Deck 10: Measuring Exposure to Exchange Rate Fluctuations

Question 1

A high correlation between two currencies would be desirable for achieving low exchange rate risk if one is an inflow currency and the other is an outflow currency.

Answer 1

True

Question 2

The degree to which a firm's present value of future cash flows can be influenced by exchange rate fluctuations is referred to as transaction exposure.

Answer 2

False

Question 3

In general, translation exposure is larger with MNCs that have a larger proportion of earnings generated by foreign subsidiaries.

Answer 3

True

Question 4

Some MNCs are subject to economic exposure without being subject to transaction exposure.

Question 5

A purely domestic firm is never exposed to exchange rate fluctuations.

Question 6

Under FASB 52, consolidated earnings are sensitive to the functional currency's weighted average exchange rate.

Question 7

Since earnings can affect stock prices, many MNCs are concerned about translation exposure.

Question 8

Regression analysis cannot be used to assess the sensitivity of a company's performance to economic conditions because economic conditions are unpredictable.

Question 9

The exposure of an MNC's consolidated financial statements to exchange rate fluctuations is known as transaction exposure.

Question 10

Firms with more in foreign costs than in foreign revenues will be favorably affected by a stronger foreign currency.

Question 11

The maximum one-day loss estimated using the value-at-risk (VaR) method is independent of the confidence level used.

Question 12

A reduction in hedging will probably reduce transaction exposure.

Question 13

The VaR method presumes that the distribution of exchange rate movements is normal.

Question 14

Assume that exchange rate movements were unusually stable in a recent period (but will not continue to be so stable in the future) that was used to derive the estimated maximum expected loss based on the VaR method. The estimated expected loss derived using VaR based on that recent period will likely overestimate the actual maximum expected loss in the future.

Question 15

A firm's transaction exposure in any foreign currency is based solely on the size of its open position in that currency.

Question 16

A company may become more exposed or sensitive to an individual currency's movements over time for several reasons, including a reduction in hedging, a greater involvement in the foreign country, or an increased use of the foreign currency.

Question 17

An MNC's stock valuation will not be affected by translation exposure if the MNC's consolidated financial statements are prepared according to the accounting rules in FASB 52.

Question 18

One argument why exchange rate risk is irrelevant to corporations is that shareholders may be able to hedge this risk individually.

Question 19

An MNC can avoid translation exposure if its foreign subsidiaries do not remit their earnings to the parent.

Question 20

Dollar cash flows associated with two foreign inflow currencies will normally be less volatile if the standard deviations of the individual currencies are lower.

Question 21

The VaR method assumes that the volatility (standard deviation) of exchange rate movements changes over time.

Question 22

A set of currency cash inflows is more volatile if the correlations are low.

Question 23

Two highly negatively correlated currencies move in tandem almost as if they are the same currency.

Question 24

Assume a regression model in which the dependent variable is the firm's stock price percentage change, and the independent variable is the percentage change in the foreign currency. The coefficient is negative. This implies that the company's stock price increases if the foreign currency appreciates.

Question 25

Under FASB 52:

A) translation gains and losses are included in the reported net income.
B) translation gains and losses are included in stockholder's equity.
C) translation gains and losses are included in the reported net income AND translation gains and losses are included in stockholder's equity.
D) None of these are correct.

Question 26

The Canadian dollar's volatility has changed over time but is normally less than the volatility of other currencies.

Question 27

If positions in a specific currency among an MNC's subsidiaries offset each other, the decision by one subsidiary to hedge its position in that currency would increase the MNC's overall exposure.

Question 28

​Appreciation in a firm's local currency causes a(n) ____ in cash inflows and a(n) ____ in cash outflows.

A) ​reduction; reduction
B) ​increase; increase
C) ​increase; reduction
D) ​reduction; increase

Question 29

​Magent Co. is a U.S. company that has exposure to the Swiss franc (SF) and Danish kroner (DK). It has net inflows of SF200 million and net outflows of DK500 million. The present exchange rate of the SF is about $.40 while the present exchange rate of the DK is $.10. Magent Co. has not hedged these positions. The SF and DK are highly correlated in their movements against the dollar. If the dollar weakens, then Magent Co. will:

A) ​benefit, because the dollar value of its SF position exceeds the dollar value of its DK position.
B) ​benefit, because the dollar value of its DK position exceeds the dollar value of its SF position.
C) ​be adversely affected, because the dollar value of its SF position exceeds the dollar value of its DK position.
D) ​be adversely affected, because the dollar value of its DK position exceeds the dollar value of its SF position.

