Deck 13: Foreign Exchange Risk Management

Question 1

During 2004, the Eurodollar became the most widely traded currency.

Answer 1

False

Question 2

The exchange rate quoted for transactions within two business days is the

A) spot rate.
B) the forward rate.
C) the current rate.
D) the swap rate.

Answer 2

A

Question 3

A simultaneous spot and forward transaction is a (an)

A) direct transaction.
B) indirect transaction.
C) swap.
D) option.

Answer 3

C

Question 4

Economic exposure is also known as operating exposure.

Question 5

Forwards are traded on organized exchanges.

Question 6

The amount of the local currency equivalent to one unit of the foreign currency is the

A) direct rate.
B) indirect rate.
C) bid rate.
D) offer rate.

Question 7

If the spread between a forward and the spot is negative, the currency is at a premium.

Question 8

An option is considered "in-the-money" if the strike price is unfavorable relative to the market price.

Question 9

If the forward rate is greater than the spot rate on a direct quote basis, the foreign currency would be selling at a

A) cross rate.
B) premium.
C) discount.
D) bid rate.

Question 10

Transaction exposure depends on financial statement net asset positions.

Question 11

The bid rate is

A) the rate at which the foreign exchange trader will buy foreign currency.
B) the rate at which the foreign exchange trader will sell foreign currency.
C) the rate at which the company doing business with the trader will buy foreign currency.
D) the rate at which the company doing business with the trader will sell foreign currency.

Question 12

The amount of foreign currency required for one unit of the local currency is the

A) direct rate.
B) indirect rate.
C) bid rate.
D) offer rate.

Question 13

The interbank market is the most important market in trading foreign exchange.

Question 14

Most companies do nothing about foreign exchange rate risk.

Question 15

The major market for foreign exchange is

A) the interbank market.
B) between banks and their non-bank corporate clients.
C) between banks and speculators.
D) between foreign exchange brokers and non-bank financial institutions.

Question 16

If the forward rate is less than the spot rate on a direct quote basis, the foreign currency would be selling at a

A) cross rate.
B) premium.
C) discount.
D) bid rate.

Question 17

The forward exchange rate is

A) the rate quoted for delivery within two business days.
B) usually higher than the spot rate.
C) a contract rate between the corporation and the foreign exchange trader at the bank.
D) usually at a premium for sales and a discount for purchases.

Question 18

Over the long run, exchange rates are determined by purchasing power parity.

Question 19

An outright forward is the single purchase or sale of a currency for future delivery.

Question 20

The offer rate is

A) the rate at which the foreign exchange trader will buy foreign currency.
B) the rate at which the foreign exchange trader will sell foreign currency.
C) the rate at which the company doing business with the trader will buy foreign currency.
D) the rate at which the company doing business with the trader will sell foreign currency.

Question 21

A transaction exposure risk can be eliminated with a

A) call option
B) put option
C) forward
D) bank deposit in the foreign country

Question 22

Assume that Lewis International sells running shoes to a British importer on June 1 and that the sale is denominated at £75,000 and will be collected on July 15. Also assume that Lewis closes its books at the end of each month. The following are the relevant exchange rates.
$\begin{array}{ll}\text { Spot rate on June 1 } & \$ 1.6200 \\ \text { Forward rate for July } & \\ \text { 15 delivery } & \$ 1.6000 \\ \text { Spot rate on June 30 } & \$ 1.6100 \\ \text { Spot rate on July 15 } & \$ 1.5950\end{array}$

For questions 25-29, assume FASB Statement 52 treatment and that Lewis enters into a forward contract.

-What is the amount of cash that Lewis will receive for the sale?

A) $120,750
B) $120,000
C) $119,625
D) $121,500

Question 23

Assume that Lewis International sells running shoes to a British importer on June 1 and that the sale is denominated at £75,000 and will be collected on July 15. Also assume that Lewis closes its books at the end of each month. The following are the relevant exchange rates.
$\begin{array}{ll}\text { Spot rate on June 1 } & \$ 1.6200 \\ \text { Forward rate for July } & \\ \text { 15 delivery } & \$ 1.6000 \\ \text { Spot rate on June 30 } & \$ 1.6100 \\ \text { Spot rate on July 15 } & \$ 1.5950\end{array}$

For questions 25-29, assume FASB Statement 52 treatment and that Lewis enters into a forward contract.

-If Lewis had purchased merchandise rather than sold it, what would be your answer to question 30?

