Deck 12: Management of Economic Exposure

Question 1

A firm's operating exposure is:

A) defined as the extent to which the firm's operating cash flows would be affected by the random changes in exchange rates.
B) determined by the structure of the markets in which the firm sources its inputs, such as labor and materials, and sells its products.
C) determined by the firm's ability to mitigate the effect of exchange rate changes by adjusting its markets, product mix, and sourcing.
D) all of these

Answer 1

D

Question 2

Operating exposure can be defined as:

A) the future home currency values of the firm's assets and liabilities.
B) the extent to which the firm's operating cash flows would be affected by random changes in exchange rates.
C) the sensitivity of realized domestic currency values of the firm's contractual cash flows denominated in foreign currencies to unexpected exchange rate changes.
D) the potential that the firm's consolidated financial statement can be affected by changes in exchange rates.

Answer 2

B

Question 3

After the appreciation of the Canadian dollar,firm ABC loses market share in the United States because American firms can sell their products at a lower price.This is an example of:

A) Competitive effect.
B) Conversion effect.
C) Exchange rate effect.
D) Unfair competition.

Answer 3

A

Question 4

It is conventional to classify foreign currency exposures into the following types:

A) economic exposure, transaction exposure, and translation exposure.
B) economic exposure, non-economic exposure, and political exposure.
C) national exposure, international exposure, and trade exposure.
D) conversion exposure, and exchange exposure.

Question 5

Exposure to currency risk can be measured by the sensitivities of:

A) the future foreign currency values of the firm's assets and liabilities.
B) the firm's operating cash flows to specific changes in exchange rates.
C) the future home currency values of the firm's assets and liabilities.
D) None of these.

Question 6

The table below provides the information about the future possible exchange rates and the value of your foreign assets. State Prob.P* S($/£)P(=SP*)
1 0)25 £950 1.5 $1,425
2 0)5 £1,000 1.6 $1,600
3 0)25 £1,100 1.7 $1,870
Based on this information,you can construct a perfect hedge by buying £2700 of call options and some put options with strike price 1.6$/£.How many put options you need to buy:

A) 1500
B) 1750
C) 2000
D) 2700

Question 7

The table below depicts the three possible values of future spot exchange rate and your foreign assets.You used the simple regression model to estimate of the effect of the exchange rate on the assets' value.Find the estimated slope of this regression b. State Prob.P* S($/£)P(=SP*)
1 1/3 £1059 1.7 $1,800
2 1/3 £1,000 1.8 $1,800
3 1/3 £947 1.9 $1,800

A) -167
B) 0
C) c: 167
D) 250

Question 8

The exposure coefficient,b,is defined as:

A) Cov (P, S)/Cov (S).
B) Cov (P, S)/Var (S).
C) Var (S)/Cov (P,S).
D) Cov (P, S)/Var (P).

Question 9

The variability of the dollar value of an asset (invested overseas)depends on:

A) the variability of the dollar value of the asset that is related to specific changes in the exchange rate.
B) the dollar value variability that is dependent on the exchange rate movements.
C) the dollar value variability that is independent of exchange rate movements.
D) None of these.

Question 10

A U.S. firm holds an asset in Israel and faces the following scenario:
$\begin{array} { l l l l } \hline & \text { State 1 } & \text { State 2 } & \text { State 3 } \\\hline \text { Probability } & 25 \% & 50 ^ { \circ } \text { o } & 25 \% \\\text { Spot rate } & \$ 0.30 \text { ILS } & \text { \$0.20 ILS } & \$ 0.15 / \text { ILS } \\\text { P* } & \text { ILS2,000 } & \text { ILS5,000 } & \text { ILS3,000 } \\\text { P } & \$ 3,000 & \text { \$2.500 } & \text { \$750 }\end{array}$
where,
P* = Israeli new shekel (ILS) price of the asset held by the U.S. firm
P = dollar price of the same asset


-The "exposure" (i.e.the regression coefficient beta)is: (Round your final answer to nearest whole dollar and intermediate calculations to 6 decimal places) Hint: Calculate the expression Cov(P,S)/Var(S)

A) 128.
B) 1,289.
C) 12,894.00.
D) None of these.

Question 11

A U.S. firm holds an asset in Israel and faces the following scenario:
$\begin{array} { l l l l } \hline & \text { State 1 } & \text { State 2 } & \text { State 3 } \\\hline \text { Probability } & 25 \% & 50 ^ { \circ } \text { o } & 25 \% \\\text { Spot rate } & \$ 0.30 \text { ILS } & \text { \$0.20 ILS } & \$ 0.15 / \text { ILS } \\\text { P* } & \text { ILS2,000 } & \text { ILS5,000 } & \text { ILS3,000 } \\\text { P } & \$ 3,000 & \text { \$2.500 } & \text { \$750 }\end{array}$
where,
P* = Israeli new shekel (ILS) price of the asset held by the U.S. firm
P = dollar price of the same asset


-The expected value of the investment in U.S.dollars is: (Do not round intermediate calculations):

A) $2,083.33.
B) $2,187.50.
C) $6,250.00.
D) $6,562.50.

