International Corporate Finance International Flow of Funds.docx

International Flow of Funds Recently, the U.S. experienced an annual balance of trade representing a __________. A) large surplus (exceeding $100 billion) B) small surplus C) level of zero D) deficit ANSWER: D 2. A high home inflation rate relative to other countries would _______ the home country’s current account balance, other things equal.  A high growth in the home income level relative to other countries would _______ the home country’s current account balance, other things equal. A) increase; increase B) increase; decrease C) decrease; decrease D) decrease; increase ANSWER: C 3. If a country’s government imposes a tariff on imported goods, that country’s current account balance will likely __________ (assuming no retaliation by other governments). A) decrease B) increase C) remain unaffected D) either A or C are possible ANSWER: B 4. _________ purchases more U.S. exports than the other countries listed here. A) Italy B) Spain C) Mexico D) Canada ANSWER: D 5. An increase in the current account deficit will place _______ pressure on the home currency value, other things equal. A) upward B) downward C) no D) upward or downward (depending on the size of the deficit) ANSWER: B 6. If the home currency begins to appreciate against other currencies, this should ____________ the current account balance, other things equal (assume that substitutes are readily available in the countries, and that the prices charged by firms remain the same). A) increase B) have no impact on C) reduce D) all of the above are equally possible ANSWER: C 7. The International Financial Corporation was established to: A) enhance development solely in Asia through grants. B) enhance economic development through nonsubsidized loans (at market interest rates). C) enhance economic development through lowinterest rate loans (belowmarket rates). D) enhance economic development of the private sector through investment in stock of corporations. ANSWER: D 8. The World Bank was established to: A) enhance development solely in Asia through grants. B) enhance economic development through nonsubsidized loans (at market interest rates). C) enhance economic development through lowinterest rate loans (belowmarket rates). D) enhance economic development of the private sector through investment in stock of corporations. ANSWER: B 9. The International Development Association was established to: A) enhance development solely in Asia through grants. B) enhance economic development through nonsubsidized loans (at market interest rates). C) enhance economic development through lowinterest rate loans (belowmarket rates). D) enhance economic development of the private sector through investment in stock of corporations. ANSWER: C 10. Which of the following would likely have the least direct influence on a country’s current account? A) inflation. B) national income. C) exchange rates. D) tariffs. E) a tax on income earned from foreign stocks. ANSWER: E 11. The “J curve” effect describes: A) the continuous longterm inverse relationship between a country’s current account balance and the country’s growth in gross national product. B) the short-run tendency for a country’s balance of trade to deteriorate even while its currency is depreciating. C) the tendency for exporters to initially reduce the price of goods when their own currency appreciates. D) the reaction of a country’s currency to initially depreciate after the country’s inflation rate declines. ANSWER: B 12. An increase in the use of quotas is expected to: A) reduce the country’s current account balance, if other governments do not retaliate. B) increase the country’s current account balance, if other governments do not retaliate. C) have no impact on the country’s current account balance unless other governments retaliate. D) increase the volume of a country’s trade with other countries. ANSWER: B 13. The U.S. typically has a balance-of-trade surplus in its trade with __________ . A) China B) Japan C) A and B D) none of the above ANSWER: D 14. The North American Free Trade Agreement (NAFTA) increased restrictions on: A) trade between Canada and Mexico. B) trade between Canada and the U.S. C) direct foreign investment in Mexico by U.S. firms. D) none of the above. ANSWER: D 15. According to the text, international trade (exports plus imports combined) as a percentage of GDP is: A) higher in the U.S. than in European countries. B) lower in the U.S. than in European countries. C) higher in the U.S. than in about half the European countries, and lower in the U.S. than the others. D) about the same in the U.S. as in European countries. ANSWER: B 16. The direct foreign investment positions by U.S. firms have generally ________ over time; the direct foreign investment positions in the U.S. by non-U.S. firms have generally ______ over time. A) increased; increased B) increased; decreased C) decreased; decreased D) decreased; increased ANSWER: A 17. Which of the following is the biggest target of direct foreign investment by U.S. firms? A) Mexico. B) Japan. C) United Kingdom. D) Germany. ANSWER: C 18. The primary component of the current account is the: A) balance of trade. B) balance of money market flows. C) balance of capital market flows. D) unilateral transfers. ANSWER: A 19. As a result of the European Union, restrictions on exports between _______ were reduced or eliminated. A) member countries and the U.S. B) member countries C) member countries and European non-members D) none of the above ANSWER: B 20. Over the last several years, international trade (exports plus imports) as a percentage of GDP has generally: A) increased for most major countries. B) decreased for most major countries. C) stayed about constant for most major countries. D) increased for about half the major countries and decreased for the