Chapter 16

16.1 Nikken Microsystems (A). Assume Nikken Microsystems has sold Internet
servers to Telecom España for €700,000. Payment is due in three months and will be
made with a trade acceptance from Telecom España Acceptance. The acceptance fee
is 1.0% per annum of the face amount of the note. This acceptance will be sold at a
4% per annum discount. What is the annualized percentage all-in cost in euros of this
method of trade financing?

16.2 Nikken Microsystems (B). Assume that Nikken Microsystems prefers to receive
U.S. dollars rather than euros for the trade transaction described in Problem 16.1. It is
considering two alternatives: (1) sell the acceptance for euros at once and convert the
euros immediately to U.S. dollars at the spot rate of exchange of $1.00/€; or (2) hold
the euro acceptance until maturity but at the start sell the expected euro proceeds
forward for dollars at the 3-month forward rate of $1.02/€.
a. What are the U.S. dollar net proceeds received at once from the discounted trade
acceptance in alternative 1?
b. What are the U.S. dollar net proceeds received in three months in alternative?
c. What is the break-even investment rate that would equalize the net U.S. dollar
proceeds from both alternatives?
d. Which alternative should Nikken Microsystems choose?

16.3 Motoguzzie (A). Motoguzzie exports large-engine motorcycles (greater than

700cc) to Australia and invoices its customers in U.S. dollars. Sydney Wholesale
Imports has purchased $3,000,000 of merchandise from Motoguzzie, with payment
due in six months. The payment will be made with a bankers’ acceptance issued by
Charter Bank of Sydney at a fee of 1.75% per annum. Motoguzzie has a weighted
average cost of capital of 10%. If Motoguzzie holds this acceptance to maturity, what
is its annualized percentage all-in cost?
16.4 Motoguzzie (B). Assuming the facts in Problem 16.3, Bank of America is now
willing to buy Motoguzzie’s bankers’ acceptance for a discount of 6% per annum.
What would be Motoguzzie’s annualized percentage all-in cost of financing its
$3,000,000 Australian
receivable?
16.5 Nakatomi Toyota. Nakatomi Toyota buys its cars from Toyota Motors (U.S.),
and sells them to U.S. customers. One of its customers is EcoHire, a car rental firm
that buys cars from Nakatomi Toyota at a wholesale price. Final payment is due to
Nakatomi Toyota in six months. EcoHire has bought $200,000 worth of cars from
Nakatomi, with a cash down payment of $40,000 and the balance due in six months
without any interest charged as a sales incentive. Nakatomi Toyota will have the
EcoHire receivable accepted by Alliance Acceptance for a 2% fee, and then sell it at a
3% per annum discount to Wells Fargo Bank.
a. What is the annualized percentage all-in cost to Nakatomi Toyota?
b. What are Nakatomi’s net cash proceeds, including the cash down payment?
CHAPTER 6
Question 6.2 Purchasing Power Parity. Define the two forms of purchasing power
parity, absolute and relative.
6.3 Big Mac Index. How close does the Big Mac Index conform to the theoretical
requirements for a law of one price measurement of purchasing power parity?
6.4 Undervaluation and Purchasing Power Parity. According to the theory of
purchasing power parity, what should happen to a currency that is undervalued?
6.12 The International Fisher Effect. Define the international Fisher effect. Would
it discourage local investors from capitalizing on higher foreign interest rates?
6.13 Interest Rate Parity. Define interest rate parity. What would it say about
interest rates if spot rates and forward rates were the same?
6.14 Covered Interest Arbitrage. Ignoring transaction costs, under what conditions
will covered interest arbitrage be plausible?
6.1 Malaysian Island Resort. Theresa Nunn is planning a 30-day vacation on
PulauPenang, Malaysia, one year from now. The present charge for a luxury suite plus
meals in Malaysian ringgit (RM) is RM1,045/day. The Malaysian ringgit presently
trades at RM3.1350/$. She determines that the dollar cost today for a 30-day stay
would be $10,000. The hotel informs her that any increase in its room charges will be
limited to any increase in the Malaysian cost of living. Malaysian inflation is expected
to be 2.75% per annum, while U.S. inflation is expected to be 1.25%.
a. How many dollars might Theresa expect to need one year hence to pay for her 30-
day vacation?
b. By what percent will the dollar cost have gone up? Why?
6.2 Argentine Float. The Argentine peso was fixed through a currency board at
Ps1.00/$ throughout the 1990s. In January 2002, the Argentine peso was floated. On
January 29, 2003, it was trading at Ps3.20/$. During that one-year period, Argentina’s
inflation rate was 20% on an annualized basis. Inflation in the United States during
that same period was 2.2% annualized.
a. What should have been the exchange rate in January 2003 if PPP held?
b. By what percentage was the Argentine peso undervalued on an annualized basis?
c. What were the probable causes of undervaluation?
6.3 Derek Tosh and Yen-Dollar Parity. Derek Tosh is attempting to determine
whether U.S./Japanese financial conditions are at parity. The current spot rate is a flat
¥89.00/$, while the 360-day forward rate is ¥84.90/$. Forecast inflation is 1.100% for
Japan, and 5.900% for the United States. The 360- day euroyen deposit rate is
4.700%, and the 360-day eurodollar deposit rate is 9.500%.
a. Diagram and calculate whether international parity conditions hold between Japan
and the United States.
b. Find the forecasted change in the Japanese yen/ U.S. dollar (¥/$) exchange rate one
year from now.
6.4 Chan’s Homes: Hong Kong to Toronto. Albert Chan owns homes in Toronto,
Canada and Hong Kong, China. He travels between the two cities at least four times a
year. Because of his frequent trips,he wants to buy some high-quality luggage. He has
done some research and has decided to purchase a Samsonite three-piece luggage set.
There are retail stores in Toronto and Hong Kong that carry the luggage set he intends
to purchase. Albert was a finance major and wants to use purchasing power parity to
determine if he is paying the same price regardless of where he makes his purchase.
a. If the price of the three-piece luggage set in Toronto is C$950 and the price of the
same threepiece set is HK$5,650, using purchasing power parity, is the price of the
luggage truly equal if the spot rate is HK$6.0000/C$?
b. If the price of the luggage remains the same in Toronto one year from now,
determine the price of the luggage in Hong Kong in one year’s time if PPP holds true.
The Canadian inflation rate is 2.0% and the Hong Kong inflation rate is 3.5%.
6.7 Kamada: CIA Japan (A). Takeshi Kamada, a foreign exchange trader at Credit
Suisse (Tokyo), is exploring covered interest arbitrage possibilities. He wants to
invest$5,000,000 or its yen equivalent in a covered interest arbitrage between U.S.
dollars and Japanese yen. He faced the following exchange rate and interest rate
quotes. Is CIA profit possible?
If so, how?

