1)Distinguish between forward and future market.

(6m)
:-

2) Tools of managing transaction exposure. (6m)

:- Transaction exposure refers to the risk that a company’s future cash flows will be affected
by changes in exchange rates. Managing transaction exposure is crucial to minimize potential
losses and maximize potential gains. Here are some tools used to manage transaction
exposure:

1. *Forward Contracts*: A forward contract is an agreement to buy or sell a specific amount

of currency at a predetermined exchange rate on a specific date in the future. This tool helps
to lock in the exchange rate and reduce uncertainty.
2. *Futures Contracts*: A futures contract is similar to a forward contract, but it is traded on
an exchange and has standardized terms. Futures contracts can be used to hedge transaction
exposure.
3. *Options Contracts*: An options contract gives the buyer the right, but not the obligation,
to buy or sell a specific amount of currency at a predetermined exchange rate on or before a
specific date. Options contracts can be used to hedge transaction exposure and provide
flexibility.
4. *Swaps*: A swap is an agreement to exchange a series of cash flows in one currency for a
series of cash flows in another currency. Swaps can be used to hedge transaction exposure
and manage interest rate risk.

5. *Money Market Hedge*: A money market hedge involves borrowing or lending in one
currency and investing or repaying in another currency. This tool can be used to hedge
transaction exposure and manage short-term cash flows.
6. *Invoice in the Domestic Currency*: Invoicing in the domestic currency can help to reduce
transaction exposure by eliminating the need to convert foreign currency receipts into the
domestic currency.
7. *Lead and Lag*: Lead and lag strategies involve adjusting the timing of foreign currency
receipts or payments to take advantage of favorable exchange rate movements.
8. *Currency Diversification*: Currency diversification involves holding a portfolio of
currencies to reduce exposure to any one currency.
9. *Natural Hedge*: A natural hedge involves matching foreign currency receipts with foreign
currency payments to reduce transaction exposure.
10. *Risk Management Software*: Risk management software can be used to monitor and
manage transaction exposure by providing real-time exchange rate data, forecasting exchange
rate movements, and simulating different hedging strategies.
These tools can be used individually or in combination to manage transaction exposure and
minimize potential losses. The choice of tool depends on the company’s specific needs, risk
tolerance, and market conditions.
3) Different foreign exchange rate parity conditions. (15m)
:- Foreign exchange rate parity conditions are a set of theories that explain the relationship
between exchange rates, interest rates, and inflation rates between two countries. These
conditions help to determine the equilibrium exchange rate and ensure that there are no
arbitrage opportunities in the foreign exchange market. Here are some of the different foreign
exchange rate parity conditions:

• *Purchasing Power Parity (PPP)*: This condition states that the exchange rate between
two countries should be equal to the ratio of the price levels of the two countries. In
other words, the exchange rate should adjust to ensure that the purchasing power of
a unit of currency is the same in both countries.

Example: If the price level in the US is $100 and the price level in the UK is £80, the exchange
rate should be $1 = £0.80.
 • *Interest Rate Parity (IRP)*: This condition states that the difference in interest rates
between two countries should be equal to the difference in the forward and spot
exchange rates. In other words, the interest rate differential should be reflected in the
exchange rate.
Example: If the interest rate in the US is 5% and the interest rate in the UK is 3%, the forward
exchange rate should be higher than the spot exchange rate to reflect the interest rate
differential.

• *Forward Rate Parity (FRP)*: This condition states that the forward exchange rate
should be equal to the spot exchange rate adjusted for the interest rate differential
between the two countries.
Example: If the spot exchange rate is $1 = £0.80 and the interest rate in the US is 5% and the
interest rate in the UK is 3%, the forward exchange rate should be $1 = £0.82.
*Covered Interest Rate Parity (CIRP)*: This condition states that the interest rate differential
between two countries should be equal to the difference in the forward and spot exchange
rates, adjusted for the interest rate on the forward contract.

Example: If the interest rate in the US is 5% and the interest rate in the UK is 3%, and the
forward exchange rate is $1 = £0.82, the interest rate on the forward contract should be
adjusted to reflect the interest rate differential.

• Uncovered Interest Rate Parity (UIRP)*: This condition states that the expected
depreciation of the exchange rate should be equal to the interest rate differential
between the two countries.

Example: If the interest rate in the US is 5% and the interest rate in the UK is 3%, the expected
depreciation of the exchange rate should be 2% per annum.
These foreign exchange rate parity conditions help to explain the relationships between
exchange rates, interest rates, and inflation rates, and are used to determine the equilibrium
exchange rate and ensure that there are no arbitrage opportunities in the foreign exchange
market.
4) Discuss the external tools of foreign exchange risk management. (15m)
:- External tools of foreign exchange risk management refer to the various financial
instruments and techniques used by companies to manage their foreign exchange exposure.
These tools are external in the sense that they involve transactions with external parties, such
as banks, financial institutions, or other companies. Here are some of the most common
external tools of foreign exchange risk management:
1. _Forward Contracts_: A forward contract is an agreement to buy or sell a specific amount
of foreign currency at a predetermined exchange rate on a specific date in the future. Forward
contracts are widely used to hedge foreign exchange exposure.
2. _Futures Contracts_: A futures contract is similar to a forward contract, but it is traded on
an exchange and has standardized terms. Futures contracts are also used to hedge foreign
exchange exposure.

3. _Options Contracts_: An options contract gives the buyer the right, but not the obligation,
to buy or sell a specific amount of foreign currency at a predetermined exchange rate on or
before a specific date. Options contracts are used to hedge foreign exchange exposure and
provide flexibility.

