Question

1. In regards to the perspective of a U.S. investor, which of the below statements is FALSE?
Group of answer choices

a.The cash flows of assets denominated in a foreign currency expose the investor to uncertainty as to the actual level of the cash flow measured in that foreign currency.

b.The actual number of U.S. dollars that the investor eventually gets depends on the exchange rate between the U.S. dollar and the foreign currency at the time the nondollar cash flow is received and exchanged for U.S. dollars.

c.The cash flows of assets denominated in a foreign currency expose the investor to uncertainty as to the actual level of the cash flow measured in U.S. dollars.

d.If the foreign currency depreciates (declines in value) relative to the U.S. dollar (that is, the U.S. dollar appreciates), the dollar value of the cash flows will be proportionately less, leading to foreign exchange risk.

2. What would be the lowest fixed-rate borrowing cost available for an institution that can borrow at 12% fixed in one market, or at a variable rate equal to LIBOR+4.5% in another market, and there is an available swap of LIBOR+3% for a 10% fixed payment?

Answer 1

(a) is false. A US investor would exchange US dollars into foreign currency at the time of investing, and exchange foreign currency into US dollars at the time of selling the investment. If the exchange rate fluctuates between the time of investing and selling the investment, the actual cash flow received in US dollars is uncertain.

(b) is true. The actual receipt of US dollars depends on the exchange rate between US dollars and the foreign currency.

(c) is true. A US investor would exchange US dollars into foreign currency at the time of investing, and exchange foreign currency into US dollars at the time of selling the investment. If the exchange rate fluctuates between the time of investing and selling the investment, the actual cash flow received in US dollars is uncertain.

(d) is true. If the foreign currency depreciates, each unit of foreign currency can buy a lower quantity of US dollars. Thus, the dollar value of cash flows will be lower, resulting in foreign exchange risk.