Deck 12: Operating Exposure

Question 1

Operating cash flows may occur in different currencies and at different times,but financing cash flows may occur only in a single currency.

Answer 1

False

Question 2

An unexpected change in exchange rates impacts a firm's expected cash flows at three levels,depending on the time horizon used (Short Run,Medium Run,and Long Run).Describe the three operating exposure's phases of adjustment assuming that parity conditions do not hold among foreign exchange rates,national inflation rates,and national interest rates (disequilibrium).

Answer 2

The first level impact is on expected cash flows in the one-year operating budget.The gain or loss depends on the currency of denomination of expected cash flows.These are both existing transaction exposures and anticipated exposures.The currency of denomination cannot be changed for existing obligations,or even for implied obligations such as purchase or sales commitments.In the short run it is difficult to change sales prices or renegotiate factor costs.Therefore,realized cash flows will differ from those expected in the budget.
The second level impact is on expected medium-run cash flows assuming disequilibrium conditions.In this case,the firm may not be able to adjust prices and costs to reflect the new competitive realities caused by a change in exchange rates.The primary problem may be the reactions of existing competitors.The firm's realized cash flows will differ from its expected cash flows.The firm's market value may change because of the unanticipated results.
The third level impact is on expected long-run cash flows,meaning those beyond five years.At this strategic level a firm's cash flows will be influenced by the reactions of both existing competitors and potential competitors-possible new entrants-to exchange rate changes under disequilibrium conditions.In fact,all firms that are subject to international competition,whether they are purely domestic or multinational,are exposed to foreign exchange operating exposure in the long run whenever foreign exchange markets are not continuously in equilibrium.

Question 3

Even though contracts are often fixed in the short run,as time passes,prices and costs can be changed to reflect the new competitive realities caused by a change in exchange rates.

Answer 3

True

Question 4

The strategy management undertakes in response to unexpected changes in exchange rates depends to a large measure on their opinion about the price elasticity of demand.

Question 5

When considering the phases of adjustment and response to operating exposure in the LONG RUN,price changes tend to be ________ and volume changes tend to be ________.

A) fixed/contracted; contracted.
B) fixed/contracted; completely flexible.
C) completely flexible; completely flexible.
D) completely flexible; contracted.

Question 6

Unexpected changes in exchange rates is never good news for a firm's operating income.

Question 7

________ exposure is far more important for the long-run health of a business than changes caused by ________ or ________ exposure.

A) Operating; translation; transaction
B) Transaction; operating; translation
C) Accounting; translation; transaction
D) Translation; operating; transaction

Question 8

For a firm that competes internationally to sell its products,a depreciation of its domestic currency relative to markets where the firm exports goods,should eventually result in ________ sales at home and ________ sales abroad,other things equal.

A) fewer; greater
B) fewer; fewer
C) greater; greater
D) greater; fewer

Question 9

Simpson Sign Company based in Frostbite Falls,Minnesota has a 6-month C$100,000 contract to complete sign work in Winnipeg,Manitoba,Canada.The current spot rate is $1.02/C$ and the forward rate is $1.01/C$.Under conditions of equilibrium,management would use ________ today when preparing operating budgets.

A) $102,000
B) $101,000
C) $100,000
D) none of the above

Question 10

Expected changes in foreign exchange rates should already be factored into anticipated operating results by management and investors.

Question 11

Brimmo Motorcycles Inc.,a U.S.-based firm,manufactures and sells electric motorcycles both domestically and internationally.A sudden and unexpected appreciation of the U.S.dollar should allow sales to ________ at home and ________ abroad.(Assume other factors remain unchanged.)

A) increase; increase
B) decrease; decrease
C) increase; decrease
D) decrease; increase

Question 12

The higher the price elasticity of demand,the higher the degree of pass-through.

Question 13

________ cash flows arise from intracompany and intercompany receivables and payments,while ________ cash flows are payments for the use of loans and equity.

