Deck 7: Foreign Currency Transactions and Hedging Foreign Exchange Risk

Question 1

According to the World Trade Organization, what was the size of international trade in 2011?

A)$7,000,000,000 (7 billion dollars)
B)$70,000,000,000 (70 billion dollars)
C)$37,000,000,000 (37 billion dollars)
D)$18,000,000,000,000 (18 trillion dollars)

Answer 1

D

Question 2

What is foreign exchange risk exposure?

A)The possibility of a loss because of changes in the value of a foreign currency
B)Losses caused by paying for purchased goods in a foreign currency
C)Losses caused by receiving payment in a foreign currency for goods sold
D)All of the above

Answer 2

A

Question 3

What is "asset exposure" to foreign exchange risk?

A)The possibility that an asset denominated in domestic currency will decline in value because of changes in the foreign exchange rate
B)The possibility that an asset denominated in a foreign currency will change in value because of a change in the foreign exchange rate
C)The loss resulting from an import purchase when a foreign currency appreciates
D)The loss resulting from an import purchase when a foreign currency depreciates

Answer 3

B

Question 4

The number of Japanese yen (¥) required today to buy one U.S.dollar ($) today is called:

A)the spot rate.
B)the exact rate.
C)the forward rate.
D)the retail rate.

Question 5

What is a foreign currency transaction?

A)It is another name for an international transaction.
B)It is a transaction that involves payment at a date sometime in the future.
C)It is a business deal denominated in a currency other than a company's domestic currency.
D)It is an economic event measured in a currency other than U.S.dollars.

Question 6

Under U.S.GAAP, foreign exchange losses should be recorded by:

A)debiting "Foreign Exchange Loss".
B)crediting "Foreign Exchange Loss".
C)debiting "Retained Earnings".
D)debiting "Sales Revenue".

Question 7

What is a "foreign exchange rate?"

A)The price to buy a foreign currency
B)The price to buy foreign goods
C)The difference between the price of goods in a foreign currency and the price in a domestic currency
D)The cost to hold all monetary assets in a single currency

Question 8

Under U.S.GAAP, what method is required to account for foreign currency transactions?

A)A one-transaction perspective must be used.
B)The two-transaction perspective must be used.
C)A sale is not recorded until payment is received and converted to U.S.dollars.
D)A sale is not recorded until payment is received in the foreign currency.

Question 9

Why must the two-transaction perspective be used for recording foreign currency transactions under U.S.GAAP?

A)The two-transaction perspective is required under IFRS.
B)U.S.GAAP requires conservatism in financial reporting.
C)All other methods are excessively complicated to use and therefore obscure the essence of the transaction.
D)Management made two decisions: one to sell and another to extend credit in a foreign currency.

Question 10

A bank exchanging foreign currency makes its profit in what manner?

A)On the difference between the spot rate and the foreign rate
B)A bank is forbidden, by law, to charge a premium in foreign currency exchange
C)On the present value of the forward rate discounted to the date an option is purchased
D)On the difference between the buying and selling rates

Question 11

Under U.S.GAAP, what is the proper treatment of unrealized foreign exchange losses?

A)They should be deferred on the Balance Sheet until the cash is paid.
B)They should not be recognized until cash is received to complete the transaction.
C)They should be recorded on the Income Statement in the period the exchange rate changes.
D)They should be deferred on the Balance Sheet until an offsetting foreign exchange gain is realized.

Question 12

King's Bank, a British company, purchases market research services from Harris Interactive, a U.S.company.As per the terms of the contract, payment is to be made three months later in U.S.dollars when the report is delivered.How would King's Bank like to see the exchange rate move, assuming it isn't hedging the transaction?

A)It hopes that the U.S.dollar appreciates in value against the British pound.
B)It hopes that the British pound appreciates in value against the U.S.dollar.
C)It makes no difference, since they are the customer and the sale takes place in the U.K.
D)It hopes that there is no change between the spot rate and the forward rate.

Question 13

The central bank of Country X buys and sells its own currency to ensure that the currency is always exchanged in a ratio of 2:1 with the currency of Country Y.What can we conclude about these two currencies?

