Corporate Finance (The Mcgraw-hill/Irwin Series in Finance, Insurance, and Real Estate)
Corporate Finance (The Mcgraw-hill/Irwin Series in Finance, Insurance, and Real Estate)
11th Edition
ISBN: 9780077861759
Author: Stephen A. Ross Franco Modigliani Professor of Financial Economics Professor, Randolph W Westerfield Robert R. Dockson Deans Chair in Bus. Admin., Jeffrey Jaffe, Bradford D Jordan Professor
Publisher: McGraw-Hill Education
bartleby

Videos

Textbook Question
Book Icon
Chapter 31, Problem 18QP

Using the Exact International Fisher Effect From our discussion of the Fisher effect in Chapter 8, we know that the actual relationship between a nominal rate, R, a real rate, r, and an inflation rate, h, can be written as follows:

1 + r =(1 + R)/(1 + h)

This is the domestic Fisher effect.

  1. a. What is the nonapproximate form of the international Fisher effect?
  2. b. Based on your answer in (a), what is the exact form for UIP? (Hint: Recall the exact form of IRP and use UFR.)
  3. c. What is the exact form for relative PPP? (Him: Combine your previous two answers.)
  4. d. Recalculate the NPV for the Kihlstrom drill bit project (discussed in Section 31.5) using the exact forms for the UIP and the international Fisher effect. Verify that you get precisely the same answer either way.

a.

Expert Solution
Check Mark
Summary Introduction

To explain: Non approximate form of international fisher effect.

Exchange Rate:

Exchange rate defines the value of one currency against the other currency. Exchange rate has two main components one is the currency used to compare that is domestic currency and other is the currency used to compare against that is foreign currency.

Explanation of Solution

The domestic fisher effect is:

1+RUS=(1+rUS)(1+hUS)1+rUS=(1+RUS)(1+hUS)

Here,

  • RUS is country U interest rate.
  • hUS is country U inflation rate.

This relationship must hold for any country that is.

1+rFC=(1+RFC)(1+hFC)

As per the international Fisher effect the real rates are equal across countries so,

1+rUS=(1+RUS)(1+hUS)=(1+RFC)(1+hFC)=1+rFC

Conclusion

So, non approximate form of international fisher effect is equals to 1+rFC .

b.

Expert Solution
Check Mark
Summary Introduction

To explain: Exact form of unbiased interest rate parity.

Explanation of Solution

The exact form of unbiased parity rate is,

E[St]=Ft=S0[(1+RFC)1+RUS]t

Here,

  • E[St] is parity rate.
  • S0 is the spot rate.
  • RFC is foreign currency interest rate.
  • RUS is country U interest rate.
  • t is the time period.
Conclusion

So the exact form of unbiased parity rate is S0[(1+RFC)1+RUS]t .

c.

Expert Solution
Check Mark
Summary Introduction

To explain: Exact form of relative purchasing power parity.

Explanation of Solution

Relative purchasing power parity,

E[St]=S0[(1+hFC)(1+hUS)]t

Here,

  • E[St] is purchasing power parity.
  • S0 is the spot rate.
  • hFC is foreign currency inflation rate.
  • hUS is country U inflation rate.
  • t is the time period.
Conclusion

So exact form of purchasing power parity is S0[(1+hFC)(1+hUS)]

d.

Expert Solution
Check Mark
Summary Introduction

To calculate: Net present value by country U using the exact form of UIP and the international fisher effect.

Explanation of Solution

Calculation of expected currency spot rate:

Given,

Spot rate is €0.5.

Foreign currency inflation rate is 7%.

Inflation in rate in country U is 5%.

Formula to calculate expected currency spot rate at time,

Corporate Finance (The Mcgraw-hill/Irwin Series in Finance, Insurance, and Real Estate), Chapter 31, Problem 18QP E[St]=S0[(1+hFC)(1+hUS)]t

Here,

  • E[St] is purchasing power parity
  • S0 is the spot rate
  • hFC is foreign currency inflation rate
  • hUS is country U inflation rate.
  • t is the time period

Substitute €0.5 for Spot rate, 7%. for Foreign currency inflation rate and 5% for Inflation in rate in country U.

E[St]=(0.5)[1+0.71+0.5]t=(0.5)(1.019)t

Calculation of Net present value by converting them in E currency cash flow:

Given,

Initial cash flow is €2 million.

Cash flow for 3 years after that is €0.9 million.

Formula to calculate NPV,

NPV=imnCFi(1+r)iC0

Here,

  • NPV is net present value.
  • i is number of years.
  • C0  is initial cash flow.
  • CFi  is cash flow in particular year.
  • r is discount rate.

Substitute €2 million for initial investment, €0.9 million Cash flow for 3 years and discount rate is 1.0191.1 for 1st year 1.01921.12 for 2nd year and 1.01931.13 for 3rd year.