Question 12

Based on the following information about the future possible exchange rates and the value of your foreign assets,you have computed Var(S)= 0.00666667 and Cov(P,S)= 12.If you use the appropriate forward hedge,what will be the value of your hedged position in a situation when the future spot exchange rate is 1.4$/£?
State Prob.P* S($/£)P( = SP*)
1 1/3 £1000 1.4 $1,400
2 1/3 £1,000 1.5 $1,500
3 1/3 £1,100 1.6 $1,760

A) $1500
B) $1553
C) $1580
D) $1620

Question 13

Operating exposure can be managed by:

A) flexible sourcing policy.
B) diversification of the market.
C) financial hedging.
D) all of these.

Question 14

A U.S. firm holds an asset in Israel and faces the following scenario:
$\begin{array} { l l l l } \hline & \text { State 1 } & \text { State 2 } & \text { State 3 } \\\hline \text { Probability } & 25 \% & 50 ^ { \circ } \text { o } & 25 \% \\\text { Spot rate } & \$ 0.30 \text { ILS } & \text { \$0.20 ILS } & \$ 0.15 / \text { ILS } \\\text { P* } & \text { ILS2,000 } & \text { ILS5,000 } & \text { ILS3,000 } \\\text { P } & \$ 3,000 & \text { \$2.500 } & \text { \$750 }\end{array}$
where,
P* = Israeli new shekel (ILS) price of the asset held by the U.S. firm
P = dollar price of the same asset


-The variance of the exchange rate is: (Round your final answer and intermediate calculations to 6 decimal places)

A) 0.001968.
B) 0.002969.
C) 0.003968.
D) 0.004968.

Question 15

Which of the following is not a strategy for managing operating exposure:

A) Financial hedging.
B) Diversification of the market.
C) Lowering sale prices.
D) Product differentiation.

Question 16

A U.S. firm holds an asset in Israel and faces the following scenario:
$\begin{array} { l l l l } \hline & \text { State 1 } & \text { State 2 } & \text { State 3 } \\\hline \text { Probability } & 25 \% & 50 ^ { \circ } \text { o } & 25 \% \\\text { Spot rate } & \$ 0.30 \text { ILS } & \text { \$0.20 ILS } & \$ 0.15 / \text { ILS } \\\text { P* } & \text { ILS2,000 } & \text { ILS5,000 } & \text { ILS3,000 } \\\text { P } & \$ 3,000 & \text { \$2.500 } & \text { \$750 }\end{array}$
where,
P* = Israeli new shekel (ILS) price of the asset held by the U.S. firm
P = dollar price of the same asset


-Which of the following conclusions are correct? (Round your final answer to nearest whole dollar and round intermediate calculations to 2 decimal places)

A) most of the volatility of the dollar value of the Israeli asset can be removed by hedging exchange risk because b²[Var(S)] and Var(e) are 236,717 ($)² and 493,751 ($)² respectively
B) most of the volatility of the dollar value of the Israeli asset can not be removed by hedging exchange risk because b²[Var(S)] and Var(e) are 236,717 ($)² and 493,751 ($)² respectively
C) most of the volatility of the dollar value of the Israeli asset can not be removed by hedging exchange risk because b²[Var(S)] and Var(e) are 493,751 ($)² and 236,717 ($)², respectively
D) most of the volatility of the dollar value of the Israeli asset can be removed by hedging exchange risk because b²[Var(S)] and Var(e) are 493,751 ($)² and 236,717 ($)² respectively

Question 17

Economic exposure refers to:

A) the sensitivity of realized domestic currency values of the firm's contractual cash flows denominated in foreign currencies to unexpected exchange rate changes.
B) the extent to which the value of the firm would be affected by unanticipated changes in exchange rate.
C) the potential that the firm's consolidated financial statement can be affected by changes in exchange rates.
D) ex post and ex ante currency exposures.

Question 18

A Canadian firm holds an asset in France and faces the following scenario:
$\begin{array} { l l l l } \hline & \text { State 1 } & \text { State 2 } & \text { State 3 } \\\hline \text { Probability } & 20 \% & 50 \% & 30 \% \\\text { Spot rate } & \$ 1.6 / \text { euro } & \$ 1.65 / \text { euro } & \$ 1.70 / \text { euro } \\\begin{array} { l } \text { Price of the euro- } \\\text { asset }\end{array} & \text { euro } 2,000 & \text { euro } 3,000 & \text { euro 4,000 }\end{array}$

-The expected value of the investment in Canadian dollars is:

A) $3,000.
B) $4,950.
C) $5,155.
D) $5,550.

