Case Study

Jeff Smith established a US business that worked in

sporting shoes as he had worked in a sporting shoes
store for several years, and he had noticed that
many customers want to purchase these shoes at
lower prices. However, the sporting shoes stores
sold this product at higher prices and several of
customers could not by this product at this high
price. From his experience, Jeff was aware that low-
cost sporting shoes could possibly penetrate the
U.S. market. He also knew the operation cost of this
product. His goal was to manage the cost of this
product and sell them on a wholesale basis to
various buyers in the United States. Unfortunately,
many sporting shoes stores began to sell low-priced
products just before Jeff was about to start his
business. The firms that began to produce the low-
cost sporting shoes already provided many other
products to sporting goods stores in the United
States and therefore had already established a
business relationship with these stores. Jeff did not
believe that he could compete with these firms in
the U.S. market. Rather than pursue a different
business, Jeff decided to implement his idea on a
global basis. While sporting shoes (as it is
demanded in US) has not been a traditional product
in foreign countries, it has become more demanded
in several foreign countries. Furthermore, the
expansion of cable networks in foreign countries
would allow for much more exposure to U.S.
sporting shoes in those countries in the future. Jeff
asked many of his foreign friends in different foreign
countries if they recalled seeing sporting shoes sold
in their home countries. Most of them said they
rarely noticed sporting shoes being sold in sporting
goods stores but that they expected the demand for
US sporting shoes to increase in their home
countries. Consequently, Jeff decided to start a
business of producing low priced sporting shoes and
exporting them to sporting goods distributors in for
sporting shoes at the retail level. Jeff planned to
expand his product line over time once he identified
other sports products that he might sell to foreign
sporting goods stores. Jeff planned to produce the
sporting shoes in his small factory. Thus, his main
business expenses were the cost of the materials
used to produce these shoes and expenses
associated with finding distributors in foreign
countries who would attempt to sell the sporting
shoes to sporting goods stores. Moreover, Jeff has
decided to initially pursue the market in the British
country because British people appear to have some
interest in several sports, and no other firm has
capitalized on this idea in this country. (The sporting
goods shops in the British country do not sell
sporting shoes but might be willing to sell them.)
Jeff has contacted one sporting goods distributor
that has agreed to purchase sporting shoes on a
monthly basis and distribute them to sporting goods
stores throughout the British country. The
distributor’s demand for sporting shoes is ultimately
influenced by the demand for sporting shoes by the
British people. Jeff’s company will receive British
ponds when it sells the sporting shoes to the
distributor and will then convert the ponds into
dollars. Jeff recognizes that products exported from
U.S. firms to foreign countries (such as that will be
produced by his company) can be affected by
various factors. Each month, Jeff’s company
receives an order for sporting shoes from a British
sporting goods distributor. The monthly payment for
the sporting shoes is denominated in British ponds,
as requested by the British distributor. Thus, Jeff’s
as an owner of the sporting shoes company, must
convert the pounds received into dollars. Therefore,
it needs to closely monitor the value of the British
pond in the future. Jeff expects that inflation will
rise substantially in the British country, while
inflation in the United States will remain low. He
also expects that the interest rates in both
countries will rise by about the same amount. Jeff’s
company also anticipates that the British pound will
depreciate over time against the U.S. dollar. As
Jeff’s company exports sporting shoes to the British
country, it will receive British pounds. The check
(denominated in pounds) for last month’s exports
just arrived. Jeff normally deposits the check with
his local bank and requests that the bank convert
the check to dollars at the prevailing spot rate.
Jeff’s local bank provides foreign exchange services
for many of its business customers who need to buy
or sell widely traded currencies. Today, however,
Jeff decided to check the quotations of the spot
rate at other banks before converting the payment
into dollars.
Your answer

1. Critically analyze whether Jeff’s sporting shoes

company could be described as a multinational
corporation or not, with clarifying the different
forms that could be followed by the different
businesses to penetrate the international markets
and described as multinational businesses.
Critically analyze if you own a business which form
of the multinational businesses forms you prefer to
follow to penetrate the international markets. (2
marks)
Jeff’s sporting shoes company could be described
as a multinational corporation because it has
engaged in the international business through the
international trade.
There is a different form that could be followed by
the different businesses to penetrate the
international markets and described as
multinational businesses such as:
1. International Trade
2. Licensing
3. Franchising
4. Joint Ventures
5. Acquisition of Existing Operations
6. Establishing New Foreign Subsidiaries
As an investor I prefer to penetrate the international
business through Establishing New Foreign
Subsidiaries although it has a high risk .because the
operations can be tailored exactly to the firm’s
needs. In addition, a smaller investment may be
required than would be needed to purchase existing
operations. However, the firm will not reap any
rewards from the investment until the subsidiary is
built and a customer base established.
2. Critically analyze whether Jeff’s company may
face agency problem or not. And if it is occurred
provide your advices for the company to solve this
problem. Also, analyze why the agency costs maybe
higher in the MNCs than the national companies.
And, in your opinion this problem will be costlier or
less in the sporting industry MNCs than the MNCs. (4
marks)

 In business , an agency problem usually refers to a conflict

of interest between a company's management and the
company's stockholders
 So Jeff’s company may face an agency problem within a
minimal limits because the company doesn’t has any
subsidiaries

 Jeff can solve the agency problem Through regulations or

by incentivizing an agent to act in accordance with the
principal's best interests, so agency problems can be
reduced.
 Agency costs larger in MNCs because:

1-MNCs have subsidiaries scattered around the world ,the

monitoring for managers of distant subsidiaries is more
difficult.

2-Foreign subsidiary managers raised in different culture

may not follow uniform goals

3-Sheer size of larger MNCs

3. Critically analyze whether Jeff’s company may

have a comparative advantage over potential
competitors in foreign countries that could produce
and sell sporting shoes there. And critically analyze
the international business theories which
businesses may consider to penetrate the
international markets and form their multinational
businesses. (6 marks)
Yes Jeffs company has a comparative advantage
because jeff himself as an owner knows the
production process and hence no specialized staff
needed for the same and this will save substantially
in cost also the production will be done in his small
factory so the rent also saved so the low cost will
be the comparative advantage for the firm.
There is three theories that pursue the firm to
penetrate the international business
1.Comparative Advantage Theory
Competitive advantage is what a country, business, or individual
does that provide a better value to consumers than its
competitors. There are three strategies companies use to gain a
competitive advantage. First, they could be the low-cost provider.
Second, they could offer a better product or service. Third, they
could focus on one type of customer
2. Imperfect Markets Theory
Perfect markets are characterized by having the following:

 An unlimited number of buyers and sellers.

 Identical or substitutable products.
 No barriers to entry or exit.
 Buyers have complete information on products and prices.
 Companies are price takers meaning have no power to set
prices.

In reality, no market can ever have an unlimited number of

buyers and sellers. Economic goods in every market are
heterogeneous, not homogeneous, as long as more than one
producer exists. A diverse range of goods and tastes are
preferred in an imperfect market.
the real world suffers from imperfect market
conditions where factors of production are
somewhat immobile. There are costs and often
restrictions related to the transfer of labor and other
resources used for production. There may also be
restrictions on transferring funds and other
resources among countries. Because markets for
the various resources used in production are
“imperfect,” MNCs such as the Gap and Nike often
capitalize on a foreign country’s resources
3. Product Cycle Theory
as a firm matures, it may recognize additional
opportunities outside its home country. Whether the
firm’s foreign business diminishes or expands over
time will depend on how successful it is at
maintaining some advantage over its competition.
The advantage could represent an edge in its
production or financing approach that reduces costs
or an edge in its marketing approach that generates
and maintains a strong demand for its product.

