Test bank chapter 1 Introduction

Solution: US dollar value = $2.0032 x £10,000,000 = $20,032,000

18. What will be the approximate value of the accounts receivable in US dollars if the company makes a money-market hedge?

A. about $20,051,000
* B. about $20,093,000
C. about $20,151,000
D. about $20,293,000
E. about $30,000,000


Solution: (1) borrow £9,708,738 (10,000,000/1.03)
(2) buy $19,699,030 in exchange for £9,708,739
(3) invest $19,699,030 in the US at 2%
(4) receive $20,093,010 ($19,699,031 x 1.02)

Use the following information to answer the next five questions:

A subsidiary in Israel requires the Israel shekel equivalent of $1 million at the current exchange rate of 4 shekels per dollar. To obtain 4 million shekels for the subsidiary in Israel, the parent must open a $1 million credit in favor of as Israeli bank. The Israeli bank charges the parent 10% per year on the 4 million shekels made available to the subsidiary and pays no interest on the $1 million that the parent has deposited in favor of the bank. The parent's opportunity cost on the $1 million deposit is 20%. Two financing alternatives are direct loan and credit swap.

19. If the current exchange rate stays the same, which alternative is less expensive: direct loan or credit swap?

* A. direct loan
B. credit swap
C. both alternatives are equally expensive
D. cannot tell
E. depends on the government policy


Solution: Annual interest of the direct loan = 20%
Annual interest of the credit swap = 30%

20. Which alternative is more attractive: direct loan or credit swap?

A. direct loan
B. credit swap
C. equally attractive
* D. cannot tell
E. depends on the government policy


Solution: The direct loan is cheaper but subject to exchange risk; the credit swap is more expensive and has no exchange risk. Thus, one cannot tell for sure which alternative is more attractive.

21. What is the exchange rate that will make the cost of the direct loan equal to the cost of the credit swap?

A. Israel shekel 4.0 per $
* B. Israel shekel 4.4 per $
C. Israel shekel 4.8 per $
D. Israel shekel 5.5 per $
E. Israel shekel 9.0 per $