Deck 9: Transaction Exposure

Question 1

________ is a technique used by MNEs to deal with currency exposure.

A) No counter-measure
B) Speculation
C) Hedging
D) All are techniques MNEs could use.

Answer 1

All are techniques MNEs could use.

Question 2

Hedging, or reducing risk, is the same as adding value or return to the firm.

Answer 2

False

Question 3

Losses from ________ exposure generally reduce taxable income in the year they are realized. ________ exposure losses may reduce taxes over a series of years.

A) accounting; Operating
B) operating; Transaction
C) transaction; Operating
D) transaction; Accounting

Answer 3

transaction; Operating

Question 4

Which of the following is NOT cited as a good reason for hedging currency exposures?

A) Reduced risk of future cash flows is a good planning tool.
B) Reduced risk of future cash flows reduces the probability that the firm may not meet required cash flows.
C) Currency risk management increases the expected cash flows to the firm.
D) Management is in a better position to assess firm currency risk than individual investors.

Question 5

The key arguments in opposition to currency hedging such as market efficiency, agency theory, and diversification do not have financial theory at their core.

Question 6

MNE cash flows may be sensitive to changes in which of the following?

A) exchange rates
B) interest rates
C) commodity prices
D) all of the above

Question 7

Company X from USA has localized production near its suppliers in EU and exports its products worldwide. The company

A) does not have transactional exposure because majority of its suppliers are invoicing in Euros.
B) does not have translational exposure because it consolidates its reports in US dollars.
C) is not exposed to changes in foreign exchange rates.
D) has transactional, translational and operating type of exposure.

Question 8

Each of the following is another name for operating exposure EXCEPT

A) economic exposure.
B) strategic exposure.
C) accounting exposure.
D) competitive exposure.

Question 9

When a firm enters into a 90 day forward exchange contract

A) deliberately creates transaction exposure.
B) unintentionally eliminates all translation exposure.
C) does not create any exposure since the forward contract will deliver the notional amount at the current quote for the forward rate.
D) none of the above

Question 10

Assuming no transaction costs (i.e., hedging is "free"), hedging currency exposures should ________ the variability of expected cash flows to a firm and at the same time, the expected value of the cash flows should ________.

A) increase; not change
B) decrease; not change
C) not change; increase
D) not change; not change

Question 11

________ exposure deals with cash flows that result from existing contractual obligations.

A) Operating
B) Transaction
C) Translation
D) Economic

Question 12

Which of the following is cited as a good reason for NOT hedging currency exposures?

A) Shareholders are more capable of diversifying risk than management.
B) Currency risk management through hedging does not increase expected cash flows.
C) Hedging activities are often of greater benefit to management than to shareholders.
D) All of the above are cited as reasons NOT to hedge.

Question 13

Transaction exposure and operating exposure exist because of unexpected changes in future cash flows. The difference between the two is that ________ exposure deals with cash flows already contracted for, while ________ exposure deals with future cash flows that might change because of changes in exchange rates.

A) transaction; operating
B) operating; transaction
C) operating; accounting
D) none of the above

Question 14

Company Y submits 7 day validity offer for spare parts to be exported in Germany starting from January 1st in the following year. By doing so the company has

A) created transactional, but not quotation exposure.
B) created billing exposure in next fiscal year.
C) created limited quotation exposure.
D) did not create any types of exposure.

Question 15

________ exposure measures the change in the present value of the firm resulting from unexpected changes in exchange rates.

A) Operating
B) Transaction
C) Translation
D) Accounting

Question 16

Losses from ________ exposure generally reduce taxable income in the year they are realized. ________ exposure losses are not cash losses and therefore, are not tax deductible.

A) transaction; Operating
B) accounting; Operating
C) accounting; Transaction
D) transaction; Translation

Question 17

________ exposure is the potential for accounting-derived changes in owner's equity to occur because of the need to translate foreign currency financial statements into a single reporting currency.