Your answer

4. There are different factors that MNCS should

consider when they decide to penetrate the foreign
markets. Critically analyses this factors. And
regarding Jeff's company what are the factors that
it should analyze to penetrate UK market. Also,
according to mentioned market conditions, provide
your advice for Jeff's company whether it will be
better for this company to initially penetrate one or
many foreign markets this, critically analyze your
point view. (8 marks)
There are many factors affecting the international
trade such as
1-Inflation
If a country’s inflation rate increases relative to the
countries with which it trades, its current account
will be expected to decrease, other things being
equal. Consumers and corporations in that country
will most likely purchase more goods overseas (due
to high local inflation), while the country’s exports
to other countries will decline
Which mean that Jeff’s company may favorably
affected if it is trading with a high inflation rate as
the demand for the foreign products will be more
2-National income
If a country’s income level (national income)
increases by a higher percentage than those of
other countries, so does consumption of goods that
will most likely reflect an increased demand for
foreign goods.
Which also may favorably affected Jeff’s company
3-Government policies including :
a. policies on subsidizing exporters,
b. restrictions on imports,
c. lack of enforcement on piracy.
4- Exchange rates
The values of most currencies can fluctuate over
time because of market and government forces. If a
country’s currency begins to rise in value against
other currencies, its current account balance should
decrease. As the currency strengthens, goods
exported by that country will become more
expensive to the importing countries, thus the
demand for such goods will decrease.
All of the mentioned factors can critically affect Jeff
company
According to the mentioned market condition :
The inflation rate in UK will rise which mean more
demand for the foreign goods
On the other hand the British pound is expected to
depreciate ,a depreciating pound would be
unfavorable for Jeff’s company. because he is going
to get less amount of dollars against the same
amount of pounds
So my advise for Jeff is to try to penetrate many
foreign market to diversify its investment and hedge
against the risks in U.K market.

5. There are different methods that could be used by

businesses to penetrate the foreign markets.
Critically analyze and criticize these methods. And
regarding Jeff’s company that has no immediate
plans to conduct direct foreign investment and
decides to consider other less costly methods of
establishing his business in foreign markets, provide
this company your advice about the methods that it
can use to increase its presence in foreign markets.
Critically analyze your point view. (8 marks)
The firms Engage in International Business through
the following methods
1. International Trade
-Conservative approach to penetrate markets
(exporting) and to obtain supplies at low cost
(importing)
-this method has minimal risk- because no
needed fund for foreign investment
2. Licensing
-Licensing allows firms to use their technology
in foreign markets without amajor investment in
foreign countries and without transportation
costs that result from exporting
-A major disadvantage is that it is difficult for
MNCs to ensure quality control.
3. Franchising
-Obligates a firm to provide a specialized sales
or service strategy, support assistance, and
possibly an initial investment in the franchise in
exchange for periodic fees
-allows firms to penetrate foreign markets
without a major investment in foreign countries
 4. Joint Ventures
-Many firms penetrate foreign markets by
engaging in a joint venture with firms that
reside in those markets
-Allow two firms to apply their respective
comparative advantage in a given project.
5. Acquisition of Existing Operations
-Acquisition of an existing corporations is more
risky because of the large investment required
-If the foreign operation perform poorly, the firm
may achieve loses
6. Establishing New Foreign Subsidiaries
-May be preferred to acquisitions because the
operations can be tailored exactly to firm’s
needs.
-A smaller investment may be required than
would needed to purchase existing operations
-No reap from the investment until the
subsidiary is built and the customer bas
established.
Any method of increasing international business
that requires a direct investment in foreign
operations normally is referred to as a direct foreign
investment (DFI). International trade and licensing
usually are not considered to be DFI because they
do not involve direct investment in foreign
operations. Franchising and joint ventures tend to
require some investment in foreign operations, but
to a limited degree. Foreign acquisitions and the
establishment of new foreign subsidiaries require
substantial investment in foreign operations and
represent the largest portion of DFI.
As long asJeff’s company has no immediate plans to
conduct direct foreign investment and decides to
consider other less costly methods of establishing
his business in foreign markets, so I recommend it
to go through Licensing which allows firms to use
its technology in foreign markets without a major
investment in foreign countries and without the
transportation costs that result from exporting. The
major disadvantage of licensing is that it is difficult
for the firm providing the technology to ensure
quality control in the foreign production process.

