One and a Half Hours            

     THE UNIVERSITY OF MANCHESTER

INTERNATIONAL FINANCE

                                     15 May 2018

                                     14:00 – 15:30

                                Answer ALL questions in Section A

                                                                 and

                                 Answer ONE question from Section B

Electronic calculators may be used in accordance with the University regulations

                                                                                                                                         PTO

                                        SECTION A

                                                   Answer ALL questions

1. Identify and define the three type of exchange rate exposure.                

[10 marks]

2. Compare and contrast foreign exchange forwards and foreign exchange futures contracts.                                                                                                                

[10 marks]

3. Explain the characteristics of an interest rate swap and a currency swap.

[10 marks]

4. Define country risk. What is political risk and how does it differ?

[10 marks]

5. Define the term Foreign Direct Investment (FDI) and briefly outline the eclectic paradigm.

[10 marks]

                                           SECTION B

                                                        Answer ONE Question

6. a) Define the Quality Spread and the Quality Spread Differential. What reasons have been advanced to explain the Quality Spread Differential (QSD)? Aside from the QSD what other motivations are there for using swaps?

[30 marks]

b) You are an interest rate swap (IRS) dealer for a large  international intermediary and are required to devise a swap for two large clients. You are presented with the following information on your clients. [bps = basis points]

1

i] Assume that you are benevolent [i.e. you charge no commission], that ABC plc wishes to borrow at the floating rate and XYZ Corp wishes to borrow at the fixed rate. Design an interest rate swap that shares the savings from engaging in the swap equally between ABC plc and XYZ Corp.

[15 marks]

Question 6 continues overleaf                                                                                    PTO

Question 6 continued

ii] Now assume that you quote a bid-ask spread of  3.7%-3.85%. How does this change your answer to part i] above? Briefly explain.

[5 marks]

7. a) On March 5th 2017, a UK MNC sold goods that were worth 750,000 AUD (Australian dollars) to a customer in Queensland, Australia. However, the UK MNC has a cash flow problem and the credit sale was allowed in order to ensure that the sales contract was won. The Australian dollar payment is expected on June 5th 2017, 3 months from now. In order to both hedge the foreign exchange risk which is associated with the sales contract and alleviate the sterling (pound) cash shortage, three strategies are under consideration by the treasury department:

i) Execute a 3-months forward contract to cover the Australian dollars. An amount of pounds would be immediately borrowed from the Euro-currency market for 3-months, such that both the principal and interest payment from this deal would sum to the pound equivalent amount arising from the forward contract.

ii) Borrow an amount of Australian dollars for 3-months from the Euro- currency market, such that both the principal and interest payment from this deal would sum to the total amount of Australian dollars that will be received from the Australian customer. The principal amount would be immediately sold for pounds at the spot rate.

iii) Borrow an amount of Euros for 3-months from a Dutch subsidiary such that the principal and interest payment would sum to the 3-months forward value of the Australian dollars. The Dutch subsidiary will lend the funds at the 3-months annualised Euro-currency interest rate of 0.6725%. The amount borrowed from the Dutch subsidiary would be immediately sold for pounds at the spot rate. The MNC expects to pay the Dutch subsidiary with the forward equivalent amount of the Australian dollars.

Question 7 continues overleaf                                                                                    PTO

Question 7 continued

         On March 5th 2017 the relevant market rates including the 3-months forward           rates, are as follows. All interest rates are annualised.

                           Foreign exchange rates

                           Australian dollar spot rate to one Euro 1.5861

                           3-months forward rate                             1.5852

                           Euro spot rate to one pound                   1.1196

                           3-months forward rate                             1.1216

                           Euro-currency interest rates

                           3-months Euro-currency rates:

                           Pound                                                            0.9675% per year

                           Australian dollar                                          1.3825% per year

Calculate the current cash flow from each of the three strategies and identify which the MNC should follow.

[20 marks]

b) Firms hedge to reduce expected taxes and to reduce the costs associated with financial distress. Discuss this statement with reference to theory and the empirical literature.

[30 marks]

8. “…changes in exchange rates naturally impact the cash flows of multinational firms with operations in different foreign locations, importers and exporters and even solely domestic firms through changes in the competitive environment and the terms of trade.” (Bredin and Hyde, 2011) In light of this statement, evaluate the empirical evidence on exchange rate exposure and explain the existence of the so-called exposure puzzle.

[50 marks]

9. Why might firms engage in cross-border M&As? Does the evidence suggest that cross-border M&As are successful from the point of view of the shareholder?

[50 marks]

                                   END OF EXAMINATION PAPER