A) Transaction
B) Operating
C) Economic
D) Accounting

Question 18

A U.S. firm sells merchandise today to a British company for £100,000. The current exchange rate is $2.03/£, the account is payable in three months, and the firm chooses to avoid any hedging techniques designed to reduce or eliminate the risk of changes in the exchange rate. The U.S. firm is at risk today of a loss if

A) the exchange rate changes to $2.00/£.
B) the exchange rate changes to $2.05/£.
C) the exchange rate doesn't change.
D) all of the above.

Question 19

There is considerable question among investors and managers about whether hedging is a good and necessary tool.

Question 20

________ exposure may result from a firm having a payable in a foreign currency.

A) Transaction
B) Accounting
C) Operating
D) None of the above

Question 21

Use the information for the following problem(s).
Plains States Manufacturing has just signed a contract to sell agricultural equipment to Boschin, a German firm, for euro 1,250,000. The sale was made in June with payment due six months later in December. Because this is a sizable contract for the firm and because the contract is in euros rather than dollars, Plains States is considering several hedging alternatives to reduce the exchange rate risk arising from the sale. To help the firm make a hedging decision you have gathered the following information.
• The spot exchange rate is $1.40/euro
• The six month forward rate is $1.38/euro
• Plains States' cost of capital is 11%
• The Euro zone 6-month borrowing rate is 9% (or 4.5% for 6 months)
• The Euro zone 6-month lending rate is 7% (or 3.5% for 6 months)
• The U.S. 6-month borrowing rate is 8% (or 4% for 6 months)
• The U.S. 6-month lending rate is 6% (or 3% for 6 months)
• December put options for euro 625,000; strike price $1.42, premium price is 1.5%
• Plains States' forecast for 6-month spot rates is $1.43/euro
• The budget rate, or the lowest acceptable sales price for this project, is $1,075,000 or $1.35/euro
Refer to Instruction 9.1. If Plains States locks in the forward hedge at $1.38/euro, and the spot rate when the transaction was recorded on the books was $1.40/euro, this will result in a "foreign exchange loss" accounting transaction of

A) $0.
B) $25,000.
C) This was not a loss; it was a gain of $25,000.
D) There is not enough information to answer this question.

Question 22

________ is NOT a popular contractual hedge against foreign exchange transaction exposure.

A) Forward market hedge
B) Money market hedge
C) Options market hedge
D) All of the above are contractual hedges.

Question 23

US firm submitted a fixed bid for a Euro multimillion project in Ukraine. The contract will be awarded in 12 months and the company knows there will be no advance payments. The company

A) should pay the premium for a 3 months put currency option to hedge the quotation exposure.
B) should write 3 months put currency option, receive the premium and roll it forward.
C) should buy 12 months put option and limit the loss to the premium amount if the bid gets rejected.
D) should get 1 year Euro denominated loan equal to the bid amount.

Question 24

Use the information for the following problem(s).
Plains States Manufacturing has just signed a contract to sell agricultural equipment to Boschin, a German firm, for euro 1,250,000. The sale was made in June with payment due six months later in December. Because this is a sizable contract for the firm and because the contract is in euros rather than dollars, Plains States is considering several hedging alternatives to reduce the exchange rate risk arising from the sale. To help the firm make a hedging decision you have gathered the following information.
• The spot exchange rate is $1.40/euro
• The six month forward rate is $1.38/euro
• Plains States' cost of capital is 11%
• The Euro zone 6-month borrowing rate is 9% (or 4.5% for 6 months)
• The Euro zone 6-month lending rate is 7% (or 3.5% for 6 months)
• The U.S. 6-month borrowing rate is 8% (or 4% for 6 months)
• The U.S. 6-month lending rate is 6% (or 3% for 6 months)
• December put options for euro 625,000; strike price $1.42, premium price is 1.5%
• Plains States' forecast for 6-month spot rates is $1.43/euro
• The budget rate, or the lowest acceptable sales price for this project, is $1,075,000 or $1.35/euro
Refer to Instruction 9.1. A ________ hedge allows Plains States to enjoy the benefits of a favorable change in exchange rates for their euro receivables contract while protecting the firm from unfavorable exchange rate changes.