6. The exports and imports amounts of MNCs

significantly affect the BOP of any country. Critically
analyze the extent to which you agree with the
statement. And regarding Jeff's company, critically
analyze the extent to which the exports of Jeff’s
company may affect the current account balance
between the United States and the United Kingdom.
And analyze the factors that could affect the current
account balance between US and UK. With clarifying
how each factor may affect the British demand for
sporting shoes that are produced by Jeff’s company.
(10 marks)
The balance of paymentsis a summary of
transactions between domestic and foreign
residents for a specific country over a specified
period of time.
A balance-of-payments statement can be broken
down into various components.
Those that receive the most attention are the
current account and the capital account.
The main components of the current account are
payments for (1) merchandise
(goods) and services,(2) factor income, and (3)
transfers.which means import and export, so I’m
totally agree that the exports and imports amounts
of MNCs significantly affect the BOP of any country.
The international trade is representing a significant
part from the current account so the factor affecting
the international trade will affect the current
account as well
The most influential factors are:
• Inflation
• National income
• Government policies
• Exchange rates
 Impact of Inflation
If a country’s inflation rate increases (UK) relative
to the countries with which it trades (U.S), its
current account will be expected to decrease,
Consumers and corporations in that country will
most likely purchase more goods overseas (due to
high local inflation), while the country’s exports to
other countries will decline. That is mean more
demand from the British market to Jeff’s company
products.
 Impact of National Income
If a country’s income level (national income)
increases by a higher percentage than
those of other countries, its current account is
expected to decrease, other things being equal. As
the real income level (adjusted for inflation) rises,
so does consumption of goods. A percentage of that
increase in consumption will most likely reflect an
increased demand for foreign goods. That is mean
more demand from the British market to Jeff’s
company products.
 Impact of Government Policies
A country’s government can have a major effect on
its balance of trade due to its
policies on subsidizing exporters, restrictions on
imports, or lack of enforcement on
piracy.so in case there is BOT deficit in British the
government most probably will take actions to
correct this deficit which will reduce the British
market imported products .That is mean less
demand from the British market to Jeff’s company
products.
 Impact of Exchange Rates
If a country’s currency (British pound) begins to rise
in value against other currencies, its current
account balance should decrease, other things
being equal. As the currency strengthens, goods
exported by that country will become more
expensive to the importing countries. Therefore, the
demand for such goods will decrease.
That is mean more demand from the British market
to Jeff’s company products. because of the
competitive price .

7. The MNCs are significantly exposed to different

types of risks. Critically analyze the extent to which
you agree with the statement such with providing
your advices for these companies about the
methods that could be used to hedge their risks.
And regarding Jeff’s company, provide your advice
of how it could utilize the spot market to facilitate
the exchange of currencies. Analyze your advice. (8
marks)
The MNCs are significantly exposed to different
types of risks such as political risk and ,economic
risk factors .

The International Political Risk:

Any country can affect the level of an MNC’s sales.
A foreign government may increase taxes or impose
barriers on the MNC’s subsidiary. Alternatively,
consumers in a foreign country may boycott the
MNC if there is friction between the government of
their country and the MNC’s home country.
The following are the most common strategies used
to reduce exposure to a host
government takeover:
• Use a short-term horizon.
• Rely on unique supplies or technology.
• Hire local labor.
• Borrow local funds.
• Purchase insurance.
• Use project finance

International Economic Conditions such as :

A country’s economic growth is dependent on
several financial factors:
1- Interest rates: Higher interest rates tend to slow
the growth of an economy and
reduce demand for the MNC’s products. Lower
interest rates often stimulate the
economy and increase demand for the MNC’s
products.
2-Exchange rates. Exchange rates can influence the
demand for the country’s exports, which in turn
affects the country’s production and income level. A
strong
currency may reduce demand for the country’s
exports, increase the volume of
products imported by the country, and therefore
reduce the country’s production
and national income. A very weak currency can
cause speculative outflows and
reduce the amount of funds available to finance
growth by businesses.
3-Inflation: Inflation can affect consumers’
purchasing power and therefore their
demand for an MNC’s goods. It also indirectly
affects a country’s financial condition by influencing
the country’s interest rates and currency value. A
high level of inflation may also lead to a decline in
economic growth.
The amount of consumption in any country is
influenced by the income earned by consumers in
that country. If economic conditions weaken, the
income of consumers becomes relatively low,
consumer purchases of products decline, and an
MNC’s sales in that country may be lower than
expected. This results in a reduction in the MNC’s
cash flows, and therefore in its value
Exchange Rate Risk
If the foreign currencies to be received by a U.S.-
based MNC suddenly weaken against the Dollar, the
MNC will receive a lower amount of dollar cash
flows than was expected. This may reduce the
value of the MNC.
the economic conditions can lead to high fluctuation
in tghe exchange rate which needs to be hedged by
using the suitable derivatives
regarding Jeff Company ,it would have an account
with a commercial bank. As it receives payment in
pounds each month it would deposit the check at a
bank that provides foreign exchange services. Each
month, the bank would liquidate the check, and then
convert the British pounds received into dollars f at
the prevailing spot rate.
Jeff Company is exposed to exchange rate risk,
because the value of the British pound will change
over time. If the pound depreciates over time, the
payment in pounds will convert to fewer dollars. Jeff
Company could engage in a forward contract to
mitigate the exchange risk.
Your answer

