Fundamentals of Multinational Finance, 3e (Moffett) Chapter 9

Transact ion Exposur 9.1

Mul tipl e Ch oic e and Tru e/F als e Qu esti ons

1)

________ exposure deals with cash flows that result from existing contractual obligations. A)

Operating B)

Transaction C)

Translation D)

Economic Answer:

Topic :

Transaction Exposure Skill:

Recognition

2)

________ e measures the change in the present value of the firm resulting from unexpected exposur changes in exchange rates. A)

Operating B)

Transaction C)

Translation D)

Accounting Answer:

Topic :

Operating Exposure Skill:

Recognition

3)

Each of the following is another name for operating exposure EXCEPT ________. A)

economic B)

exposure

strategic C)

exposure

accounting D)

exposure

competitive exposure Answer:

Topic :

Accounting Exposure Skill:

Recognition

4)

Transac tion exposur e and

operating exposure exist because of unexpected changes in future cash flows. The difference between the two is that ________ exposure deals with cash flows already contracted for, while ________ exposure deals with future cash flows that might change because of changes in exchange rates. A)

transaction; operating B)

operating; C)

transaction

operating; D)

accounting

none of the above Answer:

Topic :

Transaction and Operating Exposure Skill:

Recognition

5)

________ potential for accounting-derived changes in owner's equity to occur because of the exposur need to translate foreign currency financial statements into a single reporting e is the currency. A)

Transaction B)

Operating C)

Economic D)

Accounting Answer:

Topic :

Accounting Exposure Skill:

Recognition

6)

Losses from

________ exposure generally reduce taxable income in the year they are realized. ________ exposure losses may reduce taxes over a series of years. A)

accounting; Operating B)

operating; C)

Transaction

transaction; Operating D)

transaction; Accounting Answer:

Topic :

Transaction and Accounting Exposure Skill:

Recognition

7)

Losses from

________ exposure generally reduce taxable income in the year they are realized. ________ exposure losses are not cash losses and therefore, are not tax deductible. A)

transaction; Operating B)

accounting; Operating C)

accounting; Transaction D)

transaction; Translation Answer:

Topic :

Transaction and Accounting Exposure Skill:

Recognition

8)

MNE

cash flows may be sensitive to changes in which of the following? A)

exchange B)

rates

interest rates C)

commodity prices D)

all of the

above Answer:

Topic :

MNE Cash Flow Risk Skill:

Recognition

9)

________ is a technique used by MNEs to deal with currency exposure. A)

Do nothing B)

Speculation C)

Hedging D)

All are

techniques MNEs could use. Answer:

Topic :

MNE Cash Flow Risk Skill:

Recognition

10)

Hedging , or reducing risk, is the same as adding value or return to the firm. Answer:

FALSE

Topic :

MNE Cash Flow Risk Skill:

Conceptual

11)

Assumin ion costs (i.e., hedging is "free"), hedging currency exposures should ________ the g no variability of expected cash flows to a firm and at the same time, the expected value transact of the cash flows should ________. A)

increase; not change B)

decrease; C)

not change

not change; increase D)

not change; not change Answer:

Topic :

Hedging Skill:

Conceptual

12)

Which

of the following is NOT cited as a good reason for hedging currency exposures? A)

Reduced risk of future cash flows is a good planning tool. B)

Reduced risk cash flows reduces the probability that the firm may not meet required cash of future flows. C)

Currency risk management increases the expected cash flows to the firm. D)

Management is in a better position to assess firm currency risk than individual investors. Answer:

Topic :

Hedging Skill:

Recognition

13)

There is able question among investors and managers about whether hedging is a good and consider necessary tool. Answer:

TRUE

Topic :

Hedging Skill:

Recognition

14)

Which

of the following is cited as a good reason for NOT hedging currency exposures? A)

Shareholders are more capable of diversifying risk than management. B)

Currency risk management through hedging does not increase expected cash flows. C)

Hedging D)

activities are often of greater benefit to management than to shareholders.

