Question 1. Impact of September 11 Every quarter, Bronx Co. ships computer chips to a firm in central Asia. It has not used any trade financing because the importing firm always pays its bill in a timely manner upon receipt of the computer chips. After the September 11, 2001, terrorist attack on the United States, Bronx reconsidered whether it should use some form of trade financing that would ensure that it would be paid for its exports upon delivery. Offer a suggestion to Bronx Co. on how it could achieve its goal.
Question 2. Letters of Credit Ocean Traders of North America is a firm based in Mobile, Alabama, that spe- cializes in seafood exports and commonly uses letters of credit (L/Cs) to ensure payment. It recently experi- enced a problem, however. Ocean Traders had an irrevocable L/C issued by a Russian bank to ensure that it would receive payment upon shipment of 16,000 tons of fish to a Russian firm. This bank backed out of its obligation, however, stating that it was not authorized to guarantee commercial transactions.
a. Explain how an irrevocable L/C would normally facilitate the business transaction between the Russian importer and Ocean Traders of North America (the U.S. exporter).
b. Explain how the cancellation of the L/C could cre- ate a trade crisis between the U.S. and Russian firms.
c. Why do you think situations like this (the cancel- lation of the L/C) are rare in industrialized countries?
d. Can you think of any alternative strategy that the U.S. exporter could have used to protect itself better when dealing with a Russian importer?
Question 3. Cleveland, Inc., plans to finance its U.S. operations by repeatedly borrowing two currencies with low interest rates whose exchange rate movements are highly correlated. Will the variance of the two-currency portfolio’s effective financing rate be much lower than the variance of either individual currency’s effective financing rate? Explain.
Question 4. Analysis of Short-Term Financing Jacksonville Corp. is a U.S.-based firm that needs $600,000. It has no business in Japan but is considering 1-year financ- ing with Japanese yen because the annual interest rate would be 5 percent versus 9 percent in the United States. Assume that interest rate parity exists.
a. Can Jacksonville benefit from borrowing Japanese yen and simultaneously purchasing yen 1 year forward to avoid exchange rate risk? Explain.
b. Assume that Jacksonville does not cover its expo- sure and uses the forward rate to forecast the future spot rate. Determine the expected effective financing rate. Should Jacksonville finance with Japanese yen? Explain.
c. Assume that Jacksonville does not cover its expo- sure and expects that the Japanese yen will appreciate by 5, 3, or 2 percent, and with equal probability of each occurrence. Use this information to determine the probability distribution of the effective financing rate. Should Jacksonville finance with Japanese yen? Explain.
Question 5. Effective Yield Fort Collins, Inc., has $1 million in cash available for 30 days. It can earn 1 percent on a 30-day investment in the United States. Alternatively, if it converts the dollars to Mexican pesos, it can earn 1.5 percent on a Mexican deposit. The spot rate of the Mexican peso is $.12. The spot rate 30 days from now is expected to be $.10. Should Fort Collins invest its cash in the United States or in Mexico? Substantiate your answer.
Question 6. Investing in a Portfolio Pittsburgh Co. plans to invest its excess cash in Mexican pesos for 1 year. The 1-year Mexican interest rate is 19 percent. The proba- bility of the peso’s percentage change in value during the next year is shown next:
Possible rate of change in the Mexican peso over Probability of
The life of the investment occurrence
-15% 20%
-4 50
0 30
What is the expected value of the effective yield based on this information? Given that the U.S. interest rate for 1 year is 7 percent, what is the probability that a 1-year investment in pesos will generate a lower effective yield than could be generated if Pittsburgh Co. simply invested domestically?
