Chapter 27, Problem 1Q

Define each of the following terms:

1. a. Multinational corporation
2. b. Exchange rate; fixed exchange rate system; floating exchange rate
3. c. Trade deficit; devaluation; revaluation
4. d. Exchange rate risk; convertible currency; pegged exchange rate
5. e. Interest rate parity; purchasing power parity
6. f. Spot rate; forward exchange rate; discount on forward rate; premium on forward rate
7. g. Repatriation of earnings; political risk
8. h. Eurodollar; Eurobond; international bond; foreign bond
9. i. The euro

Summary Introduction

To determine: The definition of multinational corporation.

Explanation of Solution

In at least one country other than its home country, a multinational corporation (MNC) has facilities and other resources. Generally, a multinational company has offices and or factories for different countries and a centralized headquarters where global management is coordinated. These firms, also known as international, stateless, or transnational corporate organizations tend to have budgets that go beyond those of many small countries.

Summary Introduction

To determine: The definition of the rate of exchange, fixed exchange rate system, and floating exchange rate.

Explanation of Solution

The exchange rate determines the amount of units that can be exchanged from a given currency for one unit from another currency. From the end of the Second World War until August 1971, the fixed exchange rate regime remained in effect. Under this scheme, the country U The dollar was linked to gold at a rate of $35 an ounce, and the dollar was then connected to other currencies. Under the new floating exchange rate regime, supply and demand forces with little government intervention are allowed to determine currency prices.

Summary Introduction

To determine: The definition of trade deficit, devaluation, and revaluation.

Explanation of Solution

If a country imports extra goods from abroad than it exports, it has a deficit trade balance. Devaluation is the lowering of the currency's value relative to another currency through policy action. The country B pound, for example, was devalued from $2.80 per pound to $2.50 per pound in 1967. Revaluation happens when the relative value of a currency is increased, the reverse of devaluation.

Summary Introduction

To determine: The definition of exchange rate risk, convertible currency, and pegged exchange rate.

Explanation of Solution

Exchange rate risk refers to currency-to-currency fluctuations over time. A convertible currency is one that can be exchanged and redeemed at prevailing market rates in the currency markets. The rate is set against a major currency like the country U when an exchange rate is pegged country U Dollars. Dollars. As a result, the pegged currency values are moving together over time.

Summary Introduction

To determine: The definition of interest rate parity and purchasing power parity.

Explanation of Solution

Interest rate parity holds that after adjustment for risk, investors must assume to earn the similar return in all countries. Purchasing power parity, sometimes stated to as the "law of one price," suggests that the level of exchange rates adjusts so that in different countries alike goods cost the same.

Summary Introduction

To determine: The definition of spot rate, forward exchange rate, and discount on forward rate and premium on forward rate.

Explanation of Solution

The spot rate is the exchange rate that relates to trades "on the spot" or, more accurately, exchanges that happen two days after the trading day. In other words, for current exchanges, the spot rate is. The forward exchange rate is the predominant exchange rate (delivery) at some agreed-upon future date, typically 30, 90, or 180 days from the date of agreement of the transaction. Future exchange rates are close to future commodity market prices.

The forward rate sells at a discount when the indirect spot rate of the foreign currency is lower than the forward rate; i.e., the foreign currency is predictable to devalue (based on forward rates) in relation to the home currency. Conversely, if the foreign currency indirect spot rate is higher than the forward rate, the forward rate is selling at a premium; i.e., the foreign currency is expected to appreciate (based on forward rate) with respect to the home currency.

Summary Introduction

To determine: The definition of repatriation of earnings and political risk.

Explanation of Solution

The repatriation of earnings is the cash flow from the foreign branch or subsidiary to the parent company, usually in the form of dividends or royalties. These cash flows have to be converted into the parent's currency and are therefore subject to future changes in the exchange rate. A foreign government can restrict the amount of money that can be repatriated.

 Political risk refers to the probability of expropriation and a foreign government's sudden restriction of cash flows to the parent.

Summary Introduction

To determine: The definition of euro dollar, euro bond, international bond and foreign bond.

Explanation of Solution

A Euro dollar is a country U dollar on foreign bank deposit, or a foreign branch of country U Bank. Eurodollars are used throughout Europe and the rest of the world to conduct transactions.

An international bond is any bond that is sold outside the borrower's country. Two forms of international bonds are available: Eurobonds and foreign bonds. A Eurobond is any bond sold in any other country than the one in which the bond is denominated in the currency. So, a country U Company selling Swiss dollar bonds is selling Eurobonds.

An international bond is a bond sold by a foreign borrower but denominated in the country's currency where the issue is sold. So, a country U business issuing securities denominated in Swiss francs issues foreign bonds in country S.

Summary Introduction

To determine: The definition of euro.

Explanation of Solution

The Euro is a currency used by the nations that signed the Maastricht Treaty in the European Monetary Union.