A) forward
B) call option
C) put option
D) money market

Question 25

A U.S. firm sells merchandise today to a British company for £100,000. The current exchange rate is $2.03/£, the account is payable in three months, and the firm chooses to avoid any hedging techniques designed to reduce or eliminate the risk of changes in the exchange rate. If the exchange rate changes to $2.05/£ the U.S. firm will realize a ________ of ________.

A) loss; $2000
B) gain; $2000
C) loss; £2000
D) gain; £2000

Question 26

Use the information for the following problem(s).
Plains States Manufacturing has just signed a contract to sell agricultural equipment to Boschin, a German firm, for euro 1,250,000. The sale was made in June with payment due six months later in December. Because this is a sizable contract for the firm and because the contract is in euros rather than dollars, Plains States is considering several hedging alternatives to reduce the exchange rate risk arising from the sale. To help the firm make a hedging decision you have gathered the following information.
• The spot exchange rate is $1.40/euro
• The six month forward rate is $1.38/euro
• Plains States' cost of capital is 11%
• The Euro zone 6-month borrowing rate is 9% (or 4.5% for 6 months)
• The Euro zone 6-month lending rate is 7% (or 3.5% for 6 months)
• The U.S. 6-month borrowing rate is 8% (or 4% for 6 months)
• The U.S. 6-month lending rate is 6% (or 3% for 6 months)
• December put options for euro 625,000; strike price $1.42, premium price is 1.5%
• Plains States' forecast for 6-month spot rates is $1.43/euro
• The budget rate, or the lowest acceptable sales price for this project, is $1,075,000 or $1.35/euro
Refer to Instruction 9.1. The cost of a call option to Plains States would be

A) $17,653.
B) $16,733.
C) $18,471.
D) There is not enough information to answer this question.

Question 27

The structure of a money market hedge is similar to a forward hedge. The difference is the cost of the money market hedge is determined by the differential interest rates, while the forward hedge is a function of the forward rates quotation.

Question 28

Use the information for the following problem(s).
Plains States Manufacturing has just signed a contract to sell agricultural equipment to Boschin, a German firm, for euro 1,250,000. The sale was made in June with payment due six months later in December. Because this is a sizable contract for the firm and because the contract is in euros rather than dollars, Plains States is considering several hedging alternatives to reduce the exchange rate risk arising from the sale. To help the firm make a hedging decision you have gathered the following information.
• The spot exchange rate is $1.40/euro
• The six month forward rate is $1.38/euro
• Plains States' cost of capital is 11%
• The Euro zone 6-month borrowing rate is 9% (or 4.5% for 6 months)
• The Euro zone 6-month lending rate is 7% (or 3.5% for 6 months)
• The U.S. 6-month borrowing rate is 8% (or 4% for 6 months)
• The U.S. 6-month lending rate is 6% (or 3% for 6 months)
• December put options for euro 625,000; strike price $1.42, premium price is 1.5%
• Plains States' forecast for 6-month spot rates is $1.43/euro
• The budget rate, or the lowest acceptable sales price for this project, is $1,075,000 or $1.35/euro
Refer to Instruction 9.1. Money market hedges almost always return more than forward hedges because of the greater risk involved.

Question 29

Use the information for the following problem(s).
Plains States Manufacturing has just signed a contract to sell agricultural equipment to Boschin, a German firm, for euro 1,250,000. The sale was made in June with payment due six months later in December. Because this is a sizable contract for the firm and because the contract is in euros rather than dollars, Plains States is considering several hedging alternatives to reduce the exchange rate risk arising from the sale. To help the firm make a hedging decision you have gathered the following information.
• The spot exchange rate is $1.40/euro
• The six month forward rate is $1.38/euro
• Plains States' cost of capital is 11%
• The Euro zone 6-month borrowing rate is 9% (or 4.5% for 6 months)
• The Euro zone 6-month lending rate is 7% (or 3.5% for 6 months)
• The U.S. 6-month borrowing rate is 8% (or 4% for 6 months)
• The U.S. 6-month lending rate is 6% (or 3% for 6 months)
• December put options for euro 625,000; strike price $1.42, premium price is 1.5%
• Plains States' forecast for 6-month spot rates is $1.43/euro
• The budget rate, or the lowest acceptable sales price for this project, is $1,075,000 or $1.35/euro
Refer to Instruction 9.1. Plains States could hedge the Euro receivables in the money market. Using the information provided, how much would the money market hedge return in six months assuming Plains States reinvests the proceeds at the U.S. investment rate?

