with scientific notation where the
"/" symbol would mean "per." In fact it is exactly opposite! In this same example, the quote USD/EUR = 0.80 means 1 dollar is worth 0.80 euros. So don't think of the
"/" sign as meaning "per."

17-3b Direct Quotes versus Indirect Quotes

A direct quote reports the number of units of the home currency per unit of foreign currency. An indirect quote is the inverse of a direct quote and shows the number
of foreign currency per unit of home currency. Traders use direct quotes for the euro and British pound. Traders use indirect quotes for all other currencies.

To convert a direct quote into an indirect quote, take the inverse of the direct quote.

To convert an indirect quote into a direct quote, take the inverse of the indirect quote.

17-3c Reporting Foreign Exchange Rates

Traders work with the direct quotes for euros and British pounds, but indirect quotes for all other currencies. However, most sources of exchange rate quotes, such
as The Wall Street Journal, report direct and indirect quotes for all currencies. For euros and pounds, the reported indirect quote is the inverse of the direct quote.
For all other currencies, the reported direct quote is the inverse of the indirect quote.

Table 17-1
Selected Exchange Rates

Direct Quote: U.S. Indirect Quote:

Dollars Required Number of Foreign
to Buy a Unit of Currency Units
Currency Name and Foreign Currency Required to buy a
ISO Currency Symbol (FOREIGN/HOME ) U.S. Dollar
Country Code (2) (3) (4)
Direct Quote Currencies:
Euro area EUR Euro (€) 1.1641 0.8590
U.K. GPB U.K. (British) pound (£ 1.3071 0.7651
Indirect Quote Currencies:
 Canada CAD Canadian dollar ($) 0.7594 1.3168
China CNY Chinese yuan (¥) 0.1488 6.7222
India INR Indian rupee (₹ ) 0.0146 68.4750
Japan JPY Japanese yen (¥) 0.0089 112.84
Mexico MXN Mexican peso ($) 0.0529 18.8955
South Korea KRW South Korea won (₩) 0.0009 1,131.16
Switzerland CHF Swiss franc (SFr) 1.0011 0.9989
Data date: 7/18/2018
Source: The Wall Street Journal, online.wsj.com.

Note: The financial press usually quotes British pounds and euros as direct quotations, so Column 4
equals 1.0 divided by Column 3 for these currencies. The financial press usually quotes all other
currencies as indirect quotations, so Column 3 equals 1.0 divided by Column 4 for these currencies. We
use italic to denote a quote that is an inverse of the actual reported quote.

17-3d Transactions Involving U.S. Currency

1. Converting U.S. Dollars into a Direct Quote Currency (Euros or British Pounds)

Suppose a U.S. company wishes to convert dollars into 100 million British pounds.

Pounds needed = £100.00 million £ is the symbol for U.K. pound

GBP/USD = 1.3071 dollars per pound
This means: £1 = $1.3071

Value in dollars = Value in pounds ⨯ Dollars per pound

Value in dollars = £100,000,000 ⨯ 1.3071
Value in dollars = $130,710,000 ≈ $130.71 million

2. Converting a Direct Quote Currency into Dollars

Suppose a French company wishes to convert euros to 80 million dollars.

Dollars needed = $80 million

EUR/USD = 1.1641 dollars per euro
This means: €1 = $1.1641 € is the symbol for the euro

Value in euros = Value in dollars / Dollars per euro

Value in euros = $80,000,000 / 1.1641
Value in euros = € 68,722,618 ≈ € 68.72 million

3. Converting Dollars into an Indirect Quote Currency (any currency other than Euros or British Pounds)

A U.S. company needs to convert dollars into 9 billion South Korean won.

Wons needed = ₩9 billion ₩ is the symbol for the South Korean won
USD/KRW = 1131.1600 won per dollar
This means: $1 = ₩1,131.1600

Value in dollars = Value in won / Won per dollar

Value in dollars = ₩9,000,000,000 / 1131.1600
Value in dollars = $7,956,434 ≈ $7.96 million

4. Converting an Indirect Quote Currency into U.S. Dollars

An Indian company wishes to convert rupees into 37 million dollars.