All of the

above are cited as reasons NOT to hedge. Answer:

Topic :

Hedging Skill:

Recognition

15)

The key nts in opposition to currency hedging such as market efficiency, agency theory, and argume diversification do not have financial theory at their core. Answer:

FALSE

Topic :

Hedging Skill:

Conceptual

16)

________ exposure may result from a firm having a payable in a foreign currency. A)

Transaction B)

Accounting C)

Operating D)

None of the above Answer:

Topic :

Hedging Skill:

Conceptual

17)

The stages in the life of a transact

ion exposure can be broken into three distinct time periods. The first time period is the time between quoting a price and reaching an actual sale agreement or contract. The next time period is the time lag between taking an order and actually filling or delivering it. Finally, the time it takes to get paid after delivering the product. In order, these stages of transaction exposure may be identified as, A)

backlog, B)

quotation, and billing exposure.

billing, C)

backlog, and quotation exposure.

quotation, D)

backlog, and billing exposure.

quotation, billing, and backlog exposure. Answer:

Topic :

Transaction Exposure Skill:

Recognition

18)

A U.S. firm sells mercha

ndise today to a British company for 100,000. The current exchange rate is $2.03/ , the account is payable in three months, and the firm chooses to avoid any hedging techniques designed to reduce or eliminate the risk of changes in the exchange rate. The U.S. firm is at risk today of a loss if A)

the B)

exchange rate changes to $2.00/.

the C)

exchange rate changes to $2.05/.

the D)

exchange rate doesn't change.

all of the

above. Answer:

Topic :

Transaction Exposure Skill:

Analytical

19)

A U.S. firm sells mercha ndise

today to a British company for 100,000. The current exchange rate is $2.03/ , the account is payable in three months, and the firm chooses to avoid any heding techniques designed to reduce or eliminate the risk of changes in the exchange rate. If the exchange rate changes to $2.05/ the U.S. firm will realize a ________ of ________. A)

loss; $2000 B)

gain; $2000 C)

loss; 2000 D)

gain; 2000 Answer:

Topic :

Transaction Exposure Skill:

Analytical

20)

A U.S. firm sells mercha ndise

today to a British company for 100,000. The current exchange rate is $2.03/ , the account is payable in three months, and the firm chooses to avoid any heding techniques designed to reduce or eliminate the risk of changes in the exchange rate. If the exchange rate changes to $2.01/ the U.S. firm will realize a ________ of ________. A)

loss; $2,000 B)

gain; $2,000 C)

loss; 2000 D)

gain; 2000 Answer:

Topic :

Transaction Exposure Skill:

Analytical

21)

________ is NOT a popular contractual hedge against foreign exchange transaction exposure. A)

Forward B)

market hedge

Money C)

market hedge

Options D)

market hedge

All of the

above are contractual hedges. Answer:

Topic :

Contractual Hedges Skill:

Recognition

22)

A hedge refers to an offsetting operating cash flow such as a payable arising from the ________ conduct of business. A)

financial B)

natural C)

contractual D)

futures Answer:

Topic :

Natural Hedge Skill:

Recognition

Instruction 9.1: Use the information for following problem(s). Plains States Manufacturing has just signed a contract to sell agricultural equipment to Boschin, a German firm, for euro 1,250,000. The sale was made in June with payment due six months later in December. Because this is a sizable contract for the firm and because the contract is in euros rather than dollars, Plains States is considering several hedging alternatives to reduce the exchange rate risk arising from the sale. To help the firm make a hedging decision you have gathered the following information. The spot exchange rate is $1.40/euro The six month forward rate is $1.38/euro Plains States' cost of capital is 11% The Euro zone 6-month borrowing rate is 9% (or 4.5% for 6 months) The Euro zone 6-month lending rate is 7% (or 3.5% for 6 months) The U.S. 6-month borrowing rate is 8% (or 4% for 6 months) The U.S. 6-month lending rate is 6% (or 3% for 6 months) December put options for euro 625,000; strike price $1.42, premium price is 1.5% Plains States' forecast for 6-month spot rates is $1.43/euro The budget rate, or the lowest acceptable sales price for this project, is $1,075,000 or $1.35/euro 23)

Refer to on 9.1. If Plains States chooses not to hedge their euro receivable, the amount they Instructi receive in six months will be ________. A)

$1,750,000 B)

$1,250,000 C)

$892,857 D)

undetermina ble today Answer:

Topic :

Forward Hedge Computation Skill:

Analytical

24)

Refer to on 9.1. If Plains States chooses to hedge its transaction exposure in the forward Instructi market, it will ________ euro 1,250,000 forward at a rate of ________. A)

sell; B)

$1.38/euro

sell; C)

$1.40/euro

buy; D)

$1.38/euro

buy;

$1.40/euro Answer:

Topic :

Forward Hedge Computation Skill:

Analytical

25)

Refer to on 9.1. Plains States chooses to hedge its transaction exposure in the forward market Instructi at the available forward rate. The payoff in 6 months will be ________. A)

$1,750,000 B)

$1250,000 C)

$1,725,000 D)

$1787,500 Answer:

Topic :