Question 19

The dollar operating cash flows following a depreciation of a foreign currency may change for the following reasons:

A) the conversion effect.
B) the competitive effect.
C) the conversion effect and the conversion effect.
D) None of these.

Question 20

The extent to which the value of the firm is affected by unanticipated changes in exchange rates is called:

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

Question 21

A Canadian firm holds an asset in France and faces the following scenario:
$\begin{array} { l l l l } \hline & \text { State 1 } & \text { State 2 } & \text { State 3 } \\\hline \text { Probability } & 20 \% & 50 \% & 30 \% \\\text { Spot rate } & \$ 1.6 / \text { euro } & \$ 1.65 / \text { euro } & \$ 1.70 / \text { euro } \\\begin{array} { l } \text { Price of the euro- } \\\text { asset }\end{array} & \text { euro } 2,000 & \text { euro } 3,000 & \text { euro 4,000 }\end{array}$

-The "exposure" (i.e.the regression coefficient beta)is:

A) 67.97
B) 679.78
C) 6797.80
D) None of these.

Question 22

ABC Inc.,a Canadian paper manufacturer,has a subsidiary in the United States which sources its wood from Canada.The US dollar depreciates rapidly.Discuss the likely competitive and conversion effects of the depreciation of the US dollar.

Question 23

Banff Inc.is headquartered in Calgary and produces high-end living room furniture.The firm has a subsidiary in Germany.The wooden frames of the sofas are made in Calgary by an independent contractor and then shipped to Germany.The German subsidiary then upholsters the sofas using Belgium fabrics.Each frame costs the subsidiary C$1,500.The materials and labour for the upholstery amount to euro 2,000 per sofa.Fixed overhead costs are euro 1,500,000 for the subsidiary.Banff Inc.expects to be able to sell 3,000 Sofas for 5,000 euros each.The firm can depreciate 1,000,000 euros per year.The German income tax rate is 40%.The current exchange rate is C$1.5/euro.How would the operating cash flows (expressed in Canadian dollars)change if the exchange rate is C$1.4/euro,all else equal?

Question 24

How can operating exposure be managed?

Question 25

A Canadian firm holds an asset in France and faces the following scenario:
$\begin{array} { l l l l } \hline & \text { State 1 } & \text { State 2 } & \text { State 3 } \\\hline \text { Probability } & 20 \% & 50 \% & 30 \% \\\text { Spot rate } & \$ 1.6 / \text { euro } & \$ 1.65 / \text { euro } & \$ 1.70 / \text { euro } \\\begin{array} { l } \text { Price of the euro- } \\\text { asset }\end{array} & \text { euro } 2,000 & \text { euro } 3,000 & \text { euro 4,000 }\end{array}$

-The variance of the exchange rate is:

A) 0.001225
B) 0.056058
C) 0.075058
D) 0.085058

Question 26

Which of the following statements is true?

A) Exchange rate exposure on a foreign asset can be eliminated completely via hedging in all cases.
B) Exchange rate exposure on a foreign asset can be eliminated completely via hedging if the value of the foreign asset is fixed.
C) Exchange rate exposure on a foreign asset can be eliminated completely via hedging if the value of the foreign asset is variable.
D) Exchange rate exposure on a foreign asset can never be eliminated completely.

Question 27

Banff Inc.is headquartered in Calgary and produces high-end living room furniture.The firm has a subsidiary in Germany.The wooden frames of the sofas are made in Calgary by an independent contractor and then shipped to Germany.The German subsidiary then upholsters the sofas using Belgium fabrics.Each frame costs the subsidiary C$1,500.The materials and labour for the upholstery amount to euro 2,000 per sofa.Fixed overhead costs are euro 1,500,000 for the subsidiary.Banff Inc.expects to be able to sell 3,000 Sofas for 5,000 euros each.The firm can depreciate 1,000,000 euros per year.The German income tax rate is 40%.The current exchange rate is C$1.5/euro.How would the operating cash flows (expressed in Canadian dollars)change if the exchange rate is C$1.6/euro,all else equal?

Question 28

Banff Inc.is headquartered in Calgary and produces high-end living room furniture.The firm has a subsidiary in Germany.The wooden frames of the sofas are made in Calgary by an independent contractor and then shipped to Germany.The German subsidiary then upholsters the sofas using Belgium fabrics.Each frame costs the subsidiary C$1,500.The materials and labour for the upholstery amount to euro 2,000 per sofa.Fixed overhead costs are euro 1,500,000 for the subsidiary.Banff Inc.expects to be able to sell 3,000 Sofas for 5,000 euros each.The firm can depreciate 1,000,000 euros per year.The German income tax rate is 40%.The current exchange rate is C$1.5/euro.How would the operating cash flows (expressed in Canadian dollars)change if the exchange rate is C$1.4/euro,the German inflation rate is 3% but the firm will not be able to raise the price for its products and due to new competition from the Russian market (with a more favorable exchange rate)unit sales drop to 2,500?