Question 1

You are the treasurer of Montana Corp. and must decide how to hedge (if at all) future payables of 1,000,000 Japanese yen 90 days from now. Call options are available with a premium of $.01 per unit and an exercise price of $.01031 per Japanese yen. The forecasted spot rate of the Japanese yen in 90 days is:

The 90-day forward rate of the Japanese yen is $.01033.

What is the probability that the call option will be exercised (assuming Montana purchased it)?

Accepted Answer

The answer of You are the treasurer of Montana Corp....

Question 2

A cross-hedging strategy is most effective with currencies that are _____, whereas currency diversification is most effective with currencies that are ______.

Accepted Answer

Cross-hedging is most effective with currencies that are highly positively correlated because the movements of one currency can predict the movements of another, allowing for effective hedging. Currency diversification, on the other hand, works best with currencies that are not highly correlated, as it spreads the risk across currencies that do not move in tandem.

Question 3

Linden Co. has 1,000,000 euros as payables due in 90 days, and is certain that the euro is going to depreciate substantially over time. Assuming the firm is correct, the ideal strategy is to:​

Accepted Answer

The answer of Linden Co. has 1,000,000 euros as payables...

Question 4

To hedge a payables position in a foreign currency with a money market hedge, the MNC would borrow the foreign currency, convert it to dollars, and invest that amount in the United States until the payables are due.

Accepted Answer

To hedge a payables position in a foreign currency with a money market hedge, the MNC would borrow in its own currency (dollars), convert those dollars to the foreign currency, and then invest the foreign currency in the foreign country until the payables are due.

Question 5

If interest rate parity exists, and transaction costs do not exist, the option hedge will yield the same results as no hedge.

Accepted Answer

Interest rate parity ensures that the forward exchange rate is set so that arbitrage opportunities are eliminated, but an option hedge, which involves the use of currency options, provides a different payoff structure compared to no hedge or a forward contract hedge. An option hedge allows for the benefit of movement in exchange rates while limiting losses, which is not the case with no hedge or a forward contract hedge where the outcome is fixed.

Question 6

Futures, forward, and money market hedges all lock into a certain price to be received from hedging a receivable. For a currency option hedge with a put option, however, the exact amount received is not known until the option is (or is not) exercised.

Accepted Answer

With a currency option hedge using a put option, the exact amount received is not known until the option is either exercised or expires.

Question 7

Johnson Co. has 1,000,000 euros as payables due in 30 days, and is certain that the euro is going to appreciate substantially over time. Assuming the firm is correct, the ideal strategy is to:​

Accepted Answer

By purchasing euros forward, Johnson Co. can lock in a fixed exchange rate and protect itself from a potential appreciation of the euro. This way, even if the euro does appreciate, the firm will still be able to pay its payables due in 30 days without incurring additional costs. Selling euros forward (option A) would be more appropriate if Johnson Co. had receivables in euros, not payables. Purchasing euro currency put options (option B) would provide the firm with the right to sell euros at a certain price, but this strategy is more suitable for firms that have assets denominated in euros, not liabilities. Purchasing euro currency call options (option C) would provide the firm with the right to buy euros at a certain price, but this is not necessary since the payables are already in euros. Remaining unhedged (option E) would expose Johnson Co. to currency risk, which may result in higher costs if the euro appreciates as expected.

Question 8

When a parent company tries to convince a subsidiary to hedge its transaction exposure, this is called leading.

Accepted Answer

This is called "pressuring," not "leading." Leading and lagging are techniques used in managing the timing of payments and receipts in foreign currency to take advantage of expected currency movements, not specifically about convincing a subsidiary to hedge its transaction exposure.

Question 9

MNCs should hedge receivables using bear spreads only for currencies that are expected to appreciate substantially prior to option expiration.

Accepted Answer

MNCs should hedge receivables using bear spreads only for currencies that are expected to depreciate or remain stable, not for currencies that are expected to appreciate substantially. A bear spread is a strategy used to profit from a decrease in the price of an underlying asset or currency, which would not be beneficial if the currency is expected to appreciate.

Question 10

A money market hedge involves taking a money market position to cover a future payables or receivables position.

Accepted Answer

A money market hedge involves taking a position in the money market to offset the risk of a future payables or receivables position. The idea is to use financial instruments, such as forward contracts or options, to protect against unfavorable exchange rate movements that could create losses for the business.