Forward Hedge Computation Skill:

Analytical

26)

Refer to If Plains States locks in the forward hedge at $1.38/euro, and the spot rate when the Instructi transaction was recorded on the books was $1.40/euro, this will result in a "foreign on 9.1. exchange loss" accounting transaction of ________. A)

$0 B)

$25,000 C)

This was not a loss; it was a gain of $25,000. D)

There is not enough information to answer this question. Answer:

Topic :

Forward Hedge Computation Skill:

Analytical

27)

Refer to Plains States would be ________ by an amount equal to ________ with a forward hedge Instructi than if they had not hedged and their predicted exchange rate for 6 months had on 9.1. been correct. A)

better off; B)

$43,750

better off; C)

$62,500

worse off; D)

$43,750

worse off; $62,500 Answer:

Topic :

Forward Hedge Computation Skill:

Analytical

28)

The money market hedge is similar to a forward hedge. The difference is the cost of the structur money market hedge is determined by the differential interest rates, while the e of a forward hedge is a function of the forward rates quotation. Answer:

TRUE

Topic :

Money Market Hedge Skill:

Conceptual

29)

In markets, interest rate parity should assure that the costs of a forward hedge and efficient money market hedge should be approximately the same. Answer:

TRUE

Topic :

Money Market Hedge Skill:

Conceptual

Instruction 9.1: Use the information for following problem(s). Plains States Manufacturing has just signed a contract to sell agricultural equipment to Boschin, a German firm, for euro 1,250,000. The sale was made in June with payment due six months later in December. Because this is a sizable contract for the firm and because the contract is in euros rather than dollars, Plains States is considering several hedging alternatives to reduce the exchange rate risk arising from the sale. To help the firm make a hedging decision you have gathered the following information. The spot exchange rate is $1.40/euro The six month forward rate is $1.38/euro Plains States' cost of capital is 11% The Euro zone 6-month borrowing rate is 9% (or 4.5% for 6 months) The Euro zone 6-month lending rate is 7% (or 3.5% for 6 months) The U.S. 6-month borrowing rate is 8% (or 4% for 6 months) The U.S. 6-month lending rate is 6% (or 3% for 6 months) December put options for euro 625,000; strike price $1.42, premium price is 1.5% Plains States' forecast for 6-month spot rates is $1.43/euro The budget rate, or the lowest acceptable sales price for this project, is $1,075,000 or $1.35/euro 30)

Refer to Plains States could hedge the Euro receivables in the money market. Using the Instructi information provided, how much would the money market hedge return in six months on 9.1. assuming Plains States reinvests the proceeds at the U.S. investment rate? A)

$1,250,000 B)

$1,724,880 C)

$1,674,641 D)

$1,207,371 Answer:

Topic :

Money Market Hedge Skill:

Analytical

31)

Refer to on 9.1. Money market hedges almost always return more than forward hedges Instructi because of the greater risk involved. Answer:

FALSE

Topic :

Money Market Hedge Skill:

Conceptual

32)

Refer to on 9.1. If Plains States chooses to implement a money market hedge for the Euro Instructi receivables, how much money will the firm borrow today? A)

euro B)

1,201,923

$1,201,923 C)

euro D)

1,196,172

$1,196,172 Answer:

Topic :

Money Market Hedge Skill:

Analytical

33)

Refer to A ________ hedge allows Plains States to enjoy the benefits of a favorable change in Instructi exchange rates for their euro receivables contract while protecting the firm from on 9.1. unfavorable exchange rate changes. A)

forward B)

call option C)

put option D)

money

market Answer:

Topic :

Put Option Hedge Skill:

Conceptual

34)

Refer to What is the cost of a put option hedge for Plains States' euro receivable contract? Instructi (Note: Calculate the cost in future value dollars and assume the firm's cost of capital on 9.1. as the appropriate interest rate for calculating future values.) A)

$27,694 B)

$26,250 C)

euro 27,694 D)

euro 26,250 Answer:

Topic :

Put Option Hedge Skill:

Analytical

35)

Refer to Instruction 9.1. The cost of a call option to Plains States would be ________. A)

$17,653 B)

$16,733 C)

$18,471 D)

There is not enough information to answer this question. Answer:

Topic :

Put Option Hedge Skill:

Analytical

36)

Refer to If Plains States purchases the put option, and the option expires in six months on the Instructi same day that Plains States receives the euro 1,250,000, the firm will exercise the on 9.1. put at that time if the spot rate is $1.43/euro. Answer:

FALSE

Topic :

Put Option Hedge Skill:

Analytical

37)

A hedge and a ________ hedge guarantee fixed payoffs but a ________ hedge or ________ ________ hedge offer uncertain outcomes. A)

money B)

market; currency option; forward; no hedge at all

no hedge at all; currency option; forward; money market C)

money D)

market; forward; currency option; no hedge at all

forward; no hedge at all; money market; currency option Answer:

Topic :

Multiple Hedges Skill:

Conceptual

38)

Choosin transaction exposure hedging strategy is best for a particular transaction depends on g which which of the following? A)

the firm's B)

risk tolerance

the firm's C)

expectations about changes in currency exchange rates

the costs D)

associated with each alternative

all of the

above Answer:

Topic :

Transaction Exposure Skill:

Conceptual

39)

Hedging payable foreign currency exchange risk would likely consider the purchase of a account ________ option whereas hedging accounts receivable currency exchange risk would s be likely be to purchase a ________ option. A)

put; call B)

put; put C)

call; put D)

call; call Answer:

Topic :

Options Skill:

Conceptual

Instruction 9.2: Use the information for following problem(s). Oregon Transportation Inc. (OTI) has just signed a contract to purchase light rail cars from a manufacturer in Germany for euro 2,500,000. The purchase was made in June with payment due six months later in December. Because this is a sizable contract for the firm and because the contract is in euros rather than dollars, OTI is considering several hedging alternatives to reduce the exchange rate risk arising from the sale. To help the firm make a hedging decision you have gathered the following information. The spot exchange rate is $1.40/euro The six month forward rate is $1.38/euro OTI's cost of capital is 11% The Euro zone 6-month borrowing rate is 9% (or 4.5% for 6 months) The Euro zone 6-month lending rate is 7% (or 3.5% for 6 months) The U.S. 6-month borrowing rate is 8% (or 4% for 6 months) The U.S. 6-month lending rate is 6% (or 3% for 6 months) December call options for euro 625,000; strike price $1.42, premium price is 1.5% OTI's forecast for 6-month spot rates is $1.43/euro The budget rate, or the highest acceptable purchase price for this project, is $3,625,000 or $1.45/euro 40)

Refer to on 9.2. If OTI chooses not to hedge their euro payable, the amount they pay in six Instructi months will be ________. A)

$3,500,000 B)

$3,450,000 C)

euro D)

3,450,000

unknown

today Answer:

Topic :

Transaction Exposure Skill:

Analytical

41)

Refer to on 9.2. If OTI chooses to hedge its transaction exposure in the forward market, it will Instructi ________ euro 2,500,000 forward at a rate of ________. A)

buy; $1.38 B)

buy; $1.40 C)

sell; $1.38 D)

sell; euro 1.40 Answer:

Topic :

Forward Hedge Skill:

Analytical

42)

Refer to OTI chooses to hedge its transaction exposure in the forward market at the available Instructi forward rate. The required amount in dollars to pay off the accounts payable in 6 on 9.2. months will be ________. A)

$2,500,000 B)

$3,450,000 C)

$3,500,000 D)

$3,575,000 Answer:

Topic :

Forward Hedge Skill:

Analytical

43)

Refer to If OTI locks in the forward hedge at $1.38/euro, and the spot rate when the Instructi transaction was recorded on the books was $1.40/euro, this will result in a "foreign on 9.2. exchange accounting transaction ________" of ________. A)

loss; $50,000 B)

loss; euro C)

50,000

gain; D)

$50,000

gain; euro 50,000 Answer:

Topic :

Forward Hedge Skill:

Analytical

44)

Refer to OTI would be ________ by an amount equal to ________ with a forward hedge than if Instructi they had not hedged and their predicted exchange rate for 6 months had been on 9.2. correct. A)

better off; B)

$125,000

better off; C)

euro 125,000

worse off; D)

$125,000

worse off; euro 125,0000 Answer:

Topic :

Forward Hedge Skill:

Analytical

45)

Refer to What is the cost of a call option hedge for OTI's euro receivable contract? (Note: Instructi Calculate the cost in future value dollars and assume the firm's cost of capital as the on 9.2. appropriate interest rate for calculating future values.) A)

$52,500 B)

$55,388 C)

$56,125 D)

$58,275 Answer:

Topic :

Call Option Skill:

Analytical

46)

Refer to Instruction 9.2. The cost of a put option to OTI would be ________. A)

$52,500 B)

$55,388 C)

$58,275 D)

There is not enough information to answer this question. Answer:

Topic :

Put Option Skill:

Analytical

47)

