Deck 12: Options and International Financial Management

Question 1

Thomas Duckworth owns and operates Stones Asset Management. The firm manages $10 billion in assets and focuses on exploiting arbitrage opportunities. Duckworth uses put - call parity to price put and call options. According to his put - call parity analysis Duckworth realizes that puts with a strike price of $30 and 1 month remaining until expiration on Medusa's Inc. should be priced at $2.30. However he realizes that the $30 puts are trading for $2.75 in the open market. How should Duckworth exploit this arbitrage opportunity?

A) sell the puts in the open market, buy Medusa's stock, short a zero coupon bond with a face value of $30 and maturity of 1 month, and buy a 1 month call with a strike price of $30
B) buy the puts in the open market, short Medusa's stock, short a zero coupon bond with a face value of $30 and maturity of 1 month, and buy a 1 month call with a strike price of $30
C) sell the puts in the open market, lend $30 at the risk free rate, buy a 1 month $30 call on Medusa's, and short the underlying stock.
D) buy a zero coupon bond with a face value of $30 and maturity of 1 month and buy a 1 month call with a strike price of $30

Answer 1

sell the puts in the open market, lend $30 at the risk free rate, buy a 1 month $30 call on Medusa's, and short the underlying stock.

Question 2

The spot rate for the U.S. dollar relative to the Euro is $1.47/€. The spot rate for the U.S. dollar relative to the Canadian dollar is $0.765/C$. What is the cross exchange rate for the C$ and €?

A) C$1.922/€
B) €1.922/C$
C) C$0.5204/€
D) €0.5204/C$

Answer 2

C$1.922/€

Question 3

Gates Auto Inc. manufactures automobile engines in the United States. Gates Auto Inc. sells 200 of its 8 - cylinder Hoste model engines to a company in Canada. The total price for these engines is C$60,000. Gates Auto Inc. will deliver the engines today and receive payment in 3 months from the Canadian company. When payment is received Gates Auto will convert the C$60,000 into U.S. dollars. The spot rate is $0.7865/C$ and if the spot rate in 3 months is $0.7622/C$, how much will Gates Auto Inc. gain or lose due to exchange rate movements on this transaction if it does not perform any hedges.

A) They will lose $1,458.29
B) They will gain $1,458.29
C) They will not gain or lose anything on this transaction.
D) They will gain $31,530

Answer 3

They will lose $1,458.29

Question 4

Beech Industries is a U.S. company that sells shoes to Japanese retailers. Beech Industries just signed a contract to sell 1,000 pairs of shoes to Yakata Inc. The total price for these shoes is ¥200,000. The shoes will be delivered today but Beech Industries won't receive payment for 6 months. The current spot rate is ¥127/$ and the 6-month forward rate is ¥128/$. Marcus Duncan, the treasurer at Beech Industries, expects that in 6 months the spot rate will ¥131/$. Based on the information given Beech Industries is most likely to

A) enter into a 6-month forward contract and lock in the rate ¥128/$
B) remain unhedged on this transaction
C) demand payment today instead of in 6 months
D) cancel the transaction with Yakata Inc. because they will lose too much of their profit due to exchange rate movements.

Question 5

Suppose that a United States firm is considering an investment that will yield cash flows in Canadian dollars. The projects cash flows will be the following: Initial cost = C$-1,000,000, Year 1 = C$550,000, Year 2 = C$340,000, Year 3 = C$125,000. The U.S. firm plans to evaluate the project by discounting the cash flows at the Canadian cost of capital of 7% and then converting the NPV back to U.S. dollars at the current spot rate which is $0.8213/C$. What is the NPV of the project in U.S. dollars?

A) $-71,433
B) $-86,975
C) C$-86,975
D) C$-71,433

Question 6

Mark Duncan owns a furniture manufacturing firm in the United States. He is considering an investment in Japan which will have the following cash flows: Initial cost = ¥-300,000,000, Year 1 = ¥150,000,000, Year 2 = ¥200,000,000, Year 3 = ¥250,000,000 and Year 4 = ¥100,000,000. The appropriate discount rate that should be used to discount yen-denominated cash flows is 11%. Calculate the NPV of the project, if Duncan plans on converting the NPV from Yen into U.S. dollars at the current spot rate of ¥123/$.

A) ¥246,130,565
B) $246,130,565
C) $2,001,062
D) ¥2,001,062

Question 7

Crum Industries is a paper manufacturing company based in the United States. The CEO of the company Hannah Monstzka is considering an investment in Canada to take advantage of Canadian government subsidies. The investment will have the following cash flows: Initial cost = C$-2,000,000, Year 1 = C$1,250,000, Year 2 = C$1,000,000, Year 3 = C$750,000. Monstzka plans on hedging the cash flows using forward contracts throughout the life of the project. The risk-free rate of interest in Canada is 5% and the risk-free rate of interest in the U.S. is 4%. Currently the spot rate is $0.7134/C$ and the project should be discounted at a U.S. adjusted rate of 9%. Assume Monstzka will be able to convert the Canadian dollar cash flows into U.S. dollars at the implied forward rates when they are received. What is the NPV of the project in U.S. dollars?

A) $374,071
B) $567,606
C) $404,930
D) $393,465

Question 8

The spot rate for U.S. dollars and Euros is $1.232/€. The 90 day forward rate for the two currencies is $1.254/€. The U.S. dollar

A) trades at a 1.79% 90 day forward premium.
B) trades at a 7.14% annual forward premium.
C) trades at a 1.79% 90 day forward discount.
D) trades at a 7.14% annual forward discount.

Question 9

If the €/$ exchange rate is $1.2267/€ and the $/£ exchange rate is $1.7894/£, what is the €/£ exchange rate?

A) 2.1951
B) 1.4587
C) 0.6855
D) 2.9564

Question 10

Smith Enterprises International Investment
Smith Enterprises is considering opening a new manufacturing plant in France. The cost of the new plant will be €25 million and the plant is expected to generate after tax cash flows of €10 million at the end of each year for the next 4 years. After that the plant will be worthless. The current €/$ exchange rate is €0.8166/$. The expected rate of inflation for the U.S is 2.5% per year. The risk free rate in the U.S. is 4% and the risk free rate in France is 6%.

-Refer to Smith Enterprises International Investment. What is the cost of the manufacturing plant in U.S. dollars?

A) $20,415,000
B) $25,760,000
C) $30,615,000
D) $32,340,000