Question 1

The text refers to three different sources of risk that, while not unique to MNEs, are particularly important for firms competing in the global environment and can be managed using specialized financial market instruments. What are these three sources of risk?

Accepted Answer

Exchange rate risk, interest rate risk, and commodity price risk are the three sources of risk that are particularly important for firms competing in the global environment.

Question 2

The primary types of contractual hedge include all except which of the following?

Accepted Answer

Operating hedge is not a type of contractual hedge. Contractual hedges involve specific financial contracts like forwards, options, and money market instruments, whereas operating hedges involve operational strategies such as diversifying production locations or sourcing.

Question 3

Commodities that are traded in futures markets are usually grouped into what three categories?

Accepted Answer

Commodities traded in futures markets are commonly categorized into agriculture products (like wheat, corn, soybeans), metals (such as gold, silver, copper), and energy (including oil and natural gas). These categories cover a broad range of commodities that are essential for various industries and are actively traded on futures exchanges.

Question 4

One way to categorize risks is to divide them into two groups, one dealing with specific transactions and the other with ongoing operations. Which of the following statements is/are correct regarding these risks?

Accepted Answer

Continuing risks indeed relate to aggregated items in financial statements affected by changing rates, and discrete risks are associated with specific transactions that impact the income statement upon realization. However, accounting exposures do not create real economic gains or losses but rather impact how financial results are reported.

Question 5

Hedging, or the creation of offsetting assets and liabilities so that gains on one side offset losses on the other, is a common but controversial practice. Arguments in favor of hedging include which of the following statements?

Accepted Answer

The answer of Hedging, or the creation of offsetting assets...

Question 6

Hedging, or the creation of offsetting assets and liabilities so that gains on one side offset losses on the other, is a common but controversial practice. Arguments against hedging include which of the following statements?

Accepted Answer

All the statements provided are arguments against hedging. Statement A suggests that shareholders can manage risk more effectively on their own. Statement B implies that hedging does not add value in efficient markets. Statement C argues that market efficiency already incorporates currency risk into stock prices, making hedging unnecessary.

Question 7

Which of the following statements about currency hedging are incorrect?

Accepted Answer

A) is incorrect because a covered forward contract is a financial, not an operating hedge. Operating hedges involve adjustments to business operations or corporate strategies, not financial instruments.

Question 8

If a company has floating-rate debt tied to dollar LIBOR and wants to eliminate the possibility that LIBOR will exceed a particular rate (but preserve the possibility the LIBOR could decline), which of the following instruments would it most likely use?

Accepted Answer

An interest rate cap is the most suitable instrument for a company looking to eliminate the possibility that LIBOR will exceed a specific rate while still benefiting if LIBOR declines. This is because an interest rate cap sets a maximum (cap) on the interest rate the company will pay, without eliminating the potential benefit of paying a lower interest rate if LIBOR falls.

Question 9

Which of the following statements are correct about economic exposure?

Accepted Answer

All the statements accurately describe aspects of economic exposure, including the integration of transaction exposures, the limitations of financial markets in managing macroeconomic changes, and the importance of strategic operating decisions.

Question 10

If a company has floating-rate debt tied to dollar LIBOR and wants to eliminate the risk associated with changes in LIBOR, it can use all except which of the following instruments?

Accepted Answer

All the instruments listed (interest rate futures, forward rate agreement, coupon swap, and zero width interest rate collar) can be used to hedge against the risk of changing LIBOR rates. Each of these financial instruments can be structured in a way to offset the risk associated with floating-rate debt tied to LIBOR.

Question 11

Erwin Manufacturing Company has a floating-rate interest payment tied to LIBOR due in June 2005. The CFO wants to use interest rate futures to hedge the risk that LIBOR could increase. How would he do this?

Accepted Answer

To hedge against the risk of rising interest rates, the CFO should sell an interest rate futures contract (take a short position). If interest rates rise, the value of the futures contract will decrease, offsetting the increased cost of the floating-rate interest payment.

Question 12

Cosgrove Manufacturing Company just sold products to a German company for €1,275,000. The account receivable was booked as $1,568,250 at the current spot rate of $1.2300/€. Cosgrove is worried that the dollar might strengthen against the euro in the 30 days until the account will be collected, so it decides to hedge the transaction at the 30-day forward rate of $1.2310/€. By hedging, Cosgrove will lock in a ______ of _______?

