MIB Master of International Business: Multinational Financial Management 4 — Questions and Answers
Question 1: A currency is said to be 'overvalued' according to Purchasing Power Parity (PPP) when:
- Its nominal interest rate exceeds the foreign rate
- Its current exchange rate exceeds the PPP-implied rate (Correct answer)
- Its current account surplus is unusually large
- Its inflation rate is below the global average
Correct answer: Its current exchange rate exceeds the PPP-implied rate
PPP overvaluation occurs when the actual market exchange rate makes the currency stronger than warranted by relative price levels, implying goods are more expensive domestically.
Question 2: The 'bid-ask spread' in the foreign exchange market represents:
- The cost of hedging currency exposure with options
- The bank's profit margin on a currency transaction (Correct answer)
- The difference between spot and forward rates
- The interest rate differential between two countries
Correct answer: The bank's profit margin on a currency transaction
The bid-ask spread is the difference between the rate at which a market maker will buy (bid) and sell (ask) a currency, representing the dealer's transaction profit.
Question 3: An MNC discovers that EUR/USD is 1.20 in New York and 1.22 in London simultaneously. Which action exploits this arbitrage?
- Buy USD in London and sell in New York
- Buy EUR in New York at 1.20 and sell in London at 1.22 (Correct answer)
- Short EUR futures in Chicago
- Enter a EUR/USD forward contract for three months
Correct answer: Buy EUR in New York at 1.20 and sell in London at 1.22
The arbitrageur buys euros cheaply in New York (1.20 USD/EUR) and simultaneously sells them at the higher London rate (1.22 USD/EUR), locking in a risk-free profit.
Question 4: A 'blocked funds' problem arises when:
- A subsidiary cannot obtain financing in local capital markets
- A host government restricts the repatriation of profits to the parent (Correct answer)
- The parent cannot raise equity capital due to regulatory constraints
- Transfer pricing disputes freeze intercompany settlements
Correct answer: A host government restricts the repatriation of profits to the parent
Blocked funds occur when host country regulations prevent a subsidiary from transferring dividends, royalties, or other cash flows back to the parent company.
Question 5: Which of the following best describes 'economic exposure' for a multinational?
- The impact of exchange rates on the value of foreign-currency denominated assets and liabilities on the balance sheet
- The change in a firm's present value of future cash flows due to unexpected exchange rate movements (Correct answer)
- The risk arising from translating subsidiary financial statements into the parent's currency
- The exposure to exchange rate changes on already-contracted foreign currency transactions
Correct answer: The change in a firm's present value of future cash flows due to unexpected exchange rate movements
Economic exposure (also called operating exposure) measures how unexpected exchange rate changes affect the present value of a firm's future operating cash flows and competitive position.
Question 6: The Fisher Effect in international finance predicts that countries with higher nominal interest rates tend to have:
- Stronger currencies due to capital inflows
- Higher expected inflation rates (Correct answer)
- Lower real interest rates
- More favorable trade balances
Correct answer: Higher expected inflation rates
The Fisher Effect states that nominal interest rates reflect expected inflation, so higher nominal rates indicate higher expected inflation rather than higher real returns.
Question 7: A 'parallel loan' (back-to-back loan) arrangement between an MNC and a foreign company serves primarily to:
- Reduce import duties on cross-border goods
- Circumvent currency controls by having each firm lend in its home currency to the other's subsidiary (Correct answer)
- Consolidate intercompany receivables on a net basis
- Exploit interest rate differentials through covered interest arbitrage
Correct answer: Circumvent currency controls by having each firm lend in its home currency to the other's subsidiary
Parallel loans allow two firms to effectively lend to each other's foreign subsidiaries in local currencies, avoiding official currency markets and exchange controls.
MIB Master of International Business: Multinational Financial Management 4
A currency is said to be 'overvalued' according to Purchasing Power Parity (PPP) when: