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Chapter 5: Q3 DQ (page 679)

List the factors that affect the value of a currency in foreign exchange markets.

Short Answer

Expert verified

The factors are inflation, interest rates, government policies, the balance of payments, and other factors.

Step by step solution

01

Explanation of Foreign Exchange Rate

Foreign exchange rate refers to the relationship between the currencies of two countries.

02

Factors affecting the value of the currency in foreign exchange markets

The factors are as follows:

  • Inflation: If the inflation rate between two countries changes, it also changes the exchange rates.
  • Interest rates: The difference in the interest rates of two countries affect the exchange rates.
  • Balance of payments: Deficit in the balance of payments declines the currency's value.
  • Government policies: The country's government intervenes in the exchange market to regulate the value of the currency in the exchange market.
  • Other factors: Increasing demand for the currency may affect the currency's exchange rate.

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Most popular questions from this chapter

What procedures would you recommend for a multinational company in studying exposure to political risk? What actual strategies can be used to guard against such risk?

If a firm wishes to achieve immediate appreciation in earnings per share as a result of a merger, how can this be best accomplished in terms of exchange variables? What is a possible drawback to this approach in terms of long-range considerations?

Differentiate between the spot exchange rate and the forward exchange rate.

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Chicago Savings Corp. is planning to make an offer for Ernie鈥檚 Bank & Trust. The stock of Ernie鈥檚 Bank & Trust is currently selling for \(44 a share.

a.If the tender offer is planned at a premium of 50 percent over market price, what will be the value offered per share for Ernie鈥檚 Bank & Trust?

b.Suppose before the offer is actually announced, the stock price of Ernie鈥檚 Bank & Trust goes to \)60 because of strong merger rumors. If you buy the stock at that price and the merger goes through (at the price computed in part a), what will be your percentage gain?

c.Because there is always the possibility that the merger could be called off after it is announced, you also want to consider your percentage loss if that happens. Assume you buy the stock at \(60 and it falls back to its original value after the merger cancellation, what will be your percentage loss?

d. If there is an 80 percent probability that the merger will go through when you buy the stock at \)60, and only a 20 percent chance that it will be called off, does this appear to be a good investment? Compute the expected value of the return on the investment.
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