Flashcards in BEC 3 Deck (30):

1

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What is the effect when a foreign competitor's currency becomes weaker compared to the U.S. dollar?

The foreign company will have an advantage in the U.S. market.

The foreign company will be disadvantaged in the U.S. market.

The fluctuation in the foreign currency's exchange rate has no effect on the U.S. company's sales or cost of goods sold.

It is better for the U.S. company when the value of the dollar strengthens.

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The foreign company will have an advantage in the U.S. market.

When a foreign currency becomes weaker compared to the U.S. dollar (or the dollar becomes stronger compared to the foreign currency), the U.S. dollar will exchange for more units of the foreign currency. As a result, dollars will buy more of the foreign competitor's goods, giving the foreign company an advantage in the U.S. market.

2

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Assuming exchange rates are allowed to fluctuate freely, which one of the following factors would likely cause a nation's currency to appreciate on the foreign exchange market?

(This question is CMA adapted)

A relatively rapid rate of growth in income that stimulates imports.

A high rate of inflation relative to other countries.

A slower rate of growth in income than in other countries, which causes imports to lag behind exports.

Domestic real interest rates that are lower than real interest rates abroad.

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A slower rate of growth in income than in other countries, which causes imports to lag behind exports.

The lag in imports in relation to exports means that there will be more demand for the currency from other countries to pay for the country's exported goods.

3

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What is the effect when a foreign competitor's currency becomes weaker compared to the U.S. dollar?

The foreign company will have an advantage in the U.S. market.

The foreign company will be disadvantaged in the U.S. market.

The fluctuation in the foreign currency's exchange rate has no effect on the U.S. company's sales or cost of goods sold.

It is better for the U.S. company when the value of the dollar strengthens.

###
The foreign company will have an advantage in the U.S. market.

When a foreign currency becomes weaker compared to the U.S. dollar (or the dollar becomes stronger compared to the foreign currency), the U.S. dollar will exchange for more units of the foreign currency. As a result, dollars will buy more of the foreign competitor's goods, giving the foreign company an advantage in the U.S. market.

4

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Assuming that the real rate of interest is the same in both countries, if Country A has a higher nominal interest rate than Country B, then the currency of Country A will likely be selling at a

Forward discount relative to the currency of Country B.

Forward premium relative to the currency of Country B.

Spot discount relative to the currency of Country B.

Spot premium relative to the currency of Country B.

###
Forward discount relative to the currency of Country B.

If the real rates of interest are the same, the country with the higher nominal interest rate is expected to experience a higher rate of inflation. A higher rate of inflation is associated with the devaluing of a currency, so the currency of the country with the higher nominal interest rate (Country A) likely will sell at a forward discount relative to the currency of the other country (Country B).

5

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An American importer of English clothing has contracted to pay an amount fixed in British pounds three months from now. If the importer worries that the US dollar may depreciate sharply against the British pound in the interim, it would be well advised to

Buy pounds in the forward exchange market.

Sell pounds in the forward exchange market.

Buy dollars in the futures market.

Sell dollars in the futures market.

###
Buy pounds in the forward exchange market.

By buying pounds today with a forward exchange contract, the firm protects itself against depreciation in the value of the dollar in relation to the pound.

6

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Simon Corp., a U.S. company, has made a large sale to a French company on a 120-day account payable in euros. If management of Simon wants to hedge the transaction risk related to a decline in the value of the euro, which of the following strategies would be appropriate?

Lend euros to another company for payment in 120 days.

Enter into a forward exchange contract to purchase euros for delivery in 120 days.

Enter into a futures contract to sell euros for delivery in the future.

Purchase euros on the spot market.

###
Enter into a futures contract to sell euros for delivery in the future.

By selling euros in the futures market, the firm has locked in the exchange rate today.

7

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An American importer expects to pay a British supplier £500,000 in three months. Which of the following hedges is best for the importer to fix the price in dollars?

Buying British pound call options.

Buying British pound put options.

Selling British pound put options.

Selling British pound call options.

###
Buying British pound call options.

Since the American importer will be paying in British pounds, it would want an option to buy pounds in the future, thus, it would buy a call option to acquire British pounds.

