Question

Please answer the question below, thanks!

1. Suppose a company has estimated the following cash flows in each of the next three years for operations in various countries.

Year	New Zealand	Japan
1	160 NZD	16,415 JYP
2	174 NZD	17,844 JYP
3	181 NZD	18,401 JYP

If the USD/JPY is 100 and the USD/NZD is 110, what are the expected cash flows in each of the next three years?

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2. If the Euro ask price is $1.35 and the Euro bid price is $1.28, what is the bid-ask spread in percentage terms?

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3. States THREE factors that influence exchange rates.

Answer 1

Answer(1):

Since nothing has been mentioned in the question:let us assume that USD is the domestic currency of the company and hence we need to convert the estimated cash flows from operations in terms of USD.

For New Zealand Dollar(NZD)

The estimated cash flow in terms of USD Dollars will be= NZD Dollars Estimated Cashflow*USD/NZD

As given in the question:USD/NZD= 110 and the estimated cash flows in NZD are: 160 NZD, 174 NZD and 181 NZD

Putting these values into the above formula we get:

For Year 1: 160*110 ie. USD 17,600

For Year 2: 174*110 ie. USD: 19,140

For Year 3: 181*110 ie. USD: 19,910

For Japanese Yen:

The estimated cash flow in terms of USD Dollars will be= JYP Estimated Cashflow*USD/JYP

As given in the question:USD/JYP= 100 and the estimated cash flows in JPY are: 16,415 JPY, 17,844 JPY and 18,401 JPY

Putting these values into the above formula we get:

For Year 1: 16415*100 ie. USD 16,41,500

For Year 2: 17,844*100 ie. USD 17,84,400

For Year 3: 18, 401*100 ie. USD 18,40,100

Answer (2)

Bid-Ask Spread(in %)=[ (Ask Price-Bid Price)/Ask Price]*100

As given in the question: Ask Price= $1.35 and Bid Price= $1.28.Putting these values into the above formula we get:

Bid-Ask Spread(in %)= [($1.35-$ 1.28)/$1.35]*100 ie. 5.19%

Answer(3):

The three factors that influence the exchange rate are :

1. Inflation Differential : Inflation Differential refers to the difference between the inflation rates of two countries.Usually a country with a lower inflation rate will have a rising currency value(increase in exchange rate) as its purchasing power will rise relative to the other country.
2. Interest Rate Differential:Interest Rate Differential refers to the difference in the interest rate between two countries.A higher interest rate will imply higher return and hence it will attract foreign investors which will lead to a rise in its currency value ie. its exchange rate will rise.
3. Government Debt: Countries having a large government debt is expected to experience a higher inflation adn subsequently a decline in the exchange rate.