Question 11

To hedge a receivables position with a currency option hedge, an MNC would buy a put option.

Accepted Answer

Buying a put option gives the MNC the right to sell a currency at a specified strike price, which can be used to hedge against a decline in the value of the currency and protect the value of their receivables.

Question 12

Cross-hedging may involve taking a forward position in a currency that is highly correlated with the currency an MNC needs to hedge.

Accepted Answer

Cross-hedging involves hedging with a financial instrument that is not a perfect match for the asset being hedged. In the case of currency, cross-hedging may involve taking a forward position in a currency that is highly correlated with the currency an MNC needs to hedge. This is because movements in the correlated currency may provide some protection against movements in the target currency.

Question 13

A money market hedge on payables would involve, among others, borrowing ____ and investing in the ____.

Accepted Answer

A money market hedge involves borrowing in the currency in which payables are denominated and investing the proceeds in the currency of the home country. Therefore, to hedge payables denominated in a foreign currency, dollars should be borrowed and invested in the foreign country. Option C is the only choice that represents this strategy.

Question 14

An advantage of using options to hedge is that the MNC can let the option expire. However, a disadvantage of using options is that a premium must be paid for it.

Accepted Answer

Options allow the MNC to choose whether or not to exercise the option, so they can simply let it expire if it is not needed. However, purchasing an option requires paying a premium, which can be a disadvantage compared to other hedging strategies.

Question 15

Overhedging refers to the hedging of a larger amount in a currency than the actual transaction amount.

Accepted Answer

Overhedging occurs when a company hedges more than the actual transaction amount, which can lead to unnecessary costs and potential losses.

Question 16

Lagging refers to the delay of payment by a subsidiary if the currency denominating the payable is expected to depreciate.

Accepted Answer

Lagging is a tactic used by subsidiaries to delay payment if they expect the currency in which the payable is denominated to depreciate, which allows them to pay with weaker currency at a later date.

Question 17

If a firm is hedging payables with futures contracts, it may end up paying more for the payables than it would have had it remained unhedged if the foreign currency depreciates.

Accepted Answer

When a firm hedges payables with futures contracts, it locks in a price for the foreign currency needed to pay those payables. If the foreign currency depreciates, the firm will still have to pay the locked-in price, which may end up being higher than the current exchange rate. Therefore, it is possible for the firm to pay more for the payables than it would have had it remained unhedged.

Question 18

If hedging projections cause a firm to believe that it will definitely be adversely affected by its transaction exposure, a currency option hedge is more appropriate than other methods.

Accepted Answer

The answer of If hedging projections cause a firm to...

Question 19

Most MNCs can completely hedge all of their transactions.

Accepted Answer

While hedging is a common practice for MNCs to manage their currency risk, it may not always be possible to completely hedge all transactions due to various factors such as market volatility, liquidity constraints, and transaction costs.

Question 20

Mender Co. will be receiving 500,000 Australian dollars in 180 days. Currently, a 180-day call option with an exercise price of $.68 and a premium of $.02 is available. Also, a 180-day put option with an exercise price of $.66 and a premium of $.02 is available. Mender plans to purchase options to hedge its receivables position. Assuming that the spot rate in 180 days is $.67, what is the amount received from the currency option hedge (aFter considering the premium paid)?​

Accepted Answer

If Mender Co. wants to hedge against the risk, it should purchase the put option to sell AUD at a fixed rate of $.66. If the spot rate is lower than the exercise price, Mender Co. can exercise the option and sell AUD at the higher currency rate.

Here, the amount received from the hedge will be:

Amount received = (Exercise price - Spot rate) x Contract amount + Premium paid

Amount received = ($.66 - $.67) x 500,000 + $.02 x 500,000

Amount received = - $5,000 + $10,000

Amount received = $5,000

Therefore, the amount received from the currency option hedge (after considering the premium paid) will be $325,000 (i.e., $5,000 + $320,000). The correct answer is B.

Quiz 11: Managing Transaction Exposure

A cross-hedging strategy is most effective with currencies that are _, whereas currency diversification is most effective with currencies that are __.

Linden Co. has 1,000,000 euros as payables due in 90 days, and is certain that the euro is going to depreciate substantially over time. Assuming the firm is correct, the ideal strategy is to:

To hedge a payables position in a foreign currency with a money market hedge, the MNC would borrow the foreign currency, convert it to dollars, and invest that amount in the United States until the payables are due.