Dollars needed = $37 million

USD/INR = 68.4750 dollars per rupee
This means: ₹ 1 = $68.4750 ₹ is the symbol for the rupee

Value in rupees = Value in dollars ⨯ Rupees per dollar

Value in rupees = $37,000,000 ⨯ 68.4750
Value in repees = ₹ 2,533,575,000.00 ≈ ₹ 2.53 billion

17-3e Currency Cross Rates for Transactions Not Involving U.S. Currency

A cross rate allows you to express the value of one country's currency relative to a currency other than the U.S. dollar. Calculating cross rates does, however, involve
using the U.S. dollar exchange rates of those currencies. For instance, to calculate the cross rate between euros and British pounds, we will use their direct quotations,
since these currencies are quoted in direct quotations. Mathematically speaking, we want to construct a ratio that has euros in the numerator and British pounds in
the denominator. Such a mathematical expression will tell us the cross rate for euros and pounds.
 A cross rate allows you to express the value of one country's currency relative to a currency other than the U.S. dollar. Calculating cross rates does, however, involve
using the U.S. dollar exchange rates of those currencies. For instance, to calculate the cross rate between euros and British pounds, we will use their direct quotations,
since these currencies are quoted in direct quotations. Mathematically speaking, we want to construct a ratio that has euros in the numerator and British pounds in
the denominator. Such a mathematical expression will tell us the cross rate for euros and pounds.

1. Exchange direct quote currency for direct quote currency:

Cross rate of euros per pound = Dollars per British pound / Dollars per euro
= 1.3071 / 1.1641
= 1.1228

This quote would be listed as GBP/EUR = 1.1228

Take the inverse to get EUR/GBP = 0.8906

2. Exchange indirect quote currency for indirect quote currency:

Cross rate of yen per peso = Yen per dollar / Pesos per dollar
= 112.8400 / 18.8955
= 5.9718

This quote would be listed as MXN/JPN = 5.9718

Take the inverse to get JPN/MXN = 0.1675

3. Exchange direct quote currency for indirect quote currency:

Cross rate of pesos per euro = Pesos per dollar ⨯ Dollars per euro
= 18.8955 ⨯ 1.1641
= 21.9963

This quote would be listed as GPB/JPN = 21.9963

Take the inverse to get JPN/GPB = 0.0455

4. Exchange indirect quote currency for direct quote currency:

Cross rate of euros per peso = 1/(Dollars per euro) ⨯ 1/(Pesos per dollar)
= 0.8590 ⨯ 0.0529
= 0.0455

This quote would be listed as MXN/EUR = 0.0455

Take the inverse to get EUR/MXN = 21.9963

Notice that Situations 3 and 4 involve pesos and euros. If you need the number of pesos per euro, Situation 3's method is easiest. If instead you need the
number of euros per peso, you could use Situation 4's method, or you could use Situation 3's method and then take the inverse. As shown above, both
methods provide the same answer.

Following is a table of currency cross rates calculated from the direct quotations of British pounds and euros and the indirect quotations of all other
currencies (since this is how the currencies are quoted in the financial markets). This table is read as the cross rate of the currency in the row of the
left hand column relative to the currency designated by the appropriate column heading. The numbers in this table may differ slightly from those in
published sources due to rounding.

Not Shown in Text

Cross Rates for Currencies in Table 17-1

U.S. Dollar Euro U.K. pound Canadian dollar Indian rupee Japanese Yen Mexican peso
 U.S. Dollar Euro U.K. pound Canadian dollar Chinese yuan Indian rupee Japanese Yen Mexican peso
U.S. Dollar — 1.1641 1.3071 0.7594 0.1488 0.0146 0.0089 0.0529
Euro 0.8590 — 1.1228 0.6524 0.1278 0.0125 0.0076 0.0455
U.K. pound 0.7651 0.8906 — 0.5810 0.1138 0.0112 0.0068 0.0405
Canadian dollar 1.3168 1.5329 1.7212 — 0.1959 0.0192 0.0117 0.0697
Chinese yuan 6.7222 7.8253 8.7866 5.1050 — 0.0982 0.0596 0.3558
Indian rupee 68.4750 79.7117 89.5037 52.0011 10.1864 — 0.6068 3.6239
Japanese yen 112.8400 131.3570 147.4932 85.6926 16.7862 1.6479 — 5.9718
Mexican peso 18.8955 21.9963 24.6983 14.3496 2.8109 0.2759 0.1675 —
South Korean won 1,131.1600 1,316.7834 1,478.5392 859.0219 168.2723 16.5193 10.0245 59.8640
Swiss franc 0.9989 1.1628 1.3057 0.7586 0.1486 0.0146 0.0089 0.0529

Data date: 7/18/2018 Source: Derived from Table 17-1.