4. _Swaps_: A swap is an agreement to exchange a series of cash flows in one currency for a
series of cash flows in another currency. Swaps are used to hedge foreign exchange exposure
and manage interest rate risk.
5. _Currency Options_: Currency options are options contracts that give the buyer the right to
buy or sell a specific amount of foreign currency at a predetermined exchange rate. Currency
options are used to hedge foreign exchange exposure and provide flexibility.
6. _Currency Futures_: Currency futures are futures contracts that are traded on an exchange
and have standardized terms. Currency futures are used to hedge foreign exchange exposure.
7. _Foreign Exchange Swaps_: Foreign exchange swaps are agreements to exchange a series
of cash flows in one currency for a series of cash flows in another currency. Foreign exchange
swaps are used to hedge foreign exchange exposure and manage interest rate risk.
8. _Cross-Currency Swaps_: Cross-currency swaps are agreements to exchange a series of cash
flows in one currency for a series of cash flows in another currency, with the exchange of
principal amounts at maturity. Cross-currency swaps are used to hedge foreign exchange
exposure and manage interest rate risk.
9. _Currency Deposits_: Currency deposits are deposits of foreign currency with a bank or
financial institution. Currency deposits are used to hedge foreign exchange exposure and earn
interest income.
10. _Foreign Exchange Certificates_: Foreign exchange certificates are certificates issued by a
bank or financial institution that represent a deposit of foreign currency. Foreign exchange
certificates are used to hedge foreign exchange exposure and earn interest income.

These external tools of foreign exchange risk management can be used individually or in
combination to manage foreign exchange exposure and minimize potential losses. The choice
of tool depends on the company’s specific needs, risk tolerance, and market conditions.
5) Scope of the multinational business finance.(6m)
:- The scope of multinational business finance is broad and encompasses various aspects of
financial management in a global business environment. Here are some of the key areas that
fall within the scope of multinational business finance:
1. *International Financial Markets*: Understanding the characteristics, mechanisms, and
instruments of international financial markets, including foreign exchange markets,
international bond markets, and global equity markets.

2. *Foreign Exchange Risk Management*: Managing foreign exchange risk through hedging
strategies, such as forward contracts, futures contracts, options contracts, and swaps.
3. *International Investment Decisions*: Evaluating investment opportunities in foreign
markets, considering factors such as market potential, competition, regulatory environment,
and cultural differences.
4. *Global Sourcing and Procurement*: Managing global supply chains, including sourcing and
procurement of goods and services from foreign suppliers.
5. *International Financial Reporting and Analysis*: Understanding international financial
reporting standards, such as IFRS, and analyzing financial statements of multinational
corporations.
6. *Cross-Border Mergers and Acquisitions*: Evaluating and executing cross-border mergers
and acquisitions, considering factors such as cultural integration, regulatory compliance, and
financial integration.

7. *International Tax Planning*: Understanding international tax laws and regulations, and
planning tax strategies to minimize tax liabilities and maximize tax benefits.
8. *Global Cash Management*: Managing global cash flows, including cash pooling, cash
concentration, and cash disbursement.

9. *International Risk Management*: Managing various types of international risks, such as

country risk, political risk, and economic risk.
10. *Global Financial Strategy*: Developing a global financial strategy that aligns with the
company’s overall business strategy, considering factors such as market entry strategies,
financing options, and risk management.
These areas are not exhaustive, and the scope of multinational business finance may vary
depending on the specific needs and goals of the organization.
6) Distinguish between exposure and risk with an example. (6m)
:- Exposure and risk are two related but distinct concepts in the context of financial
management.
Exposure :- refers to the potential impact of a change in a variable (such as exchange rates,
interest rates, or commodity prices) on a company’s financial position or performance.
Exposure can be positive or negative, and it can be measured in terms of the potential gain or
loss resulting from a change in the variable.
Risk :- on the other hand, refers to the uncertainty or unpredictability of a future event or
outcome that can affect a company’s financial position or performance. Risk is a measure of
the likelihood and potential impact of an adverse event or outcome.
Here’s an example to illustrate the difference between exposure and risk:
Suppose a US-based company, XYZ Inc., imports raw materials from a supplier in Japan. The
company has a contract to purchase 1 million units of the raw material at a price of ¥100 per
unit, with payment due in 3 months. The current exchange rate is ¥100/$1.
In this scenario:
- Exposure: XYZ Inc. has an exposure to the Japanese yen (JPY) because its payment obligation
is denominated in JPY. If the JPY appreciates against the US dollar (USD) over the next 3
months, XYZ Inc. will have to pay more USD to settle its payment obligation. The company’s
exposure to the JPY is ¥100 million (1 million units x ¥100 per unit).
- Risk: The risk associated with this exposure is the uncertainty surrounding the future
exchange rate between the JPY and the USD. If the JPY appreciates significantly against the
USD, XYZ Inc. will face a larger-than-expected payment obligation, which could negatively
impact its financial performance. Conversely, if the JPY depreciates against the USD, XYZ Inc.
will benefit from a lower payment obligation.
In this example, the exposure is the potential impact of a change in the JPY/USD exchange rate
on XYZ Inc.’s payment obligation, while the risk is the uncertainty surrounding the future
exchange rate and its potential impact on the company's financial performance.
7) Determinants of foreign exchange rate. (15m)
:- The determinants of foreign exchange rates are the factors that influence the value of one
currency relative to another. These factors can be broadly categorized into economic, political,
and market-related factors. Here are some of the key determinants of foreign exchange rates:
Economic Factors:
1. *Inflation Rate*: A country with a high inflation rate will see its currency depreciate, as the
purchasing power of the currency decreases.