A) $375 foreign exchange gain
B) $375 foreign exchange loss
C) $1500 foreign exchange loss
D) $1500 foreign exchange gain

Question 24

An example of an operating hedging strategy is

A) a forward option.
B) a put option.
C) building a plant in foreign market
D) a swap.

Question 25

Using the data for the problem, assume that you entered into an option with Goldman Sachs for one contract worth £75,000 at a premium of $.0325, a strike price of 162 and a brokerage fee of $25 to get into the option and also to exercise the option. Would you exercise the option?

A) yes
B) no
C) It depends on the June 1 spot rate.
D) This is not an appropriate situation for an option.

Question 26

Assume that Lewis International sells running shoes to a British importer on June 1 and that the sale is denominated at £75,000 and will be collected on July 15. Also assume that Lewis closes its books at the end of each month. The following are the relevant exchange rates.
$\begin{array}{ll}\text { Spot rate on June 1 } & \$ 1.6200 \\ \text { Forward rate for July } & \\ \text { 15 delivery } & \$ 1.6000 \\ \text { Spot rate on June 30 } & \$ 1.6100 \\ \text { Spot rate on July 15 } & \$ 1.5950\end{array}$

For questions 25-29, assume FASB Statement 52 treatment and that Lewis enters into a forward contract.

-What is the dollar value of the sale on July 15?

A) $120,750
B) $120,000
C) $119,625
D) $121,500

Question 27

The economic theory that explains how a country with a higher nominal interest rate should have a higher inflation rate is

A) purchasing power parity.
B) the Fisher Effect.
C) the International Fischer Effect.
D) the Foreign Exchange Reserves Effect.

Question 28

The difference between the spot and forward rate is

A) deferred until Lewis receives payment from the British importer.
B) taken to the income statement when the contract is entered into.
C) an adjustment to retained earnings.
D) adjusted for foreign exchange gains and losses over the life of the contract.

Question 29

When the currency of an exporter is strengthening the corresponding importer

A) would tend to decrease prices
B) might begin producing the goods domestically
C) might begin producing the goods in the exporting country
D) would only use a financial hedging strategy

Question 30

If a U.S exporter were to receive payment in U.S. dollars from a British importer

A) there is a transaction exposure
B) there is an economic exposure
C) there is no exposure
D) there is a translation exposure

Question 31

The right but not the obligation to trade foreign currency in the future is a

A) forward contract.
B) swap.
C) premium.
D) option.

Question 32

The most widely traded currency in the world is the

A) Japanese yen.
B) German mark.
C) British pound.
D) U.S. dollar.

Question 33

Assume that Lewis International sells running shoes to a British importer on June 1 and that the sale is denominated at £75,000 and will be collected on July 15. Also assume that Lewis closes its books at the end of each month. The following are the relevant exchange rates.
$\begin{array}{ll}\text { Spot rate on June 1 } & \$ 1.6200 \\ \text { Forward rate for July } & \\ \text { 15 delivery } & \$ 1.6000 \\ \text { Spot rate on June 30 } & \$ 1.6100 \\ \text { Spot rate on July 15 } & \$ 1.5950\end{array}$

For questions 25-29, assume FASB Statement 52 treatment and that Lewis enters into a forward contract.

-The difference between the spot rate on June 1 and the forward rate is a

A) $375 foreign exchange gain
B) $375 foreign exchange loss
C) $1500 foreign exchange loss
D) $1500 foreign exchange gain

Question 34

International foreign exchange exposures include all of the following except

A) economic
B) Fisher effect
C) translation
D) transaction

Question 35

The economic theory that explains exchange rate movements by looking at the relative prices in one country versus another is

A) purchasing power parity.
B) the Fisher Effect.
C) the International Fischer Effect.
D) the Foreign Exchange Reserves Effect.

Question 36

The institution established to promote exchange rate stability worldwide is the

A) United Nations.
B) Organization for Monetary Union.
C) International Monetary Fund.
D) Global Exchange Rate Coordinating Commission.

Question 37

An option where the holder has the right to buy foreign currency from the writer of the option is a

A) forward option.
B) put option.
C) call option.
D) swap option.

Question 38

An exposed asset position

A) only exists when the foreign subsidiary's currency is weakening
B) is one where the liabilities translated at the current rate exceed the assets translated at the current rate
C) is one where the assets translated at the current rate exceed the assets translated at the historical rate
D) is one where the assets translated at the current rate exceed the liabilities translated at the current rate

Question 39

The most widely used exchange rate regime is the

A) pegged system with one percent flexibility.
B) limited flexibility system with 2 1/4 percent flexibility.
C) floating exchange rate system.
D) dollar-based system.

