跨国公司财务管理基础(1)

TEXAS TECH UNIVERSITY

SECOND SUMMER 2012 RAWLS COLLEGE OF BUSINESS AREA OF FINANCE

FIN 4328-001-62167 - In ternatio nal F inance

Dr. Dan??o?lu

Homework #1

Due on Thursday, July 19, 2012

1. Please answer Questions 1 and 3 from the eAnpdpoefndix 1A: The Origins and Consequences of Internationaol nTrade pages 27 through 30 of your book. Please do not answer Question

2.

1. a. Is there a logical flaw in Bastiat's satirical argument?

A NSWER. No. Bastiatis preciselyright. The objectiveof trade is to gain accessto goodsand servicesat lowerquality- adjusted pricesT.he ultimateconsequenceis to make more efficientuse of the world'sresources andtherebyincrease worldwide production and consumption. Protectionism aims to prevent this end. If protectionism succeeds, world outp consumption are lower than they might otherwise be because resources are not being put to their highest valued use examplecited by Bastiat, protectionismwill lead to a squandering ofresources byreplicatingwhat the sun can do less expensively.

1.b. Do Japanese automakers prefer a tariff or a quota on their U.S. auto exports? Why? Is there likely to be consens among the Japanese carmakers on this point? Might there be any Japanese automakers that are likely to prefer U.S. restrictions? Why? Who are they?

A NSWER. It depends. To understand why, it helps to recognize the consequences of these alternative trade barriers.

B tariffs and quotas will lead to higher prices to U.S. consumers of imported Japanese cars. With tariffs, however, most price increase will go to the U.S. government in the form of tariffs. Japanese companies (or their dealers), on the othe will collect most, if not all, of the higher prices associated with the scarcity of imported Japanese cars. Once the Japa producers hit their quota limit, they have no incentive to compete with each other by cutting price because they canno more cars than they alreadyare. The net result is that the U.S. marketwill be extraordinarilyprofitableto Japanese automakers, which it was.

Since quotastend to be allocatedbasedon currentsales, thoseautomakerslike Toyotaand Nissanwith large market shares would prefer quotas, whereas those automakers like Honda and Mitsubishi with smaller market shares would tariffs. The reason for the latter's preference for tariffs is that efficient companies can eventually overcome the effects tariffs by cutting costs and prices, whereas efficiency counts for nothing in the case of quotas. Regardless of the type trade barrier imposed, U.S. automakers will raise their prices in line with higher import prices. However, U.S. automak are likely to prefer quotas because quotas enable them to disguise the reason for higher U.S. car prices. Consumers be much quicker to figure out the cause-effect relationship between higher tariffs and higher prices on U.S. and Japa cars.

1.c. What characteristics of the U.S. auto industry have helped it gain protection? Why does protectionism persist des the obvious gains to society from free trade?

A NSWER. The U.S. auto industry hasreceivedas muchprotection asit has for two key reasons.First,it is a large and powerful industry. Second, it is concentrated in several politically important states, such as Michigan and Illinois.

3.a. Do you expect trade to take place between countries A and B? Why?

A NSWER. Yes. Given the data presented, we can see that if country A has 6 units of resources and it devotes X of thes units to steel productionw,here X is an integer,it can producea total of 6X tons of steel and 3(6- X) bushels ofcorn Similarly, with 54 units of resources, country

B of which it devotes Y units to steel production, it can produce Y tons o plus (54 - Y) bushels of corn. The net effect of these producti on functions is that one bushel of corn is worth 2 tons of in country A. In contrast, one bushel of corn is worth only one ton of steel in country B. These relative prices

indicate country A has a comparativeadva ntagei n the productionof steel, whereasB has a comparativeadva ntagei n the producti on of corn.

3.b. Which country will export steel? Which will export corn? Explai n.

