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Challenge

(continued )

S&P Problems

STANDARD &POORS

PART EIGHT Topics in Corporate Finance a. What is the nonapproximate form of the international Fisher effect?

b. Based on your answer in (a), what is the exact form for UIP? (Hint: Recall the exact form of IRP and use UFR.)

c. What is the exact form for relative PPP? (Hint: Combine your previous two answers.)

d. Recalculate the NPV for the Kihlstrom drill bit project (discussed in Section 22.5) using the exact forms for UIP and the international Fisher effect. Verify that you get precisely the same answer either way.

1. American Depository Receipts Nestlé S. A. has American Depository Receipts listed on the Nasdaq over-the-counter market. Many ADRs listed on U.S. exchanges are for fractional shares. In the case of Nestlé, 20 ADRs are equal to one registered share of stock. Find the information for Nestlé using the ticker symbol "3NSRGY."

a. Click on the "Mthly. Adj. Prices" link and find Nestlé's closing price for August 2001. Assume the exchange rate on that day was $/SFr 1.624 and Nestlé shares traded for SFr 630. Is there an arbitrage opportunity available? If so, how would you take advantage of it?

b. What exchange rate is necessary to eliminate the arbitrage opportunity available in a?

c. Dividend payments made to ADR shareholders are in U.S. dollars. Suppose you own 90 Nestlé ADRs. Assume the current exchange rate is the rate you calculated in b. Nestlé declares a dividend of SFr 5.20. What U.S. dollar dividend payment will you receive?

On the Web?

22.1 Purchasing Power Parity One of the more famous examples of a violation of absolute purchasing power parity is the Big Mac index calculated by The Economist. This index calculates the dollar price of a McDonald's Big Mac in different countries. You can find the Big Mac index by going to www.economist.com, following the "Markets & Data" link and then the "Big Mac index" link. Using the most recent index, which country has the most expensive Big Macs? Which country has the cheapest Big Macs? Why is the price of a Big Mac not the same in every country?

22.2 Inflation and Exchange Rates Go to www.marketvector.com and follow the "Exchange Rates" link. Select the "Australian Dollar" link. Is the U.S. dollar expected to appreciate or depreciate compared to the Australian dollar over the next six months? What is the difference in the annual inflation rates for the United States and Australia over this period? Assume that the anticipated rate is constant for both countries. What relationship are you relying on in answering?

22.3 Interest Rate Parity Go to the Financial Times site at www.ft.com, click on the "Markets" link and then the "Currencies" link. Find the current exchange rate between the U.S. dollar and the euro. Next, follow the "Currencies home" link and the "Money rates" link to find the U.S. dollar LIBOR and the Euro LI-BOR interest rates. What must the one-year forward rate be to prevent arbitrage? What principle are you relying on in your answer?

Ross et al.: Fundamentals of Corporate Finance, Sixth Edition, Alternate Edition

VIII. Topics in Corporate Finance

23. Risk Management: An Introduction to Financial Engineering

© The McGraw-Hill Companies, 2002

Ross et al.: Fundamentals of Corporate Finance, Sixth Edition, Alternate Edition

23. Risk Management: An Introduction to Financial Engineering

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