*, „

Week 1-2: Tutorial Questions - FM303

March 25, 2022

PART I: An Overview of
International Finance (Chapter 1)
Answer atleast 3 questions from Part I, which are not answered ,.
1. How are the operation of international rms aected by the exchange rate
system, the presence of capital controls and the segmentation of capital
markets?
2. How are the nature of international operations changed since the early
1970s and particularly since the beginning of the 1980s?
Early 1970s marked the end of Waord War II and was characterized by the
operation of a system of xed exchange rates, the presence of captial controls
and the segmentation of nancial markets. Focus was mainly on international
trade and the benets due to comparative advantage. Emphasis was placed
upon the mechanisms and settings of international settlements and the
consequences for the balance of payments. For business rms, there was less
interest or ability to engage in international or cross-country nancing and
investment. International transactions were mainly to nance exports and
imports, and the international rms were key players.

Beginning of the 1980s: marked by the collapse of Bretton Woods sys-

tem of xed exchange rate (1971) and major countries shifted to a system of
exbile or oating exchange rates. The onset of the 1980sm exhange rates
had become misalingned and volatile. This was accompanied by abolition of
capital controls and the implementation of nancial deregulation (mainly in
the developed countries).

3. What is the eect of exchange rate volatility and misalignment on the

operation of international rms?
* Questions compiled from Moosa (2010), International Finance
„ Compiled by Course co-cordinator, Ronald R. Kumar, Semester 1, 2022, School of Ac-
counting, Economics and Finance, University of the South Pacic.

1
 4. Distinguish between international, multinational and transnational rms.
• International rms - referred to rms engaged in the cross-border activities
of importing and exporting; goods were produced in the home country and
exported abroad.
• A multinational rm carries out some of its production activity abroad
by establishing presence in foreign countries via subsidiaries (aliates and
branches) and joint ventures. The subsidiaries have dierent base currencies
(currencies of the countries where they are situated), hence exposing the multi-
national rms to greater currency and nancial risk. Multinational rms are
often characterized as conduits for foreign direct investment.
• Where cross-border activity expands to the extent that distinction between
'home' and 'abroad' becomes blurred, making it dicult to identify the home
country or the country of orgin of the rm, is what characterizes a transna-
tional rm.
NB: nancial risk arises from changes in foreign nancial variables such as
interest rates and the risk for nancial contagion. Foreign exchange rish results
from uncertainty about future exchange rates that aects sales, prices and
prots. Country risk results from economic, political and social factors that
may have adverse implications for sales, prices and prots.

5. Why are we concerned about what happens in the US economy and nan-
cial markets and those of other major countries?

6. Describe a scenario whereby a decision by the European Central Bank

results in foreign exchange losses for and Australian trading rm?
7. Distinguish between the macro and micro aspects of international nance.
8. What are the issues that the nancial manager needs to be concerned with?
Fluctuations in exchange rates and itnerest rates, balance of payment di-
culties, and nancial contagion. The volatility of exchange and interest rates
implies volatility of protability and raises the need for managing nancial
risk. Financial contagion means that what happens in one country aects
other countries and rms operating therein.

9. Describe a scenario whereby a rm is forced into bankruptcy because of

unfavourable changes in exchane rates.
10. What must the nancial manager be acquainted with?
11. What are the indicators of internationalisation of nance?
12. What are the major developments that have shaped the present economic
and nancial environment?
The emergence of Eurodollar market
Currency convertibility
The European Economic Community and the European Union
Changes in the relative economic sixe

2
13. What is the 'twin decit' problem? How did this problem aect interest
rates and exchange rates in the 1980s?
I +G+X =S+T +M
(X − M ) = (S − I) + (T − G)
which means the currency account decit (X − M ) is the sum of the domestic
savings-investment balance, (S −I), and the budget decit, (T −G). If savings
is just adequate to cover investment, then (X − M ) = (T − G), which shows
that if domestic savings does not contribute anything to the nancing of the
current account decit, then this will be identical to the budget decit.

14. Why do some people demonstrate against globalisation when it is supposed

to be good for the economic welfair of nations?

15. In the 1980s there are a view stipoulating that indebted oil-exporting
countries, such as Nigeria and Mexico, should rejoice at the collapse of
oil prices. This view is based on a hypothetical causal relationship run-
ning from oil prices to consumer prices and consequently to interest rates.
Explain how falling oil prices may be benecal for indebted oil-exporting
countries.

16. Explain why international business rms faced a dierent macroeconomic

environment in the aftermath of the 1973/74 rise in the price of crude oil
from that which followed in 1979/80 rise.

17. Give some examples indicating that capital mobility has increased. Why
do some economists claim that capital is internationally immobile?

18. What is nancial liberalisation? Is it good or bad for economic growth?

19. Dene market integration. What is the relation between market integra-
tion and nancial deregulation?

20. What is the relation between market integration and capital mobility?
Market integration refers to the close proximity of nancial markets, which
can be due to geography and technology. Capital mobility refers to the degree
of ows of funds from one country to another. High capital mobility is a
feature of an integrated market. Hence, high capital mobility can support
market integration. Similarly, for capital to be mobile (ease of ows of funds),
nancial markets should be well connected.
21. Why has a currency union between Australia and New Zealand not ma-
terialised?

