MSc I EXAM July 08IntBus.docVIP

Calculators may be used in this examination provided that they are not capable of being used to store alphabetical information other than hexadecimal numbers. ANSWER THREE questions; at least ONE from each section. Section A Question 1 (a) A UK company can borrow $10 million in the USA for one year at an interest rate of 8 per cent. The Financial Times indicates the spot market exchange rate is $2.00/￡. and the one year forward exchange rate is $1.96/￡, reflecting lower interest rates in the USA. However, there is a strong belief by the markets that the dollar is likely to continue it’s depreciation, in particular, against the euro and the yen, over the next year. Assume you are swayed by the preceding market views, and further, you believe the dollar’s slide will also extend to sterling. You think the exchange rate at the end of the year will be $2.05/￡.. Calculate the effective cost of debt under the assumption that the spot market rate of exchange at the end of the year will be (i) today’s forward exchange rate, and (ii) your forecast. (30 marks) (b) If the company’s foreign operations are located mainly in the Far East, discuss the risks involved in borrowing money in the USA assuming: the debt raised would be used in the USA. the debt raised would be used in Europe with no operations in the USA. the debt raised would be used in the UK with no operations in the USA. (40 marks) (c) Compare and contrast the floating exchange rate system with the fixed exchange rate system. (30 marks) Total Marks 100 Question 2 (a) In 2007 it was expected that the inflation rate in the UK would be 3.5 % and in the US would be 2%. The real rate of interest in both countries is 1%. The spot market exchange rate at the beginning of 2007 was $1.90/￡. Required: Use the Purchasing Power Parity (PPP) to project the expected US$ per 1￡ at the end of 2007 (the expected future spot rat