Deck 27: Managing Risk

Question 1

One can describe a currency forward contract as

A)agreeing today to buy or sell a specified amount of a currency at a later date at a price set in the future.
B)agreeing today to buy or sell a specified amount of a currency today at its current price.
C)agreeing today to buy or sell a specified amount of a currency at a later date at a price set today.
D)agreeing today to buy or sell a specified amount of a currency today at a price that will be determined at a later date.

Answer 1

agreeing today to buy or sell a specified amount of a currency at a later date at a price set today.

Question 2

The spot peso/$US exchange rate is peso 10.9892/$US. The three-month forward rate is peso 11.0408/$US. What is the peso's forward premium (or discount) on the U.S. dollar, expressed as an annual percentage?

A)0.8 percent premium
B)1.9 percent discount
C)2.1 percent premium
D)0.5 percent discount

Answer 2

1.9 percent discount

Question 3

The spot exchange rate for British pounds is 0.5025 (GBP/USD). The one-year risk-free rates in the United States and Britain are 3 percent and 2.75 percent, respectively. What is the forward exchange rate in GBP/USD?

A)0.6170
B)0.5037
C)0.5013
D)0.6050

Answer 3

0.5013

Question 4

An important aspect of international finance includes

A)that the basic principles of corporate finance do not apply.
B)the basic principles of corporate finance do not apply and that the NPV principle cannot be applied to foreign operations.
C)the process of foreign exchange valuation of different currencies.
D)that the NPV principle cannot be applied to foreign operations.

Question 5

If a Big Mac costs $C3 in Canada and $2.31 in the United States, according to purchasing power parity, what is the implied exchange rate in terms of $C/$US?

A)1.3793
B)1.2987
C)1.3276
D)0.7700

Question 6

The spot USD/GBP exchange rate is USD1.99/GBP. What is the indirect quote?

A)GBP 0.6500/USD
B)GBP 0.5025/USD
C)GBP 1.2845/USD
D)GBP 1.4875/USD

Question 7

The spot GBP/USD exchange rate is 0.5025/USD, and the one-year forward rate is GBP 0.5048/USD. If the annual interest rate on dollar CDs is 6 percent, what would you expect the annual interest to be on GBP CDs?

A)5.52 percent
B)6.49 percent
C)3.55 percent
D)8.25 percent

Question 8

The expectations theory of exchange implies that

A)the forward rate is determined by the central bank's expectations.
B)on average, the forward rate equals the future spot rate.
C)the forward rate is determined by expectations of future spot interest rates.
D)the forward rate usually equals the future spot rate of exchange.

Question 9

The spot $US/euro exchange rate is $US1.3549/euro. The three-month forward rate is $US1.3595/euro. What is the euro's forward premium (or discount) on the U.S. dollar, expressed as an annual percentage?

A)0.3 percent premium
B)0.3 percent discount
C)1.4 percent premium
D)1.4 percent discount

Question 10

If the direct quotation for the euro is $1.3565/euro, what is the size of the indirect quotation?

A)0.2415
B)0.6435
C)0.7372
D)0.3565

Question 11

An organized market for currency for future delivery that conducts trades on an exchange is called a(n)

A)spot market.
B)forward market.
C)futures market.
D)options market.

Question 12

The spot yen/$US exchange rate is yen119.795/$US, and the one-year forward rate is yen114.571/$US. If the annual interest rate on dollar CDs is 6 percent, what annual interest rate would you expect on yen CDs?

A)1.38 percent
B)5.32 percent
C)8.06 percent
D)17.14 percent

Question 13

Which of the following statement(s) about the currency forward market is (are) true?

A)In the forward market you buy or sell currency for future delivery at a rate set today.
B)In the forward market you buy or sell currency for future delivery at a rate set today and a forward market transaction is usually a made-to-order transaction.
C)A forward market transaction is usually a made-to-order transaction and most forward transactions are settled in six months or less.
D)In the forward market you buy or sell currency for future delivery at a rate set today, a forward market transaction is usually a made-to-order transaction, and most forward transactions are settled in six months or less.

Question 14

Assume that international capital markets are competitive and that global real interest rates are the same. The one-year interest rate is 9 percent in the United States and 5 percent in Switzerland. If the expected inflation rate is 6 percent in the United States, what is the expected inflation rate in Switzerland?

A)5 percent
B)4 percent
C)3 percent
D)2 percent

Question 15

Which of the following statement(s) about currency futures market is (are) true?

A)Futures contracts are highly standardized.
B)Futures contracts are made-to-measure contracts.
C)Futures contracts are highly standardized, and futures contracts are for specified amounts and for a limited choice of delivery dates.
D)Futures contracts are highly standardized, futures contracts are made-to-measure contracts, and futures contracts are for specified amounts and for a limited choice of delivery dates.

