Deck 18: Short-Term Financing

Question 1

A negative effective financing rate for a UK firm implies that the firm:

A) will incur a loss on the project financed with the funds.
B) paid more interest on the funds than what it would have paid if it had borrowed dollars.
C) will be unable to repay the loan.
D) none of the above

Answer 1

D

Question 2

Kushter ltd would like to finance in euros. European interest rates are currently 4%, and the euro is expected to depreciate by 2% over the next year. What is Kushter's effective financing rate next year?

A) 1.92%
B) 2.00%
C) 6.08%
D) None of the above

Answer 2

A

Question 3

Cameron plc would like to simultaneously borrow Japanese yen (¥) and Sudanese dinar (SDD) for a six-month period. Cameron would like to determine the expected financing rate and the variance of a portfolio consisting of 30 per cent yen and 70 per cent dinar. Cameron has gathered the following information: Mean effective financing rate of Japanese yen for six months 4 per cent Mean effective financing rate of Sudanese dinar for six months 1 per cent Standard deviation of Japanese yen's effective financing rate 0.10 Standard deviation of Sudanese dinar's effective financing rate 0.20 Correlation coefficient of effective financing rates of these two currencies 0.23 What is the expected financing rate of the portfolio contemplated by Cameron plc?

A) 3.10%
B) 1.90%
C) 17.00%
D) 13.00%
E) None of the above

Answer 3

B

Question 4

If interest rate parity exists, the attempt to finance with a foreign currency while covering the position to avoid exchange rate risk will result in an effective financing rate that is ____ the domestic interest rate.

A) lower than
B) greater than
C) similar to
D) none of the above

Question 5

Assume that the UK interest rate is 11 per cent while the interest rate on euro is 7 per cent. If euros are borrowed by a UK firm, they would have to ____ against the pound by ____ in order to have the same effective financing rate from borrowing pounds.

A) depreciate; about 3.74%
B) appreciate; about 3.74%
C) appreciate; about 4.53%
D) depreciate; about 4.53%

Question 6

Assume the annual British interest rate is above the annual US interest rate. Also assume the dollar's forward rate in pounds equals the dollar's spot rate. Given this information, interest rate parity ____ exist, and the US firm ____ lock in a lower financing cost by borrowing pounds for one year.

A) does; could
B) does; could not
C) does not; could not
D) does not; could

Question 7

Assume that interest rate parity holds between the UK and Cyprus. The UK one-year interest rate is 7 per cent and the Cyprus one-year interest rate is 6 per cent. What is the approximate effective financing rate of a one-year loan denominated in Cyprus pounds assuming that the MNC covered its exposure by purchasing pounds one year forward?

A) 6%.
B) 7%.
C) 1%.
D) Cannot answer without more information

Question 8

Assume that the Swiss franc has an annual interest rate of 8 per cent and is expected to depreciate by 6 per cent against the pound. From a UK perspective, the effective financing rate from borrowing francs is:

A) 8%.
B) 14.48%.
C) -2%.
D) 1.52%.

Question 9

The effective financing rate:

A) adjusts the nominal interest rate for inflation over the period of concern.
B) adjusts the nominal interest rate for the change in the spot exchange rate over the period of concern.
C) adjusts the nominal rate for a change in foreign interest rates over the period of concern.
D) adjusts the nominal rate for the forward discount (or premium) over the period of concern.

Question 10

Assume that interest rate parity exists, and there are zero transactions costs. If the forward rate consistently underestimates the future spot rate, then:

A) on average, the foreign effective financing rate is greater than the domestic interest rate.
B) on average, the foreign effective financing rate is less than the domestic rate.
C) the foreign effective financing rate exceeds the domestic interest rate when its forward rate exhibits a discount and is less than the domestic interest rate when its forward rate exhibits a premium.
D) the foreign effective financing rate is less than the domestic interest rate when its forward rate exhibits a discount and exceeds the domestic interest rate when its forward rate exhibits a discount.

Question 11

If interest rate parity exists and transactions costs are zero, foreign financing with a simultaneous forward purchase of the currency borrowed will result in an effective financing rate that is:

A) less than the domestic interest rate.
B) greater than the domestic interest rate.
C) equal to the domestic interest rate.
D) greater than the domestic interest rate if the forward rate exhibits a premium and less than the domestic interest rate if the forward rate exhibits a discount.

Question 12

Assume Jelly ltd, a UK-based MNC, obtains a one-year loan of 1,500,000 Malaysian ringgit (MYR) at a nominal interest rate of 7 per cent. At the time the loan is extended, the spot rate of the ringgit is £0.14. If the spot rate of the ringgit in one year is £0.16, the pound amount initially obtained from the loan is £____, and £____ are needed to repay the loan.