A)Country X is using the Euro.
B)Country X has pegged its currency to the currency of Country Y.
C)Country X has an undesirable currency.
D)Country X allows its currency to float relative to the currency of Country Y.

Question 14

Why was there very little fluctuation in the foreign exchange rate in the period 1945-1973?

A)This was a period when the world economy was very stable.
B)There was very little growth in the world economy between 1945 and 1973.
C)Countries linked their currency to the U.S.dollar, which was backed by gold reserves.
D)Most currencies were pegged to the British pound, which could be converted to sterling silver.

Question 15

In the years between 1990 and 2001 when global gross domestic product rose 27%, what was the growth in global exports?

A)25%
B)75%
C)35%
D)50%

Question 16

For an upcoming trip, Pat wants to buy Euros at the local bank when the current exchange rate quoted on OANDA.com was $1.563 per €1.What should Pat plan to pay for €1,000?

A)exactly $1,563
B)more than $1,563
C)about $640
D)less than $640

Question 17

The number of U.S.dollars ($) today to buy one U.K.pound (£) six months from now is called:

A)the spot rate.
B)the exact rate.
C)the forward rate.
D)the prime rate.

Question 18

Which of the following statements is true about the Euro?

A)It is the currency used by all countries in the European Union.
B)It is pegged to the U.S.dollar.
C)It is the currency required to be used in financial reporting under international accounting standards.
D)None of the statements above is true.

Question 19

Under International Accounting Standards Board rules, what method is required to account for foreign currency transactions?

A)A one-transaction perspective must be used.
B)The two-transaction perspective must be used.
C)A sale is not recorded until payment is received and converted to U.S.dollars.
D)A sale is not recorded until payment is received in the foreign currency.

Question 20

When a currency is allowed to increase or decrease freely according to market forces, the currency is said to:

A)be pegged to another currency.
B)be less valuable.
C)have independent float.
D)devalue.

Question 21

What is the foreign currency exchange gain or loss on December 31, 20x1?

A)$50,000 loss
B)$50,000 gain
C)$10,000 gain
D)$10,000 loss

Question 22

Amazing Corporation, a U.S. enterprise, sold product to a customer in Wales on October 1, 20x1 for £100,000 with payment required on April 1, 20x2. Relevant exchange rates are:
$\begin{array}{lll} & \text { Spot rate } & \text { Forward rate (to } 4 / 1 / \mathrm{x} 2) \\\text { October } 1,20 \times 1 & \$ 1.87 & \$ 1.85 \\\text { December } 31,20 \times 1 & \$ 1.85 & \$ 1.84 \\\text { April 1.20x2 } & \$ 1.90 &\end{array}$
The discount factor corresponding to the company's incremental borrowing rate for 6 months is 0.95.

-Assume that Amazing Corporation enters a forward contract on October 1, 20x1 to sell £100,000 six months hence, on April 1, 20x2.How should Amazing Corporation report the forward contract on its December 31, 20x1 financial statements?

A)Asset $1,950
B)Liability $1,950
C)Asset $1,000
D)Asset $950

Question 23

If the spot rate on March 1, 20x2 was $2.45 per 100 rupees, what is the foreign currency exchange gain or loss that should be recorded that day?

A)$15,000 gain
B)$15,000 loss
C)$35,000 gain
D)$35,000 loss

Question 24

A noncancelable sales order that specifies foreign currency price and date of delivery is known as a:

A)hedge.
B)foreign currency firm commitment.
C)forward contract.
D)put option.

Question 25

What has occurred when one company arranges to buy a foreign currency sometime in the future, at an exchange rate quoted today?

A)The company has purchased a foreign currency option.
B)The company has entered a forward contract.
C)The currency has been devalued.
D)None of the above

Question 26

What term is used to describe the circumstances under which Amazing Corporation is entering the forward contract?

A)Hedge of an unrecognized foreign currency firm commitment
B)Hedge of a recognized foreign-currency-denominated asset
C)Hedge of a forecast foreign-currency-denominated transaction
D)Hedge of net investment in foreign operations

Question 27

How should U.S.companies record receivables and payables from international trade that are denominated in foreign currencies?

