OFFICE USE ONLY

Semester One 2015

Examination Period
Faculty of Business and Economics

EXAM CODES: BFF2341

TITLE OF PAPER: INTERNATIONAL FINANCIAL MANAGEMENT – PAPER 1
EXAM DURATION: 3 hours writing time
READING TIME: 10 minutes

THIS PAPER IS FOR STUDENTS STUDYING AT: (cross where applicable)

Berwick Clayton Malaysia Off‐Campus Learning Open Learning
Caulfield Gippsland Peninsula Enhancement Studies Sth Africa
Parkville Other (specify)

During an exam, you must not have in your possession, a book, notes, paper, electronic device/s,
calculator, pencil case, mobile phone or other material/item which has not been authorised for the exam
or specifically permitted as noted below.
Any material or item on your desk, chair or person will be deemed to be in your possession.
You are reminded that possession of unauthorised materials, or attempting to cheat or cheating in an
exam is a discipline offence under Part 7 of the Monash University (Council) Regulations.

No exam paper or other exam materials are to be removed from the room.

AUTHORISED MATERIALS
OPEN BOOK YES NO
CALCULATORS YES NO
(If YES, only calculators with an 'approved for use' Faculty label are permitted)
SPECIFICALLY PERMITTED ITEMS YES NO
If YES, items permitted are:

This paper consists of TEN (10) multiple choice questions and EIGHT (8) questions
printed on a total of ELEVEN (11) pages including ONE (1) page of formulae.
Students must attempt to answer ALL questions.

Candidates must complete this section if required to write answers within this paper

STUDENT ID: __ __ __ __ __ __ __ __ DESK NUMBER: __ __ __ __ __

THIS EXAMINATION PAPER MUST BE INSERTED INTO THE

ANSWER BOOK AT THE COMPLETION OF THE PAPER.

BFF2341 Dr Abey Gunasekarage Page 1 of 11

 OFFICE USE ONLY

BFF2341 INTERNATIONAL FINANCIAL MANAGEMENT

PART A: MULTIPLE CHOICE QUESTIONS (102 = 20 marks)

Instructions: For the following multiple choice questions select the BEST answer from the
choices provided and write the answer in the answer book. There is no penalty for
incorrect answers.

1. You expect to receive $960 per year at the end of each year from year 3 to year 8.
What is the present value of this annuity today, if the annual interest rate is 10%?
A. $3639.16
B. $3007.57
C. $2734.15
D. $4800.00
E. $3606.31

2. Smith is willing to invest $8,150 today in order to accumulate $15,000 at the end of
five years in order to fulfil his goal of purchasing a small sailboat. What rate of return
will Smith have to earn on his investment in order to realize his goal?

A. 6.48% per annum

B. 8.56% per annum
C. 10.88% per annum
D. 12.98% per annum
E. 15.20% per annum

3. Mary is planning to set up a fund for her retirement. She intends to deposit $4,000
into the fund at the end of each year over the next 20 years. If Mary can earn 6% per
annum compound interest on her deposits, how much will she have in the retirement
fund at the end of 20 years? Give your answer to the nearest dollar.

A. $128,645
B. $144,000
C. $ 80,000
D. $186,400
E. $147,142

4. Ricky has just taken out a $100,000 mortgage at an interest rate of 8% per annum. If
the mortgage calls for 20 equal annual payments, what is the outstanding balance on
this loan (to the nearest dollar) at the end of year 2?

A. $89,000
B. $91,995
C. $95,455
D. $96,865
E. $90,125

BFF2341 Dr Abey Gunasekarage Page 2 of 11

 OFFICE USE ONLY

BFF2341 INTERNATIONAL FINANCIAL MANAGEMENT

PART A (cont’d)

5. Which of the following is true about annuities?

A. An annuity due is an equal amount of money paid or received at the beginning

of each period.
B. An annuity due is an equal amount of money paid or received at the beginning
of each period, that increases by an equal amount in each period.
C. An ordinary annuity is an equal amount of money paid or received at the end
of each period that increases by an equal amount each period.
D. An ordinary annuity is an equal amount of money paid or received at the
beginning of each period.
E. An ordinary annuity is an annuity for which the first cash flow occurs beyond
the end of the first period.

6. Which of the following theories identifies the non‐transferability of resources as a

reason for international business?