Table 17-2
Selected Currency Cross Rates
U.S. Dollar Euro U.K. pound Japanese yen Mexican Peso
(1) (2) (3) (4) (5)
(1) (2) (3) (4) (5)
(1) U.S. Dollar — 1.1641 1.3071 0.0089 0.0529
(2) Euro 0.8590 — 1.1228 0.0076 0.0455
(3) U.K. pound 0.7651 0.8906 — 0.0068 0.0405
(4) Japanese yen 112.8400 131.3570 147.4932 — 5.9718
(5) Mexican peso 18.8955 21.9963 24.6983 0.1675 —

Data date: 7/18/2018

Source: Derived from preceding tabel, which is derived from Table 17-1.

17-4 The Fixed Exchange Rate System

To stabilize exchange rates, the price of gold would be fixed at $35 per ounce and the Federal Reserve would redeem foreign central banks’ dollars
for gold at that price. Other currencies would be tied to the dollar. For example, the exchange rate for Swiss francs was set at about SFr 4.37 per
dollar. This fixed exchange rate system lasted from 1945 and 1971.

17-5 The Floating Exchange Rate System

In a floating rate system, the exchange rate between two countries is determined by the relative supply and demand for their currencies rather than
by government intervention. International trade is a big factor affecting demand for a currency.

17-5a Determinants of Floating Exchange Rates

International trade is a big factor affecting demand for a currency.

Table 17-3
U.S. Imports, Exports, and Trade Balances in 2017 (Billions of Dollars Except Rankings)

Country Exports Imports Trade Balance Total Trade Activity

China $188 $524 -$336 $712
Canada $341 $339 $2 $680
Mexico $277 $345 -$68 $622
Japan $115 $171 -$56 $286
Germany $87 $153 -$66 $240
United Kingdom $126 $111 $15 $237
Korea, South
Seven-Country $73 $83 -$10 $156
Total $1,207 $1,726 -$519 $2,933
World Total $2,351 $2,903 -$552 $5,254
Seven-Country
Total 51.3% 59.5% 94.0% 55.8%
World Total      

Source: Bureau of Economic Analysis. For updates, go to www.bea.gov/international/index.htm, select the link named
“Trade in Goods and Services Annual Revision,” and then download the data in the link named “U.S. Trade in Goods and
Services by Selected Countries and Areas, 1999-present.”

Note: The Trade Balance in Column 3 is equal to Column 1 (Exports) minus Column 2 (Imports). Column 4 (Total
Bilateral Trade Activity) is equal to Column 1 (Exports) plus Column 2 (Imports). The countries are sorted by Total
Bilateral Trade Activity.

China trade balance as percentage of total world trade balance:

Trade Balance with U.S.

China -$336 Billion
World Total -$552 Billion

China/World Total = 60.9%

In addition to trade balances, international investment transactions also affect currency demand. The exchange rate is
largely determined by their combined effect.
Figure 17-2
Data for Chart
Figure 17-2 Year Index
U.S. Dollar Index versus Eight Major Currencies 1973 100.17
1974 102.02
1975 102.39
1976 106.44
1977 106.10
Index 1978 97.13
140 1979 95.59
1980 95.35
1981 104.76
1982 115.75
1983 120.46
120 1984 128.69
1985 133.55
1986 109.77

100

80
 140

120

1987 97.16
1988 90.43
100 1989 94.29
1990 89.91
1991 88.59
1992 87.00
1993 89.90
80 1994 88.43
1995 83.41
1996 87.25
1997 93.93
60 1998 98.45
1999 97.06
2000 101.76
2001 107.87
Year 2002 106.18
2003 93.15
2004 85.51
2005 83.86
2006 82.60
2007 77.96
2008 74.40
2009 77.67
2010 75.36
2011 70.83
2012 73.54
2013 75.93
2014 78.40
2015 90.98
2016 91.51
2017 91.08
2018

17-5b Currency Appreciation and Depreciation

Currency appreciation occurs when one currency gains value relative to another currency—in other words, the appreciating currency can buy more of
the other currency than it could before appreciating.