The function of most firms, the group typically responsible for transaction exposure treasury management, is NOT usually considered a profit center. Answer:

TRUE

Topic :

Profit Centers Skill:

Recognition

48)

________ transactions for which there are, at present, no contracts or agreements between are parties. A)

Backlog B)

exposure

Quotation C)

exposure

Anticipated exposure D)

None of the above Answer:

Topic :

Anticipated Exposure Skill:

Recognition

49)

Accordi the authors, firms that employ proportional hedges increase the percentage of ng to forward-cover as the maturity of the exposure lengthens. Answer:

FALSE

Topic :

Proportional Hedging Skill:

Recognition

50)

Accordi survey by Bank of America, the type of foreign exchange risk most often hedged by ng to a firms is ________. A)

translation B)

exposure

transaction exposure C)

contingent D)

exposure

economic exposure Answer:

Topic :

Transaction Exposure Skill:

Recognition

51)

Accordi survey by Bank of America, when firms do hedge, the most common type of hedging ng to a instruments are ________. A)

forwards B)

options C)

money D)

markets

call and puts Answer:

Topic :

Forward Hedge Skill:

Recognition

52)

Whohau ser is a U.S.based forest product

s firm. In June Whohauser delivers a shipment of raw lumber to Japan. The 55,000,000 receivable is due in 180 days. The firm's foreign exchange advisors believe the yen will be at about 115/$ then. The current spot rate is 110/$. Whohauser has received a 180 day forward quote of 108/$. If the company does nothing and the exchange rate goes to 115 as expected, how much will the firm receive in dollars in 180 days? Is this cash flow risky or known with certainty today? A)

$509,259 B)

certain

$500,000 C)

risky

$478,261 D)

risky

$500,000 certain Answer:

Topic :

Exchange Rates Skill:

Analytical

53)

Whohau ser is a U.S.based forest product s firm.

In June Whohauser delivers a shipment of raw lumber to Japan. The 55,000,000 receivable is due in 180 days. The firm's foreign exchange advisors believe the yen will be at about 115/$ then. The current spot rate is 110/$. Whohauser has received a 180 day forward quote of 108/$. If the company locks in the forward quote and the exchange rate goes to 115 as expected, how much will the firm receive in dollars in 180 days? Is this cash flow risky or known with certainty today? A)

$509,259 B)

certain

$500,000 C)

risky

$478,261 D)

risky

$500,000 certain Answer:

Topic :

Exchange Rates Skill:

Analytical

54)

Whohau ser is a U.S.based forest product s firm.

In June Whohauser delivers a shipment of raw lumber to Japan. The 55,000,000 receivable is due in 180 days. The firm's foreign exchange advisors believe the yen will be at about 115/$ then. The current spot rate is 110/$. Whohauser has received a 180 day forward quote of 108/$. If the company does nothing and the exchange rate stays the same as the current spot rate of 110/$, how much will the firm receive in dollars in 180 days? Is this cash flow risky or known with certainty today? A)

$509,259 B)

certain

$500,000 C)

risky

$479,261 D)

certain

None of the above Answer:

Topic :

Exchange Rates Skill:

Analytical

9.2

Ess

1)

Does currency exchange hedging both reduce risk and increase expected value? Explain, foreign and list several arguments in favor of currency risk management and several against. Answer:

Foreign exchange currency hedging can reduce the variability of foreign currency receivables or payables by locking in a specific exchange rate in the future via a forward contract, converting currency at the current spot rate using a money market hedge, or minimizing unfavorable exchange rate movement with a currency option. None of these hedging techniques, however, increases the expected value of the foreign currency exchange. In fact, expected value should fall by an amount equal to the cost of the hedge. Generally, those in favor of currency risk management find value in the reduction of variability of uncertain cash flows. Those opposed to currency risk management argue the NPV of such activities are $0 or less and that shareholders can reduce risk

efficiently. For a more complete answer to this question, see page 4 where the author outlines several arguments for and against currency risk management.

2)

Currenc y risk manage ment techniq ues include

forward hedges, money market hedges, and option hedges. Draw a diagram showing the possible outcomes of these hedging alternatives for a foreign currency receivable contract. In your diagram, be sure to label the X and Y-axis, the put option strike price, and show the possible results for a money market hedge, a forward hedge, a put option hedge, and an uncovered position. (Note: Assume the forward currency receivable is British pounds and the put option strike price is $1.50/, the price of the option is $0.04 the forward rate is $1.52/ and the current spot rate is $1.48/.) Answer:

The student should draw and label a diagram that looks similar to the one found on page 14.