A. Theory of comparative advantage.

B. Imperfect markets theory.
C. Product life cycle theory.
D. Perfect market theory.
E. None of the above.

7. If an Australian‐based MNC focuses completely on importing, then its valuation would

likely be adversely affected if most currencies were expected to appreciate against the
Australian dollar over time.

A. True
B. False

8. Assume that a firm wants to engage in international business without major

investment in the foreign country. Which method is least appropriate in this
situation?

A. International Trade
B. Licensing
C. Franchising
D. Acquisition of a foreign firm
E. Joint venture

BFF2341 Dr Abey Gunasekarage Page 3 of 11

 OFFICE USE ONLY

BFF2341 INTERNATIONAL FINANCIAL MANAGEMENT

PART A (Cont’d)

9. Which of the following is not an example of political risk?

A. Government may impose taxes on a subsidiary.

B. Government may impose barriers on a subsidiary.
C. Consumers may boycott the MNC.
D. Military may overthrow the government and seize power.
E. Consumers' income levels will decrease, thus decreasing
consumption.

10. Agency costs faced by multinational corporations (MNCs) may be larger than those
faced by purely domestic firms because

A. Monitoring of managers located in foreign countries is more

difficult.
B. Foreign subsidiary managers raised in different cultures may not
follow uniform goals.
C. MNCs are relatively large.
D. All of the above.
E. A and B only.
(Total = 10 × 2 = 20 marks)

BFF2341 Dr Abey Gunasekarage Page 4 of 11

 OFFICE USE ONLY

BFF2341 INTERNATIONAL FINANCIAL MANAGEMENT

PART B: QUESTIONS AND PROBLEMS (8  10 = 80 marks)

Instructions: Answer all questions. All questions carry equal marks

Question 1: Foreign Exchange Market

(a) Differentiate between the spot market and the forward market.
(3 marks)

(b) Bank of Melbourne’s bid price for the US dollar is AU$1.3158 and its ask price is
AU$1.3432. What is the bid/ask spread?
(2 marks)

(c) Australian Meat Products Ltd is an exporter of meat products to the US market. The
company is expected to receive a cheque worth US$50,000 from its US buyer in two
months’ time. It has been speculated in the financial press that the Reserve Bank of
Australia will announce a cut in the official cash rate by 25 basis points in two weeks.

Explain how the decision to cut Australian cash rate could affect the cash flows of
Australian Meat Products Ltd.
(3 marks)

(d) Assume that the Japanese yen is worth AU$0.0109 and the Indian rupee is worth
AU$0.0212. What is the cross rate of the Japanese Yen with respect to the Indian
Rupee?
(2 marks)
[Total = 3 + 2 + 3 + 2 = 10 marks]

BFF2341 Dr Abey Gunasekarage Page 5 of 11

 OFFICE USE ONLY

BFF2341 INTERNATIONAL FINANCIAL MANAGEMENT

Question 2: Currency Derivatives

(a) Your company imports soft toys from a Chinese company and sells them to Australian
retailers. You have received an invoice from the Chinese supplier for yuan 300,000.
This amount has to be settled in three months. You expect that the Chinese yuan will
appreciate against the Australian dollar during this period.

Explain how your company can use currency futures contracts to hedge against
exchange rate risk.
(3 marks)

(b) In (a) above, what limitations would your company face in using futures contracts in
hedging exchange rate risk?
(2 marks)

(c) Alice Smith purchased a put option on British pounds for AU$0.03 per unit. There are
45,000 units of British pounds in the option contract. The strike price was AU$1.85
and the spot rate at the time the option was exercised was AU$1.65.

What was Alice Smith’s net profit on the option contract?

(3 marks)

(d) Explain how you could use forward contracts to hedge possible foreign exchange risk
associated with the following transactions:

(i) An Australian company is expecting to receive 1.5 million ringgit from its
Malaysian subsidiary in three months.
(ii) An Australian company has to pay off its loan denominated in British pounds in
six months.
(2 marks)
[Total = 3 + 2 + 3 + 2 = 10 marks]

BFF2341 Dr Abey Gunasekarage Page 6 of 11

 OFFICE USE ONLY

BFF2341 INTERNATIONAL FINANCIAL MANAGEMENT

Question 3: International Arbitrage and Interest Rate Parity

(a) Explain the concept of locational arbitrage.