A) 210,000; 256,800
B) 210,000; 375,100
C) 6,000,000; 5,357,143
D) 5,357,143; 6,000,000

Question 13

A firm without any exposure to foreign exchange rates would likely increase this exposure the most by:

A) borrowing domestically.
B) borrowing a portfolio of foreign currencies that are not highly correlated.
C) borrowing a portfolio of foreign currencies that are highly correlated.
D) borrowing two foreign currencies that are negatively correlated.

Question 14

One reason an MNC may consider foreign financing is that the proceeds could be used to offset a foreign net payables position.

Question 15

MNCs may be able to lock in a lower cost from financing in a low interest rate foreign currency if they:

A) have future cash inflows in that foreign currency.
B) have future cash outflows in that foreign currency.
C) have offsetting future cash inflows and outflows in that foreign currency.
D) have no other cash flows in that foreign currency.

Question 16

Assume the UK financing rate is 10 per cent and that the financing rate in Germany is 9 per cent. An MNC would be indifferent between financing in pounds and financing in euros next year if the euro is expected to ____.

A) appreciate by 0.92%
B) depreciate by 0.92%
C) appreciate by 1.00%
D) depreciate by 1.00%

Question 17

Euronotes are underwritten by:

A) European central banks.
B) commercial banks.
C) the International Monetary Fund.
D) the Federal Reserve System.

Question 18

Assume a UK-based MNC is borrowing Romanian leu (ROL) at an interest rate of 8 per cent for one year. Also assume that the spot rate of the leu is £0.00007 and the one-year forward rate of the leu is £0.00005. The expected spot rate of the leu one-year from now is £0.00006. What is the effective financing rate (to the nearest percent) for the MNC assuming it borrows leu on a covered basis?

A) 10%.
B) -23%.
C) -1%.
D) 1%.
E) None of the above

Question 19

If interest rate parity exists, financing with a foreign currency may still be feasible, but it would have to be conducted on an uncovered basis (i.e., without use of a forward hedge).

Question 20

If interest rate parity exists, and the forward rate is an accurate estimator of the future spot rate, the foreign financing rate will be ____ the home financing rate.

A) lower than
B) greater than
C) similar to
D) none of the above

Question 21

The variance in financing costs over time is ____ for foreign financing than domestic financing. The variance when financing with foreign currencies is lower when those currencies exhibit ____ correlations, assuming the firm has no other business in those currencies.

A) lower; low
B) lower; high
C) higher; high
D) higher; low

Question 22

Assume that interest rates of most industrialized countries are similar to the UK interest rate. In the last few months, the currencies of all industrialized countries weakened substantially against the UK pound. If non-UK firms based in these countries financed with UK pound during this period (even when they had no receivables in pounds), their effective financing rate would have been:

A) negative.
B) zero.
C) positive, but lower than the interest rate of their respective countries.
D) higher than the interest rate of their respective countries.

Question 23

A risk-averse firm would prefer to borrow ____ when the expected financing costs are similar in a foreign country as in the local country.

A) locally
B) in the foreign country
C) either A or B
D) part of the funds locally, and part from the foreign country

Question 24

When a UK firm borrows a foreign currency and has no offsetting position in this currency, it will incur an effective financing rate that is always above the ____ if the currency ____.

A) foreign currency's interest rate; appreciates
B) foreign currency's interest rate; depreciates
C) domestic interest rate; depreciates
D) domestic interest rate; appreciates

Question 25

A UK firm plans to borrow Swiss francs today for a one-year period. The Swiss interest rate is 9 per cent. It uses today's spot rate as a forecast for the franc's spot rate in one year. The UK one-year interest rate is 10%. The expected effective financing rate on Swiss francs is:

A) equal to the UK interest rate.
B) less than the UK interest rate, but more than the Swiss interest rate.
C) equal to the Swiss interest rate.
D) less than the Swiss interest rate.
E) more than the UK interest rate.

Question 26

Euronotes are unsecured debt securities whose interest rate is based on the London Interbank Offer Rate (LIBOR) with typical maturities of one, three, and six months.

Question 27

If a firm repeatedly borrows a foreign currency portfolio, the variability of the portfolio's effective financing rate will be highest if the correlations between currencies in the portfolio are ____ and the individual variability of each currency is ____.

A) high; low
B) high; high
C) low; low
D) low; high

Question 28

Morton Company obtains a one-year loan of 2,000,000 Sudanese dinar (SDD) at an interest rate of 6 per cent. At the time the loan is extended, the spot rate of the dinar is £0.0027. If the spot rate of the dinar at maturity of the loan is £0.0019, what is the effective financing rate of borrowing dinar?