A) Financing; operating
B) Operating; financing
C) Operating; accounting
D) Accounting; financing

Question 14

Recently the Canadian dollar realized an unexpected appreciation in value.Which of the following actions being considered by Tall Timber Exports,a Canadian logging firm specializing in exporting raw forest products,would be considered a highly unlikely response to the appreciation of the Canadian dollar?

A) Tall Timber Exports might lower export prices in an effort to maintain market share.
B) Tall Timber Exports might raise export prices only slightly in an effort to increase market share.
C) Tall Timber Exports might leave export prices as they are and wait to determine what actions to take if any in the future.
D) all of the above

Question 15

Which of the following is NOT an example of an operating cash flow?

A) management fees and distributed overhead
B) royalties and license fees
C) rent and lease payments
D) dividend paid to parent company

Question 16

Recently the British Pound suffered an unexpected depreciation in value.Which of the following actions being considered by Coventry Furniture of London,a purely domestic furniture manufacturer and retailer,would be considered a highly unlikely response to the depreciation of the pound?

A) Coventry might choose to maintain its domestic sales prices constant in pound terms.
B) Coventry might try to raise domestic prices because competing imports are now priced higher in England.
C) Coventry might try to lower domestic prices because competing imports are now priced higher in England.
D) none of the above

Question 17

Another name for operating exposure is ________ exposure.

A) economic
B) competitive
C) strategic
D) all of the above

Question 18

Which of the following is NOT an example of a financial cash flow?

A) parent invested equity capital
B) interest on intrafirm lending
C) payment for goods and services
D) intrafirm principal payments

Question 19

What type of international risk exposure measures the change in present value of a firm resulting from changes in future operating cash flows caused by any unexpected change in exchange rates?

A) transaction exposure
B) accounting exposure
C) operating exposure
D) translation exposure

Question 20

The goal of operating exposure analysis is to identify strategic operating techniques the firm might adopt to enhance value in the face of unanticipated exchange rate changes.

Question 21

The particular strategy of trying to offset stable inflows of cash from one country with outflows of cash in the same currency is known as:

A) hedging.
B) diversification.
C) matching.
D) balancing.

Question 22

Diversification is possibly the best technique for reducing the problems associated with international transactions.Provide one example each of international financial diversification and international operational diversification and explain how the action reduces risk.

Question 23

If a firm diversifies its financing sources,it will be pre-positioned to take advantage of temporary deviations from the International Fisher Effect.

Question 24

An MNE has a contract for a relatively predictable long-term inflow of Japanese yen that the firm chooses to hedge by seeking out potential suppliers in Japan.This hedging strategy is referred to as:

A) a natural hedge.
B) currency-switching.
C) matching.
D) diversification.

Question 25

Which of the following is NOT an acceptable hedging technique to reduce risk caused by a relatively predictable long-term foreign currency inflow of Japanese yen?

A) Import raw materials from Japan denominated in yen to substitute for domestic suppliers.
B) Pay suppliers from other countries in yen.
C) Import raw materials from Japan denominated in dollars.
D) Acquire debt denominated in yen.

Question 26

Management must be able to predict disequilibria in international markets to take advantage of diversification strategies.

Question 27

An MNE has a contract for a relatively predictable long-term inflow of Japanese yen that the firm chooses to hedge by paying for imports from Canada in Japanese yen.This hedging strategy is known as:

A) a natural hedge.
B) currency-switching.
C) matching.
D) diversification.

Question 28

Which one of the following management techniques is likely to best offset the risk of long-run exposure to payables denominated in a particular foreign currency?

A) Borrow money in the foreign currency in question.
B) Lend money in the foreign currency in question.
C) Rely on the Federal Reserve Board to enact monetary policy favorable to your exposure risk.
D) none of the above

Question 29

Which of the following is NOT identified by your authors as a proactive management technique to reduce exposure to foreign exchange risk?