others. ANSWER: A 21. Which is not a concern about the North American Free Trade Agreement (NAFTA)? A) its impact on U.S. inflation. B) its impact on U.S. unemployment. C) lower environmental standards in Mexico. D) different health laws for workers in Mexico. ANSWER: A 22. A General Agreement on Tariffs and Trade (GATT) accord in 1993 called for: A) increased trade restrictions outside of North America. B) lower trade restrictions around the world. C) uniform environmental standards around the world. D) uniform worker health laws. ANSWER: B 23. Which of the following is mentioned in the text as a possible means by which the government may attempt to improve its balance of trade position (increase its exports or reduce its imports). A) It could attempt to strenthen its local currency value. B) Firms based in a country receive subsidies from their government, produce products, and then export those products at a cheap price. C) Firms based in one country are allowed by their government to offer bribes to large customers when pursuing business deals in a particular industry. D) all of the above are mentioned ANSWER: A 24. The demand for U.S. exports tends to increase when: A) economic growth in foreign countries decreases. the currencies of foreign countries strengthen against the dollar. U.S. inflation rises. D) none of the above ANSWER: B 25. “Dumping” is used in the text to represent the: A) exporting of goods that do not meet quality standards. B) sales of junk bonds to foreign countries. C) removal of foreign subsidiaries by the host government. D) exporting of goods at prices below cost. ANSWER: D ______________ is (are) income received by investors on foreign investments in financial assets (securities). Portfolio income Direct foreign income Unilateral transfers Factor income ANSWER: D A weak home currency may not be a perfect solution to correct a balance of trade deficit because: it reduces the prices of imports paid by local companies. it increases the prices of exports by local companies. it prevents international trade transactions from being prearranged. foreign companies may reduce the prices of their products to stay competitive. ANSWER: D Intracompany trade makes up approximately _____ percent of all international trade. 50 70 25 13 5 ANSWER: A Like the International Monetary Fund (IMF), the _______________ is composed of a collection of nations as members. However, unlike the IMF, it uses the private rather than the government sector to achieve its objectives. World Bank International Financial Corporation (IFC) World Trade Organization (WTO) International Development Association (IDA) Bank for International Settlements (BIS) ANSWER: B The World Bank’s Multilateral Investment Guarantee Agency (MIGA): offers various forms of export insurance. offers various forms of import insurance. offers various forms of exchange rate risk insurance. provides loans to developing countries. offers various forms of political risk insurance. ANSWER: E Also known as the “central banks’ central bank,” the __________ attempts to facilitate cooperation among countries with regard to international transactions and provides assistance to countries experiencing a financial crisis. World Bank International Financial Corporation (IFC) World Trade Organization International Development Association (IDA) Bank for International Settlements (BIS) ANSWER: E Direct foreign investment into the U.S. represents a ________. capital inflow trade inflow capital outflow trade outflow ANSWER: A A balance-of-trade surplus indicates an excess of imports over exports. True False ANSWER: B A weakening of the U.S. dollar with respect to the British pound would likely reduce the U.S. exports to Britain and increase U.S. imports from Britain over time. True False ANSWER: B The World Bank extends loans only to developed nations, while the International Development Association (IDA) extends loans only to developing nations. True False ANSWER: B The World Bank frequently enters into cofinancing agreements. Under these agreements, financing is provided by the World Bank and/or official aid agencies, export credit agencies, or commercial banks. True False ANSWER: A The balance of payments is a measurement of all transactions between domestic and foreign residents over a specified period of time. True False ANSWER: A Changes in country ownership of long-term and short-term assets are measured in the balance of payments with the capital account. True False ANSWER: A Portfolio investment represents transactions involving long-term financial assets (such as stocks and bonds) between countries that do not affect the transfer of control. True False ANSWER: A The current account represents the investment in fixed assets in foreign countries that can be used to conduct business operations. True False ANSWER: B Exporting of products by one country to other countries at prices below cost is called elasticity. True False ANSWER: B Direct foreign investment by U.S.