Q: Using the covered interest parity formula $$ F = S \times \frac{1 + r_{\$$}}{1 + r_{€}} $$, calculate the one-year forward rate if the spot rate is 1.60$$/£$, the U.S. risk-free rate is 4%, and the U.K. risk-free rate is 7%.

$$ F = 1.60 \times \frac{1.04}{1.07} = 1.5551 $$

Question 1

Which of the following best describes the purpose of a currency forward contract in international trade?

Accepted Answer

To lock in an exchange rate for a future transaction, reducing exchange rate risk.

Question 2

Given the following trade credit terms: 2/10, net 30, what is the effective annual rate (EAR) of not taking the discount? Use the formula $$ EAR = (1 + r)^n - 1 $$, where $$ r = \frac{2}{98} $$ and $$ n = \frac{365}{20} .$$

Accepted Answer

$$ EAR = (1 + \frac{2}{98}$$)^{18.25}$$ - 1 = 0.446  or 44.6$$%

Question 3

A U.S. firm must pay €500,000 to an Italian supplier in 3 months. The current spot rate is $$1.29/€. The firm enters a forward contract at 1.29$$/€. If the spot rate in 3 months is $1.35/€, what is the outcome for the U.S. firm?

Accepted Answer

The firm benefits because it pays less in dollars than it would at the future spot rate.

Question 4

Using the covered interest parity formula $$ F = S 	imes \frac{1 + r_{\$$}}{1 + r_{€}} $$, calculate the one-year forward rate if the spot rate is 1.60$$/£$, the U.S. risk-free rate is 4%, and the U.K. risk-free rate is 7%.

Accepted Answer

$$ F = 1.60 	imes \frac{1.04}{1.07} = 1.5551 $$

Question 5

Which of the following is NOT a component of net working capital?

Accepted Answer

Long-term debt

Question 6

A firm has inventory of $$3,698.3$$, cost of goods sold of $$40,653.5$$, and accounts payable of $$5,124.6. $$What are the inventory days and accounts payable days? Use $$	ext{Average daily COGS} = \frac{40,653.5}{365} = 111.38.$$

Accepted Answer

Inventory days = $$\frac{3,698.3}{111.38} = 33.2$$, Accounts payable days = $$\frac{5,124.6}{111.38} = 46.0$$

Question 7

If a firm’s cash conversion cycle (CCC) is negative, what does this imply about its operations?

Accepted Answer

The firm receives cash from customers before it pays its suppliers.

Question 8

A company is considering abandoning a 1% cash discount policy. If this results in a loss of 20 units sold per month (from 500 to 480), and the NPV of the switch is $$-78,550$$, what should the company do?

Accepted Answer

Keep the discount policy because abandoning it decreases firm value.

Question 9

Which of the following best describes the 'Just-in-Time' (JIT) inventory management system?

Accepted Answer

A system where inventory is ordered and received only as needed for production or sales.

Question 10

A firm receives trade credit terms of 3/10, net 40. If the firm does not take the discount, what is the EAR? Use $$ r = \frac{3}{97} $$, $$ n = \frac{365}{30} $$, and $$ EAR = (1 + r)^n - 1 .$$

Accepted Answer

$$ EAR = (1 + \frac{3}{97}$$)^{12.17}$$ - 1 = 0.4486  or 44.86$$%

Question 11

Which of the following is a reason for a firm to hold cash balances?

Accepted Answer

To meet day-to-day operational needs and unexpected expenses.

Question 12

If a firm stretches its accounts payable beyond the net period, what is a potential consequence?

Accepted Answer

Suppliers may impose stricter payment terms or stop doing business with the firm.

Question 13

Which of the following formulas correctly calculates the net working capital?

Accepted Answer

$$ 	ext{Net Working Capital} = 	ext{Current Assets} - 	ext{Current Liabilities} $$

Question 14

A firm’s free cash flow (FCF) is calculated as $$ 	ext{Net Income} + 	ext{Depreciation} - 	ext{Capital Expenditures} - 	ext{Increase in Working Capital} . If $$net income is $$20,000$$, depreciation is $$5,000$$, capital expenditures are $$5,000$$, and the increase in working capital is $$1,000$$, what is FCF?

Accepted Answer

$$ FCF = 20,000 + 5,000 - 5,000 - 1,000 = 19,000 $$

Question 15

Which of the following statements about hedging with forward contracts is TRUE?

Accepted Answer

Hedging eliminates exchange rate risk but may result in a worse outcome than not hedging.

Question 16

If a firm’s accounts receivable days is much higher than the industry average, what does this indicate?

Accepted Answer

The firm is slower in collecting cash from customers compared to its competitors.

Question 17

Which of the following is a benefit of reducing the cash conversion cycle (CCC)?

Accepted Answer

It frees up cash flow that can be used to increase firm value.

International Corporate Finance and Working Capital Management: Study Notes

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