Question 16

A quotation in the form yen 89.33/$US is called

A)an indirect quote in the United States.
B)a direct quote in the United States.
C)a cross-rate in Japan.
D)None of these options are correct.

Question 17

The Mexican economy is predicted to average double-digit inflation over the next two years at 10 percent per year. The inflation forecast for the United States for the same period is 4 percent per year. If the current exchange rate is $0.091/peso, what is the expected exchange rate two years from now?

A)$0.08604/peso
B)$0.08134/peso
C)$0.10180/peso
D)$0.09625/peso

Question 18

If a Big Mac costs $2.31 in the United States, and in Japan 250 yen, according to PPP, what is the implied exchange rate in yen/$US?

A)0.00924
B)108.22500
C)119.79500
D)250.00000

Question 19

Assume that both the law of one price and the expectations theory of forward rates hold. The spot rate for the Ruritanean doubloon is 0.455 doubloon/$, and the one-year forward rate is 0.476 doubloon/$. Suppose that next year's forecasted rate of inflation in Ruritania is now revised upward by 10 percent. How does this affect exchange rates?

A)The current spot rate changes to 0.500 doubloon/$.
B)The forward rate changes to 0.524 doubloon/$.
C)Next year's expected spot rate changes to 0.501 doubloon/$.
D)The forward rate changes to 0.501 doubloon/$.

Question 20

The spot yen/US dollar exchange rate is 119.795 yen/$US. The three-month forward rate is 118.397 yen/$US. What is the yen's forward premium (or discount) on the dollar, expressed as an annual percentage?

A)6.5 percent discount
B)4.7 percent premium
C)6.5 percent premium
D)4.7 percent discount

Question 21

The beta of a firm's equity in Switzerland is 1.25. The risk-free rate is 4 percent and market risk premium is 8.4 percent. Calculate the required rate of return for the equity of this firm.

A)10.5 percent
B)8.4 percent
C)14.5 percent
D)9.5 percent

Question 22

An Australian firm is evaluating a proposal to build a new plant in the United States. The expected cash flows in $US (in millions) are as follows: Year 0, -100; Year 1, 40; Year 2, 50; Year 3, 65. The discount rate in $A is 10 percent, while the discount rate in $US is 12 percent and the spot rate is $US0.60/$A. Calculate the NPV of the project in $US.

A)+36.40
B)-21.84
C)+13.10
D)+21.84

Question 23

The dollar interest rate is 6 percent, and the Swiss franc interest rate is 4 percent. If the required rate of return for a project in Switzerland is 15 percent, calculate the required rate of return in the United States for a similar project.

A)17.2 percent
B)12.8 percent
C)15 percent
D)8.5 percent

Question 24

Your U.S.-based firm is deciding between using currency futures contracts or a forward contract with its commercial bank in order to hedge a scheduled dividend from its subsidiary corporation in Germany. The dividend will be repatriated in July, while the currency futures contracts are only available for June or September delivery. Which of the following choices properly hedges the transaction without basis risk?

A)Long euro future contracts
B)Short euro future contracts
C)Forward to sell euros forward in July.
D)Forward to buy euros forward in July.

Question 25

If a government were to seize the assets of a multinational company and not provide adequate compensation to its owners, the government would be following which practice?

A)WTO resolution
B)Expropriation
C)Repatriation
D)Terrorism

Question 26

An Australian firm is evaluating a proposal to build a new plant in the United States. The expected cash flows in $US (in millions) are as follows: Year 0, -100; Year 1, 40; Year 2, 50; Year 3, 65. The discount rate in $A is 10 percent, while the discount rate in $US is 12 percent and the spot rate is $US0.85/$A. Calculate the NPV in $A.

A)+25.69
B)-21.84
C)+13.10
D)+21.84

Question 27

Suppose that the G Company knows that in one month it must pay£7 million for goods that its U.S. subsidiary will receive in Britain. The current exchange rate is $1.99£. The risk that the corporate treasurer faces is that

A)the $US/pound exchange rate falls in a month's time (i.e., the pound weakens).
B)the $US/pound exchange rate rises in a month's time (i.e., the pound strengthens).
C)the $US/pound exchange rate does not change from its current position.
D)the pound exchange rate falls in a month's time (i.e., the pound strengthens).

Question 28

In the forward exchange market, currency is traded for future delivery.

Question 29

If the peso is traded at a forward discount relative to the U.S. dollar, then the U.S. dollar is also trading at a discount relative to the peso.

Question 30

Political risk is can be thought of as

A)unanticipated changes in exchange rates.
B)unanticipated actions by the host government affecting the cash flows of a project.
C)unanticipated actions by the World Bank affecting the cash flows of a project.
D)All of these options are correct.