A)All assets and liabilities of U.S.companies must be recorded in U.S.dollars.
B)Conservatism would dictate that liabilities should be recorded in the currency in which they are payable, but assets should be recorded in U.S.dollars, regardless of what currency will be received.
C)There should be separate receivable and payable accounts for each currency that is used by the company.
D)The company should choose any one currency to use for recording receivable and payables so that there is consistency in the accounts.

Question 28

When two parties from different countries enter into a transaction:

A)the currency to be used for settling the transaction is set by the government.
B)a third country's currency must be used to denominate the transaction.
C)the two parties are free to decide the currency that should be used to settle the transaction.
D)the domestic currency of the buyer must be used to settle the transaction.

Question 29

Under U.S.GAAP, what is the proper treatment of unrealized foreign exchange gains?

A)They should be deferred on the Balance Sheet until cash is received.
B)The principle of conservatism requires that they should never be recognized.
C)They should not be recorded until cash is received and the exchange transaction is completed.
D)They should be recognized in income on the date the exchange rate changes.

Question 30

On November 1, 20x1 Zamfir Company, a U.S. corporation, purchased minerals from a Russian company for 2,000,000 rubles, payable in 3 months. The relevant exchange rates between the U.S. and Russian currencies are given: $\begin{array}{lll} & \text { Spot rate } & \text { Forward rate(at February 1,20 x 2) } \\\text { November 1,20 x 1 } 1 & \$ 0.348 & \$ 0.348\\\text {December 31,20 x1 }& \$ 0.359 & \$ 0.352 \\\text { February 1. 20 x 2 } & \$ 0.344 &\end{array}$

-If Zamfir does not attempt to hedge this transaction, what is the gain or loss that should be shown on the company's December 31, 20x1 financial statements?

A)$22,000 loss
B)$21,450 loss
C)$8,000 gain
D)$7,800 gain

Question 31

Why is the accrual method of accounting for unrealized foreign exchange gains sometimes criticized?

A)Foreign exchange gains almost never occur, so there is no reason to have an accounting standard for it.
B)It violates the principle of conservatism.
C)It is not objective.
D)There is no reliable method for measuring unrealized foreign exchange gains.

Question 32

Northland Corporation recorded £1,000,000 in Accounts Receivable for sales to customers in the United Kingdom and recorded Accounts Payable of 2,000,000 Yuan for product purchased from China.If Northland recorded a foreign currency exchange loss on its receivables and a foreign currency gain on its payables, what must have happened to each currency?

A)Yuan appreciated, Pound depreciated
B)Yuan depreciated, Pound appreciated
C)Yuan appreciated, Pound appreciated
D)Yuan depreciated, Pound depreciated

Question 33

On November 1, 20x1 Zamfir Company, a U.S. corporation, purchased minerals from a Russian company for 2,000,000 rubles, payable in 3 months. The relevant exchange rates between the U.S. and Russian currencies are given: $\begin{array}{lll} & \text { Spot rate } & \text { Forward rate(at February 1,20 x 2) } \\\text { November 1,20 x 1 } 1 & \$ 0.348 & \$ 0.348\\\text {December 31,20 x1 }& \$ 0.359 & \$ 0.352 \\\text { February 1. 20 x 2 } & \$ 0.344 &\end{array}$

-Assume that on November 1, 20x1 Zamfir Company enters a forward contract to buy 2,000,000 rubles on February 1, 20x2.What is the fair value of the forward contract on December 31, 20x1?

A)$8,000
B)$7,800
C)$22,000
D)$8,200

Question 34

What term is used for an option with a positive intrinsic value?

A)Put option
B)Over the counter
C)In the money
D)Call option

Question 35

What is the fair value of the option on December 1, 20x1?

A)$0
B)$500
C)$400
D)$10,000

Question 36

Amazing Corporation, a U.S. enterprise, sold product to a customer in Wales on October 1, 20x1 for £100,000 with payment required on April 1, 20x2. Relevant exchange rates are:
$\begin{array}{lll} & \text { Spot rate } & \text { Forward rate (to } 4 / 1 / \mathrm{x} 2) \\\text { October } 1,20 \times 1 & \$ 1.87 & \$ 1.85 \\\text { December } 31,20 \times 1 & \$ 1.85 & \$ 1.84 \\\text { April 1.20x2 } & \$ 1.90 &\end{array}$
The discount factor corresponding to the company's incremental borrowing rate for 6 months is 0.95.

