FIN 535 Week 10 Homework Assignment

FIN 535 Week 10 Homework Assignment
Homework Problems for Chapters 19 20 and 21 Due Week 10 and worth 60 points
1. Chapter 19. Questions and Applications: 10 (page 589). 10. Impact of September 11 Every quarter, Bronx Co. ships computer chips to a firm in central Asia. It has not used any trade financing because the importing firm always pays its bill in a timely manner upon receipt of the computer chips. After the September 11, 2001, terrorist attack on the United States, Bronx reconsidered whether it should use some form of trade financing that would ensure that it would be paid for its exports upon delivery. Offer a suggestion to Bronx Co. on how it could achieve its goal.
2. Chapter 19. Questions and Applications: 14 (page 589). 14. Letters of Credit Ocean Traders of North America is a firm based in Mobile, Alabama, that spe- cializes in seafood exports and commonly uses letters of credit (L/Cs) to ensure payment. It recently experienced a problem, however. Ocean Traders had an irrevocable L/C issued by a Russian bank to ensure that it would receive payment upon shipment of 16,000 tons of fish to a Russian firm. This bank backed out of its obligation, however, stating that it was not authorized to guarantee commercial transactions. a. Explain how an irrevocable L/C would normally facilitate the business transaction between the Russian importer and Ocean Traders of North America (the U.S. exporter). b. Explain how the cancellation of the L/C could cre- ate a trade crisis between the U.S. and Russian firms. c. Why do you think situations like this (the cancel- lation of the L/C) are rare in industrialized countries? d. Can you think of any alternative strategy that the U.S. exporter could have used to protect itself better when dealing with a Russian importer?
3. Chapter 20. Questions and Applications: 5 (page 608). 5. Short-Term Financing Analysis Assume that Davenport, Inc., needs $3 million for a 1-year period. Within 1 year, it will generate enough U.S. dollars to pay off the loan. It is considering three options: (1) borrowing U.S. dollars at an interest rate of 6 per- cent, (2) borrowing Japanese yen at an interest rate of 3 percent, or (3) borrowing Canadian dollars at an interest rate of 4 percent. Davenport expects that the Japanese yen will appreciate by 1 percent over the next year and that the Canadian dollar will appreciate by 3 percent. What is the expected “effective” financing rate for each of the three options? Which option appears to be most feasible? Why might Davenport, Inc., not necessarily choose the option reflecting the lowest effective financing rate?
4. Chapter 20. Questions and Applications: 16 (page 610). 16. Analysis of Short-Term Financing Jacksonville Corp. is a U.S.-based firm that needs $600,000. It has no business in Japan but is considering 1-year financ- ing with Japanese yen because the annual interest rate would be 5 percent versus 9 percent in the United States. Assume that interest rate parity exists. a. Can Jacksonville benefit from borrowing Japanese yen and simultaneously purchasing yen 1 year forward to avoid exchange rate risk? Explain. b. Assume that Jacksonville does not cover its expo- sure and uses the forward rate to forecast the future spot rate. Determine the expected effective financing rate. Should Jacksonville finance with Japanese yen? Explain. c. Assume that Jacksonville does not cover its expo- sure and expects that the Japanese yen will appreciate by 5, 3, or 2 percent, and with equal probability of each occurrence. Use this information to determine the probability distribution of the effective financing rate. Should Jacksonville finance with Japanese yen? Explain.
5. Chapter 21. Questions and Applications: 8 (page 631). 8. Effective Yield Fort Collins, Inc., has $1 million in cash available for 30 days. It can earn 1 percent on a 30-day investment in the United States. Alternatively, if it converts the dollars to Mexican pesos, it can earn 1.5 percent on a Mexican deposit. The spot rate of the Mexican peso is $.12. The spot rate 30 days from now is expected to be $.10. Should Fort Collins invest its cash in the United States or in Mexico? Substantiate your answer.
6. Chapter 21. Questions and Applications: 18 (page 631). 18. Investing in a Portfolio Pittsburgh Co. plans to invest its excess cash in Mexican pesos for 1 year. The 1-year Mexican interest rate is 19 percent. The proba- bility of the peso- percentage change in value during the next year is shown next:
POSSIBLE RATE OF CHANGE IN THE MEXICAN PESO OVER THE LIFE OF THE INVESTMENT PROBABILITY OF OCCURRENCE -15% 20% -4 50 0 30
What is the expected value of the effective yield based on this information? Given that the U.S. interest rate for 1 year is 7 percent, what is the probability that a 1-year investment in pesos will generate a lower effective yield than could be generated if Pittsburgh Co. simply invested domestically?