Example 1: Appreciation of direct quote currency relative to U.S. dollar

EUR/USD = 1.2500 dollars per euro

Euro appreciates by 20% against dollar.

New euro price:

FOREIGN/HOME = (Old FX rate)(1+ APP%)

EUR/USD = 1.5000 (Dollars per euro)

Example 2: Appreciation of dollar relative to direct quote currency

EUR/USD = 1.2500 dollars per euro

Dollar appreciates by 20% against euro.

New dollar price:

New HOM/FOR = (1 + APP%)/(FOR/HOM direct FX)

USD/EUR = 0.8000 (Euros per dollar)

USD/EUR = 0.9600 (Euros per dollar)

Example 3: Depreciation of dollar relative to indirect quote currency

MXN/USD = 20.0000 Pesos per dollar

Dollar depreciates by 10% against peso

New dollar price:

New HOM/FOR = (1 − DEP%)/(Old indirect FX)

USD/MXN = 18.0000 (Pesos per dollar)

In Example 1, by what percentage does the dollar depreciate against the euro?

Example 4:
Old dollar price:
USD/EUR = 0.8000 (Euros per dollar)

New euro price:

EUR/USD = 1.5000 (Dollars per euro)

New dollar price:

USD/EUR = 0.6667 (Euros per dollar)

Percentage change in USD/EUR:

% change = -16.67%

Exchange Rate Risk

Cost of hand blown Italian Murano glass = € 100.00

2014
Exchange rate= 1.330 $ per € or EUR/USD
Cost of glass in dollars = $133.00

2018
Exchange rate= 1.16 $ per € or EUR/USD
Cost of glass in dollars = $116.00

Cost to produce California Pinot Noir = $50.00

2014

Sales price in euros = € 45.00

Sales price in dollars = $59.85
Profit in dollars = $9.85

2018
Sales price in euros = € 45.00
Sales price in dollars = $52.20
Profit in dollars = $2.20

17-8 Forward Exchange Rates and Risk Management

The exchange rates shown earlier are called spot rates, which means the rate paid for deliver of the currency "on the spot". In foreign currency trading,
it is also possible to purchase currency at a predetermined price at some future date (30 days, 90 days, or 180 days). Forward rates for currencies is
analogous to purchasing forward contracts on commodities. Essentially, they allow investors or firms to lock in a specified exchange rate for the
currency, and it serves as a method of hedging exchange rate risk. If an individual can obtain more of the foreign currency in the forward market than
can be obtained in the spot market, that currency is said to be selling at a discount. Likewise, if an investor can obtain more of a foreign currency in the
spot market than the forward market, the currency is said to be selling at a premium. Below are some examples of spot forward rates for selected
major currencies.

17-8a Forward Exchange Rates

Table 17-4 Values in table are rounded to the number of decimal pla
Selected spot and forward rates (indirect quotations) Source for pip quotes: www.investing.com
Forward
Forward Ratesa Foreign Currency Is at Forward rates in pips
Spot Rate 30 days 90 days 180 days Currency Is: a:b 30 days
Mexico (Peso) 18.8955 18.8955 18.8955 18.8956 Depreciating Discount 0.091
Japan (Yen) 112.84 112.61 112.12 111.27 Appreciating Premium -22.54
Switzerland (Franc 0.9989 0.9964 0.9910 0.9822 Appreciating Premium -25.42
Source: Spot rates are from The Wall Street Journal for July 18, 2018, as reported in Table 17-1. Forward rates are determined from pip
quotes from Investing.com at www.investing.com.