8. Foreign exchange risk is significantly affected

MNCs, critically analyze the extent to which you
agree with the statement with clarifying the tools
that could be used by companies to hedge this type
of risk. And regarding Jeff’s company, analyze the
extent to which this company could be exposed to
the exchange rate risk. And if it is occurred, provide
him with your advice about how they can manage
and hedge the exposure to this risk. (8 marks)
foreign exchange risk, is an unavoidable risk of
foreign investment, but it can be mitigated
considerably through hedging techniques
so I’m totaly agree with this statement : for example
If the foreign currencies to be received by a U.S.-
based MNC suddenly weaken against the Dollar, the
MNC will receive a lower amount of dollar cash
flows than was expected. This may reduce the value
of the MNC
there are many tools to hedge the exchange rate
risk such as
a. Forward Market
B. Currency Futures Market
C. Currency Options Market
d. swap
jeff company can hedge that risk through the
forward contract with its bank to be more flexible in
the settlement date and the contract value ,because
the Corporations that have established relationships
with large banks tend to use forward contracts
rather than futures contracts because forward
contracts are tailored to the precise amount of
currency to be purchased or sold in the future and
the precise forward date that they prefer.
Conversely, small firms and individuals who do not
have established relationships with large banks or
prefer to trade in smaller amounts tend to use
currency futures contracts.

Your answer
9. There are different factors that affect the
depreciation and appreciation of currencies against
each other's, critically analyze these factors. And,
according to Jeff’s expectations about the British
pound, analyze whether the British pound will
appreciate or depreciate against the Dollar over
time. Analyze the extent to which Jeff’s company
will be favorably or unfavorably affected by the
future changes in the value of the pound. (8 marks)
the currency is always exposed to supply and
demand so there will be movement in the exchange
rate which can be affected by the following factors
1-Relative Inflation Rates
Changes in relative inflation rates can affect
international trade activity, which
influences the demand for and supply of currencies
and therefore influences exchange
rates.
2-Relative Interest Rates
Changes in relative interest rates affect investment
in foreign securities, which influences
the demand for and supply of currencies and
therefore influences exchange rates.
3-Relative Income Levels
A third factor affecting exchange rates is relative
income levels. Because income can
affect the amount of imports demanded, it can
affect exchange rates.
4-Government Controls
The governments of foreign countries can influence
the equilibrium exchange rate in many ways,
including (1) imposing foreign exchange barriers, (2)
imposing foreign trade barriers, (3) intervening
(buying and selling currencies) in the foreign
exchange markets, and (4) affecting macro
variables such as inflation, interest rates, and
income levels.
5-Expectations
Like other financial markets, foreign exchange
markets react to any news that may
have a future effect. News of a potential surge in
U.S. inflation may cause currency
traders to sell dollars, anticipating a future decline
in the Dollar’s value. This response
places immediate downward pressure on the Dollar.