2. *Interest Rate*: Higher interest rates in a country will attract foreign investors, causing the
currency to appreciate.
3. *Gross Domestic Product (GDP)*: A country with a high GDP growth rate will see its
currency appreciate, as investors become more optimistic about the country's economic
prospects.
4. *Balance of Payments*: A country with a trade deficit (i.e., imports more than it exports)
will see its currency depreciate, as it needs to sell more of its currency to finance its imports.
5. *Fiscal Policy*: Expansionary fiscal policies (e.g., increased government spending) can lead
to a depreciation of the currency, as the increased demand for goods and services drives up
inflation.
Political Factors:
1. *Government Stability*: A stable government with a clear economic policy will attract
foreign investors, causing the currency to appreciate.

2. *Election Uncertainty*: Uncertainty surrounding elections can lead to a depreciation of the

currency, as investors become cautious about the country's future economic prospects.
3. *Trade Agreements*: Trade agreements between countries can lead to an appreciation of
the currency, as they increase trade and investment between countries.

Market-Related Factors:
1. *Supply and Demand*: The exchange rate is determined by the supply and demand for the
currency in the foreign exchange market.
2. *Speculation*: Speculators can influence the exchange rate by buying or selling currencies
based on their expectations of future exchange rate movements.
3. *Market Sentiment*: Market sentiment, such as investor attitudes and expectations, can
influence the exchange rate.
4. *Central Bank Intervention*: Central banks can influence the exchange rate by buying or
selling currencies in the foreign exchange market.

5. *Technical Analysis*: Technical analysis, such as chart patterns and trends, can influence
the exchange rate by identifying potential buying and selling opportunities.
These determinants of foreign exchange rates are interrelated and can influence each other.
Understanding these factors can help investors, businesses, and policymakers make informed
decisions about foreign exchange markets.
8) The emergence of euro dollar markets in international capital markets. (6m)
:- The emergence of Eurodollar markets in international capital markets was a significant
development that transformed the global financial landscape. Here's a brief overview:

Eurodollars :-
Eurodollars are US dollars held in banks outside the United States, primarily in Europe. These
dollars are not subject to US banking regulations and are not guaranteed by the US Federal
Reserve.

Emergence of Eurodollar Markets

In the 1950s and 1960s, European banks, particularly in London, began to attract dollar
deposits from international investors. This was driven by several factors:
1. *Dollar Shortage*: After World War II, the US dollar became the global reserve currency,
and there was a shortage of dollars in international markets.
2. *Regulatory Arbitrage*: US banking regulations, such as the Federal Reserve's reserve
requirements, made it less attractive for banks to hold dollars in the US. European banks, with
fewer regulatory restrictions, offered more attractive terms for dollar deposits.

3. *Cold War Politics*: The Soviet Union and other Eastern Bloc countries were looking for
ways to hold dollars outside the US, as they were concerned about the potential for the US to
freeze their assets.
Characteristics of Eurodollar Markets

Eurodollar markets have several distinct characteristics:

1. *Offshore Location*: Eurodollar markets are located outside the US, primarily in Europe,
Asia, and the Caribbean.
2. *Deregulated Environment*: Eurodollar markets operate in a relatively deregulated
environment, with fewer restrictions on banking activities.
3. *Interbank Market*: Eurodollar markets are primarily interbank markets, where banks
trade with each other.
4. *Libor Benchmark*: The London Interbank Offered Rate (Libor) is a benchmark interest rate
for Eurodollar deposits.

Impact of Eurodollar Markets

The emergence of Eurodollar markets has had a significant impact on international capital
markets:
1. *Globalization of Finance*: Eurodollar markets have facilitated the globalization of finance,
enabling banks and investors to access dollar funding outside the US.
2. *Increased Liquidity*: Eurodollar markets have increased liquidity in international capital
markets, making it easier for banks and investors to access funding.
3. *Diversification of Funding*: Eurodollar markets have provided banks and investors with an
alternative source of funding, reducing their dependence on domestic markets.
4. *Regulatory Challenges*: The growth of Eurodollar markets has also raised regulatory
challenges, as authorities seek to balance the need for financial stability with the benefits of
globalized finance.
In summary, the emergence of Eurodollar markets has transformed international capital
markets, providing a new source of funding, increasing liquidity, and facilitating the
globalization of finance.
9) The various theoretical bases that explain the foreign exchange relationship between
currencies. (15m)

:- There are several theoretical bases that explain the foreign exchange relationship between
currencies. Here are some of the most widely accepted theories:
 1) Purchasing Power Parity (PPP) Theory : This theory states that the exchange rate
between two currencies should be equal to the ratio of the price levels of the two
countries. In other words, the exchange rate should adjust to ensure that the
purchasing power of a unit of currency is the same in both countries.
Example: If the price level in the US is $100 and the price level in the UK is £80, the exchange
rate should be $1 = £0.80.
2) Interest Rate Parity (IRP) Theory : This theory states that the difference in interest rates
between two countries should be equal to the difference in the forward and spot
exchange rates. In other words, the interest rate differential should be reflected in the
exchange rate.
Example: If the interest rate in the US is 5% and the interest rate in the UK is 3%, the forward
exchange rate should be higher than the spot exchange rate to reflect the interest rate
differential.
3) Fisher Effect Theory : This theory states that the nominal interest rate in a country is
equal to the real interest rate plus the expected rate of inflation. This theory is used to
explain the relationship between interest rates and exchange rates.