Notes:
a
Forward rates for pesos and francs are rounded to 4 decimal places and forward rates for yen are rounded to 2 decimal places in the
table to be consistent with reported spot rates.
Traders quote forward rates in pips (Percentage in Points). A pip is the smallest digit in which a currency is quoted. For example, the
Swiss franc is quoted out to 4 decimal places, so 1 pip is equal to 0.0001, which is 1/10,000. The pip divisor is 10,000 for the Swiss franc.
For the yen, the pip divisor is 100 (i.e., 1 pip is equal to 0.01) because the yen is quoted only to two decimal places. The quote is the
number of pips represented by the forward rate minus the spot. For example, the quote for the 30-day forward rate for the Swiss franc
was −25.42 pips. This means the forward rate calculation is equal to the spot rate plus pips/divisor: 0.9989 + (−22.52/10,000) = 0.9964,
rounded to four decimal places. For the yen, the quote was −22.54 pips. The forward rate calculation is: 112.84 + (−22.54/100) =
112.61, rounded to 2 decimal places.
b
When it takes more units of a foreign currency to buy a dollar in the future, then the value of the foreign currency is less in the forward
market than in the spot market; hence the forward rate is at a discount to the spot rate. When it takes fewer units of a foreign currency
Notes:
a
Forward rates for pesos and francs are rounded to 4 decimal places and forward rates for yen are rounded to 2 decimal places in the
table to be consistent with reported spot rates.
Traders quote forward rates in pips (Percentage in Points). A pip is the smallest digit in which a currency is quoted. For example, the
Swiss franc is quoted out to 4 decimal places, so 1 pip is equal to 0.0001, which is 1/10,000. The pip divisor is 10,000 for the Swiss franc.
For the yen, the pip divisor is 100 (i.e., 1 pip is equal to 0.01) because the yen is quoted only to two decimal places. The quote is the
number of pips represented by the forward rate minus the spot. For example, the quote for the 30-day forward rate for the Swiss franc
was −25.42 pips. This means the forward rate calculation is equal to the spot rate plus pips/divisor: 0.9989 + (−22.52/10,000) = 0.9964,
rounded to four decimal places. For the yen, the quote was −22.54 pips. The forward rate calculation is: 112.84 + (−22.54/100) =
112.61, rounded to 2 decimal places.
b
When it takes more units of a foreign currency to buy a dollar in the future, then the value of the foreign currency is less in the forward
market than in the spot market; hence the forward rate is at a discount to the spot rate. When it takes fewer units of a foreign currency
to buy a dollar in the future, the forward rate is at a premium. If using indirect quotes, a higher forward rate is at a discount and a lower
forward rate is at a premium.

17-8b Managing Exchange Rate Risk

Changes in exchange rates change the profitability for companies that import or export. Forward rates can reduce this risk.

Using Forward Rates to Lock in a Cost: An Example

Required payment in 30 days 500 million yen

Spot rate (Indirect quote) 112.8400

Payment if no change in current spot rate $4.431 million

If spot rate in 30 days decreases to 102.0000

Payment at new spot rate $4.902 million

If spot rate in 30 days increases to 115.0000

Payment at new spot rate $4.348 million

If you lock in the 30-day forward rate of 112.6100

Payment at new spot rate $4.440 million

17-97 Interest Rate Parity

Market forces determine whether a currency sells at a forward premium or discount, and the relationship between spot and forward exchange rates is
summarized in the concept called interest rate parity. Interest rate parity holds that investors should expect to earn the same return in all countries
after adjusting for risk, and it recognizes that foreign investments are subject to two major forces, return on investment and changes in the exchange
rate. Interest rate parity is expressed as follows:

ft / e0 =(1+r h) / (1+r f)

In this equation, f t is the forward exchange rate in the t-period, e 0 is the spot exchange rate, r h and r f are the periodic interest rates in the home and
foreign countries, respectively.
PROBLEM

Suppose a U.S. investor buys a default-free 180-day Swiss bond that promises a 4 percent nominal return, denominated in Swiss francs. The indirect
spot exchange rate and the 180-day direct forward rate are based on Table 17-3 as shown above.

Input data:
Foreign nominal interest rate 4.00%
to maturity on securities (in years) 0.50
rf, foreign periodic interest rate 2.00%
Indirect spot exchange rate 1.0000
Indirect forward exchange rate 0.9951

1. Convert $1,000 to Swiss francs at spot rate:

Value in Swiss francs = U.S. dollars x Spot Indirect Exchange Rate (Swiss francs per dollar)
Value in Swiss francs = $1,000 x 1.0000
Value in Swiss francs = 1,000.000

2. Invest in the Swiss bond

Value in six months = Amount x (1+Rate)
Value in six months = 1,000.00 x 102.0%
Value in six months = 1,020.000

3. Convert back to dollars at forward rate:

Value in dollars = Swiss francs / Forward Indirect Rate
Value in dollars = 1,020.00000 / 0.9951
Value in dollars = $1,025.0226

4. Find rate of return:

Periodic return = Value / $1,000 − 1
Periodic return = $1,025.02 / $1,000 − 1
Periodic return = 2.50%
Annual return = 5.00%