8

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In which of the following circumstances, as the dollar changes against the foreign currency, would an investment in a foreign currency result in fewer dollars and a borrowing in a foreign currency cost more dollars?

Investment in Foreign Currency Borrowing in Foreign Currency

Dollar weakens Dollar weakens

Dollar weakens Dollar strengthens

Dollar strengthens Dollar weakens

Dollar strengthens Dollar strengthens

###
Investment in Foreign Currency -

Dollar strengthens

Borrowing in Foreign Currency - Dollar weakens

If the dollar strengthens against a foreign currency, an investment denominated in that currency would result in fewer dollars; if the dollar weakens against a foreign currency, borrowing in that currency would cost more dollars, as more dollars would be required to service and repay the debt.

9

## Foreign Currency Exchange Risk - adverse changes in exchange rates can:

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1. Reduce the domestic currency value of returns on investments.

Ex/ If, during the period of a foreign investment, the dollar strengthens against the foreign currency, the investment will decline in domestic currency value, even if there is no change in value in the foreign investment market.

2.Increase the domestic currency cost of borrowing.

Ex/ If, during the period of foreign borrowing, the dollar weakens against the foreign currency, the dollars required to service the foreign denominated debt will increase, even though the interest rate in the foreign currency remains unchanged.

10

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A company can reduce the potential loss from host-government expropriation of a foreign subsidiary by

Financing the subsidiary with local-country capital.

Structuring operations so that the subsidiary has value as a stand-alone company.

Reducing the cost of capital to reflect political risk when assessing foreign investment opportunities.

Selling products in the local country.

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Financing the subsidiary with local-country capital.

A company can reduce the potential loss from expropriation of a foreign subsidiary by the local government by financing the subsidiary with local-country capital. If the company uses local-country capital (e.g., borrowing from a local bank), in the event of expropriation by the local government, it can default on the borrowing, thus offsetting the unpaid debt against the loss from asset expropriation.

11

## What is PESTEL stand for?

###
Political

Economic

Social

Technological

Environmental

Legal

12

## What is Economies of Scale?

### Economies of scale indicate that the higher the level of output, the lower the cost of production.

13

## When a product is elastic is the change in the quantity demanded greater than the change in price or vice versa?

### the change in the quantity demanded is greater than the change in price

14

## What does it mean when a country has a higher nominal interest rate than another country?

### This indicates that the country is expected to have a higher rate of inflation. A higher rate of inflation is associated with a devaluing currency so the currency of the country with the higher nominal interest rate will likely be selling at a forward discount.

15

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What is the weighted-average after-tax cost of capital for this company?

3.3%

7.7%

8.2%

9.8%

###
9.8%

This correct answer properly assumes a 30% tax savings on the bonds and no tax savings on the common or preferred stock. Thus, the correct answer is:

Bonds .40 x .10 = .04 x .70 = 2.8%

C/S .50 x .10 = .05 = 5.0%

P/S .10 x .20 = .02 = 2.0%

Weighted Average 9.8%

16

## Annuity Due vs Ordinary Annuity for Present Value (PV)

###
In an Annuity Due scenario - the annuity is paid at the beginning of the period as opposed to the end. This changes how you calculate PV. You would look at an annuity table and choose the appropriate factor based on the discount/interest rate and then add 1.0000 to that number to get your PV.

EX/ Factor of 3.465 for 4 year annuity, but you're receiving the annuity for 5 years. So you would add 1.0000 (because you're getting $5K immediately) to 3.465 to get 4.465 and then multiply this by the annuity amount = $5,000 *4.465 = $22,325 = PV

17

## Annuity Due vs Ordinary Annuity for Future Value (FV)

###
In an Annuity Due scenario - the annuity is paid at the beginning of the period as opposed to the end. This changes how you calculate FV. You would look at an annuity table and choose the appropriate factor based on the discount/interest rate and then minus 1.0000 to that number to get your FV.