-based MNCs occurs primarily in the Bahamas and Brazil. True False ANSWER: B The J curve effect is the initial worsening of the U.S. trade balance due to a weakening dollar because of established trade relationships that are not easily changed; as the dollar weakens, the dollar value of imports initially rises before the U.S. trade balance is improved. True False ANSWER: A Portfolio investments represent transactions involving long-term financial assets (such as stocks and bonds) between countries that do not affect the transfer of control. True False ANSWER: A Intracompany trade represents the exporting of products by one country to other countries below cost. True False ANSWER: B A tariff is a maximum limit on imports. True False ANSWER: B 47. A country’s net outflow of funds ___ affect its interest rates, and ____ affect its economic conditions. A) does; does B) does: does not C) does not: does not D) does not: does ANSWER: A 48. The sale of patent rights by a U.S. firm to a Russian firm reflects a credit to the U.S. balance of payments account. A) True B) False ANSWER: A 49. A U.S. purchase of patent rights from a firm in Mexico reflects a credit to the U.S. balance of payments account. A) True B) False ANSWER: B 50. Regarding the U.S. balance of payments, capital account items are relatively minor compared to the financial account items. A) True B) False ANSWER: A 51. In recent years, the U.S. has had a relatively (compared to other countries)____ balance of trade _____ with China. small; surplus large; surplus small; deficit large; deficit ANSWER) D 52. The Central American Trade Agreement (CAFTA) is intended to raise tariffs and regulations between the U.S., the Dominican Republic, and Central American countries. A) True B) False ANSWER: B 53. In July 2005, China established a new currency to replace the yuan. A) True B) False ANSWER: B 54. In July 2005, China shifted its exchange rate system so that the yuan was allowed to fluctuate within limits. A) True B) False ANSWER: A 55. Assume the U.S. has a balance of trade surplus with the Country of Thor. When individuals in Thor manufacture CDs and DVDs that look almost exactly like the original product produced in the U.S. and other countries, they ______ the U.S. balance of trade surplus with Thor. This activity is called _____. A) reduce; flipping B) reduce; pirating C) increase; pirating D) increase; flipping ANSWER: B 56. Japan’s annual interest rate has been relatively ____ compared to other countries for several years, because the supply of funds in its credit market has been very _____. A) low; small B) high; small C) low; large D) high; large ANSWER) C 57. Without the international capital flows, there would be _____ funding available in the U.S. across all risk levels, and the cost of funding would be _____ regardless of the firm’s risk level. A) more; lower B) more; higher C) less; lower D) less; higher ANSWER: D 58. The primary component of the capital account is the balance of trade. A) True B) False ANSWER: B 59. A balance of trade surplus indicates an excess of merchandise imports over merchandise exports. A) True B) False ANSWER: B 60. An American tourist visiting Germany and spending money there (for lodging, food, etc.) will reduce the U.S. current account deficit and reduce Germany’s current account balance. A) True B) False ANSWER: B 61. A balance of trade deficit indicates an excess of imports over exports. A) True B) False ANSWER: A 62. The capital account reflects changes in country ownership of long-term (but not short-term) assets. A) True B) False ANSWER: B 63. Outsourcing allows some MNCs to reduce costs but shifts jobs to other countries. A) True B) False ANSWER: A 64. A weakening of the U.S. dollar with respect to the British pound would likely reduce U.S. exports to the U.K. and increase U.S. imports from the U.K. A) True B) False ANSWER: B 65. The World Bank extends loans only to developed nations, while the International Development Association (IDA) extends loans only to developing nations. A) True B) False ANSWER: B 66. The ___________ is the difference between exports and imports. Balance of trade Balance on goods and services Balance of payments Current account Capital account ANSWER: A 67. Which of the following will probably not result in an increase in a country’s current account balance (assuming everything else constant)? A decrease in the country’s rate of inflation A decrease in the country’s national income level An increase in government restrictions in the form of tariffs or quotas An appreciation of the country’s currency All of the above will result in an increased current account balance. ANSWER: D 68. Which of the following factors does probably not directly affect a country’s capital account and its components? Inflation Interest rates Withholding taxes on foreign income Exchange rate movements All of the above will directly affect a country’s capital account. ANSWER: A 69. The _______________, an accord among 117 nations, called for lower tariffs around the world. General Agreement on Tariffs and Trade (GATT) North American Free Trade Agreement (NAFTA) Single European Act of 1987 European Union Accord None of the above ANSWER: A 70. Which of the following is not a “subtle” trade restriction Country X may use against Country Y? The government of Country X eliminates environmental restrictions. The government of Country X subsidizes firms in its country to facilitate dumping. The government of Country X provides tax breaks to firms in specific industries. The government of Country X imposes a tariff on goods imported from Country Y. The government of Country X allows its firms to offer bribes to large customers when pursuing business deals. ANSWER: D 71. Which of the following statements is not true? Exporters may complain that they are being mistreated because the currency of their country is too weak. Outsourcing affects the balance of trade because it means that a service is purchased in another country. Sometimes, trade policies are used to punish countries for various actions. Tariffs imposed by the EU have caused some friction between EU countries that commonly import products and other EU countries. All of the above are true. ANSWER: A 72. Which of the following would increase the current account of country X? Country Y is country X’s sole trading partner. Inflation increases in countries X and Y by comparable amounts. Country X’s and Country Y’s currencies depreciate by the same amount. Country X imposes tariffs on imports from Country Y, and Country Y retaliates by imposing an identical tax on X’s exports. The central banks of country X and country Y reduce the money supply to increase interest rates. Country X imposes a quota