Portion due to bond 4.00%

Portion due to exchange rates 1.00%

Using the Interest Rate Parity Equation

Indirect spot exchange rate 1.00000
e0, spot exchange rate (direct quotation) 1.00000

Indirect forward exchange rate 0.99510

ft, forward exchange rate (direct quotation) 1.00490

f t / e0 = (1+r h) ÷ (1+r f)
1.00490000 = 1+rh ÷ 1.02

1+rh = 1.0250
Semiannual rh = 2.4998%

Annual rh = 5.000%

17-10 Purchasing Power Parity

Having discussed the relationship between spot and future rates, we now turn to the determinants of exchange rate levels in countries. Exchange rates
are impacted by a multitude of factors, many of which are difficult to predict. However, market forces work to ensure that similar goods sell for similar
prices in different countries, adjusted for exchange rates. This relationship is called purchasing power parity (also called the law of one price), and it
implies that exchange rate levels adjust so that identical goods cost the same real amount in different countries. Purchasing power parity is illustrated
by the following equation.

Ph = ( P f ) ( e0 )
--OR--
e0 = Ph / P f

For instance, suppose a pair of tennis shoes costs $150 in the United States, and 150 pounds in Britain. This would imply that the exchange rate would
be $1.50 per pound. Consumers could purchase the shoes in Britain for 100 pounds, or exchange their 100 pounds for $150 and purchase the same
shoes in the United States, at the same effective cost.

PROBLEM

Suppose a certain microwave oven is selling for $110 in the United States today. What price should this same microwave oven be selling for in Europe, if
purchasing power parity holds? Use Table 27-1.

Price in the US = $110

Euro per $ exchange rate = 0.85900

Ph = (Pf) x ( e0 )

$110 = (Pf) x 0.85900

Price in euros 128.06 = (Pf)

Big Mac Box

Ukraine Price of Big Mac

U.S. price = $5.30
Ukraine price = 44.00 ₴ ₴ is the symbol for the Ukrainian hryvnia.
Actual indirect exchange rate (hryvnia per dollar) = 25.915 USD/UKR

Dollar equivalent of Big Mac in Ukraine = $1.70

PPP implied indirect exchange rate (hryvnia per dollar) = 8.3019

Actual direct exchange rate (dollar per hryvnia) = 0.0386

PPP implied direct exchange rate (dollar per hryvnia) = 0.1205
 Actual direct rate divided by the PPP implied direct rate = 0.3204

Percentage the actual direct rate is greater than

or less than the PPP implied direct rate = -68.0%

Switzerland Price of Big Mac

U.S. price = $5.30
Switzerland price (SFr) = 6.50
Actual indirect exchange rate (SFr per dollar) = 0.96415 USD/CHF

Dollar equivalent of Big Mac in Switzerland = $6.74

PPP implied indirect exchange rate (SFr per dollar) = 1.2264

Actual direct exchange rate (dollar per SFr) = 1.0372

PPP implied direct exchange rate (dollar per SFr) = 0.8154

Actual direct rate divided by the PPP implied direct rate = 1.2720

Percentage the actual direct rate is greater than

or less than the PPP implied direct rate = 27.2%

17-12 International Money and Capital Markets

17-12b International Bond Markets

EUR: Euro $9,772,232

USD: US Dollar $10,960,045
TO1: Total all currencies $24,652,668

Percent euro 40%

Percent dollar 44%

Data source: The Bank for International Settlements

http://stats.bis.org/bis-stats-tool/org.bis.stats.ui.StatsApplication/StatsApplication.html

(1) Select the tab for “Debt securities”.

(2) Use the built in query (first row under the tabs) and select “Outstanding International Debt
Securities by currency of denomination”.
(3) This gives data starting in 1952. To avoid this, ask it to show query details and add a filter for the
quarters you want.

17-12d Sovereign Debt

Table 17-5
Government Debt: Public Debt as a Percentage of Gross Domestic Product (Q4-2017)

Public Public Debt/GDP Public

Country Debt/GDP (%) Country (%) Country Debt/GDP (%)
Japan 196.2 Slovenia 73.5 Canada 45.1
Greece 184.6 Austria 72.3 Germany 41.4
Portugal 134.6 Ireland 70.9 Sweden 39.5
Italy 127.3 New Zealand 65.8 Mexico 35.5
United States 99.0 Iceland 63.3 Denmark 34.7
United Kingdom 90.2 Israel 59.1 Turkey 30.9
Belgium 89.5 Finland 54.2 Norway 24.8
Switzerlan
France 89.1 Poland 53.9 d 18.0
Hungary 73.9 Australia 45.6 Estonia 13.1
Source: See the Organisation for Economic Co-operation and Development (OECD) web site “OECD National Accounts
Statistics” at www.oecd-ilibrary.org/economics/data/oecd-national-accounts-statistics_na-data-en.