Jeff expects that inflation will rise substantially in

the British country, while inflation in the United
States will remain low, in that case U.K will tend to
experience less demand for its currency (pound) than U.Sthe with lower
inflation, so the pound is expected to depreciate.
And jeff’s company will be unfavorably affected because it is getting
the payable in British pound and that is mean Jeff company will get less
Dollars against the same amount of British pound

Your answer

10. Derivatives contracts could be used by MNCs to

hedge their exposure to the foreign exchange risk.
Critically analyze the extent to which you agree
with statement. And. If derivatives are used by
MNCs as a hedge tool against this type of risk,
critically analyze the pros and cons of this tool to
use. Also, and regarding Jeff’s company analyze the
extent to which can use currency derivatives
contracts (futures and options) to hedge its position
against exchange rate risk and analyze the possible
limitations of using these contracts. (10 marks)
Hedging refers to managing risk to an extent that makes it bearable. In
international trade and dealings ,foreign exchange play an important role.
Fluctuations in the foreign exchange rate can significantly impact business
decisions and outcomes. Many international trades and business deals are
shelved or become unworthy due to their significant exchange rate risk.
There are many derivities contract such as

A. Forward Market
Forward contracts are customized agreements between two parties to fix the
exchange rate for a future transaction. This simple arrangement would easily
eliminate exchange rate risk, but it has some shortcomings, particularly getting a
counter party who would agree to fix the future rate for the amount and time
period in question may not be easy.

B. Currency Futures Market

Futures contracts are standardized contracts and thus are bought and sold for just
like shares in the stock market. The futures contract is also a legal contract just
like the forward, but the obligation can be ‘removed’ before the expiry of the
contract by making an opposite transaction
Contrary to the forward contract, the futures contract has a number of features
that has been standardized. These standard features are necessary in order to
increase the liquidity in the market, i.e. the number of matching transactions. In
the practical world traders are faced with diverse conditions that need diverse
actions (like the need to hedge different amounts of currency at different points
of time in the future) such that matching transactions may be difficult to find. By
standardizing the contract size (i.e. the amount) and the futures maturity, these
different needs can be matched to some degree even though perhaps not
perfectly. Some of the standardized features include expiry date, contract month,
contract size, position limits (i.e. the number ofcontracts a party can buy or sell)
and price limit (i.e. the maximum daily price movements). These standardized
features introduce some hedging imperfections though

C. Currency Options Market

A currency option may be defined as a contract between two parties – a buyer
and a seller - whereby the buyer of the option has the right but not the obligation,
to buy or sell a specified currency at a specified exchange rate, at or before a
specified date, from the seller of the option. While the buyer of option enjoys a
right but not obligation, the seller of the option nevertheless has an obligation in
the event the buyer exercises the given right. There are two types of options: •
Call options – gives the buyer the right to buy a specified currency at a specified
exchange rate, at or before a specified date. • Put options – gives the buyer the
right to sell a specified currency at a specified exchange rate, at or before a
specified date. Of course the seller of the option needs to be compensated for
giving such a right. The compensation is called the price or the premium of the
option. Since the seller of the option is being compensated with the premium for
giving the right, the seller thus has an obligation in the event the right is exercised
by the buyer.In hedging using options, calls are used if the risk is an upward trend
in price and puts are used if the risk in a downward trend in price

Advantages of Derivatives

 Hedging risk exposure

As per the meaning of derivatives mentioned above the value of the

derivatives is dependent on the value of the underlying asset, so the
contracts are made with a view to hedge risk parameter. To hedge risk,
the investor makes purchases derivative contract whose value moves in
the opposite direction to the value of an asset.

 Identifying the price of the underlying asset

Derivatives help in identifying the price valuation of the underlying

asset.

 Market efficiency
It is considered that derivatives increase the efficiency of financial
markets. With the help of derivative contracts, one can replicate the
payoff of the assets.

Disadvantages of Derivatives

 High risk

The derivatives can be highly volatile which can incur significant losses.
Hence the risk factor in derivatives is largely high.

 Speculation oriented

Derivative are unpredictable and highly dependent on speculations. This

tool of speculation can bring huge losses if the speculation is
unreasonable.

Jeffs company can use future or option contract to hedge against the
exchange rate risk but the limitation wil be as following

In future contract there is a standardized contract size , maturity date and

initial margine which may not be suitable for jeff’s company as it has a
monthely receivables may be in adiffernet sizes .
the option may be the most expensive of all the alternatives. However, not only
does it fix the exchange rate, but also gives the opportunity to benefit from a
better exchange rate if the market moves in favour of the company.
Your answer