A) matching currency cash flows
B) cross-currency swaps
C) remaining a purely domestic firm
D) parallel loans

Question 30

Which of the following is NOT an example of a form of political risk that might be avoided or reduced by foreign exchange risk management?

A) expropriation of assets
B) destruction of raw materials through natural disaster
C) war
D) unfavorable legal changes

Question 31

Which of the following is NOT an example of diversifying operations?

A) diversifying sales
B) diversifying location of operations
C) raising funds in more than one country
D) sourcing raw materials in more than one country

Question 32

Which one of the following management techniques is likely to best offset the risk of long-run exposure to receivables denominated in a particular foreign currency?

A) Borrow money in the foreign currency in question.
B) Lend money in the foreign currency in question.
C) Increase sales to that country.
D) Increase sales in this country.

Question 33

The variability of a firm's operating cash flows is probably reduced by international diversification of its production,sourcing,and sales because exchange rate changes under disequilibrium conditions are likely to increase the firm's competitiveness in some markets while reducing it in others.

Question 34

When disequilibria in international markets occur,management can take advantage by:

A) doing nothing if they are already diversified and able to realize beneficial portfolio effects.
B) recognizing disequilibria faster than purely domestic competitors.
C) shifting operational of financing activities to take advantage of the disequilibria.
D) all of the above

Question 35

Moral hazard may occur when a firm or individual takes on more risk when it knows that someone else will "pick up the tab."

Question 36

A U.S.timber products firm has a long-term contract to import unprocessed logs from Canada.To avoid occasional and unpredictable changes in the exchange rate between the U.S.dollar and the Canadian dollar,the firms agree to split between the two firms the impact of any exchange rate movement.This type of agreement is referred to as:

A) risk-sharing.
B) currency-switching.
C) matching.
D) a natural hedge.

Question 37

Which of the following is probably NOT an advantage of foreign exchange risk management?

A) the reduction of the variability of cash flows due to domestic business cycles
B) increased availability of capital
C) reduced cost of capital
D) All of the above are potential advantages of foreign exchange risk management.

Question 38

Diversifying the financing base means diversifying sales,location of production facilities,and raw material sources.

Question 39

Purely domestic firms will be at a disadvantage to MNEs in the event of market disequilibria because:

A) domestic firms lack comparative data from its own sources.
B) international firms are already so large.
C) all of the domestic firm's raw materials are imported.
D) None of the above; domestic firms are not at a disadvantage.

Question 40

Which of the following is NOT an example of diversification in financing?

A) raising funds in more than one market
B) raising funds in more than one country
C) diversifying sales
D) All of the above qualify.

Question 41

Which of the following is NOT an important impediment to widespread use of parallel loans?

A) difficulty in finding an appropriate counterparty
B) the risk that one of the parties will fail to return the borrowed funds when agreed
C) the process does not avoid exchange rate risk
D) All of the above are significant impediments.

Question 42

Costs associated with the purchase of sizeable put options positions include each of the following EXCEPT:

A) the purchase price of the options.
B) the opportunity cost of buying the options rather than diversifying operations to reduce risk.
C) executive salaries of having corporate offices in more than one country.
D) none of the above

Question 43

A British firm has a subsidiary in the U.S.,and a U.S.firm,known to the British firm,has a subsidiary in Britain.Define and then provide an example for each of the following management techniques for reducing the firm's operating cash flows.The following are techniques to consider:
a)matching currency cash flows
b)risk-sharing agreements
c)back-to-back or parallel loans

Question 44

NorthRim Inc.(NRI),imports extreme condition outdoor wear and equipment from The Allofit Territories Company (ATC)located in Canada.With the steady decline of the U.S dollar against the Canadian dollar NRI is finding a continued relationship with ATC to be an increasingly difficult proposition.In response to NRI's request,ATC has proposed the following risk-sharing arrangement.First,set the current spot rate as the base rate.As long as spot rates stay within 5% (up or down)NRI will pay at the base rate.Any rate outside of the 5% range,ATC will share equally with NRI the difference between the spot rate and the base rate.If NRI has a payable of C$100,000 due today and the current spot rate is C$1.17/$,how much does LBC owe in U.S.dollars?