NPV=[{900,000[1.019(0.5)]1.1}+{900,000[1.0192(0.5)]1.12}+{900,000[1.0193(0.5)]1.13}[2,000,000(0.5)]]=[{$900,0000.56045}+{$900,0000.6282}+{$900,0000.7041}{$4,000,000}]=[$1,605,852.44+$1,432,645.588+$1,278,120.785$4,000,000]=$316,618.813

So value of NPV in dollars is $316,618.813.

Calculation of return in e currency,

RFC=1.10(1.071.05)1=0.1209

Calculation of NPV in e currency,

NPV=[(900,000)1.1209+(900,000)1.12092+(900,000)1.120932,000,000]=[802,926.22+716,322.7942+639,060.39272,000,000]=158,309.4069

So, Net present value at in E currency is €158,309.4069.

Convert e currency to dollars at the current exchange rate,

NPV($)=158,309.4069(0.5)$1=158,309.4069$0.5=$316,618.813

So value of NPV in dollars is $316,618.813.

Conclusion

So, the net present value in dollars is $316,618.813 which is same as computed above.

Want to see more full solutions like this?

Subscribe now to access step-by-step solutions to millions of textbook problems written by subject matter experts!
Students have asked these similar questions
< When you purchased your car, you took out a 5-year annual-payment loan with an interest rate of 5% per year. The annual payment on the car is $5,200. You have just made a payment and have now decided to pay off the loan by repaying the outstanding balance. What is the payoff amount for the following scenarios? a. You have owned the car for 1 year (so there are 4 years left on the loan)? b. You have owned the car for 4 years (so there is 1 year left on the loan)? a. You have owned the car for 1 year (so there are 4 years left on the loan)? The payoff if there are 4 years left on the loan is $ (Round to the nearest cent.) b. You have owned the car for 4 years (so there is 1 year left on the loan)? The payoff if there is 1 year left on the loan is $ (Round to the nearest cent.)
Victoria Exports (Canada). A Canadian exporter, Victoria Exports, will be receiving six payments of €13,800, ranging from now to 12 months in the future. Since the company keeps cash balances in both Canadian dollars and U.S. dollars, it can choose which currency to exchange the euros for at the end of the various periods. Which currency appears to offer the better rates in the forward market? (Click on the icon to import the table into a spreadsheet.) Period Days Forward spot 1 month C$/euro 1.3347 1.3370 US$/euro 1.3219 1.3224 m 2 months 3 months 1.3392 30 60 1.3229 90 1.3235 180 1.3438 12 months 360 1.3464 1.3239 1.3269 6 months 1.3416 Calculate the forward premium, the Canadian dollar proceeds, and the difference from the spot rate proceeds in the C$/Euro forward market below: (Round the forward premium to three decimal places and the Canadian dollar amounts to the nearest cent.) Days Forward Premium C$ Proceeds of Difference Period Forward C$/euro on the C$/euro €13,800 Over Spot…
identify the primary sources of financing, both traditional and alternative, accessible to companies seeking sources of funding. To do so, you should: Collect and curate data and documentary resources from various sources (magazine articles, newspapers, online content, working papers from various institutions, activity reports, performance reports, legal regulations, speeches, appearances, press conferences, etc.). Analyze the documentary content you have previously curated and collected. During your analysis, consider the context, location, timing, and target audience of the texts. Reference Article: One Park Financial. (2022). Best alternative business loans and financing for entrepreneurs. https://www.oneparkfinancial.com/blog/alternative-business-funding Questions: Identify and summarize the traditional financial avenues available to businesses. What are the most innovative financing options they could find? Open-ended question: if you were in the opposite position, as an…

Chapter 31 Solutions

Corporate Finance (The Mcgraw-hill/Irwin Series in Finance, Insurance, and Real Estate)

Knowledge Booster
Background pattern image
Finance
Learn more about
Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, finance and related others by exploring similar questions and additional content below.
Similar questions
SEE MORE QUESTIONS
Recommended textbooks for you
Text book image
Intermediate Financial Management (MindTap Course...
Finance
ISBN:9781337395083
Author:Eugene F. Brigham, Phillip R. Daves
Publisher:Cengage Learning
Text book image
International Financial Management
Finance
ISBN:9780357130698
Author:Madura
Publisher:Cengage
Text book image
Pfin (with Mindtap, 1 Term Printed Access Card) (...
Finance
ISBN:9780357033609
Author:Randall Billingsley, Lawrence J. Gitman, Michael D. Joehnk
Publisher:Cengage Learning
Text book image
EBK CONTEMPORARY FINANCIAL MANAGEMENT
Finance
ISBN:9781337514835
Author:MOYER
Publisher:CENGAGE LEARNING - CONSIGNMENT
The Exchange Rate and the Foreign Exchange Market [AP Macroeconomics Explained]; Author: Heimler's History;https://www.youtube.com/watch?v=JsKLBpy6cEc;License: Standard Youtube License