International Financial Management

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Question 1:
a) Calculate the new exchange rate up to 4 decimals after 2% increase in dollar price.
If EURUSD=1.1 then it means, 1 EUR= 1.1 USD, conversely if we see
like 1/1.1 then 0.9091 EUR will be bought through 1 USD, with an increase of 2% in USD value,
we can say that, USD = 1 + 2% = 1 + 0.022 = 1.02,
according to this situation we will see that, 1.02/1.1 =
0.9273, it means an Increase of 2% in value of USD will help to buy EUR 0.9273 in 1 USD, then
new exchange rate will be; 1.1/1.02 = 1.0784
b) For this scenario we are given two different pair of currencies and we have to deduce a third
pair from these two pairs; first one is EURUSD with 1.1043, while the second one is GBPUSD
1.2970, by looking at EURUSD we see that 1 EUR = 1.1043 USD, or alternatively we can say that
1 USD = 1/1.1043 = 0.9056 EUR, then according to second pair, we see that exchange rate is
GBPUSD 1.2970, meaning for every 1 GBP we gain 1.2970 USD, conversely we say that 1 USD =
1/ 1.2970 = 0.7710 GBP, now we have to calculate exchange rate for new pair GBPEUR, or we
have to find cross exchange rate, for this we will use this method, GBPEUR = EURUSD x USDGBP
= 1.1043 x 0.7710 = 0.8514, from above result we say that we used two different pairs of
currencies to find cross rate for two currencies which aren’t paired publically for forex
purposes.
c) The part b of the question uses method of cross rate to determine rate of exchange between
two usually not paired currencies, we see that USD is most common basis for currency
exchange, however there are some conditions where traders are interested in using forward
rates to accumulate higher profit on pre-determined currency swaps, this situation is known as
triangular arbitrage, where uncommon currency trading practices are taken place to get more
profit from exchanging currencies other than USD, the “b” part of the question elaborates “ask”
and “bid” phenomenon, however this is not a common practice.
Question 2:
a) The given condition provides us with information about exchange rates during two periods of
year in EURUSD, according to situation, the year starting exchange rate between EUR and USD
for USA based people was EURUSD 1.100, it implies that during month of January 1 EUR was
equal to 1.100 USD, or we say that each USD could be equal to 0.9091 EUR, while during last
month of year the rate between two currencies for USA people was EURUSD 1.144, meaning
that each EUR was equal to 1.144 USD, alternatively we can say that 1 USD was equal to 0.8741
EUR, the USA had higher inflation during the year, because each unit of its currency would buy
less EUR currency units than, the each currency unit of EUROPE, furthermore the during
December 2017 the inflation rates will be high in USA because of increased money supply; the
rates of inflation could be found to be 3%
b) By going if the inflation rate is 3% higher in USA then the changes in real values of both the
currencies could be following,
I) for USA = (0.8741 – 0.9091) / 0.9091 8*100 = -3.85%
II) for EUROPE = (1.144-1.1)/1.1*100 = 4%, these two equations show the
impacts of money supply on value of currencies, which has led to increased inflation in one
country, this also tells that people will use cross exchanges to benefit from currency
devaluation of one country.
c) With this kind of exchange rates where one currency from pair is devaluing it means that
there will be higher interest rates in USA as compared to EUROPE.
d) The interests rate in USA will be higher due to less value of their currency in USD, because
lenders will be willing to insure their lending by higher rates, as the contingencies of further
value fall in USD are still there, that’s why interest rates will be higher, as they will be facing
higher risk, because the investors will be looking to charge more on the landings, and the
condition of triangular arbitrage will arise.
e) There will be similar kind of rates on both the the USD and EUR bonds, as these are
associated with systematic risk, and these investments pay less or called risk free rates, because
government bonds are safest forms of investment, bearing minimum risk.
Question 3
Country Risk Analysis: When transections involve foreign market risk, then the analysis of this
risk is known as country risk analysis.
Exchange Rate Volatility: It is the fluctuation in value of one domestic currency and other
foreign currency.
Both the exchange rate risks and country risk analysis are inter-dependents, we
will look at their comparison and differences,
I) Political Risk Comparison: both the country risk analysis and
exchange rate risks depend on good political situations in region where the countries lie, the
situation must be stable and hence the country risk and exchange risks will be low.
II) Economic Risk Comparison: With less economic risk, it
means that country possesses higher investment opportunities, and it has more cash available,
which in turn is positive sign for strong exchange rates and hence less risks.
III) Sovereign Risk Comparison: this is risk
where the exchange value of one country is zero or nullified, hence resulting in higher inflation
rates, and more investment risks arise in the country.
IV) Inflation Factor Risk: When the inflation
rate in country is low, it means that the exchange risks of that country are also low, on other
side, when inflation rate is low the investing opportunities are brighter because a healthy
return could be expected in investments. V) Interest Rate Risk: The exchange rates
are highly effected by interest rates, if they are higher it means that the money supply is also
higher, similarly when investing in country investors evaluate the risks they also analyze the
interest rates, which if are high, then less opportunities for investors exist in the market.
Question 4
MNCs: Theses are corporations which operate in different countries simultaneously.
Globalization: The phenomenon when goods and services reach all parts of world
simultaneously.
Generally the major source of globalization are MNCs, however like many advantages, there are
also some cons of globalization too, here we will see the both the sides of globalization and
deduce whether it is good thing or bad.
Efficiencies and Opportunities: with globalization the markets are open and businesses are
beneficial from these opportunities because businesses communicate effectively and efficiently
with their stakeholders, and they are better in management of their resources, similarly with
globalization the local producers have greater opportunities to sell their commodities at distant
places too with a greater speed.
Easy Credit and Great Leverage: When there are more players in money market, then money
flows easily across national and international boundaries, which in turn boost aggregate
demand as lenders are unable to distinguish between good borrowers and bad borrowers,
hence everyone in the world gets equal opportunities for growth and employment.
New Risks and Uncertainties: When there is greater degree of integration between
national and international market, the competition gets intense, the degree of imitation is high,
the price and profit swings and products and businesses get destroyed, all the corporations face
unpredictable and unstable demand, and with this the corporations have low pricing power
through their goods.
Tight Credit and Deleverage: When lenders are unable to decide about good and bad
borrowers, they begin to tighten the credit rates, which depresses the aggregate demand,
which in results produces less growth and employment opportunities