Question 40

An option where the holder has the right to sell foreign currency to the writer of the option is a

A) forward option.
B) put option.
C) call option.
D) swap option.

Question 41

Assume that RadCo International purchases ski equipment on account from a German exporter on October 1 and that the sale is denominated in 500,000 German marks. RadCo closes its books at the end of each month, and the payable is due on November 15. The following are the relevant exchange rates.
$\begin{array}{lr}\text { Spot rate on October 1 } & \$ 0.5939 \\ \text { Forward rate for Nov 15 delivery } & \$ 0.5945 \\ \text { Spot rate on October 31 } & \$ 0.5948 \\ \text { Spot rate on Nov 15 } & \text { S0.5941 }\end{array}$

Questions 34-38 assumes the treatment of FASB Statement 52 and that no forward contract is entered into.

-What is the amount of the foreign exchange gain or loss that it will recognize on November 15?

A) $350 gain
B) $200 loss
C) $100 loss
D) $350 loss
E) gain or loss is deferred

Question 42

Assume that RadCo International purchases ski equipment on account from a German exporter on October 1 and that the sale is denominated in 500,000 German marks. RadCo closes its books at the end of each month, and the payable is due on November 15. The following are the relevant exchange rates.
$\begin{array}{lr}\text { Spot rate on October 1 } & \$ 0.5939 \\ \text { Forward rate for Nov 15 delivery } & \$ 0.5945 \\ \text { Spot rate on October 31 } & \$ 0.5948 \\ \text { Spot rate on Nov 15 } & \text { S0.5941 }\end{array}$

Questions 34-38 assumes the treatment of FASB Statement 52 and that no forward contract is entered into.

-How much cash will RadCo International have to pay?

A) $297,050
B) $296,950
C) $297,250
D) $297,400

Question 43

Using the data for the problem, assume that you entered into an option with Goldman Sachs for one contract worth £75,000 at a premium of $.0325, a strike price of 155 and a brokerage fee of $25 to get into the option and also to exercise the option. Would you exercise the option?

A) yes.
B) no
C) It depends on the June 1 spot rate.
D) This is not an appropriate situation for an option.

Question 44

In the case of a forward contract used to hedge a foreign currency commitment,

A) the gain or loss on the contract should be deferred and included in the measurement of the related foreign currency transaction.
B) the gain or loss on the contract should be recognized in the period in which the exchange rate changes.
C) the premium or discount must be written off over the life on the contract.
D) the related foreign currency transaction will be recorded on the books at the rate in effect when title passes.

Question 45

Assuming that you entered into the option and the strike price were 154, what would be your net cash proceeds on July 15?

A) $117,000.00
B) $114,537.50
C) $114,512.50
D) $115,500.00

Question 46

Assuming the tax treatment for foreign currency transactions, what is the foreign exchange gain or loss on November 15?

A) $100 gain
B) $300 gain
C) $350 gain
D) $100 loss
E) gain or loss is deferred

Question 47

Assume that RadCo enters into a forward contract. What is the dollar value of the purchases on November 15?

A) $297,050
B) $296,950
C) $297,250
D) $297,400

Question 48

Assume that RadCo enters into a forward contract. What is the amount of cash that it will pay for the merchandise?

A) $297,050
B) $296,950
C) $297,250
D) $297,400

Question 49

According to IAS 21, the preferred treatment for recognizing gains and losses on foreign currency transactions

A) is similar to the way U.S. tax accounting treats gains and losses.
B) is to recognize differences as income or expense in the period in which they arise.
C) follows the German approach of conservatism.
D) is to recognize losses but not gains in the period in which they arise.

Question 50

Foreign exchange gains and losses on foreign currency transactions

A) must be recognized in income in the period in which the rate changes.
B) are deferred until the monetary part of the transaction is settled.
C) can be used to adjust the cost of the foreign currency transaction under the temporal but not the current rate method.
D) can be written off over the life of the debt according to Statement 52, according to the current rate method.

Question 51

The difference between the spot rate on October 1 and the forward rate is

A) a premium discount.
B) a premium gain.
C) a premium loss.
D) a discount gain.
E) a discount loss.

Question 52

In terms of derivatives, FASB Statement 52 deals with

A) forward contracts and futures contracts.
B) forward contracts and currency swaps.
C) all types of derivatives.
D) options but not forwards.