-Assuming that Amazing Corporation does not hedge this transaction, what is the amount of exchange gain or loss that it should show on its December 31, 20x1 income statement?

A)Loss $1,000
B)Loss $2,000
C)Gain $1,000
D)Gain $1,900

Question 37

What has occurred when one company purchases the right to buy a foreign currency sometime in the future at an exchange rate quoted today?

A)The company has acquired a call option.
B)The company has entered a forward contract.
C)The currency has appreciated relative to the dollar.
D)The company has acquired a put option.

Question 38

What is a "strike price?"

A)The exchange rate that is used to buy a foreign currency today
B)The price that will be paid for goods in a forward contract
C)The exchange rate that will be used if a foreign currency option is executed
D)The difference between the wholesale rate and the retail rate for foreign currency exchange

Question 39

What is the intrinsic value of a foreign currency option?

A)The difference between the spot rate and the strike price
B)The gain that could be realized if the option was exercised immediately
C)The chance that a currency will rise over time to make the option in the money
D)The difference between a call option and a put option

Question 40

What is the fair value of the option on December 31, 20x1?

A)$0
B)$500
C)$400
D)$10,000

Question 41

Which of the following statements is true of the relationship between foreign currency transactions, exchange rate changes, and foreign exchange gains and losses?

A)In an export sales, depreciation of the foreign currency causes a foreign exchange gain.
B)In an import purchase, appreciation of the foreign currency causes a foreign exchange gain.
C)In an import purchase, depreciation of the foreign currency causes a foreign exchange loss.
D)In an export sales, appreciation of the foreign currency causes a foreign exchange gain.

Question 42

Excel Sources Inc.is a U.S.incorporated company.Due to change in exchange rate, it receives $150,000 as payment against a sale of $165,000.Under the two-transaction perspective:

A)no journal entry will be prepared on the date of sale.
B)the sale will be recorded at $150,000 on the date of sale.
C)foreign exchange loss will be recorded for $15,000.
D)Accounts Receivable will be debited for $15,000 on the date of payment.

Question 43

What is the primary difference between a cash flow hedge and a fair value hedge?

A)The fair value hedge must completely offset the variability in the cash flow from the foreign currency receivable or payable.
B)The cash flow hedge can only be used to offset potential foreign currency losses on accounts receivable.
C)The cash flow hedge must completely offset the variability in cash flow from the foreign currency receivable or payable.
D)The fair value hedge can only be used to offset the variability in cash flow from long-term fixed assets related to foreign currency fluctuations.

Question 44

Under U.S.GAAP, which of the following conditions must be met to qualify for hedge accounting?

A)There must be formal documentation of the hedging relationship.
B)A derivative must be used specifically to hedge fair value exposure or cash flow exposure.
C)The hedge must be effective.
D)All of the above must be met in order to qualify for hedge accounting.

Question 45

How is the fair value of a foreign currency option calculated?

A)By using the Box-Jenkins technique
B)Using the modified Black-Scholes pricing model
C)Through an arms-length transaction
D)Using quotes given daily in the Wall Street Journal

Question 46

What information is needed to determine the fair value of a foreign currency forward contract?

A)The forward rate at the date the contract was entered
B)The current forward rate for a contract that matures on the same dates as the forward contract that was entered into
C)A discount rate to determine the present value of the contract
D)All of the above information is needed

Question 47

How should discounts or premiums on forward contracts be treated if the derivative is hedging a foreign-currency-denominated asset?

A)Carried on the balance sheet until the contract is completed
B)Included in income in the period the derivative is acquired
C)Amortized over the life of the forward contract
D)None of the above

Question 48

What is the requirement for reporting derivatives under international accounting standards and U.S.GAAP?

A)They may be shown on the balance sheet or they may be treated as off-balance sheet investments.
B)They must be shown on the balance sheet at fair value.
C)They must be shown on the balance sheet at historical cost.
D)They may be shown on the balance sheet at historical cost or at net realizable value.

