Explain 2 methods by which foreign project can be evaluated? 1st method: -take foreign CF as given. discount that foreign CF with foreign interest rate. calculate NPV. convert NPV to domestic currency at current spot rate. 2nd method: working out the forward exchange rate for each year of the project (using spot rate& interest rate that exist between 2 countries). converting foreign CF into domestic CF using forward rate. the domestic CF are discounting with domestic WAAC. calculate NPV Companies prefer the 1st method, because they are worried about unpredictability of exchange rate over time. Why would you not exercise an option early? When might you exercise early? The option price is made up of exercise value and time value during its life. At expiry it will only have exercise value. If you exercise early you will lose the time value (which has a value up to the point of expiry, because potentially anything could happen to the share even one day before expiry – a bid might come along, an accounting black hole may be discovered). Early exercise may be worthwhile if the company announces a special dividend (shares at 500p announces a 100p special dividend, which would reduce the share price to 400p). The option holder does not receive the special dividend, the shareholder does, by exercising their option the option holder becomes a shareholder. With regard to foreign assets, what should a company hedge? Foreign assets will either be real assets (land, buildings etc) or financial assets (cash flows). Real assets will be protected in that they will rise with any inflation in the foreign country so they don’t need to be hedged. Financial assets will be affected if the foreign currency weakens – resulting in less £ when converted back, so businesses need to hedge their cash flows in overseas markets. Forwards, Futures, Swaps & Options (derivative instruments) Their value is derived from the price performance of an underlying asset. Forwards, futures and swap

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