22. 'The introduction of the new European currency (the euro) is not a su-
cient condition for boosting trade in Europe'. Explain.

3
 Although single currency is an important factor, it is not sucient for boost-
ing trade. The very existence of borders create some other factors that aect
adversely the environment in which business operate. Such factor like ad-
ministrative rules and standards, social and religious phenomena, capabilities
(including geography and natural resources) and information dierences (in-
cluding language) can restrict trade. It must be noted that while a single cur-
rency makes it easier to compate prices, Europe currently has heterogeneous
customers buying heterogeneous products. In terms of the capital markets,
European share markets remain fragmented with little cross listing.

23. Risk management as an independent activity emerged in the 1980s due

to increased volatility of interest and exhange rates. Why has volatility
increased?

24. What is nancial contagion? Are nancial crises really contagious? If so,
why is it that Australia did not catch the 'Asian u?'

25. What is securitisation? What factors have led to the popularity of securi-
tisation? What are the problems associated with securitisation?

26. Dene nancial innovation. What is the motivation for nancial innova-
tion?

27. Explain how the 1990 upgrading of the Closer Economic Relation (CER)
Agreement between Australia and New Zealand might have aected trade
between the two countries. Obtain some data (from the Internet or other
sources) on trade between the two countries and show whether or not
trade has increased following the upgrading of the agreement.

28. Explain how the global nancial crisis has changed ideas and attitudes
with respect to many of the issues discussed in this chapter.

PART II: The Foreign Exchange

Market (Chapter 2)
Answer at least 3 questions from the Warm-up and at least 3 questions from
the Applications, sections.

Warm-up

1. What is (a) a price taker and (b) a price maker in the foreign exchange
market?

4
 2. What is the dierence between a broker and a dealer?

3. Central banks are not prot-making institutions. Why, then, do they buy
and sell currencies on the foreign exchange market?

4. What are Herstatt risk and liquidity risk? How can they be dealt with?

5. What are 'exotic' currencies?

6. Distinguish between direct and indirect quotations of exchange rates. What

happens to the domestic currency as the exchange rate rises if it is mea-
sured in direct quotation?

7. Suppose that you are a foreign exhange dealer wishing to buy the Aus-
tralian dollar against the US dollar. Given market conditions, you are will-
ing to buy at 0.5820. You phone another dealer who quotes 0.5480-0.5510.
What would happen, assuming that you abide by market etiquette?

8. Dene/Discuss the following terms:

(a) position squaring

(b) valuation
(c) marking to market
(d) point and a pip

Applications

1. On 12 August, a Commonwealth Bank dealer in Melbourne concluded a

transaction with a Citibank dealer in New York. The former agreed to
buy from the latter USD5, 000, 000 at an exchange rate (AUD/USD) of
1.77 for delivery on 14 August. On the delivery date, the exchange rate
rose to 1.83. How much would the Commonwealth Bank be required to
pay to settle the transaction?

2. The exchange rate between the British pound and the Australian dollar
(GBP/AUD) rose from 0.3780 to 0.3960 in one week.

(a) Calculate the percentage appreciation or depreciation of the Aus-

tralian dollar.
(b) Using the result obtained in (a), calculate the percentage appreciation
or depreciation of the pound.
(c) Calculate the corresponding values of the AUD/GBP exchange rate.
(d) Using the result obtained in (c), calculate the percentage appreciation
or depreciation of the pound.
(e) Using the result obtained in (d), calculate the percentage apprecia-
tion or depreciation of the Australian dollar.

5
3. If the exchange rate between the British pound and the Australian dollar
(GBP/AUD) is 0.3980, what is:

(a) the direct quote from an Australian perspective?

(b) the indirect quote from an Australian perspective?
(c) the direct quote from a British perspective?
(d) the indirect quote from a British perspective?

4. The USD/AUD exchange rate is quoted as 0.4977−0.5176.

(a) What is the bid-oer spread in points and in percentage terms? What
is the monetary value of the point in this case?
(b) Calculate the AUD/USD exchange rate. What is the bid-oer spread
in points and in percentage terms? What is the monetary value of
the point in this case?

5. Dealer A quotes 0.6030−0.6050 for the EUR/AUD exchange rate to Dealer

B. What is:

(a) the price at which A is willing to buy the Australian dollar?

(b) the price at which A is willing to buy the euro?
(c) the price at which B can buy the Australian dollar?
(d) the price at which B can buy the euro?
(e) the price at which A is willing to sell the Australian dollar?
(f) the price at which A is willing to sell the euro?
(g) the price at which B can sell the Australian dollar?
(h) the price at which B can sell the euro?

6. If the exchange rate between the Australian dollar and the Japanese yen,
expressed in indirect quotation from an Australian perspective, is 70.10 
71.60, what is the direct quotation for this rate? What are the mid rates
in both cases?