6.12 Casper Landsten—CIA (A). Casper Landsten is a foreign exchange trader for a
bank in New York. He has $1 million (or its Swiss franc equivalent) for a short-term
money market investment and wonders whether he should invest in U.S. dollars for
three months or make a CIA investment in the Swiss franc. He faces the following
quotes:

6.17 Chamonix Rentals. You are planning a ski vacation to Mt. Blanc in Chamonix,
France, one year from now. You are negotiating the rental of a chateau. The chateau’s
owner wishes to preserve his real income against both inflation and exchange rate
changes, and so the present weekly rent of €9,800 (Christmas season) will be adjusted
upward or downward for any change in the French cost of living between now and
then. You are basing your budgeting on purchasing power parity (PPP). French
inflation is expected to average 3.5% for the coming year, while U.S. dollar inflation
is expected to be 2.5%. The current spot rate is $1.3620/€. What should you budget as
the U.S. dollar cost of the 1-week rental?

6.18 East Asiatic–Thailand. The East Asiatic Company (EAC), a Danish company
with subsidiaries throughout Asia, has been funding its Bangkok subsidiary primarily
with U.S. dollar debt because of the cost and availability of dollar capital as opposed
to Thai baht-denominated (B) debt. The treasurer of EAC–Thailand is considering a
1-year bank loan for $250,000. The current spot rate is B32.06/$, and the dollar-based
interest is 6.75% for the 1-year period. 1-year loans are 12.00% in baht.
a. Assuming expected inflation rates for the coming year of 4.3% and 1.25% in
Thailand and the United States, respectively, according to purchase power parity,
what would be the effective cost of funds in Thai baht terms?
b. If EAC’s foreign exchange advisers believe strongly that the Thai government
wants to push the value of the baht down against the dollar by 5% over the coming
year (to promote its export competitiveness in dollar markets), what might be the
effective cost of funds in baht terms?
c. If EAC could borrow Thai baht at 13% per annum, would this be cheaper than
either part (a) or part (b)?