A) 37.8%.
B) 51.43%.
C) -25.41%.
D) -6%.
E) None of the above

Question 29

Cameron Corporation Cameron plc would like to simultaneously borrow Japanese yen (¥) and Sudanese dinar (SDD) for a six-month period. Cameron would like to determine the expected financing rate and the variance of a portfolio consisting of 30% yen and 70% dinar. Cameron has gathered the following information: Mean effective financing rate of Japanese yen for six months 4% Mean effective financing rate of Sudanese dinar for six months 1% Standard deviation of Japanese yen's effective financing rate .10 Standard deviation of Sudanese dinar's effective financing rate .20 Correlation coefficient of effective financing rates of these two currencies .23 What is the expected standard deviation of the portfolio contemplated by Cameron?

A) 2.24%
B) 14.98%
C) 2.89%
D) 17.00%
E) None of the above

Question 30

To benefit from the low correlation between the Canadian dollar (C$) and the Japanese yen (¥), Martha ltd decides to borrow 50 per cent of funds needed in Canadian dollars and the remainder in yen. The domestic financing rate for a one-year loan is 7 per cent. The Canadian one-year interest rate is 6 per cent and the Japanese one-year interest rate is 10 per cent. Martha has determined the following possible percentage changes in the two individual currencies as follows: Currency
Percentage Change
Probability
Canadian dollar
2)0%
30%
Canadian dollar
4)0%
70%
Japanese yen
-3)0%
60%
Japanese yen
1)0%
40%
What is the expected effective financing rate of the portfolio Martha is contemplating (assume the two currencies move independently from one another)?

A) 9.03%
B) 7.00%
C) 10.00%
D) 7.59%
E) None of the above

Question 31

____ are free of default risk.

A) Euronotes
B) Eurobonds
C) Euro-commercial paper
D) None of the above

Question 32

A negative effective financing rate implies that a euro based firm actually paid fewer euros in total loan repayment than the number of euros borrowed.

Question 33

If interest rate parity exists, transactions costs are zero, and the forward rate is an accurate predictor of the future spot rate, then the effective financing rate on a foreign currency:

A) would be equal to the UK interest rate.
B) would be less than the UK interest rate.
C) would be more than the UK financing rate.
D) would be less than the UK interest rate if the forward rate exhibited a discount and more than the UK interest rate of the forward rate exhibited a premium.

Question 34

MNCs can use short-term foreign financing to reduce their exposure to exchange rate fluctuations. For example, if an American-based MNC has ____ in Algerian dinars, it could borrow ____, resulting in an offsetting effect.

A) payables; dinars
B) receivables; dinars
C) payables; dollars
D) receivables; dollars

Question 35

Assume the euro interest rate is 7.5 per cent, the New Zealand interest rate is 6.5 per cent, the spot rate of the NZ$ is 0.28 euro, and the one-year forward rate of the NZ$ is 0.25 euro. At the end of the year, the spot rate is £0.23 euro. Based on this information, what is the effective financing rate for a euro firm that takes out a one-year, uncovered NZ$ loan?

A) About -12.6%
B) About 0.0%
C) About 14.7%
D) About 15.4%
E) About 8.3%

Question 36

Firms that believe the forward rate is an unbiased predictor of the future spot rate will prefer borrowing the foreign currency.

Question 37

Assume a UK-based MNC is borrowing Romanian leu (ROL) at an interest rate of 8 per cent for one year. Also assume that the spot rate of the leu is £0.00007 and the one-year forward rate of the leu is £0.0006. The expected spot rate of the leu one-year from now is £0.000065. What is the effective financing rate (to the nearest percent) for the MNC assuming it borrows leu on an uncovered basis?

A) about 10%.
B) about -10%.
C) about -1%.
D) about 0%.
E) None of the above

Question 38

A negative effective financing rate indicates that a UK MNC:

A) paid only a small amount in interest over and above the amount borrowed.
B) has been negatively affected by a large appreciation of the foreign currency.
C) actually paid fewer pounds to repay the loan than it borrowed.
D) would have been better off borrowing in the UK.

Question 39

Assume the UK one-year interest rate is 8 per cent, and the euro one-year interest rate is 6 per cent. The one-year forward rate of the euro is £0.67. The spot rate of the euro at the beginning of the year is £0.65. By the end of the year, the euro's spot rate is £0.68. Based on the information, what is the effective financing rate for a UK firm that takes out a one-year, uncovered euro loan?

A) About 12.4%
B) About 7.1%
C) About 13.5%
D) About 10.9%
E) About 11.3%

Question 40

____ typically have maturities of less than one year.

A) Eurobonds
B) Euro-commercial paper
C) Euronotes
D) ADRs

Question 41

The degree of volatility of financing with a currency portfolio depends on only the standard deviations of effective financing rates of the individual currencies within the portfolio.

Question 42

If all currencies in a financing portfolio are not correlated with each other, financing with such a portfolio would not be very different from financing with a single foreign currency.

Question 43

The interest rate of euronotes is based on the T-bill rate.

Question 44

Countries with a ____ rate of inflation tend to have a ____ interest rate.

A) high; low
B) low; high
C) high; high
D) A and B are correct.