A NSWER Giventhese comparativeadvantagesA will exportsteel and

B will export corn. The price of corn will settle somewhere betwee n one and two tons of steel. Suppose it settles at 1.5 tons of steel. Then, in stead of produci ng, sa tons of steel and 3 bushels of corn, it can devote an additi onal resource unit to the producti on of an additi onal 6 tons It can trade these 6 tons of steel with B for 6/1.5 = 4 bushels of corn, leaving it one bushel of corn better off. Similarly now get 6 tons of steel for the 4 bushels of corn it trades to A in stead of the 4 tons of steel it could produce on its owr the resources it took to produce the 4 bushels of corn.

2. In the sec ond half of 1997, the Indon esia n rupiah devalued by 84% aga inst the U.S. dollar. By how much has the c appreciated aga inst the rupiah?

A NSWER. If e o is the initial dollar value of the rupiah and is the post—devaluation exchange rate, then we know from Equati on 2.1 thae (——e o)/e o = —84%. Sol ving for i in terms oe o yieldse i = O.16J O. From Equati on 2.2, we know that the dollar's appreciation against the rupiah eqe o—&)◎, or e —O.1@O)/O.16T O = 0.84/.16 = 525%.

3. Betwee n 1988 and 1991, the price of a room at the Mila n Hilton rose from Lit 346,400 to Lit 475,000. At the same t the exchange rate went from Lit 1,302/$ in 1988 to Lit 1,075/$ in 1991.

a. By how much has the dollar cost of a room at the Mila n Hilt on cha nged over this three-year period?

A NSWER. The dollar price of a room at the Milan Hilton in 1988 was 346,400/1,302 = $266. By 1991, that same room c 475,000/1,075 = $442. Thus, the dollar price of a room rose during this three-year period266(446 = 66.2%. This invo lved a comb in ati on of a 21.2% appreciati on in the dollar value of the lira and a 37.1% in crease in the lira price of room (1.211 x 1.371 = 1.661).

b. What has happe ned to the lira's dollar value duri ng this period?

A NSWER. According to Equation 2.1, the lira's dollar value has appreciated by

(1/1075) - (1/1302) _ 1302 - 1075 _ 一…

(1/1302) 1075

4. Read the followi ng mi ni case from yduxtbook: “ The Euro Reacts to New In formatio82). Brie fl y aPag e r the questio ns give n in the case.

1. Explainthe differing initial and subsequent reactions of the euro to news about the European Central Bank policy.

Give full details, drawing on any theories you are familiar with.

A NSWER. The in itial react ion is based on the expectati on of no tighte ning in the money supply. The result will be highei inflation than previously expected —dcording to purchasing power parityi depreciating euro. The euro ' s subs reactionwas basedon the view that monetarypolicywouldin fact be tightenec(that the objectiveof an interestrate in crease) and in flatio n would be reduced. At the same time, a higher real in terest rate would be expected to attract m capital and boost the euro ' s value as well.

2. How does a strong pound reduce the threat of imported inflation and work against higher interest rates?

A NSWER. A weak pound will bring higher prices of foreign goods and services, enabling domestic producers to raise

th prices and leadingto higher inflation.Conversely,a strongerpoundwill bring lower-pricedforeigngoods and services, putt ing dow nward pressure on domestic prices and reduci ng the threat of in flati on. Lower in flation/Wilth e aFisher effec—o lower in terest rates. At the same time, the expectati on of lower in flati on mea ns the Bank of En gla nd will be u less pressure to raise interest rates to fight nonexistent inflation.

3. Which U.K. manufacturers are likely to be pressured by a strong pound?

A NSWER. Those British manufacturers who compete with imports or who export will be hurt by a stronger pound becau foreigncompetitorswill see their pound-equi/alenptricesfall. In addition,British manufacturerswho use domestically- sourced inputs in competition with those who use imported inputs will suffer.

