### INSTRUCTIONS.

I. SHOW YOUR WORK.

II. YOUR GRADE DEPENDS ON YOUR CONVICTION, CORRECTNESS, ELABORATION AND ELUCIDATION OF YOUR ANSWERS.

III. YOU OUGHT TO DO ALL PROBLEMS. ADDITIONALLY, YOU SHOULD COMPLETE ALL THE ESSAYS. THE POBLEMS ARE WORTH 70 POINTS, AND THE ESSAYS ARE WORTH 30 POINTS.

IV. YOU MAY WORK TOGETHER ON THIS TEST. THE HIGHEST NUMBER IS THREE COLLABORATORS.

V. IT IS DUE TUESDAY, THE FIRST OF DECEMBER. HOPEFULLY, YOU CAN GIVE ME A HARD COPY BY THEN (MY MAIL BOX ON THE THIRD FLOOR).

TEST

I. PROBLEMS.(70 points)

(Two pages )

A..*We, William Paterson and associates, a US MNE, join forces with Wasniowska,

a Polish national, who is well versed in the Polish culture, as a minority shareholder, and invest $10 million in Poland in a furniture factory. The information we have is as follows. The European Union subsidizes the investment up to 60% of the cost and 40% of the interest. Thus, we borrow $30 million and receive $60 million free money from the EU. The agreement is to pay interest and amortize the principal in the next 10 years. The prognosis of the project’s profitability is that revenue the first ten years will be $20 million per annum, the cost of goods sold will be $3.5 million, the SGA expenses will be $9 million, the interest expense will be $1.8 million annually, and the tax rate will be 20%. Furthermore, the Polish T bond rate is 6%, the bond rate for WP/Wasniowska is 11%, the bheta of this firm is 2.5, and the ROR for the Polish stock market has been 12% annually. After the first ten year period, the NCF and the expenses will grow forever at a 4% growth rate.

Moreover, the zloty, the polish currency, has had weakness against the US $ and the euro and all currencies during the 10 year analysis, and the forecast is that this experience will continue. Furthermore, the price elasticity of demand of furniture in the world (which is the market for this factory) is 6 (this matters in connection with the weak value of the zloty relatively to the other currencies.) The income elasticity of demand is extremely high, as well, hovering at about 5. The prognosis is that incomes will continue to increase in the markets of this factory.

a. Compute the NCF, COC and NPV of WP/Wasniowska.(20 points)

b. Explicate this FDI from a behavioral viewpoint.(5 points)

B. The inflation rates in the British pound and the Australian dollar are 2% and 8% respectively. What should the Sex /Forward ER be, if the Spot ER is BP/ A$ .1? Describe the concept of purchasing power. (10 points) (One page)

C.The interest rates in the $ and the euro are 2% and 5% respectively. If the Spot exchange rate is $ 1/euro 1, what will the expected spot rate be, if the IFE applies? (10 points.) What is the meaning of IFE? Does it relate to PPP? (One page)

D..We know that the yen and the swiss franc have a 100yen/ sf 1 exchange rate, meaning one swiss franc buys 100 yen in the spot ER market. The 1 year forward rate is 80 yen /swiss franc , or 1 franc buys 80 yen in the forward market. If the swiss franc has an interest rate of .02, what should the yen rate be for IPT (interest parity theory) to be attained? If the yen rate were 6%, would there be equilibrium? If so, what would transpire? Show both amounts and differentials. Also, show everything in both yen and franc terms. (25 points)

(One page)

ESSAYS(30 points) (One page for each )

A. Expound on the balance of payments/current account view of exchange rates.

B. Analyze the portfolio balance view.

C Explicate the monetary approach to exchange rates.