on imports, and Country Y retaliates by imposing an identical quota on X’s exports. ANSWER: D 73. ____________ represent aid, grants, and gifts from one country to another. Transfer payments Factor income The balance of trade The balance of payments The capital account ANSWER: A 74. Which of the following is not a goal of the International Monetary Fund (IMF)? To promote cooperation among countries on international monetary issues To promote stability in exchange rates To enhance a country’s long-term economic growth via the extension of structural adjustment loans To promote free trade To promote free mobility of capital funds across countries ANSWER: C 75. According to the “J curve effect,” a weakening of the U.S. dollar relative to its trading partners' currencies would result in an initial ____________ in the current account balance, followed by a subsequent _____________ in the current account balance. Decrease; increase Increase; decrease Decrease; decrease Increase; increase ANSWER: A 2. Clover Machines Case: Dabbling in International Markets? What are overall benefits of tapping international markets? Does it make sense for Clover given its success in using domestic capital markets? Global financial markets are often larger than domestic financial markets. This means that financing issue size can be larger, costs can be lower and contract flexibility can be higher. But global markets are typically only available for large firms. Clover appears to be of sufficient size for tapping global markets. Clover is a well-known issuer of capital in domestic markets and a large number of analysts (16) follow the firm. It might be the right time to explore global markets and make its brand known in other countries also: this may produce long-term benefits for Clover as it expands and requires more capital. Why did the report contain no mention of foreign equity markets? While global debt markets offer opportunities for U.S. issuers, the U.S. equity markets offer unsurpassed strength and opportunity. Consequently, U.S. firms like Clover do not even consider foreign equity markets when they desire additional equity infusion. This posture on the part of U.S. firms has been evident in recent decades, but there is no certainty that the situation will persist in the future. What are general pros and cons of medium-term versus long-term debt financing? Floating versus fixed rate? Given Clover’s current situation, is one approach generically better than another, without giving consideration of financing specifics? The three possibilities identified by Mr. Peng include a medium-term offering and two long-term offerings. In fact, the medium-term offering is a floating rate note and is similar to a short-term offering that is rolled-over annually. What are general considerations affecting debt maturity? Asset structure is one important factor: the more permanent the assets are, the greater the bias toward long-term funding. From the case it appears that Clover needs more permanent assets. It also appears that funding needs will increase in the future; this again biases us toward a long-term solution. Clover faces continuing large setup costs and its free cash flows (surplus of operating cash flows over investments) may not be sufficient to fund these investments. What are the pros and cons of tapping the Eurobond market? Does Clover fit the profile of firms using this market? What are pre-conditions for successful participation? Clover may face initial hurdles in tapping the Eurobond markets: potential investors may not be familiar with the firm. But Clover does satisfy a key requirement: Eurobond issues are large issues; since Clover needs large amounts of capital, this market is appropriate. Pre-conditions for a successful offering are: (a) well-known firm and (b) large offering. Clover does not have any business in Japan. Given this, does it make any sense to obtain JPY financing? What might be the downside of the attractive rate that is offered? It is interesting that one of the alternatives is a Samurai issue (JPY issue in Japan). Such an issue might be quite valuable if Clover has business in Japan and can offset JPY operating cash flows against JPY debt related cash flows. But even without this benefit, there are advantages to “diversifying” funding sources (a topic discussed in chapters 10 and 11). One problem that Clover needs to consider is the potential for JPY to strengthen; if this happens, debt service (that is, repayment of interest and principal) will be at disadvantageous currency rates. The report shows no indication or model of how to translate the effects of obtaining floating rate financing. Mr. Bent resolved to ask Mr. Peng to construct a spreadsheet—using plausible scenarios—to demonstrate cash flow consequences of the floating rate note. There are two complications in modeling cash flows related to the FRN. First, market interest rates can change. The coupon is set at EURIBOR + 30bp. The current level of EURIBOR is 4.3%, so this implies that the first coupon payment is 4.6%. Clover expects the rate to diminish somewhat, so one could model a rate such as EURIBOR = 4%. Second, interest payments are denominated in EUR. Clover is a US firm and would be interested in cash flows converted to USD. Spot EURUSD = 1.60 with a plausible range of 1.50 – 1.70. One simple method is to construct two scenarios: best case and worst case. In the best case scenario, EURIBOR = 4% and EURUSD = 1.50. In the worst case scenario, EURIBOR = 4.3% and EURUSD = 1.70. If the issue size is EUR 1 million, the coupon payment (in USD) in years 2-4 would equal: Best Case: 1,000,000 × (4% + 0.3%) × 1.50 Worst Case: 1,000,000 × (4.3% + 0.3%) × 1.70 The principal repayment at t=4 would equal: Best Case: 1,000,000 × 1.50 Worst Case: 1,000,000 × 1.70 Such analysis can be depicted in a simple spreadsheet.