Question 30

If the U.S. dollar appreciates, an MNC's:

A) U.S. sales will probably decrease.
B) exports denominated in U.S. dollars will probably increase.
C) interest owed on foreign funds borrowed will probably increase.
D) exports denominated in foreign currencies will probably increase.
E) All of these are correct.

Question 31

Purely domestic firms are never affected by economic exposure.

Question 32

The transaction exposure of two inflow currencies is offset when the correlation between the currencies is high.

Question 33

Currency correlations are generally negative.

Question 34

U.S. exporters may not necessarily benefit from weak-dollar periods if foreign competitors are willing to reduce their profit margins.

Question 35

Translation exposure affects an MNC's cash flows.

Question 36

A firm produces products for which substitute products are produced in all countries. Appreciation of the firm's local currency should:

A) increase local sales as it reduces foreign competition in local markets.
B) increase the firm's exports denominated in the local currency.
C) increase the returns earned on the firm's foreign bank deposits.
D) increase the firm's cash outflow required to pay for imported supplies denominated in a foreign currency.
E) None of these are correct.

Question 37

If the net inflow of one currency is about the same amount as a net outflow in another currency, the firm will benefit if these two currencies are negatively correlated because the transaction exposure is offset.

Question 38

Transaction exposure reflects:

A) the exposure of a firm's international transactions to exchange rate fluctuations.
B) the exposure of a firm's local currency value to transactions between foreign exchange traders.
C) the exposure of a firm's financial statements to exchange rate fluctuations.
D) the exposure of a firm's cash flows to exchange rate fluctuations.

Question 39

If the functional currencies for reporting purposes are highly correlated, translation exposure is magnified.

Question 40

Because creditors may prefer that firms maintain low exposure to exchange rate risk, and because investors may prefer corporations to perform hedging for them, exchange rate risk is probably relevant.

Question 41

​According to the text, currency volatility levels ____ perfectly stable over time, and currency correlations ____ perfectly stable over time.

A) ​are; are not
B) ​are; are
C) ​are not; are not
D) ​are not; are

Question 42

Assume that your firm is an importer of Mexican chairs denominated in pesos. Your competition is mainly U.S. producers of chairs. You wish to assess the relationship between the percentage change in the firm's stock price (SP_t) and the percentage change in the peso's value relative to the dollar (PESO_t). SP_t is the dependent variable. You apply the regression model to an earlier subperiod and a more recent subperiod. In the recent subperiod, you increased your importing volume. You should expect that the regression coefficient in the PESO_t variable would be ____ in the first subperiod and ____ in the second subperiod.

A) negative; positive
B) positive; positive
C) positive; negative
D) negative; negative

Question 43

Jenco Co. imports raw materials from Japan, invoiced in U.S. dollars. The price it pays is not expected to change for the next several years. If the Japanese yen appreciates, Jenco's imports from Japan will probably ____ and if the Japanese yen depreciates, its imports from Japan will probably ____.

A) increase; decrease
B) decrease; increase
C) increase; stay the same
D) stay the same; stay the same

Question 44

Generally, MNCs with less foreign costs than foreign revenues will ____ affected by a ____ foreign currency.

A) be favorably; stronger
B) not be; stronger
C) be favorably; weaker
D) not be; weaker
E) not be; stronger AND not be; weaker

Question 45

Exhibit 10-2
Volusia, Inc. is a U.S.-based exporting firm that expects to receive payments denominated in both euros and Canadian dollars in one month. Based on today's spot rates, the dollar value of the funds to be received is estimated at $500,000 for the euros and $300,000 for the Canadian dollars. Based on data for the last 50 months, Volusia estimates the standard deviation of monthly percentage changes to be 8 percent for the euro and 3 percent for the Canadian dollar. The correlation coefficient between the euro and the Canadian dollar is 0.30.
Refer to Exhibit 10-2. What is the portfolio standard deviation?

A) 3.00 percent
B) 5.44 percent
C) 17.98 percent
D) None of these are correct.

Question 46

​Assume that the British pound and Swiss franc are highly correlated. A U.S. firm anticipates the equivalent of $1 million cash outflows in francs and the equivalent of $1 million cash outflows in pounds. During a ____ cycle, the firm is ____ affected by its exposure.

A) ​strong dollar; favorably
B) ​weak dollar; not
C) ​strong dollar; not
D) ​weak dollar; favorably

Question 47

Vada, Inc. exports computers to Australia, invoiced in U.S. dollars. Its main competitor is located in Japan. Vada is subject to:

A) economic exposure.
B) transaction exposure.
C) translation exposure.
D) economic exposure AND transaction exposure.