Example: If the real interest rate in the US is 2% and the expected rate of inflation is 3%, the
nominal interest rate should be 5%.
4) International Fisher Effect Theory : This theory states that the difference in nominal
interest rates between two countries should be equal to the difference in the expected
rates of inflation between the two countries. This theory is used to explain the
relationship between interest rates and exchange rates.
Example: If the nominal interest rate in the US is 5% and the nominal interest rate in the UK is
3%, the expected rate of inflation in the US should be higher than the expected rate of inflation
in the UK.
5) Balance of Payments Theory : This theory states that the exchange rate between two
currencies should be determined by the balance of payments between the two
countries. In other words, the exchange rate should adjust to ensure that the balance
of payments is in equilibrium.
Example: If the US has a trade deficit with the UK, the exchange rate should adjust to make
US exports more competitive and reduce the trade deficit.
6) Monetary Approach Theory : This theory states that the exchange rate between two
currencies should be determined by the relative money supplies and demands in the
two countries. In other words, the exchange rate should adjust to ensure that the
money supply and demand are in equilibrium.
Example: If the money supply in the US increases relative to the money supply in the UK, the
exchange rate should adjust to make the US dollar less valuable relative to the UK pound.
 7) Portfolio Balance Theory : This theory states that the exchange rate between two
currencies should be determined by the relative attractiveness of assets denominated
in the two currencies. In other words, the exchange rate should adjust to ensure that
investors are indifferent between holding assets denominated in the two currencies.
8) Example: If investors become more optimistic about the US economy and prefer to
hold US assets, the exchange rate should adjust to make the US dollar more valuable
relative to the UK pound.

These theories are not mutually exclusive, and the actual exchange rate between two
currencies is likely to be influenced by a combination of factors.
10) Internal and external techniques of foreign exchange risk management. (15m)
:- Foreign exchange risk management involves using various techniques to mitigate the
potential losses or gains arising from fluctuations in exchange rates. Here are some internal
and external techniques of foreign exchange risk management:
Internal Techniques
1. *Matching*: Matching involves matching foreign currency receipts with foreign currency
payments to minimize the impact of exchange rate fluctuations.

2. *Netting*: Netting involves offsetting foreign currency receipts and payments to reduce the
net exposure to exchange rate fluctuations.
3. *Leading and Lagging*: Leading and lagging involve adjusting the timing of foreign currency
receipts and payments to take advantage of favorable exchange rate movements.

4. *Invoicing in Domestic Currency*: Invoicing in domestic currency involves invoicing foreign

customers in the domestic currency to avoid exchange rate risk.
5. *Natural Hedge*: A natural hedge involves matching foreign currency receipts and
payments within the same subsidiary or affiliate to minimize exchange rate risk.

External Techniques
1. *Forward Contracts*: Forward contracts involve buying or selling a foreign currency at a
predetermined exchange rate on a specific date in the future.
2. *Futures Contracts*: Futures contracts involve buying or selling a foreign currency at a
predetermined exchange rate on a specific date in the future, with standardized contract sizes
and settlement dates.
3. *Options Contracts*: Options contracts involve buying or selling the right to buy or sell a
foreign currency at a predetermined exchange rate on or before a specific date.
4. *Swaps*: Swaps involve exchanging a series of cash flows in one currency for a series of
cash flows in another currency, often used to hedge interest rate and exchange rate risk.
5. *Currency Options*: Currency options involve buying or selling the right to buy or sell a
foreign currency at a predetermined exchange rate on or before a specific date.
6. *Currency Futures*: Currency futures involve buying or selling a foreign currency at a
predetermined exchange rate on a specific date in the future, with standardized contract sizes
and settlement dates.

7. *Money Market Hedge*: A money market hedge involves borrowing or lending in one
currency and investing or repaying in another currency to hedge exchange rate risk.
These internal and external techniques can be used individually or in combination to manage
foreign exchange risk, depending on the company’s specific needs and risk tolerance.

11) The implications of covered IRP with reference to lending and borrowing in the
international context. (6m)
:- Covered Interest Rate Parity (CIRP) is a fundamental concept in international finance that
explains the relationship between interest rates and exchange rates. In the context of lending
and borrowing, CIRP has significant implications:
Implications of Covered IRP for Lending
1. *Risk-Free Arbitrage*: CIRP implies that there are no risk-free arbitrage opportunities in the
foreign exchange market. This means that lenders cannot earn a risk-free profit by lending in
one currency and borrowing in another.

2. *Interest Rate Parity*: CIRP states that the interest rate differential between two currencies
is equal to the forward premium/discount on the exchange rate. This means that lenders can
earn the same interest rate in different currencies, adjusted for the forward
premium/discount.

3. *Covered Interest Rate Arbitrage*: CIRP implies that covered interest rate arbitrage is not
possible. This means that lenders cannot earn a profit by lending in one currency, hedging the
exchange rate risk using a forward contract, and earning a higher interest rate in another
currency.

Implications of Covered IRP for Borrowing

1. *Cost of Borrowing*: CIRP implies that the cost of borrowing in one currency is equal to the
cost of borrowing in another currency, adjusted for the forward premium/discount. This
means that borrowers can borrow at the same effective interest rate in different currencies.

2. *Exchange Rate Risk*: CIRP implies that borrowers can hedge their exchange rate risk using
forward contracts. This means that borrowers can lock in the exchange rate for future
payments, reducing their exposure to exchange rate fluctuations.
3. *Comparing Borrowing Costs*: CIRP implies that borrowers can compare the borrowing
costs in different currencies, adjusted for the forward premium/discount. This means that
borrowers can choose the currency with the lowest effective interest rate, taking into account
the forward premium/discount.
Implications for International Lending and Borrowing
1. *Integration of International Capital Markets*: CIRP implies that international capital
markets are integrated, and interest rates are equalized across currencies, adjusted for the
forward premium/discount.