Question 31

If the U.S. dollar interest rate is 4 percent and the peso interest rate is 7 percent, what is the likely one-year forward rate if the spot dollar-peso rate is peso 11/$US?

A)11.54
B)11.32
C)10.68
D)10.23

Question 32

Currency risk exposure can be categorized as

A)transaction exposure.
B)economic exposure.
C)None of these options are correct.
D)All of these options are correct.

Question 33

The risk associated with unanticipated actions by the host country government or its courts towards a multinational firm is called

A)economic risk.
B)transaction risk.
C)political risk.
D)translation risk.

Question 34

XJ Company from the United States is evaluating a proposal to build a new plant in the United Kingdom. The expected cash flows in pounds are as follows: Year 0, -50; Year 1, 25; Year 2, 35; Year 3, 40. The discount rate in BP is 14 percent and the discount rate in the $US is 12 percent. The spot rate is $US1.99/BP. Calculate the NPV in $US.

A)+25.86
B)+28.69
C)+51.46
D)+45.14

Question 35

The current spot rate is $US0.8543/$A. The one-year forward rate is $US0.8475/$A. A U.S. exporter denominates its exports to Australia in $A and expects to receive $A600,000 in one year. What is the value of these exports in one year in $US given that the firm executes a forward hedge?

A)$US 508,500
B)$US 512,580
C)$US 707,965
D)$US 702,329

Question 36

The phrase "stronger currency" implies a forward premium. Given a euro-U.S. dollar exchange rate of $1.45/euro, which of the following values for the forward rate shows the strongest dollar?

A)1.55
B)1.65
C)1.35
D)1.25

Question 37

Interest rate parity gives the relationship between the forward rate and the spot rate of exchange in terms of interest rates.

Question 38

The current spot rate is GBP 0.5024/USD. The three-month forward rate is GBP 0.5040/USD. The TE Company expects a payment of GBP 100 million in three months. If the firm hedges this transaction in the forward market, what is the USD amount it will receive in three months?

A)USD198.41 million
B)USD199.04 million
C)USD 50.40 million
D)USD 50.24 million

Question 39

XJ Company from the United States is evaluating a proposal to build a new plant in the United Kingdom. The expected cash flows in pounds are as follows: Year 0, -50; Year 1, 25; Year 2, 35; Year 3, 40. The discount rate in BP is 14 percent and the discount rate in $US is 12 percent. The spot rate is $US1.99/BP. Calculate the NPV of the project in BP.

A)+28.69
B)+25.86
C)+42.67
D)+22.68

Question 40

The country with the most favorable political risk score is

A)the United States.
B)France.
C)Norway.
D)the United Kingdom.

Question 41

In general, the countries with the highest interest rates also have the highest inflation rates.

Question 42

If the price of a Big Mac in the United States is $2.56, and in Japan it is yen 300, then the implied exchange rate is yen 117.19/$US.
Yen 300/$2.56 = Yen 117.19/$1.

Question 43

Briefly explain the expectations theory of forward exchange rates.

Question 44

Purchasing power parity provides a better long-run indicator for future price changes than short-run indicator.

Question 45

The risk that an unfriendly government might expropriate a firm's assets is called political risk.

Question 46

Briefly describe what happens in foreign exchange markets.

Question 47

Briefly explain the term transaction exposure.

Question 48

Purchasing power parity implies that any differences in inflation rates will be offset by a change in the exchange rate.

Question 49

The true cost of hedging foreign currency risk is the difference between the forward rate and the expected spot rate.

Question 50

The terms transaction exposure and economic exposure are two names for the same foreign exchange risk.

Question 51

The Big Mac exchange rate matches official exchange rate quotes for different currencies.

Question 52

Briefly explain the concept of interest rate parity.

Question 53

Briefly describe the different types of currency markets.

Question 54

The strength of a currency is directly related to its interest rate and inflation expectations.

Question 55

When a currency gets stronger, the forward rate of that currency must have increased against all currencies.

Question 56

For a project's cost of capital measured in Swiss francs, one should use Swiss interest rates and beta with respect to Swiss market.

Question 57

Project financing is often designed to reduce a foreign government's incentive to expropriate capital investment.

Question 58

When estimating the cash flows and NPV for a foreign project, there is no need to forecast exchange rates for the life of the project.

Question 59

The true cost of hedging foreign currency risk is the difference between the forward rate and today's spot rate.

Question 60

Briefly explain the concept of purchasing power parity.

Question 61

What is wrong with the following news report? "Today the dollar ended the trading session stronger."

Question 62

Briefly explain the term political risk.

Question 63

Briefly explain why a currency forecast is not necessarily required when a multinational firm estimates the cash flows from an international project?

Question 64

Briefly explain the term economic exposure.