Question 48

​Translation exposure reflects:

A) ​the exposure of a firm's international transactions to exchange rate fluctuations.
B) ​the exposure of a firm's local currency value to transactions between foreign exchange traders.
C) ​the exposure of a firm's financial statements to exchange rate fluctuations.
D) ​the exposure of a firm's cash flows to exchange rate fluctuations.

Question 49

​If a U.S. firm's sales in Australia are much greater than its cost of goods sold in Australia, the appreciation of the Australian dollar has a ____ impact on the firm's ____.

A) ​positive; interest expenses
B) ​positive; gross profit
C) ​negative; interest expenses
D) ​negative; gross profit

Question 50

​Consider an MNC that is exposed to the Bulgarian lev (BGL) and the Romanian leu (ROL); 30 percent of the MNC's funds are lev and 70 percent are leu. The standard deviation of exchange movements is 10 percent for lev and 15 percent for leu. The correlation coefficient between movements in the value of the lev and the leu is .85. Based on this information, the standard deviation of this two-currency portfolio is approximately:

A) ​17.28 percent.
B) ​13.15 percent.
C) ​14.50 percent.
D) ​12.04 percent.

Question 51

Which of the following is not true regarding currency correlations?

A) Two highly positively correlated currencies act almost as if they are the same currency.
B) If two inflow currencies are highly positively correlated, transaction exposure is somewhat offset.
C) If two inflow currencies are negatively correlated, transaction exposure is somewhat offset.
D) If two currencies, one an inflow currency and the other an outflow currency, are highly positively correlated, transaction exposure is somewhat offset.

Question 52

​Consider an MNC that is exposed to the Taiwan dollar (TWD) and the Egyptian pound (EGP); 25 percent of the MNC's funds are Taiwan dollars and 75 percent are pounds. The standard deviation of exchange movements is 7 percent for Taiwan dollars and 5 percent for pounds. The correlation coefficient between movements in the value of the Taiwan dollar and the pound is .7. Based on this information, the standard deviation of this two-currency portfolio is approximately:

A) ​5.13 percent.
B) ​2.63 percent.
C) ​4.33 percent.
D) ​5.55 percent.

Question 53

The ____ the percentage of an MNC's business conducted by its foreign subsidiaries, the ____ the percentage of a given financial statement item that is susceptible to translation exposure.

A) greater; smaller
B) smaller; greater
C) greater; greater
D) None of these are correct.

Question 54

In general, a firm that concentrates on local sales, has very little foreign competition, and obtains foreign supplies (denominated in foreign currencies) will likely ____ a(n) ____ local currency.

A) be hurt by; appreciated
B) benefit from; depreciated
C) be hurt by; depreciated
D) None of these are correct.

Question 55

Which of the following operations benefit(s) from depreciation of the firm's local currency?

A) borrowing in a foreign country and converting the funds to the local currency prior to the depreciation
B) purchasing foreign supplies
C) investing in foreign bank accounts denominated in foreign currencies prior to depreciation of the local currency
D) borrowing in a foreign country and converting the funds to the local currency prior to the depreciation AND purchasing foreign supplies

Question 56

A firm produces products for which substitute products are produced in all countries. Depreciation of the firm's local currency should:

A) decrease local sales as foreign competition in local markets is reduced.
B) decrease the firm's exports denominated in the local currency.
C) decrease the returns earned on the firm's foreign bank deposits.
D) decrease the firm's cash outflow required to pay for imported supplies denominated in a foreign currency.
E) None of these are correct.

Question 57

A U.S. MNC has the equivalent of $1 million cash outflows in each of two highly negatively correlated currencies. During ____ dollar cycles, cash outflows are ____.

A) weak; somewhat stable
B) weak; favorably affected
C) weak; adversely affected
D) None of these are correct.

Question 58

​When the dollar strengthens, the reported consolidated earnings of U.S.-based MNCs are ____ affected by translation exposure. When the dollar weakens, the reported consolidated earnings are ____.

A) ​favorably; favorably affected but by a smaller degree
B) ​favorably; favorably affected by a higher degree
C) ​unfavorably; favorably affected
D) ​favorably; unfavorably affected

Question 59

​____ is (are) not a determinant of translation exposure.