Question 49

What kind of exposure exists for recognized foreign currency assets and liabilities?

A)Fair value exposure
B)Cash flow exposure
C)Both fair value exposure and cash flow exposure
D)Neither fair value exposure nor cash flow exposure

Question 50

Under U.S.GAAP, what method of amortizing discounts or premiums on forward contracts must be used?

A)Weighted average method or accelerated method
B)Sum of digit method only
C)Effective interest rate method or straight line method
D)Straight line method only

Question 51

Which of the following is done when accounting for a cash flow hedge, but is not done when accounting for a fair value hedge?

A)The hedged asset or liability is adjusted to fair value.
B)Foreign exchange gains or losses on the hedged asset or liability are recorded in net income.
C)Increases or decreases in a derivative's fair value are recorded in accumulated other comprehensive income.
D)Gains or losses resulting from adjusting the fair value of a derivative are recorded in net income.

Question 52

In hedge accounting, which of the following exposure should be hedged by foreign currency derivative?

A)Temporal exposure
B)Fair value exposure
C)Derivative exposure
D)Forward contract exposure

Question 53

Under U.S.GAAP, where are changes in the fair value of derivatives reported?

A)As part of "Accumulated Other Comprehensive Income" on the Balance Sheet
B)They are not recognized until the options are exercised
C)Retained Earnings
D)None of the above

Question 54

What is "hedge accounting?"

A)Any record keeping related to purchase, sale, or valuation of derivatives.
B)Recording options and other derivatives on the Balance Sheet.
C)Matching gains or losses from hedging with losses or gains from the risk being hedged.
D)Using multiple accounting methods to offset the effect of foreign currency exchange.

Question 55

Which of the following statements is true of intrinsic value of options?

A)When the option strike price is more than the spot rate, the intrinsic value is zero.
B)When the option strike price is equal to the spot rate, the intrinsic value is positive.
C)When the option strike price is less than the spot rate, the intrinsic value is zero.
D)When the option strike price is more than the spot rate, the intrinsic value is negative.

Question 56

When accounting for forward contracts, what is meant by the term "executory contract"?

A)No cash changes hands
B)The CEO of the company is the only one authorized to engage in the contract
C)There must be a price paid for the option
D)The contract is valid if one of the parties sign it

Question 57

On May 1, 20x1, Ustar purchased a put option to sell £50,000 on April 30, 20x2 at a strike price equal to $2, which was the spot rate on May 1, 20x1.Ustar paid a premium of $0.01 per pound.How should the option be recorded on May 1, 20x1?

A)Debit Foreign Currency Option for $100,500.
B)Credit Foreign Currency Option for $100,500.
C)Debit Foreign Currency Option for $500.
D)Debit Hedge Expense for $500.

Question 58

What kind of exposure exists for foreign currency firm commitments?

A)Fair value exposure
B)Cash flow exposure
C)Both fair value exposure and cash flow exposure
D)Neither fair value exposure nor cash flow exposure

Question 59

On 1 January, 2015, Hikers Inc., a U.S.-based company, borrowed £200,000 on a two-year note at a per annum interest of 4.5%.The spot rate on this day was $1.65 per pound.The spot rate on 31 December, 2015, was $1.64 per pound.The journal entries to account for this foreign currency borrowing will include:

A)a debit to Cash for $200,000 on January 1, 2015.
B)a credit to Notes Payable for $330,000 on December 31, 2015.
C)a debit to Foreign Exchange Loss for $90 on December 31, 2015.
D)a debit to Interest Expense for $14,760 on December 31, 2015.

Question 60

Which of the following statements is true about hedge accounting under U.S.GAAP?

A)Companies may choose whether to account for derivatives as cash flow hedges or fair value hedges.
B)If a derivative qualifies as a cash flow hedge, the hedging instrument is adjusted to fair value on each balance sheet date.
C)If a derivative is elected by the company not to be designated as a cash flow hedge, it must be accounted for as such.
D)Hedge accounting is only advantageous when a foreign currency depreciates between the transaction date and the payment date.