4. Why might higher pound interest rates send sterling e/en higher? Gi/e two possible reasons.

A NSWER. Higher British interest rates occasioned by a tightening of monetary policy will lead to lower expected inflatio Accordingto purchasingpowerparity, countrieswith lower rates of inflationwill tend to see their currenciesappreciate relati/e to those of countries with higher rates of inflation. At the same time, if the higher nominal interest rate is also higher real interest rate, this will attract capital to the U.K. seeking to earn the higher real return. The greater demand sterling for in/estment purposes will boost its /alue.

5. What tools are a/ailable to the European Central Bank and the Bank of England to manage their monetary policie

A NSWER Both cen tral banks can use ope n market operawhiich invo Ives buying and selli ng bonds denomin ated in their currencies to regulate the money supply. It may be more difficult for the ECB, howe/er, as it doesn denominated in euros but there will be other bonds issued in the euro that it can buy or sell. The central banks can al raise or lower the interest rate at which they lend money to banks and regulate the reserve requirements of banks. An tool of monetarypolicyis foreignexchangemarketintervention,which involvesbuyingor selling their currenciesin the foreign exchange market.

5. supposethe centralrates withinthe ERM for the Frenchfranc andDM are FF

6.90403/ECU andDM 2.05853/ECU, respectively.

a. What is the cross-exchange rate between the franc and the mark?

A NsWER. since things equal to the same thing are equal to each other, we have FF 6.90403= DM 2.05853.Hence,

FF1 = DM 0.298164 [=(2.05853/6.90403)]. Equivalently, DM 1 = FF 3.35386 [=(6.90403/2.05853)].

b. Under the original2.25% margin on either side of the central rate, what were the approximateupper and lower intervention limits for France and Germany?

A NsWER.Given the answer to part a, the French franc could rise to approximately DM 0.298164 x 1.0225 = DM 0.304 or fall as far as DM 0.298164 x 0.9775 = DM 0.291455. similarly, the upper limit for the DM is FF 3.42933 and the low limit is FF 3.27840.

c. Underthe revised15% marginon eitherside of the centralrate,what are the currentapproximateupperand lower intervention limits for France and Germany?

A NsWER.Given the answer to part a, the French franc could rise to approximately DM 0.298164 x 1.15 = DM

0.342888 fall as far as DM 2.98164 x 0.85 = DM 0.253439. similarly, the upper limit for the DM is FF 3.85694 and the lower lim FF 2.85078.

6. In 1987, the British government cut taxes significantly, raising the after-tax return on investments in Great Britain. W would be the likely consequence of this tax cut on the equilibrium value of the British pound? Explain.

A NSWER. The cut in British tax rates should raise after-tax returns, making investment in England more attractive to bo British and foreign investors. In response, investors should demand more pounds to acquire the now more

lucrative m British assets, driving up the value of the pound. This is, in fact, what happened.

7. An India-based manufacturing firm has problems with the price of one of its products sold in the rapidly growing Bra market. The product is produced entirely in India and its costs and price are initially quoted in Indian rupees (Rp) and converted to Brazilian reais (R$) when the product is sent to Brazil for distribution and sales. In 2009 the price of the p was 21,900 rupees and the Brazilian price was 895 reais. In 2010, the Brazilian currency appreciated against the rup the exchange rate was around Rp26.15/R$. In order to preserve the reais price what should be the new rupee price o product? Can the rupee profit margin be preserved at the new price? Explain.

A NSWER. The implied exchange rate in 2009 is 21,900Rp/895R$ = Rp24.47/R$.

The new Rupee price of the product in 2010 is 895R$ x Rp26.15/R$ = Rp23,404.25.

The Rupee has depreciated in value against the real. Therefore, the new Rupee price is highset ryethaarn l'a s price. This means that the Indian firm can enjoy a higher Rupee profit margin (assuming its Rupee cost of production does not c and still maintain its competitiveness in the Brazilian market by keeping its Real price constant.

As an alternative, the company can decrease the Real price just enough to maintain its original Rupee profit margin. T would allow the company to increase its market share in Brazil (since the product is going to be cheaper).