A) ​The MNC's degree of foreign involvement
B) ​The locations of foreign subsidiaries
C) ​The local (domestic) earnings of the MNC
D) ​The accounting methods used

Question 60

Jensen Co. expects to pay €50,000 in one month for its imports from France. It also expects to receive €200,000 for its exports to Belgium in one month. Jensen estimates the standard deviation of monthly percentage changes of the euro to be 2.5 percent over the last 50 months. Assume that these percentage changes are normally distributed. Using the value-at-risk (VaR) method based on a 97.5 percent confidence level, what is the maximum one-month loss in dollars if the expected percentage change of the euro during next month is 2 percent? Assume that the current spot rate of the euro (before considering the maximum one-month loss) is $1.35.

A) -$4,303
B) -$7,830
C) -$5,873
D) -$1,958

Question 61

​Lampon Co. is a U.S. firm that has a subsidiary in Hong Kong that produces light fixtures and sells them to Japan, denominated in Japanese yen. Its subsidiary pays all of its expenses, including the cost of goods sold, in U.S. dollars. The Hong Kong dollar is pegged to the U.S. dollar. If the Japanese yen appreciates against the U.S. dollar, the Hong Kong subsidiary's revenue will ____, and its expenses will ____.

A) ​increase; decrease
B) ​decrease; remain unchanged
C) ​decrease; increase
D) ​increase; remain unchanged

Question 62

​The maximum one-day loss computed for the value-at-risk (VaR) method does not depend on:

A) ​the expected percentage change in the currency for the next day.
B) ​the standard deviation of the daily percentage changes in the currency over a previous period.
C) ​the current level of interest rates.
D) ​the confidence level used.

Question 63

Exhibit 10-2
Volusia, Inc. is a U.S.-based exporting firm that expects to receive payments denominated in both euros and Canadian dollars in one month. Based on today's spot rates, the dollar value of the funds to be received is estimated at $500,000 for the euros and $300,000 for the Canadian dollars. Based on data for the last 50 months, Volusia estimates the standard deviation of monthly percentage changes to be 8 percent for the euro and 3 percent for the Canadian dollar. The correlation coefficient between the euro and the Canadian dollar is 0.30.
​

-Refer to Exhibit 10-2. Assuming an expected percentage change of 0 percent for each currency during the next month, what is the maximum one-month loss of the currency portfolio? Use a 95 percent confidence level and assume the monthly percentage changes for each currency are normally distributed.

A) -9 percent
B) -30 percent
C) -5 percent
D) None of these are correct.

Question 64

​Diz Co. is a U.S.-based MNC with net cash inflows of euros and net cash inflows of Swiss francs. These two currencies are highly correlated in their movements against the dollar. Yanta Co. is a U.S.-based MNC that has the same level of net cash flows in these currencies as Diz Co. except that its euros represent net cash outflows. Which firm has a higher exposure to exchange rate risk?

A) ​Diz Co.
B) ​Yanta Co.
C) ​The firms have about the same level of exposure.
D) ​Neither firm has any exposure.

Question 65

Lazer Co. is a U.S. firm that exports computers to Belgium, invoiced in euros, and to Italy, invoiced in dollars. Additionally, Lazer Co. has a subsidiary in South Korea that produces computers and sells them there. Lazer also has competitors in different countries. Lazer Co. is subject to:

A) transaction exposure.
B) economic exposure.
C) translation exposure.
D) All of these are correct.

Question 66

Which of the following operations benefits from appreciation of the firm's local currency?

A) borrowing in a foreign currency and converting the funds to the local currency prior to the appreciation
B) receiving earnings dividends from foreign subsidiaries
C) purchasing supplies locally rather than overseas
D) exporting to foreign countries

Question 67

Economic exposure refers to:

A) the exposure of a firm's international transactions to exchange rate fluctuations.
B) the exposure of a firm's local currency value to transactions between foreign exchange traders.
C) the exposure of a firm's financial statements to exchange rate fluctuations.
D) the exposure of a firm's cash flows to exchange rate fluctuations.
E) the exposure of a country's economy (specifically GDP) to exchange rate fluctuations.

Question 68

Treck Co. expects to pay €200,000 in one month for its imports from Spain. It also expects to receive €250,000 for its exports to Italy in one month. Treck Co. estimates the standard deviation of monthly percentage changes of the euro to be 3 percent over the last 40 months. Assume that these percentage changes are normally distributed. Using the value-at-risk (VaR) method based on a 95 percent confidence level, what is the maximum one-month loss in dollars if the expected percentage change of the euro during next month is -2 percent? Assume that the current spot rate of the euro (before considering the maximum one-month loss) is $1.23.

