International arbitrage and multinational capital budgeting - One Line Questions
1.
What is a key difference between arbitrage and hedging? —
Arbitrage seeks to profit from price discrepancies, while hedging seeks to reduce risk.
2.
If the interest rate in the US is 5% and in the UK is 3%, and the forward rate for GBP/USD is at a premium, what arbitrage opportunity might exist? —
Borrowing GBP, converting to USD, investing in USD, and covering back to GBP
3.
How can a company mitigate the risk of blocked funds in a foreign country? —
By negotiating with the host government for repatriation rights or exploring alternative uses for funds within the country
4.
How are exchange rate forecasts typically incorporated into multinational capital budgeting? —
By projecting future exchange rates and converting future cash flows to the home currency
5.
In multinational capital budgeting, why is it important to consider the potential for 'capital controls'? —
Capital controls can restrict the ability to move money into or out of a country, affecting cash flows
6.
Covered interest arbitrage involves simultaneous borrowing and lending in different currencies to profit from: —
Differences in interest rates and forward exchange rates
7.
What is the 'host country's perspective' in multinational capital budgeting? —
Evaluating the project based on its contribution to the local economy and subsidiary's profitability
8.
What is the 'parent company's perspective' in multinational capital budgeting? —
Evaluating the project based on its impact on the overall value of the parent company, considering all cash flows and risks
9.
What does 'Purchasing Power Parity' (PPP) suggest? —
Exchange rates will adjust so that a basket of goods costs the same in different countries
10.
What is 'locational arbitrage'? —
Exploiting price differences for the same asset in different geographic locations
11.
When evaluating a project in a country with high inflation, how should this be reflected in capital budgeting? —
Use a nominal discount rate that reflects the expected inflation
12.
When evaluating a foreign project, if the projected cash flows in the local currency are expected to decline in value relative to the home currency, this will likely: —
Decrease the project's NPV in home currency terms
13.
Which of the following is NOT a common method to adjust for political risk in multinational capital budgeting? —
Ignoring political risk and assuming it will not materialize
14.
What is a key advantage of using the IRR (Internal Rate of Return) method in multinational capital budgeting? —
It represents the project's percentage rate of return, which can be compared to the cost of capital
15.
How does the 'sunk cost fallacy' relate to multinational capital budgeting? —
It means past costs should be ignored when making future investment decisions
16.
How does triangular arbitrage differ from simple two-currency arbitrage? —
It exploits discrepancies involving three currencies
17.
What is a potential disadvantage of using IRR for multinational projects, especially when comparing mutually exclusive projects? —
It assumes cash flows are reinvested at the project's IRR, which may be unrealistic
18.
How does the risk of currency fluctuations impact multinational capital budgeting? —
It requires forecasting future exchange rates and incorporating them into cash flows
19.
What is the main implication of 'transfer pricing' for multinational capital budgeting? —
It affects the allocation of profits and taxes between countries, influencing cash flows available to the parent
20.
What is the 'international Fisher effect'? —
It suggests that the difference in nominal interest rates between two countries is related to the expected change in the exchange rate between their currencies
21.
Which is a key challenge in multinational capital budgeting compared to domestic capital budgeting? —
Higher levels of political and economic risk
22.
If a company expects to receive €1 million in 6 months, and the current 6-month forward rate is $1.10/€, what is the expected USD value of this receipt if they hedge using a forward contract? —
$1.1 million
23.
What is a major consideration when evaluating foreign investment projects related to taxes? —
Differences in corporate tax rates, tax treaties, and withholding taxes
24.
What is the primary risk associated with project financing in developing countries? —
High levels of political instability and less developed legal frameworks
25.
Which capital budgeting technique is generally preferred for multinational projects due to its ability to account for the time value of money? —
Net Present Value (NPV)
26.
What is 'multinational capital budgeting'? —
The process of planning and evaluating long-term investment decisions for a multinational corporation
27.
Which of the following is a common method for forecasting exchange rates, used in multinational capital budgeting? —
All of the above
28.
What is a key assumption in the theory of pure arbitrage? —
Absence of risk
29.
Which type of arbitrage involves exploiting discrepancies in exchange rates across three different currencies? —
Triangular arbitrage
30.
What is the primary difference between speculation and arbitrage? —
Speculation involves risk, while arbitrage aims for risk-free profit
31.
Which condition must hold for covered interest arbitrage to be profitable? —
Interest rate differential equals forward premium/discount
32.
Which financial instrument is commonly used to hedge against currency risk for a specific future transaction? —
Forward contract
33.
When using Net Present Value (NPV) for multinational projects, what discount rate is typically used? —
The parent company's cost of capital, adjusted for project-specific risks
34.
Which concept is central to the idea that arbitrage opportunities are quickly eliminated in efficient markets? —
The efficient market hypothesis
35.
In the context of international arbitrage, what is 'spot rate'? —
The exchange rate for immediate delivery
36.
What is meant by the 'cost of capital' for a multinational corporation? —
The average rate of return a company must pay to its security holders (debt and equity) to finance its assets
37.
What is the 'forward rate' in foreign exchange markets? —
The rate agreed upon today for exchange at a future date
38.
What is the 'Fisher effect' in international finance? —
The relationship between interest rates and inflation
39.
What does 'expropriation' risk refer to in multinational capital budgeting? —
The risk of a foreign government seizing the company's assets
40.
What is 'political risk' in the context of multinational capital budgeting? —
The risk of government actions that negatively affect the project's profitability, such as expropriation or regulatory changes
41.
In multinational capital budgeting, 'remittance risk' refers to: —
The risk that a host government will impose restrictions on the repatriation of profits or capital
42.
When assessing a foreign subsidiary's performance, if the parent company uses a home currency perspective, it implies: —
The subsidiary's cash flows are converted to the home currency using projected exchange rates.
43.
What is the role of 'tax treaties' in multinational capital budgeting? —
They aim to reduce double taxation and facilitate cross-border investment
44.
What is the primary goal of hedging in international finance? —
To reduce or eliminate exposure to unwanted risks, particularly currency risk
45.
How can the Fisher effect be applied to multinational capital budgeting? —
To understand the relationship between nominal interest rates, real interest rates, and expected inflation in different countries
46.
What is the primary objective of international arbitrage? —
To exploit price differences in different markets for risk-free profit
47.
When comparing international investment opportunities, what is the primary goal? —
To maximize the value of the parent company
48.
What is a 'forward exchange contract' used for in international finance? —
To lock in an exchange rate for a future transaction, reducing currency risk