2. *Efficient Allocation of Capital*: CIRP implies that capital is allocated efficiently across
international borders, as lenders and borrowers can earn the same interest rates in different
currencies, adjusted for the forward premium/discount.
3. *Reduced Transaction Costs*: CIRP implies that transaction costs are reduced, as lenders
and borrowers can hedge their exchange rate risk using forward contracts, reducing the need
for costly currency conversions.
In summary, CIRP has significant implications for lending and borrowing in the international
context, including the integration of international capital markets, efficient allocation of
capital, and reduced transaction costs.
12) The factors to be considered while designing an optimum capital structure of a
multinational business unit. (15m)
:- Designing an optimum capital structure for a multinational business unit involves
considering several factors. Here are some key factors to consider:

Internal Factors
1. *Business Risk*: The volatility of the company's earnings and cash flows.
2. *Financial Flexibility*: The ability to respond to changing market conditions and investment
opportunities.

3. *Cost of Capital*: The cost of debt and equity financing.

4. *Taxation*: The tax implications of different capital structures.
5. *Management Preferences*: The risk tolerance and financial goals of management.
External Factors

1. *Market Conditions*: The state of the capital markets and the availability of funding.
2. *Industry Norms*: The typical capital structure of companies in the same industry.
3. *Country-Specific Factors*: The regulatory environment, tax laws, and cultural factors in
different countries.

4. *Exchange Rate Risk*: The potential impact of exchange rate fluctuations on the company's
financial performance.
5. *Global Economic Conditions*: The state of the global economy and the potential impact
of economic downturns.
Multinational Considerations
1. *Subsidiary Capital Structure*: The capital structure of foreign subsidiaries and the
potential impact on the parent company's financial performance.
2. *Cross-Border Financing*: The availability and cost of financing in different countries.

3. *Tax Efficiency*: The tax implications of different capital structures in different countries.
4. *Regulatory Requirements*: The regulatory requirements and restrictions on capital
structure in different countries.
5. *Currency Risk Management*: The potential impact of exchange rate fluctuations on the
company's financial performance and the need for currency risk management strategies.
Optimum Capital Structure
1. *Debt-Equity Mix*: The optimal mix of debt and equity financing.
2. *Cost of Capital*: The cost of debt and equity financing and the weighted average cost of
capital.
3. *Financial Flexibility*: The ability to respond to changing market conditions and investment
opportunities.
4. *Risk Management*: The potential impact of exchange rate fluctuations and other risks on
the company's financial performance.

5. *Tax Efficiency*: The tax implications of different capital structures and the need for tax-
efficient financing strategies.
By considering these factors, a multinational business unit can design an optimum capital
structure that balances the need for financial flexibility, risk management, and tax efficiency
with the need to minimize the cost of capital.
13) Critically examine the home currency approach and the foreign currency approach of a
multinational capital budgeting. (15m)
:- Capital budgeting is a critical aspect of multinational corporations (MNCs), as it involves
evaluating and selecting investment projects that align with the company's strategic
objectives. When it comes to capital budgeting, MNCs face a unique challenge: how to
evaluate investment projects in foreign currencies. There are two primary approaches to
multinational capital budgeting: the home currency approach and the foreign currency
approach.
Home Currency Approach
The home currency approach involves evaluating investment projects in the parent company's
home currency. This approach is also known as the "parent company perspective" or "home
currency method." Here's how it works:

1. *Translate foreign currency cash flows*: Translate the foreign currency cash flows into the
home currency using the spot exchange rate or a forecasted exchange rate.
2. *Evaluate projects in home currency*: Evaluate the investment project using the translated
cash flows in the home currency.
3. *Discount cash flows*: Discount the cash flows using the parent company's cost of capital.

Advantages:
1. *Simplifies evaluation*: Evaluating projects in the home currency simplifies the evaluation
process, as it eliminates the need to consider exchange rate fluctuations.

2. *Consistent evaluation*: The home currency approach ensures consistent evaluation of

investment projects across different countries.
Disadvantages:
1. *Ignores exchange rate risk*: The home currency approach ignores exchange rate risk,
which can be significant in multinational capital budgeting.
2. *Assumes stable exchange rates*: The approach assumes stable exchange rates, which may
not always be the case.
Foreign Currency Approach
The foreign currency approach involves evaluating investment projects in the local currency
of the foreign subsidiary. This approach is also known as the "subsidiary perspective" or "local
currency method." Here's how it works:
1. *Evaluate projects in local currency*: Evaluate the investment project using the local
currency cash flows.

2. *Discount cash flows*: Discount the cash flows using the local cost of capital or the
subsidiary's cost of capital.
3. *Translate results*: Translate the results into the parent company's home currency using
the spot exchange rate or a forecasted exchange rate.

Advantages:
1. *Considers exchange rate risk*: The foreign currency approach considers exchange rate risk,
which is essential in multinational capital budgeting.
2. *More accurate evaluation*: Evaluating projects in the local currency provides a more
accurate evaluation of the investment project.
Disadvantages:
1. *Complex evaluation*: Evaluating projects in the local currency can be complex, as it
requires considering exchange rate fluctuations and local market conditions.
2. *Inconsistent evaluation*: The foreign currency approach can lead to inconsistent
evaluation of investment projects across different countries.
In conclusion, both the home currency approach and the foreign currency approach have their
advantages and disadvantages. The choice of approach depends on the specific needs and
goals of the multinational corporation. A combination of both approaches may provide a more
comprehensive evaluation of investment projects.