EX/ Factor of 6.9757 for year 6 of a 5 year annuity, so you're receiving the annuity for 5 years. So you would minus 1.0000 (because you're getting $5K immediately) from 6.975 to get 5.975 and then multiply this by the annuity amount = $5,000 *5.975 = $29,875 = FV

18

## Formula for Present Value of a Perpetual Annuity (also called simply a “Perpetuity”)

### PV = Annual payment/Interest rate (discount rate)

19

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On December 31, 2013, Jet Co. received a $10,000 note receivable from Maxx, Inc. in exchange for services rendered. Interest is calculated on the outstanding balance at the interest rate of 3% compounded annually and payable at maturity. The note from Maxx, Inc. is due in five years. The market interest rate for similar notes on December 31, 2013, was 8%. The compound interest factors are as follows:

Future value of $1 due in nine months at 3% = 1.0225

Future value of $1 due in five years at 3% = 1.1593

Present value of $1 due in nine months at 8% = .944

Present value of $1 due in five years at 8% = .680

At what amounts should this note receivable be reported in Jet's December 31, 2013 balance sheet?

$6,800

$7,820

$6,200

$7,883

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$7,883

The correct answer $7,883. Accounting standards state that receivables bearing an unreasonably low stated interest rate should be recorded at their present value. The Maxx receivable would be recorded at its present value, since it matures in five years. The Maxx receivable will result in a lump-sum collection of $11,593 ($10,000 × 1.1593), so its present value is $7,883 ($11,593 × .680).

20

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Which of the following changes would result in the highest present value?

A $100 decrease in taxes each year for four years.

A $100 decrease in the cash outflow each year for three years.

A $100 increase in disposal value at the end of four years.

A $100 increase in cash inflows each year for three years.

###
A $100 decrease in taxes each year for four years.

This question is intended to test a candidate's understanding of the conceptual relationships between present values of single amounts and present values of annuities, and the impact of length of time on present value amounts. Getting the correct answer does not require (or expect) the actual calculation of present values for each of the four choices. Here is the logic:

1. Recognize that all of the choices are for the same amount, $100. Therefore, the amount of the principal will not create a difference in present values for the choices.

2. Next, notice that choices A, B, and D are for annuities; choice C is for a single amount to be received in four years, longer than choices B and D, and as long as choice A. Since the present value of a single amount has to be less than the present value of a series of equal amounts due within the same or less time, choice C cannot result in the highest present value.

3. Next, since choices A, B, and D are all for annuities of the same amount, the longer the annuity, the higher the present value. Choices B and D are for three years; choice A is for four years.

4. Therefore, choice A will result in the highest present value.

21

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Pole Co. is investing in a machine with a 3-year life. The machine is expected to reduce annual cash operating costs by $30,000 in each of the first 2 years and by $20,000 in year 3. Present values of an annuity of $1 at 14% are:

Period

1 0.88

2 1.65

3 2.32

Using a 14% cost of capital, what is the present value of these future savings?

$59,600

$60,800

$62,900

$69,500

###
$62,900

Since only present values of an annuity factor are given, the correct answer can be determined only by converting the values given into two annuities. An annuity is a series of equal payments. The given values are:

$30,000 for years 1 and 2, and $20,000 for year 3.

Those values are not equal for every year (therefore not an annuity), so the annuity factors given cannot be used with those values (as given). But, they can be converted into two series of equal payments comprised of:

$20,000 for years 1, 2 and 3, and $10,000 for years 1 and 2.

Those two cash flow streams would look like:

YEAR STREAM 1 STREAM 2 STREAM 3

Year 1 $20,000 + $10,000 = $30,000

Year 2 $20,000 + $10,000 = $30,000

Year 3 $20,000 + = $20,000

Note that now there are two series, each of equal amounts, but which total to the same amounts as the values given. The present value of an annuity for 3 years can now be applied to $20,000 and the present value of an annuity for 2 years can be applied to $10,000. The results would be:

(1) $10,000 annuity for two years: $10,000(1.65) = $16,500

(2) $20,000 annuity for three years $20,000(2.32) 46,400

Total present value = $62,900 (16,500+46,400)

22

## Annual percentage rate (APR) formula

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APR = interest (cost)/ (principal*time fraction of year)

Ex/ $600 of interest on 10K loan paid back in 180 would yield; APR = 600 / (10000*(180/360))= 12%

23

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A corporation obtains a loan of $200,000 at an annual rate of 12%. The corporation must keep a compensating balance of 20% of any amount borrowed on deposit at the bank, but it normally does not have a cash balance account with the bank. What is the effective cost of the loan?