A) $1,250,000
B) $1,724,880
C) $1,674,641
D) $1,207,371

Question 30

Use the information for the following problem(s).
Plains States Manufacturing has just signed a contract to sell agricultural equipment to Boschin, a German firm, for euro 1,250,000. The sale was made in June with payment due six months later in December. Because this is a sizable contract for the firm and because the contract is in euros rather than dollars, Plains States is considering several hedging alternatives to reduce the exchange rate risk arising from the sale. To help the firm make a hedging decision you have gathered the following information.
• The spot exchange rate is $1.40/euro
• The six month forward rate is $1.38/euro
• Plains States' cost of capital is 11%
• The Euro zone 6-month borrowing rate is 9% (or 4.5% for 6 months)
• The Euro zone 6-month lending rate is 7% (or 3.5% for 6 months)
• The U.S. 6-month borrowing rate is 8% (or 4% for 6 months)
• The U.S. 6-month lending rate is 6% (or 3% for 6 months)
• December put options for euro 625,000; strike price $1.42, premium price is 1.5%
• Plains States' forecast for 6-month spot rates is $1.43/euro
• The budget rate, or the lowest acceptable sales price for this project, is $1,075,000 or $1.35/euro
Refer to Instruction 9.1. If Plains States chooses to implement a money market hedge for the Euro receivables, how much money will the firm borrow today?

A) euro 1,201,923
B) $1,201,923
C) euro 1,196,172
D) $1,196,172

Question 31

Use the information for the following problem(s).
Plains States Manufacturing has just signed a contract to sell agricultural equipment to Boschin, a German firm, for euro 1,250,000. The sale was made in June with payment due six months later in December. Because this is a sizable contract for the firm and because the contract is in euros rather than dollars, Plains States is considering several hedging alternatives to reduce the exchange rate risk arising from the sale. To help the firm make a hedging decision you have gathered the following information.
• The spot exchange rate is $1.40/euro
• The six month forward rate is $1.38/euro
• Plains States' cost of capital is 11%
• The Euro zone 6-month borrowing rate is 9% (or 4.5% for 6 months)
• The Euro zone 6-month lending rate is 7% (or 3.5% for 6 months)
• The U.S. 6-month borrowing rate is 8% (or 4% for 6 months)
• The U.S. 6-month lending rate is 6% (or 3% for 6 months)
• December put options for euro 625,000; strike price $1.42, premium price is 1.5%
• Plains States' forecast for 6-month spot rates is $1.43/euro
• The budget rate, or the lowest acceptable sales price for this project, is $1,075,000 or $1.35/euro
Refer to Instruction 9.1. If Plains States chooses not to hedge their euro receivable, the amount they receive in six months will be

A) $1,750,000.
B) $1,250,000.
C) $892,857.
D) undeterminable today.

Question 32

Use the information for the following problem(s).
Plains States Manufacturing has just signed a contract to sell agricultural equipment to Boschin, a German firm, for euro 1,250,000. The sale was made in June with payment due six months later in December. Because this is a sizable contract for the firm and because the contract is in euros rather than dollars, Plains States is considering several hedging alternatives to reduce the exchange rate risk arising from the sale. To help the firm make a hedging decision you have gathered the following information.
• The spot exchange rate is $1.40/euro
• The six month forward rate is $1.38/euro
• Plains States' cost of capital is 11%
• The Euro zone 6-month borrowing rate is 9% (or 4.5% for 6 months)
• The Euro zone 6-month lending rate is 7% (or 3.5% for 6 months)
• The U.S. 6-month borrowing rate is 8% (or 4% for 6 months)
• The U.S. 6-month lending rate is 6% (or 3% for 6 months)
• December put options for euro 625,000; strike price $1.42, premium price is 1.5%
• Plains States' forecast for 6-month spot rates is $1.43/euro
• The budget rate, or the lowest acceptable sales price for this project, is $1,075,000 or $1.35/euro
Refer to Instruction 9.1. If Plains States purchases the put option, and the option expires in six months on the same day that Plains States receives the euro 1,250,000, the firm will exercise the put at that time if the spot rate is $1.43/euro.

