Question 1

A firm with net positive USD receivables is said to be:

Accepted Answer

Net inflow in USD means the firm benefits if USD appreciates → long USD.

Question 2

PPP (Purchasing Power Parity) primarily links exchange rate to:

Accepted Answer

PPP connects exchange rate movement with **relative price levels/inflation**.

Question 3

World Bank mainly provides:

Accepted Answer

World Bank focuses on long-term development projects and programs.

Question 4

Interest Rate Parity (IRP) relates:

Accepted Answer

IRP links interest differential with forward premium/discount.

Question 5

A Eurobond is:

Accepted Answer

Eurobond is issued in a foreign currency relative to country where it is issued.

Question 6

Transaction exposure arises mainly due to:

Accepted Answer

Transaction exposure relates to receivables/payables/loans in foreign currency.

Question 7

A call option on foreign currency is mainly useful for:

Accepted Answer

Importer needs to buy foreign currency → call option (right to buy).

Question 8

Political risk is a subset of:

Accepted Answer

Political risk is part of country risk (policy change, expropriation, controls).

Question 9

International finance primarily deals with:

Accepted Answer

International finance focuses on **cross-border money flows** and **foreign exchange (FX)** issues.

Question 10

Bid rate is the rate at which the dealer:

Accepted Answer

Bid is the price at which dealer **buys** the base currency (customer sells base).

Question 11

Which of the following belongs to the current account?

Accepted Answer

Imports/exports of goods and services are part of the **current account**.

Question 12

A key factor in international cost of capital is:

Accepted Answer

Country risk can require adding a premium to discount rate or adjusting cash flows.

Question 13

International financial management primarily deals with:

Accepted Answer

IFM covers investing, financing, WC and risk management across countries/currencies.

Question 14

In foreign capital budgeting, cash flows can be evaluated by:

Accepted Answer

Foreign project appraisal needs FX conversion and inflation/tax adjustments.

Question 15

Relative PPP states that expected change in exchange rate is approximately equal to:

Accepted Answer

Relative PPP: %ΔS ≈ inflation differential.

Question 16

Balance of Payments (BoP) is:

Accepted Answer

BoP records transactions between **residents and the rest of the world** for a period.

Question 17

Capital account convertibility refers to:

Accepted Answer

Capital account convertibility relates to cross-border investment/borrowing flows.

Question 18

Hedging in international finance means:

Accepted Answer

Hedging reduces the impact of adverse exchange rate movements.

Question 19

International working capital management becomes complex mainly due to:

Accepted Answer

Cross-border WC is affected by FX, settlement lags, regulations, and banking systems.

Question 20

The difference between ask and bid is called:

Accepted Answer

Spread = **Ask − Bid**, dealer’s margin for liquidity.

Question 21

What is foreign exchange (FX)?

Accepted Answer

**Foreign exchange (FX)** means foreign currency and the process/market of converting one currency into another for trade, investment and payments.

Question 22

What is a currency swap?

Accepted Answer

**Currency swap** is an agreement to exchange principal and interest payments in two different currencies over a period.

Question 23

What is natural hedging?

Accepted Answer

**Natural hedging** means reducing FX exposure operationally by matching foreign currency inflows and outflows (without derivatives).

Question 24

Define international financial management (IFM).

Accepted Answer

**International Financial Management (IFM)** is financial decision-making for firms operating in more than one country/currency, focusing on investment, financing, working capital and risk management internationally.

Question 25

Expand FX.

Accepted Answer

**FX** = **Foreign Exchange**.

Question 26

What is country risk?

Accepted Answer

**Country risk** is the risk that economic/political conditions or government actions in a country will negatively affect investment returns and cash flows.

Question 27

Define international capital market.

Accepted Answer

**International capital market** is the market where long-term funds are borrowed and lent across national boundaries through equity, bonds and long-term loans.

Question 28

State one reason why countries use capital controls.

Accepted Answer

Countries use capital controls to reduce risk of **sudden capital outflows** and protect financial stability.

Question 29

Define exchange rate regime.

Accepted Answer

**Exchange rate regime** is the system/method by which a country determines and manages the value of its currency relative to other currencies.

Question 30

Define hedging.

Accepted Answer

**Hedging** means taking an action/position to reduce or offset the risk of adverse exchange rate movement on foreign currency exposure.

Question 31

Explain call option and put option with their typical users (any three points) with a table.

Accepted Answer

### **Call vs Put Options (Currency)**

- **Call option**: right to **buy** foreign currency; useful for importers.
- **Put option**: right to **sell** foreign currency; useful for exporters.
- Options give protection but require paying **premium**.

Table:

| Option | Right | Typical user |
|---|---|---|
| **Call** | buy FX | importer (payable) |
| **Put** | sell FX | exporter (receivable) |

Thus, options hedge downside risk while keeping potential upside if exchange rate moves favorably.

Question 32

Differentiate spot and forward market (any three points) with a table.

Accepted Answer

### **Spot vs Forward Market**

- **Spot** deals with immediate/near settlement; **forward** deals with future settlement.
- spot rate reflects current market; forward rate is fixed today for future date.
- forward is commonly used for **hedging** future exposures.

Table:

| Basis | Spot | Forward |
|---|---|---|
| Settlement | immediate/near | future date |
| Rate | spot rate | forward rate |
| Use | instant conversion | **hedging** & planning |

Thus, forward contracts reduce uncertainty in future foreign currency cash flows.

Question 33

Explain international cost of capital (exam-style): factors and importance with a table.

Accepted Answer

### **International Cost of Capital (Basics)**

**International cost of capital** is the required return used to evaluate projects when funding and risks are international.

Factors (any three):
- access to **global funding** sources and rates.
- **currency choice** (cheaper foreign debt vs FX risk).
- **country risk premium** for risky host countries.