12.0%

13.3%

15.0%

16.0%

###
15.0%

The effective cost of the loan (i.e., the effective interest rate on the loan) is determined as the annual dollar cost of the loan divided by the net useable proceeds of the loan. The annual dollar cost is the principal multiplied by the annual rate, or $200,000 x .12 = $24,000. The net useable proceeds of the loan is the principal amount less the amount of the compensating balance that must be maintained with the bank, or $200,000 - ($200,000 x .20) = $200,000 - $40,000 = $160,000. Therefore, the effective cost of the loan is $24,000/$160,000 = .15 (or 15%).

24

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An entity is examining potential investments and notes that 1-year maturity yields are higher than those for 10-year maturities. Which of the following explanations for this occurrence is best?

The short-term investments have higher liquidity and therefore carry a higher rate of interest.

The short-term investments carry a more immediate default risk premium resulting in higher rates of return.

The long-term instruments provide a longer stream of investment income and therefore carry a lower rate of return.

Investors are expecting reduced inflation in the future as reflected in the lower long-term returns.

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Investors are expecting reduced inflation in the future as reflected in the lower long-term returns.

When investors expect reduced inflation in the future, a lower risk premium will be assessed on an investment (often called the “expectation theory”). The inflation risk premium compensates investors for the expected adverse effects of future inflation on the security. That premium is based on the expected average inflation rate over the life of the security. Therefore, an expected reduction in inflation in the future would be reflected in a lower long-term rate of return.

25

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A company wants to approximate the 12% annual interest rate based on a 365-day year it pays on its working capital loan. Which of the following terms should the company offer its customers?

2.00%, 15, net 45.

1.00%, 15, net 45.

0.75%, 10, net 30.

0.50%, 10, net 30.

###
1.00%, 15, net 45.

These terms would provide the desired 12% annual interest rate. The interest rate associated with discount terms is computed as:

[Discount Rate/Principal] × [1/(Length of discount period/365)]; where:

Principal = Amount after discount

Length of discount period = Difference between discount date and net date

Using the facts in this question: [.01/.99] × [1/(30/365)] = .0101 × (365/30) =

.0101 × 12.16 = 12.28 (or 12% rounded) annual interest rate, the correct answer.

(NOTE: An easier and quicker approximation can be made by dividing the discount period into the days in a year, or 45 – 15 = 30 days; 365/30 = 12.1, and multiplying that by the discount amount = 12.1 × .01 = .121 (or 12% rounded), the correct answer.)

26

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An individual exhibiting the following savings and consumption pattern has a marginal propensity to consume of

Year Income level Savings Consumption

1 $10,000 $2,000 $8,000

2 $15,000 $5,000 $10,000

0.40

0.60

0.67

0.80

###
0.40

This answer is correct. The marginal propensity to consume is calculated as follows:

Change in consumption = $2,000

Change in income = $5,000

2,000/5,000 = 0.40

27

## Capital Asset Pricing Model (CAPM) Formula

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RR = RFR + β (ERR – RFR)

RR = Required rate of return; the minimum rate of return that must be earned on an investment (e.g., stock, portfolio, capital project, etc.) to provide for (and at least be equal to) the rate on a risk-free investment plus a premium for the risk inherent in the particular investment

RFR = Risk-free rate of return; a measure of the time value of money, which in the United States is generally measured by the rate (yield) on U.S. government bonds

β = Beta of the investment; a measure of volatility, as described below

ERR = Expected rate of return for a benchmark for the asset class (type of asset) being valued

28

## What is the "Nominal Risk Free Rate"?

### The Nominal Risk Free Rate is equal to the US Treasury Bond rate

29

## Expected Value Formula (used in option trading

###
Expected Value = ((Probability of Price * Expected Future Gain) + Probability of Price * (Expected Future Value))/Interest (discount) rate)

EX/ If probably of $120 is 60% and probability of $80 is 40% on a $100 stock, and interest rate is 10%, expected value would be computed as:

Expected Value = ((.60*$20) + (.40*$0))/1.10 = $10.91 - that is the expected option value

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