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Chapter 18

Long-Term Financing

1. Ideally, a firm desires to denominate bonds in a currency that: A) exhibits a low interest rate and is expected to appreciate. B) exhibits a low interest rate and is expected to depreciate. C) exhibits a high interest rate and is expected to depreciate. D) exhibits a high interest rate and is expected to appreciate. ANSWER: B

2. A U.S. firm could issue bonds denominated in euros and partially hedge against exchange rate risk by:

A) invoicing its exports in U.S. dollars.

B) requesting that any imports ordered by the firm be invoiced in U.S. dollars. C) invoicing its exports in euros.

D) requesting that any imports ordered by the firm be invoiced in the currency denominating the bonds.

ANSWER: C

3. Firm “X” conducts all business transactions in U.S. dollars. If it issues a currency cocktail bond, it can:

A) reduce exchange rate risk relative to issuing a bond denominated in U.S. dollars.

B) reduce exchange rate risk relative to issuing a bond denominated in a single foreign currency. C) both of these.

D) none of these. ANSWER: B

4. Simulation is useful in the bond-denomination decision since it can:

A) precisely compute the cost of financing with bonds denominated in a single foreign currency. B) precisely compute the cost of financing with bonds denominated in a portfolio of foreign

currencies.

C) assess the probability that a bond denominated in a foreign currency will be less costly than a bond denominated in the home currency.

D) precisely compute the cost of financing with bonds denominated in either a single foreign currency or in a portfolio of foreign currencies.

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5. An interest rate swap between two firms of different countries enables the exchange of _______ for _______.

A) fixed-rate payments; floating-rate payments B) stock; interest deductions on taxes

C) interest payments on loans; ownership of debt of less developed countries D) interest payments on loans; stock

ANSWER: A

6. If U.S. firms issue bonds in _______, the dollar outflows to cover fixed coupon payments increase as the dollar _______.

A) a foreign currency; weakens B) dollars; strengthens

C) a foreign currency; strengthens D) dollars; weakens

ANSWER: A

7. The yields offered on newly issued bonds denominated in dollars have: A) consistently increased over the last 10 years.

B) consistently decreased over the last 10 years. C) remained stable.

D) none of these. ANSWER: D

8. When ignoring exchange rate risk, bond yields: A) are the same for all currencies.

B) are consistently higher for all non-U.S. bonds than U.S. bonds. C) are consistently lower for all non-U.S. bonds than U.S. bonds. D) none of these.

ANSWER: D

9. A U.S. firm has received a large amount of cash inflows periodically in Swiss francs as a result of exporting goods to Switzerland. It has no other business outside the U.S. It could best reduce its exposure to exchange rate risk by:

A) issuing Swiss franc-denominated bonds. B) purchasing Swiss franc-denominated bonds. C) purchasing U.S. dollar-denominated bonds. D) issuing U.S. dollar-denominated bonds. ANSWER: A

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10. A U.S. firm has a Canadian subsidiary that remits some of its earnings to the parent on an annual basis. The firm has no other foreign business. The firm could best reduce its exposure to exchange rate risk by issuing bonds denominated in:

A) U.S. dollars. B) Canadian dollars. C) multiple currencies.

D) a unit of account such as the SDR. ANSWER: B

11. An interest rate swap is commonly used by an issuer of fixed-rate bonds to: A) convert to floating-rate debt.

B) hedge exchange rate risk.

C) lock in the interest payments on debt. D) remove the default risk of its debt. ANSWER: A

12. A currency swap between two firms of different countries enables the exchange of _______ for _______ at periodic intervals.

A) stock; one currency

B) stock; a portfolio of foreign currencies C) one currency; stock options

D) one currency; another currency ANSWER: D

13. Assume a U.S.-based subsidiary wants to raise $1,000,000 by issuing a bond denominated in Pakistani rupees (PKR). The current exchange rate of the rupee is $.02. Thus, the MNC needs _______ rupees to obtain the $1,000,000 needed.

A) 50,000,000 B) 20,000 C) 1,000,000 D) none of these ANSWER: A

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14. An MNC issues ten-year bonds denominated in 500,000 Philippines pesos (PHP) at par. The bonds have a coupon rate of 15%. If the peso remains stable at its current level of $.025 over the lifetime of the bonds and if the MNC holds the bonds until maturity, the financing cost to the MNC will be: A) 10.0%. B) 12.5%. C) 15.0%. D) none of these. ANSWER: C

SOLUTION: Since the bonds are issued at par, and since the exchange rate remains stable over the life of the bonds and the bonds are held until maturity, the financing cost will be exactly the coupon rate of the bond.

15. New Hampshire Corp. has decided to issue three-year bonds denominated in 5,000,000 Slovakian koruna (SKK) at par. The bonds have a coupon rate of 17%. If the koruna is expected to appreciate from its current level of $.03 to $.032, $.034, and $.035 in years 1, 2, and 3, respectively, what is the financing cost of these bonds?

A) 17%. B) 23.18%. C) 22.36%. D) 23.39%. ANSWER: D SOLUTION:

Year 1 Year 2 Year 3

Annual Cost of Financing Payments in Slovakian koruna 850,000 850,000 5,850,000

Forecasted exchange rate of koruna $.032 $.034 $.035

Payments in dollars $27,200 $28,900 $204,750 23.39% 16. In a(n) _______ swap, two parties agree to exchange payments associated with bonds; in a(n)

_______ swap, two parties agree to periodically exchange foreign currencies. A) interest rate; currency

B) currency; interest rate C) interest rate; interest rate D) currency; currency ANSWER: A

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17. Good Company prefers to fixed-rate debt. Bad Company prefers fixed- to variable-rate debt. Assume the following information for Good and Bad Companies:

Fixed-Rate Bond Variable-Rate Bond

Good Company 10% LIBOR + 1%

Bad Company 12% LIBOR + 1.5%

Given this information:

A) an interest rate swap will probably not be advantageous to Good Company because it can issue both fixed and variable debt at more attractive rates than Bad Company.