Median Public Debt as a Percentage of Gross Domestic Product for OECD Countries

Median = 63.3%

17-13 Multinational Capital Budgeting

17-13a Risk Exposure

Table 17-6
The 2017 Transparency International Corruption Perceptions Index (CPI)

Top-Ranked Countries Bottom-Ranked Countries

Rank Country Rank Country
1 New Zealand 169 (tie) Iraq
2 Denmark 169 (tie) Venezuela
3 (tie) Finland 171 (tie) Korea, North
3 (tie) Norway 171 (tie) Equatorial Guinea
3 (tie) Switzerland 171 (tie) Guinea Bissau
6 (tie) Singapore 171 (tie) Libya
6 (tie) Sweden 175 (tie) Sudan
8 (tie) Canada 175 (tie) Yemen
8 (tie) Luxembourg 177 Afghanistan
8 (tie) Netherlands 178 Syria
8 (tie) United Kingdom 179 South Sudan
12 Germany 180 Somalia
<TBSRC>Source: See the Transparency International Web site at https://www.transparency.org/news/feature/corruption_perceptions_index_2017#table.

17-13b Cash Flow Estimation

A U.S. company is considering a three-year investment in Great Britain. The initial cost and expected future cash flows are shown below. The
appropriate cost of capital for a project with this risk is also shown below. The U.S. and U.K. government bond rates and the current spot exchange rate
are also shown below.
Initial cost in million of pounds = £20
Year 1 CF in pounds = £7
Year 2 CF in pounds = £9
Year 3 CF in pounds = £11
U.S. project cost of capital = 10.0%
Current exchange rate = 1.8000 $ per pound or GPB/USD
1-Year U.S. bond interest rate = 2.0%
2-Year U.S. bond interest rate = 2.8%
3-Year U.S. bond interest rate = 3.5%
1-Year U.K. bond interest rate = 4.6%
2-Year U.K. bond interest rate = 5.0%
3-Year U.K. bond interest rate = 5.2%

Use the multi-year interest rate parity relationship to estimate the future expected exchange rates:
ft = e0 [(1+r h) / (1+r f)]t

Maturity (in Spot rate Expected forward

years) rh rf ($/pounds) rate ($/pounds)
1 2.0% 4.6% 1.8000 1.7553
2 2.8% 5.0% 1.8000 1.7254
3 3.5% 5.2% 1.8000 1.7141

Table 17-5: Net Present Value of International Investment (cash flows in millions)
Year
Cash flows in 0 1 2 3
pounds
Expected -£20 £7 £9 £11
exchange
Cash flowsrates
in 1.8000 1.7553 1.7254 1.7141
dollars -$36.00 $12.29 $15.53 $18.86
Project cost of
capital = 10%
NPV = $2.18
www.bea.gov
Data for figure
Employment by U.S. Multinational Corporations (Millions)
Year Total EmployeU.S. EmployeeInternational Employees
1988 22.5 17.7 4.8
1989 23.9 18.8 5.1
1990 23.8 18.4 5.4
1991 23.3 18.0 5.4
1992 22.8 17.5 5.3
1993 22.8 17.5 5.2
1994 24.3 18.6 5.7
1995 24.5 18.6 5.9
1996 24.9 18.8 6.1
1997 26.4 19.9 6.5
1998 26.6 19.8 6.8
1999 30.8 23.0 7.8
2000 32.1 23.9 8.2
2001 31.1 22.9 8.2
2002 30.6 22.4 8.2
2003 29.3 21.1 8.2
2004 29.8 21.2 8.7
2005 30.3 21.3 8.9
2006 31.1 21.6 9.4
2007 33.2 22.8 10.4
2008 32.7 22.3 10.5
2009 33.7 22.9 10.8
2010 34.1 22.8 11.3
2011 34.8 23.0 11.9
2012 35.2 23.1 12.1
2013 35.8 23.3 12.4
2014 40.4 26.6 13.8
2015 42.4 28.3 14.1
2016 0 0 0
 South
Korean
Swiss franc
Korean
won Swiss franc
0.0009 1.0011
0.0008 0.8600
0.0007 0.7659
0.0012 1.3183
0.0059 6.7296
0.0605 68.5504
0.0998 112.9643
0.0167 18.9163
— 1,132.4056
0.0009 —
Values in table are rounded to the number of decimal places shown in spot rate quotes.
Source for pip quotes: www.investing.com
Forward rates in pips
90 days 180 days Pip Divisor
0.2809 0.5526 10,000
-71.93 -156.9 100
-78.8 -167.02 10,000
SECTION 17-3
SOLUTIONS TO SELF-TEST