If interest rate parity exists, and transaction costs do not exist, the option hedge will yield the same results as no hedge.

Futures, forward, and money market hedges all lock into a certain price to be received from hedging a receivable. For a currency option hedge with a put option, however, the exact amount received is not known until the option is (or is not) exercised.

Johnson Co. has 1,000,000 euros as payables due in 30 days, and is certain that the euro is going to appreciate substantially over time. Assuming the firm is correct, the ideal strategy is to:

When a parent company tries to convince a subsidiary to hedge its transaction exposure, this is called leading.

MNCs should hedge receivables using bear spreads only for currencies that are expected to appreciate substantially prior to option expiration.

A money market hedge involves taking a money market position to cover a future payables or receivables position.

To hedge a receivables position with a currency option hedge, an MNC would buy a put option.

Cross-hedging may involve taking a forward position in a currency that is highly correlated with the currency an MNC needs to hedge.

A money market hedge on payables would involve, among others, borrowing and investing in the .

An advantage of using options to hedge is that the MNC can let the option expire. However, a disadvantage of using options is that a premium must be paid for it.

Overhedging refers to the hedging of a larger amount in a currency than the actual transaction amount.

Lagging refers to the delay of payment by a subsidiary if the currency denominating the payable is expected to depreciate.

If a firm is hedging payables with futures contracts, it may end up paying more for the payables than it would have had it remained unhedged if the foreign currency depreciates.

If hedging projections cause a firm to believe that it will definitely be adversely affected by its transaction exposure, a currency option hedge is more appropriate than other methods.

Most MNCs can completely hedge all of their transactions.

Quiz 11: Managing Transaction Exposure

A cross-hedging strategy is most effective with currencies that are _____, whereas currency diversification is most effective with currencies that are ______.

Linden Co. has 1,000,000 euros as payables due in 90 days, and is certain that the euro is going to depreciate substantially over time. Assuming the firm is correct, the ideal strategy is to:​

To hedge a payables position in a foreign currency with a money market hedge, the MNC would borrow the foreign currency, convert it to dollars, and invest that amount in the United States until the payables are due.

If interest rate parity exists, and transaction costs do not exist, the option hedge will yield the same results as no hedge.

Futures, forward, and money market hedges all lock into a certain price to be received from hedging a receivable. For a currency option hedge with a put option, however, the exact amount received is not known until the option is (or is not) exercised.

Johnson Co. has 1,000,000 euros as payables due in 30 days, and is certain that the euro is going to appreciate substantially over time. Assuming the firm is correct, the ideal strategy is to:​

When a parent company tries to convince a subsidiary to hedge its transaction exposure, this is called leading.

MNCs should hedge receivables using bear spreads only for currencies that are expected to appreciate substantially prior to option expiration.

A money market hedge involves taking a money market position to cover a future payables or receivables position.

To hedge a receivables position with a currency option hedge, an MNC would buy a put option.

Cross-hedging may involve taking a forward position in a currency that is highly correlated with the currency an MNC needs to hedge.

A money market hedge on payables would involve, among others, borrowing ____ and investing in the ____.

An advantage of using options to hedge is that the MNC can let the option expire. However, a disadvantage of using options is that a premium must be paid for it.

Overhedging refers to the hedging of a larger amount in a currency than the actual transaction amount.

Lagging refers to the delay of payment by a subsidiary if the currency denominating the payable is expected to depreciate.

If a firm is hedging payables with futures contracts, it may end up paying more for the payables than it would have had it remained unhedged if the foreign currency depreciates.

If hedging projections cause a firm to believe that it will definitely be adversely affected by its transaction exposure, a currency option hedge is more appropriate than other methods.

Most MNCs can completely hedge all of their transactions.

A cross-hedging strategy is most effective with currencies that are _, whereas currency diversification is most effective with currencies that are __.

Linden Co. has 1,000,000 euros as payables due in 90 days, and is certain that the euro is going to depreciate substantially over time. Assuming the firm is correct, the ideal strategy is to:

Johnson Co. has 1,000,000 euros as payables due in 30 days, and is certain that the euro is going to appreciate substantially over time. Assuming the firm is correct, the ideal strategy is to:

A money market hedge on payables would involve, among others, borrowing and investing in the .