Table:

| Factor | Effect |
|---|---|
| **Currency choice** | adds/changes FX risk |
| **Country risk premium** | increases required return |

Thus, international cost of capital must reflect both financing conditions and extra country/FX risk.

Question 34

Explain functions of forex market (any three points).

Accepted Answer

Functions of forex market (any three):

- provides **currency conversion** for trade and investment.
- helps transfer **purchasing power** between countries.
- provides **hedging** facilities to manage exchange rate risk.
- supports price discovery (exchange rate determination).

Therefore, forex market supports global trade and capital flow by enabling smooth currency exchange and risk management.

Question 35

Explain money market hedge (basic steps) for a payable (3-mark) with a simple flow.

Accepted Answer

### **Money Market Hedge for Payable (Basic Steps)**

- find the present value of foreign currency payable using foreign interest rate.
- convert home currency into foreign currency today at spot.
- invest foreign currency so that it grows to exactly match the payable amount at due date.

Flow:

```text
Compute PV of payable → buy FX now (spot) → invest FX → FX grows → pay liability at maturity
```

Thus, money market hedge locks the effective exchange rate using borrowing/lending rates.

Question 36

Explain natural hedging techniques to reduce exposure (exam-style) with a table/flow.

Accepted Answer

### **Natural Hedging Techniques — Exam-Style**

Natural hedging reduces FX exposure through operational decisions (without derivatives).

Techniques:
- **matching** receivables and payables in the same currency (netting).
- **invoicing** in home currency where possible.
- **leading/lagging**: speed up or delay payments based on expected currency movement.
- **currency matching of costs and revenues**: source inputs in the same currency as revenue.

Table:

| Technique | What it does |
|---|---|
| **Netting/matching** | reduces net exposure |
| **Home-currency invoicing** | shifts risk to counterparty |
| **Lead/lag** | uses timing to reduce loss |

Flow:

```text
Identify currency inflows/outflows → match currencies → reduce net exposure → hedge only remaining residual exposure
```

**Conclusion:** Natural hedging reduces hedging cost and complexity by lowering the exposure before using financial derivatives.

Question 37

Explain net exposure measurement (exam-style) with a mini table and interpretation (long/short).

Accepted Answer

### **Net Exposure Measurement — Exam-Style**

For transaction exposure, a practical method is to compute **net foreign currency exposure**.

Steps:
- list all foreign currency **inflows** and **outflows** by currency and date.
- net them to find net position.

Net exposure = inflows − outflows

Mini table (USD):

| Item | Inflow (USD) | Outflow (USD) |
|---|---:|---:|
| Export receivable | 100,000 | 0 |
| Import payable | 0 | 60,000 |
| **Net exposure** | **100,000** | **60,000** |

Net USD exposure = 100,000 − 60,000 = **+40,000 USD**

Interpretation:
- +40,000 USD means the firm is **long USD** (benefits if USD appreciates).
- negative net would mean **short USD** (benefits if USD depreciates).

**Conclusion:** Netting gives a clear exposure number that guides hedging decision and reduces unnecessary hedges.

Question 38

Explain advantages and limitations of hedging (exam-style) with a table.

Accepted Answer

### **Advantages and Limitations of Hedging — Exam-Style**

Hedging reduces uncertainty but involves costs and trade-offs.

Advantages:
- stabilizes **cash flows** and profit margins.
- improves budgeting and pricing decisions.
- reduces financial distress risk.

Limitations:
- costs (option premium, spreads, margin requirements).
- opportunity cost (forward removes upside).
- needs expertise and monitoring.

Table:

| Advantages | Limitations |
|---|---|
| certainty & stability | cost & reduced upside |

**Conclusion:** A good hedge policy balances risk reduction with hedging cost and business objectives.

Question 39

Explain BoP identity and the role of reserves (exam-style) with a small table/example.

Accepted Answer

### **BoP Identity and Role of Reserves — Exam-Style**

BoP uses double-entry accounting, so accounts must balance conceptually.

A common identity (conceptual):
- **Current A/c + Capital A/c + Financial A/c + Errors & Omissions + Change in Reserves = 0**

#### **Role of reserves**
- if the country has a **current account deficit**, it must be financed by:
  - **financial inflows** (FDI/portfolio/loans), and/or
  - **use of official reserves**.
- reserves act as a buffer to meet external payments and smooth excessive currency volatility.

Mini example (idea):

| Item | Sign (overall idea) |
|---|---|
| Current account deficit | negative |
| Financial inflow | positive |
| Reserve change | fills the gap |

**Conclusion:** Reserves provide short-term stability, but long-term external balance requires improving exports, managing imports, and sustainable capital flows.

Question 40

Explain Fisher Effect and International Fisher Effect (IFE) (exam-style) with a table.

Accepted Answer

### **Fisher Effect and International Fisher Effect (IFE) — Exam-Style**

#### **Fisher Effect (FE)**
**Meaning:** Nominal interest rate consists of real interest rate plus expected inflation.
- **Nominal rate ≈ Real rate + Expected inflation**

Implication:
- countries with higher expected inflation generally have higher nominal interest rates.

#### **International Fisher Effect (IFE)**
**Meaning:** Differences in nominal interest rates between two countries reflect expected changes in exchange rate.
- the currency with **higher nominal interest rate** is expected to **depreciate** (on average).

Table:

| Concept | Links | Key idea |
|---|---|---|
| **FE** | interest rate ↔ inflation | nominal includes inflation |
| **IFE** | interest differential ↔ expected FX change | higher i → expected depreciation |

**Conclusion:** FE explains why interest rates differ across countries, and IFE explains how those differences relate to expected currency movement.

International Finance — Question Paper

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