14) Explain why the cash management process is more difficult in a MNC. (6m)
:- The cash management process is more difficult in a Multinational Corporation (MNC) due
to several reasons:
Complexity of Global Operations
1. *Multiple Currencies*: MNCs operate in multiple countries, dealing with various currencies,
exchange rates, and conversion complexities.

2. *Diverse Payment Systems*: Different countries have unique payment systems, such as wire
transfers, checks, and electronic funds transfers, which can be challenging to navigate.
3. *Varied Banking Systems*: MNCs must interact with various banking systems, each with its
own set of rules, regulations, and requirements.
Increased Cash Flow Volatility

1. *Exchange Rate Fluctuations*: Exchange rate changes can significantly impact cash flows,
making it difficult to predict and manage cash positions.
2. *Country-Specific Risks*: MNCs face country-specific risks, such as political instability,
economic downturns, and regulatory changes, which can disrupt cash flows.

3. *Global Economic Uncertainty*: MNCs must navigate global economic uncertainty,

including trade tensions, tariffs, and other macroeconomic factors that can impact cash flows.
Higher Transaction Costs
1. *Cross-Border Transactions*: MNCs incur higher transaction costs due to cross-border
transactions, including wire transfer fees, currency conversion fees, and other charges.
2. *Bank Fees*: MNCs must pay various bank fees, such as account maintenance fees,
overdraft fees, and other charges, which can add up quickly.
3. *Currency Conversion Costs*: MNCs face currency conversion costs, including bid-ask
spreads, commissions, and other charges, which can erode profit margins.
Regulatory and Compliance Challenges
1. *Anti-Money Laundering (AML) and Know-Your-Customer (KYC) Regulations*: MNCs must
comply with AML and KYC regulations, which can be complex and time-consuming.
2. *Tax Compliance*: MNCs must navigate complex tax laws and regulations, including
transfer pricing, value-added taxes, and other tax requirements.
3. *Data Protection and Privacy Regulations*: MNCs must comply with data protection and
privacy regulations, such as the General Data Protection Regulation (GDPR), which can impact
cash management processes.

Technology and Infrastructure Challenges

1. *Legacy Systems*: MNCs often have legacy systems that are not integrated, making it
difficult to manage cash positions and transactions.
2. *Lack of Standardization*: MNCs may lack standardization in their cash management
processes, leading to inefficiencies and errors.
3. *Cybersecurity Risks*: MNCs face cybersecurity risks, including hacking, phishing, and other
types of attacks, which can compromise cash management systems.
In summary, the cash management process is more difficult in an MNC due to the complexity
of global operations, increased cash flow volatility, higher transaction costs, regulatory and
compliance challenges, and technology and infrastructure challenges.
15) The methods of hedging used by MNCs in reducing foreign exchange exposure. (15m)

:- Multinational corporations (MNCs) use various methods to hedge against foreign exchange
exposure, which can be categorized into the following:
Transactional Hedging Methods
1. *Forward Contracts*: A forward contract is an agreement to buy or sell a currency at a
predetermined exchange rate on a specific date in the future.
2. *Futures Contracts*: A futures contract is a standardized agreement to buy or sell a
currency at a predetermined exchange rate on a specific date in the future.
3. *Options Contracts*: An options contract gives the holder the right, but not the obligation,
to buy or sell a currency at a predetermined exchange rate on or before a specific date.
4. *Swaps*: A swap is an agreement to exchange a series of cash flows in one currency for a
series of cash flows in another currency.
Translational Hedging Methods

1. *Netting*: Netting involves offsetting foreign currency receivables and payables to reduce
the net exposure to exchange rate fluctuations.
2. *Matching*: Matching involves matching foreign currency receipts with foreign currency
payments to reduce the exposure to exchange rate fluctuations.
3. *Leading and Lagging*: Leading and lagging involve adjusting the timing of foreign currency
receipts and payments to take advantage of favorable exchange rate movements.
Operational Hedging Methods
1. *Currency Diversification*: Currency diversification involves diversifying a company’s
operations and investments across multiple currencies to reduce the exposure to exchange
rate fluctuations.
2. *Pricing Strategies*: Pricing strategies involve adjusting prices to reflect changes in
exchange rates and to maintain profit margins.
3. *Supply Chain Management*: Supply chain management involves managing the supply
chain to reduce the exposure to exchange rate fluctuations, such as by sourcing materials from
countries with stable currencies.
Financial Hedging Methods
1. *Currency Options*: Currency options involve buying or selling options contracts to hedge
against exchange rate fluctuations.
2. *Currency Futures*: Currency futures involve buying or selling futures contracts to hedge
against exchange rate fluctuations.
3. *Currency Swaps*: Currency swaps involve exchanging a series of cash flows in one currency
for a series of cash flows in another currency to hedge against exchange rate fluctuations.