(2 marks)

(b) The following bid/ask spot rates are available for the New Zealand dollar:
Bank A Bank B
Bid rate for NZ dollar AU$0.97 AU$0.94
Ask rate for NZ dollar AU$0.99 AU$0.96

Assume that you have AU$1,000,000 to invest. Explain how you can use the
differences in exchange rates between the two banks to execute locational arbitrage
and calculate the profit earned from your arbitrage strategy.
(4 marks)

(c) Assume the following information :

Spot rate of Canadian Dollar = AU$0.95

90‐day forward rate of Canadian dollar = AU$0.92
90‐day Canadian interest rate = 4% per annum
90‐day Australian interest rate = 2.5% per annum

Given this information, calculate the yield from covered interest arbitrage to an
Australian investor who invests AU$500,000. Is the investor better‐off than
investing in Australian 90‐day bank deposits?
(4 marks)
[Total = 2 + 4 + 4 = 10 marks]

Question 4: Transaction Exposure

Assume that Yankee Co (domiciled in the US) expects to receive NZ$5,000,000 in one year
from its business operations in New Zealand. The current spot rate of the New Zealand
dollar is US$0.65. The one‐year forward rate of the New Zealand dollar is US$0.67. The
probability distribution (that Yankee Co uses) of the future spot rate for New Zealand dollar
in one year is as follows:

Future Spot Rate Probability

US$0.62/NZ$1 0.40
US$0.66/NZ$1 0.35
US$0.72/NZ$1 0.25

BFF2341 Dr Abey Gunasekarage Page 7 of 11

 OFFICE USE ONLY

BFF2341 INTERNATIONAL FINANCIAL MANAGEMENT

Question 4 (cont’d)

Assume that one‐year put options on New Zealand dollars are available, with an exercise
price of US$0.66 and a premium of US$0.04 per unit. One‐year call options on New Zealand
dollars are available with an exercise price of US$0.64 and a premium of US$0.03 per
unit. Assume the following money market rates:

Money Market Rates U.S. New Zealand

Deposit Rate 5% 8%
Borrowing Rate 6% 9%

(a) Given the above information, determine whether a forward hedge, money market
hedge, or a currency options hedge would be the most appropriate for Yankee Co’s
receivables.
(7.5 marks)

(b) Compare the most appropriate hedge (as in part a) to an un‐hedged strategy, and
decide whether Yankee Co should hedge its receivables position.
(2.5 marks)
[Total = 7.5 + 2.5 = 10 marks]

Question 5: International Cost of Capital and Capital Structure

(a) What are the main differences between debt and equity?
(4 marks)

(b) Briefly explain how the following characteristics of MNCs would affect the cost of
capital.
(i) Access to international capital markets.
(ii) International diversification.
(iii) Exchange rate risk.
(iv) Country risk.
(6 marks)
[Total = 4 + 6 = 10 marks]

Question 6: Foreign direct investment and political risk

(a) Briefly explain the following terms in relation to international capital investment by
giving suitable examples:
(i) Foreign Portfolio Investment (FPI)
(ii) Foreign Direct Investment (FDI).
(4 marks)

BFF2341 Dr Abey Gunasekarage Page 8 of 11

 OFFICE USE ONLY

BFF2341 INTERNATIONAL FINANCIAL MANAGEMENT

Question 6 (cont’d)
(b) What are the revenue‐related motives and the cost‐related motives of Foreign Direct
Investment?
(4 marks)
(c) Briefly explain how an MNC could reduce its overall exposure to country risk with its
strategy of diversifying projects internationally.
(2 marks)
[Total = 4 + 4 + 2 = 10 marks]

Question 7: International taxation and cash management

(a) Aus Ltd is an Australian company that has a subsidiary in Mexico. For the last financial
year, its subsidiary in Mexico has reported an earnings before tax of AU$100,000. The
subsidiary intends to remit the total earnings to its parent company in Australia.
Assume that Mexico has a double taxation agreement with Australia and under this
arrangement Aus Ltd is entitled to a tax credit in Australia up to the full amount of tax
paid in Mexico. The corporate tax rate in Mexico is 20% while the corporate tax rate in
Australia is 30%.