11. Given Jeff’s expectations concerning the

depreciation and the appreciation of the British
pound over the next month, he decides to use the
derivatives contracts (future and options) to hedge
the exchange rate risk. Critically analyze which one
of these contracts you will advise the company to
use to hedge their risk? (8 marks)
As per jeff expectation that the british Pound will
depreciate so he can hedge the exchange rate risk
through forward contract ,jeff company can sell the
british pound next month at the agreed future price
regardless the spot price at that time .
If jeff can benfits from the pound appreciation and
also hedge against the pound depreciation by option
contract using the following strategy
Buy a put option and at the same time buy a call
option also
Your answer
12. MNCs should always try to find banks which
provide them with more favorable spot rates.
Critically analyze the extent to which you agree the
statement with clarifying the importance of this
issue for the multinational businesses. And
regarding Jeff's company, critically justify whether
it will be able to find a bank that provides him with a
more favorable spot rates than his local bank. And,
critically analyze the extent to which his local bank
may provide him more reasonable quotations for the
spot rate of the British pound if it is the only bank in
town that provides foreign exchange services (10
marks)
I believe
Jeff can contact other banks and obtain foreign exchange quotes for
his requirement. However, it is unlikely that he will find a bank that will provide
him with a more favorable spot rate than his local bank. Large/significant
differences in exchange rates (for the same currency) among banks
would result in the creation of locational arbitrage opportunities
(which would involve buying at lower rates and selling at higher rates
to earn profits). Therefore, the quote for british pound is most likely to
be same (that is, the difference (if any) would be minimum) among
different banks at a particular point of time.

On the other hand Jeff bank is not likely to provide more reasonable
quotations for the spot rate of the British pound if it is the only bank in
town that provides foreign exchange services. It is because Jeff would
have no option but to transact with his bank. Presence of other banks
would increase competition and the possibility of obtaining a slightly
better exchange rate than the one offered by the Jeff's bank.
Your answer
13. The forward contracts is one the most important
and usable contract that could be used by the MNCs
to hedge the foreign exchange risk. Critically
analyze the extent to which you agree with the
statement. And, regarding Jeff's company, it is
thinking about using a forward contract to hedge
the anticipated receivables in pounds next month.
And his local bank quoted him a spot rate of $2.76
and a one month forward rate of $2.7546. Before
Jeff deciding to sell pounds one month forward, he
wants to be sure that the forward rate is
reasonable, given the prevailing spot rate. A one
month Treasury security in US currently offers a
yield of 2 percent, while a one-month Treasury
security in UK offers a yield of 2.5 percent. Critically
analyze the extent to which this one-month forward
rate will be reasonable for Jeff’s company given the
spot rate of $2.76, and provide him with your advice.
(10 marks)

a forward market for currencies enables an MNC to

lock in the exchange rate (called a forward rate) at
which it will buy or sell a currency. A forward
contract specifies the amount of a particular
currency that will be purchased or sold by the MNC
at a specified future point in time and at a specified
exchange rate. Commercial banks accommodate the
MNCs that desire forward contracts. MNCs
commonly use the forward market to hedge future
payments that they expect to make or receive in a
foreign currency. In this way, they do not have to
worry about fluctuations in the spot rate until the
time of their future payments.
Regarding the offered forward rate , Based on the
IRP, the forward rate premium should be almost
equal to the difference between the interest rate at
home and foreign interest rate
The actual premium is
P= (F-S)/S
P=(2.759-2.76)/2.76=-0.001956
Under the condition of IRP , the forward premium
suppose to be
P=(1+Ih/1+If)-1
=(1.02/1.025)-1
=-0.0048
the actual forward rate is different from this derived
forward rate, there may be potential for covered
interest arbitrage
The expected forward rate F=S(1+p) =2.76(1-
0.0048)=2.746
That is mean the covered interest arbitrage is
possible and as results the forward rate is expect
to be lower to reach the equilibrium point
So my advise is to benefit from the offered forward
rate .
For all situations in which the foreign interest
rate exceeds the home interest rate, the
forward rate should exhibit a discount
approximately equal to that differential
If the forward premium deviates substantially
from the interest rate differential, covered
interest arbitrage is possible. In this type of
arbitrage, a foreign shortterm investment in a
foreign currency is covered by a forward sale
of that foreign currency in the future. In this
manner, the investor is not exposed to
fluctuation in the foreign currency’s value.
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