Other Hedging Methods

1. *Invoicing in Domestic Currency*: Invoicing in domestic currency involves invoicing foreign
customers in the domestic currency to avoid exchange rate risk.
2. *Currency Clause*: A currency clause involves including a clause in contracts that allows for
adjustments to be made to prices or payments in response to changes in exchange rates.
MNCs can use a combination of these methods to manage their foreign exchange exposure
and minimize the impact of exchange rate fluctuations on their financial performance.
16) How the APV framework used in analysing a capital expenditure in foreign operations.
(15m)
:- The Adjusted Present Value (APV) framework is a valuation approach used to analyze capital
expenditures in foreign operations. The APV framework takes into account the complexities
of international capital budgeting, including exchange rate risk, tax differences, and
differences in capital costs.
Steps in Applying the APV Framework
1. *Estimate Cash Flows*: Estimate the cash flows associated with the capital expenditure in
the foreign operation. This includes revenues, costs, and taxes.
2. *Convert Cash Flows to Home Currency*: Convert the cash flows from the foreign currency
to the home currency using the spot exchange rate or a forecasted exchange rate.
3. *Calculate the Present Value of Cash Flows*: Calculate the present value of the cash flows
using the cost of capital for the foreign operation.
4. *Adjust for Tax Differences*: Adjust the present value of the cash flows for tax differences
between the home country and the foreign country.
5. *Adjust for Exchange Rate Risk*: Adjust the present value of the cash flows for exchange
rate risk using a risk-adjusted discount rate or a probability-weighted expected cash flow
approach.

6. *Calculate the APV*: Calculate the Adjusted Present Value (APV) by adding the present
value of the cash flows, the tax adjustments, and the exchange rate risk adjustments.
Example of APV Framework
Suppose a US-based company is considering a capital expenditure in a foreign subsidiary in
Europe. The estimated cash flows in euros are:
| Year | Cash Flow (Euros) |
|0| -100,000 |
|1| 30,000 |
|2| 40,000 |

|3| 50,000 |
The spot exchange rate is 1 euro = 1.20 USD. The cost of capital for the foreign operation is
10%. The tax rate in the foreign country is 30%, while the tax rate in the US is 25%.
APV Calculation

1. Convert cash flows to USD: 30,000 euros x 1.20 USD/euro = 36,000 USD
2. Calculate present value of cash flows: 36,000 USD / (1 + 0.10)^1 = 32,727 USD
3. Adjust for tax differences: 32,727 USD x (1 - 0.25) / (1 - 0.30) = 34,545 USD
4. Adjust for exchange rate risk: assume a risk-adjusted discount rate of 12%
5. Calculate APV: 34,545 USD / (1 + 0.12)^1 = 30,818 USD
The APV framework provides a comprehensive approach to evaluating capital expenditures in
foreign operations, taking into account the complexities of international capital budgeting.
17) What is interest rate parity theory. What are it’s assumption and conclusions.(6m)

:- The Interest Rate Parity (IRP) theory is a fundamental concept in international finance that
describes the relationship between interest rates and exchange rates between two countries.
Assumptions of Interest Rate Parity Theory
1. *Perfect Capital Mobility*: Capital can move freely between countries, and investors can
borrow and lend in different currencies.
2. *No Transaction Costs*: There are no transaction costs, such as commissions or fees,
associated with borrowing or lending in different currencies.
3. *No Exchange Rate Risk*: Investors are indifferent to exchange rate risk, and the expected
exchange rate is equal to the forward exchange rate.
4. *Perfect Information*: Investors have perfect information about interest rates and
exchange rates in different countries.

Interest Rate Parity Equation

The IRP equation states that the difference in interest rates between two countries is equal to
the difference in the forward and spot exchange rates:
R – r* = (F – S) / S

Where:
- r is the interest rate in the domestic country
- r* is the interest rate in the foreign country
- F is the forward exchange rate
- S is the spot exchange rate

Conclusions of Interest Rate Parity Theory

1. *Interest Rate Differentials*: The IRP theory suggests that interest rate differentials
between countries are driven by differences in expected inflation rates and exchange rate
expectations.

2. *Exchange Rate Determination*: The IRP theory implies that exchange rates are determined
by the interaction of interest rates and exchange rate expectations.
3. *Arbitrage Opportunities*: The IRP theory suggests that arbitrage opportunities arise when
interest rate differentials are not equal to the difference in forward and spot exchange rates.
4. *International Capital Flows*: The IRP theory implies that international capital flows are
driven by interest rate differentials and exchange rate expectations.
In summary, the Interest Rate Parity theory provides a framework for understanding the
relationship between interest rates and exchange rates between two countries. While the
theory has several conclusions and implications, it also has limitations and assumptions that
must be considered when applying it to real-world situations.
18) How exchange rate risk is hedged used forward contract. (6m)
:- Exchange rate risk can be hedged using forward contracts, which are agreements to buy or
sell a currency at a predetermined exchange rate on a specific date in the future. Here's how
it works:
Example: Hedging Exchange Rate Risk with Forward Contracts
Suppose a US-based importer, XYZ Inc., needs to purchase 100,000 euros worth of goods from
a European supplier in three months. The current spot exchange rate is 1 EUR = 1.20 USD, but
XYZ Inc. is concerned that the exchange rate may fluctuate over the next three months,
exposing them to exchange rate risk.

Forward Contract

To hedge this risk, XYZ Inc. enters into a forward contract with a bank to buy 100,000 euros in
three months at a forward exchange rate of 1 EUR = 1.25 USD.
How the Forward Contract Works
1. *Forward Contract Agreement*: XYZ Inc. agrees to buy 100,000 euros in three months at
the forward exchange rate of 1 EUR = 1.25 USD.
2. *No Initial Payment*: XYZ Inc. does not make any initial payment to enter into the forward
contract.
3. *Settlement in Three Months*: In three months, XYZ Inc. will buy 100,000 euros from the
bank at the forward exchange rate of 1 EUR = 1.25 USD, regardless of the spot exchange rate
at that time.
Benefits of Hedging with Forward Contracts
1. *Exchange Rate Risk Reduction*: By locking in the forward exchange rate, XYZ Inc. reduces
its exposure to exchange rate risk.

