Lecture 20 - International Corporate finance part 2

Question 1

Interest rate parity

Answer 1

Interest rate parity is a method of predicting foreign exchange rates based on the hypothesis that the difference between the interest rates in two countries should offset the difference between the spot rate and the forward exchange rates over the same period

Question 2

Notations for interest rate parity

Answer 2

Ft - Forward exchange rate at time t
Rhc - Home currency nominal risk free interest rate
Rfc - Foreign country nominal risk free interest rate

Question 3

Two approaches to international capital budgeting

Answer 3

Home currency approach
Foreign currency approach

Question 4

3 steps to home currency approach

Answer 4

1. Convert all the euro cash flow to dollars
2. Discount dollar cash flows using dollar discount rate
3. Find NPV in dollars

Question 5

3 steps for foreign currency approach

Answer 5

1. Determine the required return on euro investments
2. Discount the euro flows using the euro discount rate
3. Convert the euro NPV into dollars using the spot rate

Question 6

Three types of exchange rate risk

Answer 6

Short term exposure
Long term exposure
Translation exposure