B) an interest rate swap attractive to both parties could result if Good Company agreed to provide Bad Company with variable rate payments at LIBOR + 1% in exchange for fixed rate payments of 10.5%.

C) an interest rate swap attractive to both parties could result if Bad Company agreed to provide Good Company with variable rate payments at LIBOR + 1% in exchange for fixed rate payments of 10.5%.

D) none of these. ANSWER: B

18. _______ are beneficial because they may reduce transaction costs. However, MNCs may not be able to obtain all the funds that they need.

A) Private placements B) Domestic equity offerings C) Global equity offerings D) Global debt offerings ANSWER: A

19. Most MNCs obtain equity funding: A) in foreign countries.

B) in their home country. C) through global offerings. D) through private placements. ANSWER: B

20. Some firms may be uncomfortable issuing bonds denominated in foreign currencies because exchange rates are _______ difficult to predict over _______ time horizons.

A) less; long B) more; short C) more; long D) none of these

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21. Countries where bond yields are _______ tend to have a _______ risk-free interest rate. A) low; high B) high; low C) high; high D) none of these ANSWER: C

22. MNCs can use _______ to reduce exchange rate risk. This occurs when two parties provide simultaneous loans with an agreement to repay at a specified point in the future.

A) forward contracts B) currency swaps C) parallel loans D) none of these ANSWER: C

23. An upward-sloping yield curve for a foreign country means that annualized yields there are _______ for short-term debt than for long-term debt. The yield curve in this country reflects _______.

A) higher; several periods B) lower; several periods

C) higher; a specific point in time D) lower; a specific point in time ANSWER: D

24. When financing international operations, MNCs typically will not use a maturity that _______ the expected life of the business in that country.

A) is less than B) exceeds C) is the same as D) none of these ANSWER: B

25. When an MNC finances in a currency that matches its cash inflows using a relatively _______ maturity, the MNC is exposed to _______ risk.

A) short; interest rate B) long; interest rate C) short; exchange rate D) none of these ANSWER: B

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26. As a(n) _______ to an interest rate swap, a financial institution simply arranges a swap between two parties.

A) ultraparty B) broker C) counterparty D) none of these ANSWER: B

27. In general, the _______ rate payer in a plain vanilla swap believes interest rates are going to _______. A) fixed; decline B) floating; decline C) floating; increase D) none of these ANSWER: B

28. In a(n) _______ swap, the fixed rate payer has the right to terminate the swap. A) callable

B) putable C) amortizing D) zero-coupon ANSWER: A

29. In a(n) _______ swap, the notional value is increased over time. A) amortizing

B) basis C) zero-coupon D) accretion ANSWER: D

30. A _______ gives its owner the right to enter into a swap. A) basis swap

B) swaption C) callable swap D) putable swap ANSWER: B

31. Eurobonds are often issued with a floating coupon rate that is tied to LIBOR. A) true.

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32. If the currency denominating a foreign bond depreciates against the firm’s home currency, the funds needed to make coupon payments will increase.

A) true. B) false. ANSWER: B

33. If the foreign currency that was borrowed appreciates over time, an MNC will need fewer funds to cover the coupon or principal payments. (Assume the MNC has no other cash flows in that currency.)

A) true. B) false. ANSWER: B

34. Because bonds denominated in foreign currencies rarely have lower yields, U.S. corporations rarely consider issuing bonds denominated in those currencies.

A) true. B) false. ANSWER: B

35. U.S.-based MNCs whose foreign subsidiary generates large earnings may be able to offset exposure to exchange rate risk by issuing bonds denominated in the subsidiary’s local currency. A) true.

B) false. ANSWER: A

36. Some MNCs use a country’s yield curve to compare annualized rates among debt maturities, so that they can choose a maturity that has a relatively low rate.

A) true. B) false. ANSWER: A

37. The actual financing cost of a U.S. corporation issuing a bond denominated in euros is affected by the euro’s value relative to the U.S. dollar during the financing period.

A) true. B) false. ANSWER: A

38. A floating coupon rate can be an advantage to the bond issuer during periods of increasing interest rates.

A) true. B) false. ANSWER: B

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39. An MNC issuing pound-denominated bonds may be completely insulated from exchange rate risk associated with the bond if its foreign subsidiary makes the coupon and principal payments of the bond with its pound receivables.

A) true. B) false. ANSWER: A

40. If an MNC uses a long-term forward contract to hedge the exchange rate risk associated with a bond denominated in euros, it would sell euros forward.

A) true. B) false. ANSWER: B

41. Currency swaps, whereby two parties exchange currencies at a specified point in time for a specified price, are often used by MNCs to hedge against interest rate risk.

A) true. B) false. ANSWER: B

42. Two limitations of interest rate swaps are that there is a cost of time and resources associated with searching for a suitable partner and that there is a risk to each swap participant that the counterparticipant could default on his payments.

A) true. B) false. ANSWER: A

43. Many MNCs simultaneously swap interest payments and currencies. A) true.

B) false. ANSWER: A

44. A parallel loan represents simultaneous loans provided by two parties with an agreement to repay at a specified point in the future.

A) true. B) false. ANSWER: A

45. Since yield curves are identical across countries, MNCs rarely consider them when deciding on the maturity of bonds denominated in a foreign currency.

A) true. B) false.

References

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