Accepted Answer

By hedging at the forward rate of $1.2310/€, Cosgrove locks in a gain of $1,275 because the forward rate is slightly higher than the spot rate, resulting in a higher dollar amount when converted.

Question 13

Lakewood Products, Inc. just bought €2,650,000 in products from a French supplier with payment due in 30 days. The spot exchange rate today is $1.2300/€ and the 30-day forward rate is $1.2310/€. If Lakewood decides to hedge the transaction, they will have to book a ______ of _______ at the end of 30 days.

Accepted Answer

The answer of Lakewood Products, Inc. just bought €2,650,000 in...

Question 14

An investor has purchased both a call option and a put option on the same stock. The call option has a strike price of $20 and the put option has a strike price of $25. If the current stock price is $23, what payoff (per share) will the investor receive if the options were exercised?

Accepted Answer

The answer of An investor has purchased both a call...

Question 15

An investor has purchased both a call option and a put option on the same stock. The call option has a strike price of $30 and the put option has a strike price of $40. If the current stock price is $28, what payoff (per share) will the investor receive if the options were exercised?

Accepted Answer

The answer of An investor has purchased both a call...

Question 16

Milton Mining is a U.S. multinational that just purchased €1,100,000 of goods on account, due in 30 days from a German supplier. The spot exchange rate is $1.225/€. Milton wants to hedge the account payable with an OTC call option with a strike price of $1.250/€. The option premium is 0.50 percent. What is the U.S. dollar cost of the option?

Accepted Answer

The U.S. dollar cost of the option is calculated by multiplying the option premium (0.50%) by the notional amount in dollars (€1,100,000 * $1.250/€), which equals $6,737.50.

Question 17

Cosgrove Manufacturing Company just sold products to a German company for €1,275,000 on terms of net 30 days. Cosgrove is worried that the dollar might strengthen against the euro in the 30 days the credit is outstanding, so it has decided to hedge the receivable with a money market hedge. Current euro interest rates are 4.42 percent per annum or 0.3684 percent per month and U.S. interest rates are 5.40 percent per annum or 0.45 percent per month. The current spot rate is $1.2300/€ and the forward rate is $1.2310/€. How much does Cosgrove have to borrow today in euros to hedge this transaction, and will the transaction lead to a transaction gain or loss?

Accepted Answer

The answer of Cosgrove Manufacturing Company just sold products to...

Question 18

Lakewood Products, Inc. just bought €2,650,000 in products from a French supplier with payment due in 30 days. The spot exchange rate today is $1.2300/€ and the 30-day forward rate is $1.2310/€, but Lakewood is apprehensive that the dollar might fall even more during the 30-day period. The company has decided to use a money market hedge for this transaction. The French interest rate is 4.42 percent per annum or 0.3684 percent per month, and the U.S. interest rate is 5.40 percent per annum or 0.45 percent per month. How many dollars must Lakewood invest today to hedge this transaction with a money market hedge?

Accepted Answer

To hedge using a money market hedge, Lakewood needs to invest the present value of the euro payment in dollars today. The present value of €2,650,000 at the French interest rate is €2,650,000 / (1 + 0.003684) = €2,640,272. The dollar amount needed today is €2,640,272 * $1.2300/€ = $3,247,536.

Question 19

Adams Systems is a U.S. multinational that just purchased €1 million of goods on account, due in 30 days from a French supplier. The spot exchange rate is $1.235/€, while the 30-day forward rate is $1.201/€. Adams is interested in hedging this account payable by using a money market hedge. If the 30-day periodic investment rate in France is 0.15 percent, how many U.S. dollars does Adams need to invest to properly hedge the account payable?

Accepted Answer

The answer of Adams Systems is a U.S. multinational that...

Question 20

Cullen Pharmaceuticals is a U.S. multinational that just sold ¥70 million of goods to a Japanese customer on account, due in 30 days. The spot exchange rate is $0.008987/¥, while the 30-day forward rate is 0.008671/¥. Cullen is interested in hedging this account receivable by using a forward market hedge. If the 30-day periodic investment rate in Japan is 0.10 percent, how many U.S. dollars does Adams need to invest to properly hedge the account receivable?

Accepted Answer

The answer of Cullen Pharmaceuticals is a U.S. multinational that...

Quiz 15: Derivatives and Risk Management