Question 33

In efficient markets, interest rate parity should assure that the costs of a forward hedge and money market hedge should be approximately the same.

Question 34

A U.S. firm sells merchandise today to a British company for £100,000. The current exchange rate is $2.03/£, the account is payable in three months, and the firm chooses to avoid any hedging techniques designed to reduce or eliminate the risk of changes in the exchange rate. If the exchange rate changes to $2.01/£ the U.S. firm will realize a ________ of ________.

A) loss; $2,000
B) gain; $2,000
C) loss; £2000
D) gain; £2000

Question 35

German company is evaluating alternatives to hedge US1M payable in three months. A money market hedge for this transaction will be

A) raising Euro denominated short term loan at annual interest rate of 2%.
B) investing in dollar denominated short term government security yielding 0.2%.
C) one cannot hedge payable with money market hedge
D) there is no need to hedge since the US dollar has been constantly appreciating against the Euro in the past three months.

Question 36

Use the information for the following problem(s).
Plains States Manufacturing has just signed a contract to sell agricultural equipment to Boschin, a German firm, for euro 1,250,000. The sale was made in June with payment due six months later in December. Because this is a sizable contract for the firm and because the contract is in euros rather than dollars, Plains States is considering several hedging alternatives to reduce the exchange rate risk arising from the sale. To help the firm make a hedging decision you have gathered the following information.
• The spot exchange rate is $1.40/euro
• The six month forward rate is $1.38/euro
• Plains States' cost of capital is 11%
• The Euro zone 6-month borrowing rate is 9% (or 4.5% for 6 months)
• The Euro zone 6-month lending rate is 7% (or 3.5% for 6 months)
• The U.S. 6-month borrowing rate is 8% (or 4% for 6 months)
• The U.S. 6-month lending rate is 6% (or 3% for 6 months)
• December put options for euro 625,000; strike price $1.42, premium price is 1.5%
• Plains States' forecast for 6-month spot rates is $1.43/euro
• The budget rate, or the lowest acceptable sales price for this project, is $1,075,000 or $1.35/euro
Refer to Instruction 9.1. Plains States chooses to hedge its transaction exposure in the forward market at the available forward rate. The payoff in 6 months will be

A) $1,750,000.
B) $1,250,000.
C) $1,725,000.
D) $1,787,500.

Question 37

Use the information for the following problem(s).
Plains States Manufacturing has just signed a contract to sell agricultural equipment to Boschin, a German firm, for euro 1,250,000. The sale was made in June with payment due six months later in December. Because this is a sizable contract for the firm and because the contract is in euros rather than dollars, Plains States is considering several hedging alternatives to reduce the exchange rate risk arising from the sale. To help the firm make a hedging decision you have gathered the following information.
• The spot exchange rate is $1.40/euro
• The six month forward rate is $1.38/euro
• Plains States' cost of capital is 11%
• The Euro zone 6-month borrowing rate is 9% (or 4.5% for 6 months)
• The Euro zone 6-month lending rate is 7% (or 3.5% for 6 months)
• The U.S. 6-month borrowing rate is 8% (or 4% for 6 months)
• The U.S. 6-month lending rate is 6% (or 3% for 6 months)
• December put options for euro 625,000; strike price $1.42, premium price is 1.5%
• Plains States' forecast for 6-month spot rates is $1.43/euro
• The budget rate, or the lowest acceptable sales price for this project, is $1,075,000 or $1.35/euro
Refer to Instruction 9.1. If Plains States chooses to hedge its transaction exposure in the forward market, it will ________ euro 1,250,000 forward at a rate of ________.

