TB Chapter 18

Chapter 18: Long-Term Financing 51
Chapter 18
Long-Term Financing
1. Ideally, a firm desires to denominate bonds in a currency that:

A) exhibits a low interest rate and is expected to appreciate.
B) exhibits a low interest rate and is expected to depreciate.
C) exhibits a high interest rate and is expected to depreciate.
D) exhibits a high interest rate and is expected to appreciate.
ANSWER: B
2. Eurobonds are often issued with a floating coupon rate that is tied to LIBOR.
A) true.
B) false.
ANSWER: A
3. A U.S. firm could issue bonds denominated in euros and partially hedge against exchange rate risk
by:
A) invoicing its exports in U.S. dollars.
B) requesting that any imports ordered by the firm be invoiced in U.S. dollars.
C) invoicing its exports in euros.
D) requesting that any imports ordered by the firm be invoiced in the currency denominating the
bonds.
ANSWER: C
4. Firm “X” conducts all business transactions in U.S. dollars. If it issues a currency cocktail bond, it
can:
A) reduce exchange rate risk relative to issuing a bond denominated in U.S. dollars.
B) reduce exchange rate risk relative to issuing a bond denominated in a single foreign currency.
C) A and B
D) none of the above
ANSWER: B
52 International Financial Management
5. Simulation is useful in the bond-denomination decision since it can:

A) precisely compute the cost of financing with bonds denominated in a single foreign currency.
B) precisely compute the cost of financing with bonds denominated in a portfolio of foreign
currencies.
C) assess the probability that a bond denominated in a foreign currency will be less costly than a
bond denominated in the home currency.
D) A and B
ANSWER: C
6. An interest rate swap between two firms of different countries enables the exchange of __________
for __________.
A) fixed-rate payments; floating-rate payments
B) stock; interest deductions on taxes
C) interest payments on loans; ownership of debt of less developed countries
D) interest payments on loans; stock
ANSWER: A
7. If U.S. firms issue bonds in _______, the dollar outflows to cover fixed coupon payments increase
as the dollar _______.
A) a foreign currency; weakens
B) dollars; strengthens
C) a foreign currency; strengthens
D) dollars; weakens
ANSWER: A
8. The yields offered on newly issued bonds denominated in dollars have:

A) consistently increased over the last 10 years.
B) consistently decreased over the last 10 years.
C) remained stable.
ANSWER: D
9. When ignoring exchange rate risk, bond yields:

A) are the same for all currencies.
B) are consistently higher for all non-U.S. bonds than U.S. bonds.
C) are consistently lower for all non-U.S. bonds than U.S. bonds.
ANSWER: D
10. A U.S. firm has received a large amount of cash inflows periodically in Swiss francs as a result of
exporting goods to Switzerland. It has no other business outside the U.S. It could best reduce its
exposure to exchange rate risk by:
A) issuing Swiss franc-denominated bonds.
B) purchasing Swiss franc-denominated bonds.
C) purchasing U.S. dollar-denominated bonds.
D) issuing U.S. dollar-denominated bonds.
ANSWER: A
11. A U.S. firm has a Canadian subsidiary that remits some of its earnings to the parent on an annual
basis. The firm has no other foreign business. The firm could best reduce its exposure to exchange
rate risk by issuing bonds denominated in:
A) U.S. dollars.
B) Canadian dollars.
C) multiple currencies.
D) a unit of account such as the SDR.
ANSWER: B
12. If the currency denominating a foreign bond depreciates against the firm’s home currency, the funds
needed to make coupon payments will increase.
A) true.
B) false.
ANSWER: B
13. An interest rate swap is commonly used by an issuer of fixed-rate bonds to:
A) convert to floating-rate debt.
B) hedge exchange rate risk.
C) lock in the interest payments on debt.
D) remove the default risk of its debt.
ANSWER: A
14. A currency swap between two firms of different countries enables the exchange of __________ for
___________ at periodic intervals.
A) stock; one currency
B) stock; a portfolio of foreign currencies
C) one currency; stock options
D) one currency; another currency
ANSWER: D
15. Assume a U.S.-based subsidiary wants to raise $1,000,000 by issuing a bond denominated in
Pakistani rupees (PKR). The current exchange rate of the rupee is $.02. Thus, the MNC needs
___________ rupees to obtain the $1,000,000 needed.
A) 50,000,000
B) 20,000
C) 1,000,000
ANSWER: A
SOLUTION: $1,000,000/$.02 = PKR50,000,000
16. An MNC issues ten-year bonds denominated in 500,000 Philippines pesos (PHP) at par. The bonds
have a coupon rate of 15%. If the peso remains stable at its current level of $.025 over the lifetime
of the bonds and if the MNC holds the bonds until maturity, the financing cost to the MNC will be:
A) 10.0%.
B) 12.5%.
C) 15.0%.
ANSWER: C
SOLUTION: Since the bonds are issued at par, and since the exchange rate remains stable over the
life of the bonds and the bonds are held until maturity, the financing cost will be exactly the coupon
rate of the bond.
17. Minnie Corp. has decided to issue three-year bonds denominated in 5,000,000 Slovakian koruna
(SKK) at par. The bonds have a coupon rate of 17%. If the koruna is expected to appreciate from
its current level of $.03 to $.032, $.034, and $.035 in years 1, 2,and 3, respectively, what is the
financing cost of these bonds?
A) 17%.
B) 23.18%.
C) 22.36%.
D) 23.39%.
ANSWER: D
SOLUTION:
Annual Cost of
Year 1 Year 2 Year 3 Financing
Payments in Slovakian koruna 850,000 850,000 5,850,000
Forecasted exchange rate of koruna $.032 $.034 $.035
Payments in dollars $27,200 $28,900 $204,750 23.39%
18. In a(an) ___________ swap, two parties agree to exchange payments associated with bonds; in
a(an) ____________ swap, two parties agree to periodically exchange foreign currencies.
A) interest rate; currency
B) currency; interest rate
C) interest rate; interest rate
D) currency; currency
ANSWER: A
19. Good Company prefers variable to fixed rate debt. Bad Company prefers fixed to variable rate debt.
Assume the following information for Good and Bad Companies:
Fixed Rate Bond Variable Rate Bond

Good Company 10% LIBOR + 1%
Bad Company 12% LIBOR + 1.5%
Given this information:

A) an interest rate swap will probably not be advantageous to Good Company because it can issue
both fixed and variable debt at more attractive rates than Bad Company.
B) an interest rate swap attractive to both parties could result if Good Company agreed to provide
Bad Company with variable rate payments at LIBOR + 1% in exchange for fixed rate payments
of 10.5%.
C) an interest rate swap attractive to both parties could result if Bad Company agreed to provide
Good Company with variable rate payments at LIBOR + 1% in exchange for fixed rate
payments of 10.5%.
ANSWER: B
20. _____________ are beneficial because they may reduce transaction costs. However, MNCs may
not be able to obtain all the funds that they need.
A) Private placements
B) Domestic equity offerings
C) Global equity offerings
D) Global debt offerings
ANSWER: A
21. Most MNCs obtain equity funding:

A) in foreign countries.
B) in their home country.
C) through global offerings.
D) through private placements.
ANSWER: B
22. Some firms may be uncomfortable issuing bonds denominated in foreign currencies because
exchange rates are __________ difficult to predict over ________ time horizons.
A) less; long
B) more; short
C) more; long
ANSWER: C
23. If the foreign currency that was borrowed appreciates over time, an MNC will need fewer funds to
cover the coupon or principal payments. [Assume the MNC has no other cash flows in that
currency.]
A) true.
B) false.
ANSWER: B
24. U.S.-based MNCs whose foreign subsidiary generates large earnings may be able to offset exposure
to exchange rate risk by issuing bonds denominated in the subsidiary’s local currency.
A) true.
B) false.
ANSWER: A
25. Countries where bond yields are ________ tend to have a _______ risk-free interest rate.
A) low; high
B) high; low
C) high; high
ANSWER: C
26. MNCs can use __________ to reduce exchange rate risk. This occurs when two parties provide
simultaneous loans with an agreement to repay at a specified point in the future.
A) forward contracts
B) currency swaps
C) parallel loans
ANSWER: C
27. The United States typically has a(n) ___________-sloping yield curve, which means that the
annualized yields are ________ for short-term debt than for long-term debt.
A) downward; higher
B) downward; lower
C) upward; higher
D) upward; lower
ANSWER: D
28. When financing international operations, MNCs typically will not use a maturity that _________
the expected life of the business in that country.
A) is less than
B) exceeds
C) is the same as
ANSWER: B
29. When an MNC financesin a currency that matches its cash inflows using a relatively _______
maturity, the MNC is exposed to __________ risk.
A) short; interest rate
B) long; interest rate
C) short; exchange rate
ANSWER: B
30. Some MNCs use a country’s yield curve to compare annualized rates among debt maturities, so that
they can choose a maturity that has a relatively low rate.
A) true.
B) false.
ANSWER: A
31. As a ________ to an interest rate swap, a financial institution simply arranges a swap between two
parties.
A) ultraparty
B) broker
C) counterparty
ANSWER: B
32. In general, the _________ rate payer in a plain vanilla swap believes interest rates are going to
_______.
A) fixed; decline
B) floating; decline
C) floating; increase
ANSWER: B
33. In a(n) ___________ swap, the fixed rate payer has the right to terminate the swap.
A) callable
B) putable
C) amortizing
D) zero-coupon
ANSWER: A
34. In a(n) _________ swap, the notional value is increased over time.
A) amortizing
B) basis
C) zero-coupon
D) accretion
ANSWER: D
35. A ___________ gives its owner the right to enter into a swap.
A) basis swap
B) swaption
C) callable swap
D) putable swap
ANSWER: B
36. Because bonds denominated in foreign currencies rarely have lower yields, U.S. corporations rarely
consider issuing bonds denominated in those currencies.
A) true.
B) false.
ANSWER: B
37. The actual financing cost of a U.S. corporation issuing a bond denominated in euros is affected by
the euro’s value relative to the U.S. dollar during the financing period.
A) true.
B) false.
ANSWER: A
38. A floating coupon rate can be an advantage to the bond issuer during periods of increasing interest
rates.
A) true.
B) false.
ANSWER: B
39. An MNC issuing pound-denominated bonds may be completely insulated from exchange rate risk
associated with the bond if its foreign subsidiary makes the coupon and principal payments of the
bond with its pound receivables.
A) true.
B) false.
ANSWER: A
40. If an MNC uses a long-term forward contract to hedge the exchange rate risk associated with a
bond denominated in euros, it would sell euros forward.
A) true.
B) false.
ANSWER: B
41. Currency swaps, whereby two parties exchange currencies at a specified point in time for a
specified price, are often used by MNCs to hedge against interest rate risk.
A) true.
B) false.
ANSWER: B
42. Two limitations of interest rate swaps are that there is a cost of time and resources associated with
searching for a suitable partner and that there is a risk to each swap participant that the
counterparticipant could default on his payments.
A) true.
B) false.
ANSWER: A
43. Many MNCs simultaneously swap interest payments and currencies.

A) true.
B) false.
ANSWER: A
44. A back-to-back (also called parallel) loan represents simultaneous loans provided by two parties
with an agreement to repay at a specified point in the future.
A) true.
B) false.
ANSWER: A
45. Since yield curves are identical across countries, MNCs rarely consider them when deciding on the
maturity of bonds denominated in a foreign currency.
A) true.
B) false.
ANSWER: B

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TB Chapter 18

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Chapter 18: Long-Term Financing 51

1. Ideally, a firm desires to denominate bonds in a currency that:

5. Simulation is useful in the bond-denomination decision since it can:

8. The yields offered on newly issued bonds denominated in dollars have:

9. When ignoring exchange rate risk, bond yields:

SOLUTION: $1,000,000/$.02 = PKR50,000,000

Fixed Rate Bond Variable Rate Bond

Given this information:

21. Most MNCs obtain equity funding:

43. Many MNCs simultaneously swap interest payments and currencies.

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