Question 53

In the case of a forward contract to hedge a foreign currency transaction,

A) the gain or loss on the contract should be deferred and included in the measurement of the related foreign currency transaction.
B) the gain or loss on the contract should be recognized in the period in which the exchange rate changes.
C) a gain will occur if the foreign currency strengthens against the dollar, and a loss will occur if the foreign currency weakens against the dollar.
D) the related foreign currency transaction will be recorded on the books at each new exchange rate until the monetary part of the transactions (the receivable or payable) is settled.

Question 54

The premium or discount is

A) adjusted for foreign exchange gains and losses over the life of the contract.
B) an adjustment to the purchases account.
C) is taken to the income statement when the contract is entered into.
D) is deferred until RadCo pays the German supplier.

Question 55

Assuming the tax treatment for foreign currency transactions, what is the foreign exchange gain or loss on October 31?

A) $300 loss
B) $450 loss
C) $450 gain
D) $150 loss
E) gain or loss is deferred

Question 56

In the United States, derivatives held for trading or speculative purposes are

A) carried at the original spot rate.
B) are deferred and amortized over the useful life of the derivative.
C) are marked-to-market.
D) and not permitted in the case of foreign currencies.

Question 57

The balancing of a foreign exchange gain or loss on a transaction with a derivative loss or gain is known as

A) hedge accounting.
B) a swap.
C) a forward option.
D) luck.

Question 58

Assuming that you entered into the option and the strike price were 160, what would be your net cash proceeds on July 15?

A) $117,000.00
B) $120,000.00
C) $117,537.50
D) $117,512.50

Question 59

Assume that RadCo International purchases ski equipment on account from a German exporter on October 1 and that the sale is denominated in 500,000 German marks. RadCo closes its books at the end of each month, and the payable is due on November 15. The following are the relevant exchange rates.
$\begin{array}{lr}\text { Spot rate on October 1 } & \$ 0.5939 \\ \text { Forward rate for Nov 15 delivery } & \$ 0.5945 \\ \text { Spot rate on October 31 } & \$ 0.5948 \\ \text { Spot rate on Nov 15 } & \text { S0.5941 }\end{array}$

Questions 34-38 assumes the treatment of FASB Statement 52 and that no forward contract is entered into.

-What is the amount of the foreign exchange gain or loss that it will recognize on October 31?

A) $300 loss
B) $450 loss
C) $450 gain
D) $150 loss
E) gain or loss is deferred

Question 60

Assume that RadCo International purchases ski equipment on account from a German exporter on October 1 and that the sale is denominated in 500,000 German marks. RadCo closes its books at the end of each month, and the payable is due on November 15. The following are the relevant exchange rates.
$\begin{array}{lr}\text { Spot rate on October 1 } & \$ 0.5939 \\ \text { Forward rate for Nov 15 delivery } & \$ 0.5945 \\ \text { Spot rate on October 31 } & \$ 0.5948 \\ \text { Spot rate on Nov 15 } & \text { S0.5941 }\end{array}$

Questions 34-38 assumes the treatment of FASB Statement 52 and that no forward contract is entered into.

-What is the dollar value of purchases on October 31?

A) $297,050
B) $296,950
C) $297,250
D) $297,400

Question 61

Hedging

A) guarantees speculative gains
B) eliminates speculative gains
C) is not done by many companies
D) always includes a swap

Question 62

The first step in a foreign exchange risk management strategy is

A) organize and implement a reporting system that monitors exposure and exchange-rate movements
B) define and measure exposure
C) formulate strategies for hedging exposure
D) adopt a policy assigning responsibility for minimizing exposure

Question 63

Which of the following is true concerning the accounting for a foreign currency option?

A) Hedge accounting is allowed when the characteristics and terms of the transaction cannot be identified.
B) Hedge accounting is not allowed when the anticipated transaction will most likely occur.
C) The option is carried as fair value on the balance sheet.
D) Options gains are deferred, whereas options losses are recognized in the period in which they occur.

Question 64

The choice of exposures to be hedged depends on

A) the desired return on equity
B) the use of options and futures
C) the risk aversion of the company
D) the international Fisher effect

Question 65

Which of the following is not a criterion that must exist for hedge accounting to function:

A) Item to be hedge exposes the enterprise to price, currency, or interest rate risk.
B) The hedge position reduces the exposure.
C) The hedge position is designated as a hedge.
D) The enterprise would suffer a loss in the absence of the hedge.

Question 66

In the U.S. a firm's foreign exchange management program

A) does not have to be disclosed
B) is required
C) is usually outsourced to a bank
D) may not be disclosed but the various risks of the securities must be disclosed

Question 67

All of the following are exposures that a firm would manage in foreign exchange except

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