A) sell; $1.38/euro
B) sell; $1.40/euro
C) buy; $1.38/euro
D) buy; $1.40/euro

Question 38

Use the information for the following problem(s).
Plains States Manufacturing has just signed a contract to sell agricultural equipment to Boschin, a German firm, for euro 1,250,000. The sale was made in June with payment due six months later in December. Because this is a sizable contract for the firm and because the contract is in euros rather than dollars, Plains States is considering several hedging alternatives to reduce the exchange rate risk arising from the sale. To help the firm make a hedging decision you have gathered the following information.
• The spot exchange rate is $1.40/euro
• The six month forward rate is $1.38/euro
• Plains States' cost of capital is 11%
• The Euro zone 6-month borrowing rate is 9% (or 4.5% for 6 months)
• The Euro zone 6-month lending rate is 7% (or 3.5% for 6 months)
• The U.S. 6-month borrowing rate is 8% (or 4% for 6 months)
• The U.S. 6-month lending rate is 6% (or 3% for 6 months)
• December put options for euro 625,000; strike price $1.42, premium price is 1.5%
• Plains States' forecast for 6-month spot rates is $1.43/euro
• The budget rate, or the lowest acceptable sales price for this project, is $1,075,000 or $1.35/euro
Refer to Instruction 9.1. Plains States would be ________ by an amount equal to ________ with a forward hedge than if they had not hedged and their predicted exchange rate for 6 months had been correct.

A) better off; $43,750
B) better off; $62,500
C) worse off; $43,750
D) worse off; $62,500

Question 39

US firm submitted a fixed bid for a Euro multimillion project in Ukraine. The contract will be awarded in 12 months and the company knows there will be no advance payments. The company

A) should pay the premium for a 3 months put currency option to hedge the quotation exposure.
B) should write 3 months put currency option, receive the premium and roll it forward.
C) should buy 12 months put option and limit the loss to the premium amount if the bid gets rejected.
D) should get 1 year Euro denominated loan equal to the bid amount.

Question 40

Use the information for the following problem(s).
Plains States Manufacturing has just signed a contract to sell agricultural equipment to Boschin, a German firm, for euro 1,250,000. The sale was made in June with payment due six months later in December. Because this is a sizable contract for the firm and because the contract is in euros rather than dollars, Plains States is considering several hedging alternatives to reduce the exchange rate risk arising from the sale. To help the firm make a hedging decision you have gathered the following information.
• The spot exchange rate is $1.40/euro
• The six month forward rate is $1.38/euro
• Plains States' cost of capital is 11%
• The Euro zone 6-month borrowing rate is 9% (or 4.5% for 6 months)
• The Euro zone 6-month lending rate is 7% (or 3.5% for 6 months)
• The U.S. 6-month borrowing rate is 8% (or 4% for 6 months)
• The U.S. 6-month lending rate is 6% (or 3% for 6 months)
• December put options for euro 625,000; strike price $1.42, premium price is 1.5%
• Plains States' forecast for 6-month spot rates is $1.43/euro
• The budget rate, or the lowest acceptable sales price for this project, is $1,075,000 or $1.35/euro
Refer to Instruction 9.1. What is the cost of a put option hedge for Plains States' euro receivable contract? (Note: Calculate the cost in future value dollars and assume the firm's cost of capital as the appropriate interest rate for calculating future values.)

A) $27,694
B) $26,250
C) euro 27,694
D) euro 26,250

Question 41

List and define the three types of foreign exchange exposure presented by your authors.

Question 42

Does foreign currency exchange hedging both reduce risk and increase expected value? Explain, and list several arguments in favor of currency risk management and several against.

Question 43

Currency risk management techniques include forward hedges, money market hedges, and option hedges. Draw a diagram showing the possible outcomes of these hedging alternatives for a foreign currency receivable contract. In your diagram, be sure to label the X and Y-axis, the put option strike price, and show the possible results for a money market hedge, a forward hedge, a put option hedge, and an uncovered position. (Note: Assume the forward currency receivable is British pounds and the put option strike price is $1.50/£, the price of the option is $0.04 the forward rate is $1.52/£ and the current spot rate is $1.48/£.)