2. *Predictable Costs*: XYZ Inc. knows exactly how much it will pay for the euros in three
months, which helps with budgeting and cash flow management.
3. *No Initial Payment*: XYZ Inc. does not need to make any initial payment to enter into the
forward contract.

Limitations of Hedging with Forward Contracts

1. *Obligation to Buy or Sell*: XYZ Inc. is obligated to buy 100,000 euros in three months,
regardless of whether it needs them or not.
2. *No Benefit from Favorable Exchange Rate Movements*: If the spot exchange rate in three
months is more favorable than the forward exchange rate, XYZ Inc. will not benefit from the
favorable movement.
In summary, forward contracts can be an effective way to hedge exchange rate risk, but they
require careful consideration of the potential benefits and limitations.
19) Merits of various foreign currency and euro dollar bonds. (15m)
:- Foreign currency bonds and Eurodollar bonds are popular debt financing options for
multinational corporations (MNCs) and governments. Here are the merits of various foreign
currency and Eurodollar bonds:

Merits of Foreign Currency Bonds

1. *Access to Global Capital Markets*: Foreign currency bonds allow borrowers to access
global capital markets, increasing their funding options.
2. *Lower Interest Rates*: Borrowers may benefit from lower interest rates in foreign markets,
reducing their borrowing costs.
3. *Diversification of Funding Sources*: Foreign currency bonds enable borrowers to diversify
their funding sources, reducing dependence on domestic markets.
4. *Increased Liquidity*: Foreign currency bonds can increase liquidity for borrowers, as they
can tap into a broader pool of investors.
Merits of Eurodollar Bonds
1. *Lower Interest Rates*: Eurodollar bonds often offer lower interest rates compared to
domestic bonds, reducing borrowing costs.
2. *Less Regulatory Burden*: Eurodollar bonds are subject to less stringent regulatory
requirements, making it easier for borrowers to issue debt.
3. *Increased Flexibility*: Eurodollar bonds offer more flexible terms and conditions, allowing
borrowers to tailor the bond to their specific needs.
4. *Global Investor Base*: Eurodollar bonds can be marketed to a global investor base,
increasing the potential for diversification and reduced borrowing costs.
Merits of Specific Types of Foreign Currency Bonds
1. *Yen-Denominated Bonds (Samurai Bonds)*: Offer access to Japanese investors and can
provide lower interest rates.

2. *Euro-Denominated Bonds*: Offer access to European investors and can provide lower
interest rates.
3. *Pound-Denominated Bonds*: Offer access to UK investors and can provide lower interest
rates.

4. *Dim Sum Bonds (RMB-Denominated Bonds)*: Offer access to Chinese investors and can
provide lower interest rates.
Merits of Specific Types of Eurodollar Bonds
1. *Eurodollar Notes*: Offer flexibility in terms of maturity and interest rates.
2. *Eurodollar Commercial Paper*: Offers short-term funding options with competitive
interest rates.
3. *Eurodollar Certificates of Deposit*: Offers time deposits with fixed interest rates and
maturity dates.
In summary, foreign currency bonds and Eurodollar bonds offer various benefits, including
access to global capital markets, lower interest rates, and increased liquidity. The specific type
of bond and market will depend on the borrower's needs and goals.
20) Marginal utility of interest rate parity theory to a global financial manager. (6m)
:- The Interest Rate Parity (IRP) theory has significant marginal utility to a global financial
manager in several ways:
Understanding Exchange Rate Dynamics
1. *Exchange Rate Forecasting*: IRP helps global financial managers understand the
relationship between interest rates and exchange rates, enabling them to forecast exchange
rate movements.
2. *Exchange Rate Risk Management*: By understanding the IRP relationship, global financial
managers can develop effective exchange rate risk management strategies.
Investment and Financing Decisions
1. *Investment Opportunities*: IRP helps global financial managers identify investment
opportunities in countries with high interest rates, while considering the potential impact of
exchange rate fluctuations.
2. *Financing Decisions*: IRP informs financing decisions by considering the interest rate
differentials between countries and the potential impact of exchange rate fluctuations on
borrowing costs.
Hedging and Arbitrage Opportunities
1. *Hedging Strategies*: IRP helps global financial managers develop hedging strategies to
mitigate exchange rate risk, such as using forward contracts or options.

2. *Arbitrage Opportunities*: IRP identifies potential arbitrage opportunities arising from

deviations in the IRP relationship, enabling global financial managers to exploit these
opportunities and earn risk-free profits.
Portfolio Management
1. *Asset Allocation*: IRP informs asset allocation decisions by considering the interest rate
and exchange rate environment in different countries.
2. *Risk Management*: IRP helps global financial managers manage portfolio risk by
considering the potential impact of exchange rate fluctuations on investment returns.
Marginal Utility in Practice

1. *Improved Forecasting*: IRP helps global financial managers improve their exchange rate
forecasting, enabling them to make more informed investment and financing decisions.
2. *Enhanced Risk Management*: IRP enables global financial managers to develop more
effective risk management strategies, mitigating the potential impact of exchange rate
fluctuations on investment returns.

3. *Increased Returns*: By exploiting arbitrage opportunities and making informed

investment decisions, global financial managers can increase returns on investment.
In summary, the Interest Rate Parity theory has significant marginal utility to a global financial
manager, enabling them to make more informed investment and financing decisions, manage
exchange rate risk, and increase returns on investment.
21) Compare call option and put option as strategies for currency risk management. (6m)
:-

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