A) -$38,468
B) -$21,371
C) -$17,097
D) -$4,274

Question 69

If a U.S. firm's cost of goods sold exposure is much greater than its sales exposure in Switzerland, the Swiss franc's depreciation against the dollar will have a ____ overall impact on ____.

A) positive; revenue denominated in Swiss francs
B) positive; gross profit
C) negative; gross profit
D) negligible; gross profit

Question 70

​If a U.S. firm's cost of goods sold in Switzerland is much greater than its sales in Switzerland, the appreciation of the Swiss franc has a ____ impact on the firm's ____.

A) ​positive; interest expenses
B) ​positive; gross profit
C) ​negative; gross profit
D) ​negative; interest expenses

Question 71

Assume that the Japanese yen is expected to depreciate substantially over the next year. A U.S.-based MNC has a subsidiary in Japan, where its costs exceed revenues. The overall value of the MNC will ____ because of the yen's depreciation.

A) decrease
B) increase
C) remain unchanged
D) decrease OR remain unchanged

Question 72

​Vermont Co. has one foreign subsidiary. Its translation exposure is directly affected by each of the following, except:

A) ​the interest rate in the country of the subsidiary.
B) ​the proportion of business conducted by the subsidiary.
C) ​its accounting method.
D) ​the exchange rate movements of the subsidiary's currency.

Question 73

Assume that Mill Corp., a U.S.-based MNC, has applied the following regression model to estimate the sensitivity of its cash flows to exchange rate movements: PCF_t = a₀ + a₁e_t + $\mu$ _t

Where the term on the left-hand side is the percentage change in inflation-adjusted cash flows measured in the firm's home currency over period t, and e_t is the percentage change in the exchange rate of the currency over period t. The regression model estimates a coefficient of a₁ of 2. This indicates that if the foreign currency:

A) appreciates by 1 percent, Mill's cash flows will decline by 2 percent.
B) appreciates by 1 percent, Mill's cash flows will decline by .2 percent.
C) depreciates by 1 percent, Mill's cash flows will increase by 2 percent.
D) depreciates by 1 percent, Mill's cash flows will decline by 2 percent.
E) None of these are correct.

Question 74

Which of the following is not a form of exposure to exchange rate fluctuations?

A) transaction exposure
B) credit exposure
C) economic exposure
D) translation exposure

Question 75

Subsidiary A of Mega Corp. has net inflows in Australian dollars of A$1,000,000, while Subsidiary B has net outflows in Australian dollars of A$1,500,000. The expected exchange rate of the Australian dollar is $.55. What is the net inflow or outflow as measured in U.S. dollars?

A) $500,000 outflow
B) $500,000 inflow
C) $275,000 inflow
D) $275,000 outflow

Question 76

​Generally, MNCs with less foreign revenues than foreign costs will be ____ affected by a ____ foreign currency.

A) ​favorably; stronger
B) ​favorably; weaker
C) ​not; stronger
D) ​not; weaker

Question 77

Jacko Co. is a U.S.-based MNC with net cash inflows of euros and net cash inflows of Sunland francs. These two currencies are highly negatively correlated in their movements against the dollar. Kriner Co. is a U.S.-based MNC that has the same exposure as Jacko Co. in these currencies, except that its Sunland francs represent cash outflows. Which firm has a higher exposure to exchange rate risk?

A) Jacko Co.
B) Kriner Co.
C) The firms have about the same level of exposure.
D) Neither firm has any exposure.

Question 78

If an MNC expects cash inflows of equal amounts in two currencies, and the two currencies are ____ correlated, the MNC's transaction exposure is relatively ____.

A) negatively; high
B) negatively; low
C) positively; low
D) None of these are correct.

Question 79

​Yomance Co. is a U.S. company that has exposure to Japanese yen and British pounds. It has net inflows of 5,000,000 yen and net outflows of 60,000 pounds. The present exchange rate of the Japanese yen is $.012 while the present exchange rate of the British pound is $1.50. Yomance Co. has not hedged its positions. The yen and pound movements against the dollar are highly and positively correlated. If the dollar strengthens, then Yomance Co. will:

A) ​benefit, because the dollar value of its pound position exceeds the dollar value of its yen position.
B) ​benefit, because the dollar value of its yen position exceeds the dollar value of its pound position.
C) ​be adversely affected, because the dollar value of its pound position exceeds the dollar value of its yen position.
D) ​be adversely affected, because the dollar value of its yen position exceeds the dollar value of its pound position.

Question 80

Economic exposure can affect:

A) MNCs only.
B) purely domestic firms only.
C) MNCs only AND purely domestic firms only.
D) None of these are correct.