A) $83,333
B) $85,470
C) $85,837
D) $117,000

Question 45

Most swap dealers arrange swaps so that each firm that is a party to the transaction does not know who the counterparty is.

Question 46

After being introduced in the 1980s,currency swaps have remained a relatively insignificant financial derivative instrument.

Question 47

Swap agreements are treated as off-balance sheet transactions via U.S.accounting methods.

Question 48

A Canadian firm with a U.S.subsidiary and a U.S.firm with a Canadian subsidiary agree to a parallel loan agreement.In such an agreement,the Canadian firm is making a/an ________ loan to the ________ subsidiary while effectively financing the ________ subsidiary.

A) indirect; U.S.; Canadian
B) indirect; Canadian; U.S.
C) direct; U.S.; Canadian
D) direct; Canadian; U.S.

Question 49

A ________ resembles a back-to-back loan except that it does not appear on a firm's balance sheet.

A) forward loan
B) currency hedge
C) counterparty
D) currency swap

Question 50

Swap agreements are treated as line items on the balance sheet via U.S.accounting methods.

Question 51

A ________ occurs when two business firms in separate countries arrange to borrow each other's currency for a specified period of time.

A) natural hedge loan
B) forward loan
C) currency switch loan
D) back-to-back loan

Question 52

A British firm and a U.S.Corporation each wish to enter into a currency swap hedging agreement.The British firm is receiving U.S.dollars from sales in the U.S.but wants pounds.The U.S.firm is receiving pounds from sales in Britain but wants dollars.Which of the following choices would best satisfy the desires of the firms?

A) The British firm pays dollars to a swap dealer and receives pounds from the dealer. The U.S. firm pays pounds to the swap dealer and receives dollars.
B) The U.S. firm pays dollars to a swap dealer and receives pounds from the dealer. The British firm pays pounds to the swap dealer and receives dollars.
C) The British firm pays pounds to a swap dealer and receives pounds from the dealer. The U.S. firm pays dollars to the swap dealer and receives dollars.
D) The British firm pays dollars to a swap dealer and receives dollars from the dealer. The U.S. firm pays pounds to the swap dealer and receives pounds.

Question 53

The empirical evidence strongly supports the proposition that contractual hedges can effectively eliminate operating exposure.

Question 54

NorthRim Inc.(NRI),imports extreme condition outdoor wear and equipment from the Allofit Territories Company (ATC)located in Canada.With the steady decline of the U.S dollar against the Canadian dollar NRI is finding a continued relationship with ATC to be an increasingly difficult proposition.In response to NRI's request,ATC has proposed the following risk-sharing arrangement.First,set the current spot rate as the base rate.As long as spot rates stay within 5% (up or down)NRI will pay at the base rate.Any rate outside of the 5% range,ATC will share equally with NRI the difference between the spot rate and the base rate.If the current spot rate is C$1.20/$,what are the upper and lower limits for trading to take place at C$1.20?

A) C$1.205/$ - C$1.195/$
B) C$1.15/$ - C$1.25/$
C) C$1.14/$ - C$1.26/$
D) none of the above

Question 55

Currency swaps are exclusively for periods of time under one year.

Question 56

After being introduced in the 1980s,currency swaps have gained increasing importance as financial derivative instruments.

Question 57

A ________ is the term used to describe a foreign currency agreement between two parties to exchange a given amount of one currency for another,and after a period of time,to give back the original amounts.

A) matched flow
B) currency swap
C) back-to-back loan
D) none of the above

Question 58

Most swap dealers arrange swaps so that each firm that is a party to the transaction knows who the counterparty is.