Calculate the amount of tax, if any, that Aus Ltd has to pay in Australia.
(2 marks)

(b) Briefly explain how “tax havens” could be misused by MNC’s to avoid the payment of
taxes.
(2 marks)

(c) A US company, Miami Limited, plans to invest its excess cash in Mexican pesos for one
year. The one year Mexican interest rate is 17.5% per annum. The probability of the
peso’s percentage change in value relative to US$ during the next year is shown
below:
Possible Rates of Change in the Probability of
Mexican Peso relative to the US$ occurrence
‐11% 20%
‐7% 50%
0% 30%

(i) Using this information, calculate the expected value of the effective yield of the
peso.
(ii) Assume that the one year US$ interest rate is 7% per annum. What is the
probability that a one year investment in pesos will generate a lower effective
yield than which could be generated if Miami Limited simply invested its excess
cash domestically?
(6 marks)
[Total = 2+2+6 = 10 marks]

BFF2341 Dr Abey Gunasekarage Page 9 of 11

 OFFICE USE ONLY

BFF2341 INTERNATIONAL FINANCIAL MANAGEMENT

Question 8: International Capital Budgeting

Alpha Industries, a parent company based in Australia, is planning to expand its business in
China by investing in a new project. The following information has been gathered to assess
this project:
 The initial investment required is Chinese Yuan (CNY) 45 million. This investment
outlay will be depreciated on a straight line basis over its useful life.
 The project will be terminated at the end of Year 3 when the subsidiary will be sold.
 The Chinese government charges a corporate tax of 30% on profit. In addition, it will
impose a tax of 10% on all funds remitted by the subsidiary to the parent company. The
Australian Government would allow a tax credit on taxes paid in the foreign country
and would not impose any additional taxes.
 All cash flows received by the subsidiary are sent to the parent at the end of each year.
 In three years’ time, the subsidiary is to be sold for CNY 30 million. Assume that this
amount is not subject to any tax.
 Alpha Industries’ required rate of return on this project is 20% per annum.
 You have been given the following additional information:
Year Exchange rate Product cost and revenue information
Variable costs Other cash
CNY/A$ Price per unit Sales (No. per unit expenses
(forecast) (CNY) of units) (CNY) (CNY)
0 4.70
1 4.50 120.0 300,000 50.0 2,250,000
2 4.45 125.0 350,000 55.0 3,000,000
3 4.25 130.0 400,000 60.0 4,500,000

Required:

Calculate the net present value (NPV) of the project from the parent company’s perspective,
and determine whether Alpha Industries should undertake this project.
[Total = 10 marks]

END OF EXAMINATION

BFF2341 Dr Abey Gunasekarage Page 10 of 11

 OFFICE USE ONLY

BFF2341 INTERNATIONAL FINANCIAL MANAGEMENT

FORMULA SHEET

Cross‐rate between A$ and £ : S(A$/£) = S(A$/$) / S(£/$) = S($/£) / S($/A$ ) = S(A$/$)  S($/£)
Interest Rate Parity condition: (1 + i$) / (1 + i¥) = F / S
Forward premium/discount = (F ‐ S) / S
Bid/ask spread = (ask rate – bid rate) / ask rate
Appreciation/depreciation of a currency: (e1 ‐ e0)/e0 or (e0 ‐ e1)/e1 or Δx + Δy + Δx × Δy = 0
Time value of an option = Option price ‐ Intrinsic value of the option
Value of a currency call option at exercise = Max[S ‐ E, 0]
Value of a currency put option at exercise = Max[E ‐ S, 0]
Capital Asset Pricing Model: Ri = Rf + βi (Rm – Rf )
FV = CF × (1+k)n ; FV of ordinary annuity = CF × [(1+k)n – 1] / k
PV = CF / (1+k)n ; PV of ordinary annuity = CF × [1‐ (1+k)‐n ] / k
PV of perpetuity = CF / k , provided k>0
NPV =  CFt / (1+k)t – I
IRR involves solving the equation:  CFt / (1+k)t – I = 0
Weighted Average Cost of Capital: K = We  Ke + Wd  (1‐T)  Kd

Effective return (cost) from investing (borrowing) in a foreign currency:

(1 + Rd) = (1 + Rf) × (1 + Ef)

BFF2341 Dr Abey Gunasekarage Page 11 of 11