FINM7406 International Financial Management
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Question 1: (10 marks)
Part A
Suppose you are a China-based investor who just sold Australian Commonwealth Bank
(CBA) shares that you had bought six months ago. You had invested Yuan 446,000 to buy
CBA shares for $70 per share. The exchange rate was 4.46Yuan/$. You sold the stock for
$65 per share and converted the dollar proceeds into Yuan at the exchange rate of
5.46Yuan/$.
a) Determine the percentage return from this investment in Australian dollars. Show all
workings. (2 marks)
b) Compute the rate of return on your investment in Yuan terms. Show all workings. (2
marks)
Part B
c) With regard to international diversification, what is home bias? Give two possible
explanations for why it occurs. (3 marks)
d) Var (Ri$) = Var(Ri) + Var(si) + 2Cov(Ri,si)
This equation demonstrates that exchange rate fluctuations contribute to the risk of
foreign investment through two channels.
What are they? (2 marks)
e) What are the two missing words in the sentence below?
As the number of assets in a portfolio increases, the portfolio variance becomes more
dependent on the _______________ and less dependent on the ____________.
(1 mark)
FINM7406 International Financial Management
Page 2 of 5
Question 2: (10 marks)
Billy Samuels of Brisbane just purchased a Korean company that produces plastic nuts
and bolts for car manufacturers. The purchase price was KRW 7030 million. KRW 1000
million has already being paid and the remaining KRW 6030 million is due in six months.
The current spot rate is KRW 1200 / AUD and the 6-month forward rate is KRW 1260 /
AUD.
Additional Data:
6-month Korean interest rate 16% pa
6-month Australian interest rate 4% pa
6-month call option on KRW at KRW 1200/AUD 3%
6-month put option on KRW at KRW 1200/AUD 2.4%
Billy Samuels can invest at the given rates above, or borrow at 2% pa above these rates.
Billy Samuel’s WACC is 25% pa.
a) Calculate the cost of a money market hedge at the time the payment is due. (4 marks)
b) Calculate the cost of an option hedge at the time the payment is due assuming you
exercise the option (4 marks)
c) With regards to futures contracts, what is the difference between a maintenance margin
and a variation margin? (2 marks)
FINM7406 International Financial Management
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Question 3: (10 marks)
During the semester you studied the “Porsche Exposed” case study. In relation to this
study:
“Porsche has the heaviest U.S. exposure (and this is increasing), yet it has the lowest
level of natural hedging in the sector.”
Porsche, Citigroup Smith Barney, September 24, 2003, p.5.
With regards to natural hedging:
a) What was the financial (natural) hedge proposed to Porsche? How would this have
worked? (2 marks)
b) What was the operation (natural) hedge proposed to Porsche? How would this have
worked? (2 marks)
c) Why did Porsche not want to use the operation hedge proposed? What are the
arguments for and against this position? (3 marks)
d) Which of the financial hedge or the operation hedge would you recommend to
Porsche? Why? (3 marks)
FINM7406 International Financial Management
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Question 4: (10 marks)
Red Baron Company, a U.S. MNC, is contemplating making a foreign capital expenditure
in New Zealand. The initial cost of the project is NZD12,000. The annual cash flows
over the five year economic life of the project in NZD are estimated to be 2,000, 3,000,
4,000, 5,000, and 8,000. The parent firm’s cost of capital in USD is 10 percent. Long-
run inflation is forecasted to be 4 percent per annum in the U.S. and 8 percent in New
Zealand. The current spot foreign exchange rate is NZD/USD = 4.20. Determine the
NPV for the project in USD by:
a) Calculating the NPV in NZD using the NZD equivalent cost of capital according to the
Fisher Effect and then converting to USD at the current spot rate. (Must show all
workings) (4 marks)
b) Converting all cash flows from NZD to USD at Purchasing Power Parity forecasted
exchange rates and then calculating the NPV at the USD cost of capital. (Must show all
workings) (6 marks)
FINM7406 International Financial Management
Page 5 of 5
Question 5: (10 marks)
a) Currently, 3 ordinary shares of Australian company ABC limited are equivalent to 1
ABC ADR in the US. If the ASX ABC price is AUD15, while the ABC ADR is USD 26
and the exchange rate is USD0.6500/AUD, what is the synthetic price for one ABC
ADR? (Be sure to indicate the currency in your answer.) (2 marks)
b) Now ignore your answer for part a, and assume the synthetic price for one ABC ADR
is USD 30 and all other details in part a are the same. How would an arbitrager take
advantage of this and how much would they profit/lose? (3 marks)
c) What are the three unique characteristics of the Eurobond market? (1 marks)
d) Assume you are the CFO of Tiger Limited. Tiger is considering setting up a subsidiary
in New Jackson (a fictitious country). New Jackson is run by a dictator, and has been for
the last 20 years. During this time, a number, but not all foreign companies that have
established subsidiaries in New Jackson have been subject to some various forms of
expropriation.
Given this history, how would you advise Tiger to minimise exposure to political risk?
Specifically, give two methods used to reduce exposure and a short explanation of how
each of these would reduce the political risk. (4 marks)
END OF EXAMINATION