Assume that the indirect quote is for 10.0 Mexican pesos per U.S. dollar. What is the direct quote for dollars per peso?

Mexican pesos per U.S. dollar 10.0

U.S. dollars per Mexican peso 0.1000

Assume that the indirect quote is for 115 Japanese yen per U.S. dollar and that the direct quote is for 1.25 U.S. dollars
per euro. What is the yen per euro exchange rate?

Japanese yen per U.S. dollar 115

U.S. dollar per euro 1.25

Japanese yen per euro 143.75

SECTION 17-9
SOLUTIONS TO SELF-TEST

Assume that 90-day U.S. securities have a 4.5% annualized interest rate, whereas 90-day Swiss securities have a 5% annualized
interest rate. In the spot market, 1 U.S. dollar can be exchanged for 1.2 Swiss francs. If interest rate parity holds, what is the 90-day
forward rate exchange between U.S. and Swiss francs?

Indirect spot rate: Swiss francs / U.S. dollar 1.2

U.S. nominal annual rate 4.5%
Swiss nominal annual rate 5.0%
Direct spot rate: U.S. dollar/Swiss franc 0.8333
90-day U.S. rate 1.1%
90-day Swiss rate 1.3%

Direct 90-day forward rate: U.S. dollar/Swiss franc 0.8323

Indirect 90-day forward rate: Swiss franc/U.S. dollar 1.2015

SECTION 17-10
SOLUTIONS TO SELF-TEST

A computer sells for $1,500 U.S. dollars. In the spot market, $1 = 115 Japanese yen. If purchasing power parity
holds, what should be the price (in yen) of the same computer in Japan?

Price in the U.S. $1,500

Yen / U.S. dollar 115.0

Pf JPY 172,500
SECTION 17-13
SOLUTIONS TO SELF-TEST

The current exchange rate is 1.1 dollars per euro. A 5-year U.S. government bond has a 3% yield and a 5-year French government
bond has a yield of 4%. What is the expected 5-year forward rate?

Current exchange rate (direct quote) = 1.1000 US dollars / Euro

Bond maturit (years) = 5
5-Year U.S. bond interest rate = 3.0%
5-Year French bond interest rate = 4.0%

Use the multi-year interest rate parity relationship to estimate the future expected exchange rates (direct quotes):
ft = e0 [(1+r h) / (1+r f)]t

Spot rate Expected forward

Maturity (in years) rh rf ($/€) rate ($/€)
5 3.0% 4.0% 1.1000 1.0481

The current exchange rate is 0.8000 Swiss francs per dollar. A 5-year U.S. government bond has a 3% yield and a 5-year Swiss
government bond has a yield of 2%. What is the expected 5-year forward rate? Hint: Remember that the interest rate parity equation
is for direct quotes.

Current exchange rate (indirect quote) = 0.8000 Swiss francs / US dollar

Bond maturit (years) = 5
5-Year U.S. bond interest rate = 3.0%
5-Year Swiss bond interest rate = 2.0%

First, convert the indirect spot rate into a direct quote:

Current exchange rate (direct quote) = 1.25 US dollars / Swiss franc

Second, use the multi-year interest rate parity relationship to estimate the future expected exchange rates (direct quotes):
ft = e0 [(1+r h) / (1+r f)]t

Spot rate Expected forward

Maturity (in years) rh rf ($/franc) rate ($/franc)
5 3.0% 2.0% 1.2500 1.3125

Third, convert the direct forward rate into an indirect quote:

Expected forward rate (indirect quote) = 0.7619 Swiss francs / US dollar