Deck 11: Managing Transaction Exposure

Question 1

When comparing the forward hedge to the options hedge, the MNC can easily determine which hedge is more desirable, because the cost of each hedge can be determined with certainty.

Answer 1

False

Question 2

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

Answer 2

True

Question 3

Many MNCs use selective hedging, in which they consider each type of transaction separately.

Answer 3

True

Question 4

When the real cost of hedging payables is positive, this implies that hedging was more favorable than not hedging.

Question 5

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

Question 6

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

Question 7

If an MNC is extremely risk-averse, it may decide to hedge even though its hedging analysis indicates that remaining unhedged will probably be less costly than hedging.
​

Question 8

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.

Question 9

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

Question 10

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

Question 11

The hedging of a foreign currency for which no forward contract is available with a highly correlated currency for which a forward contract is available is referred to as cross-hedging.

Question 12

The exact cost of hedging with call options (as measured in the text) is not known with certainty at the time that the options are purchased.

Question 13

To hedge a payables position with a currency option hedge, an MNC would write a call option.

Question 14

If interest rate parity exists, the forward hedge will always outperform the money market hedge.
​

Question 15

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

Question 16

When comparing the forward hedge to the money market hedge, the MNC can easily determine which hedge is more desirable, because the cost of each hedge can be determined with certainty.

Question 17

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.

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.

Question 19

Currency futures are very similar to forward contracts, except that they are standardized and are more appropriate for firms that prefer to hedge in smaller amounts.

Question 20

The real cost of hedging payables in Japanese yen is especially high when the yen appreciates over time.

Question 21

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:

A) sell euros forward.
B) purchase euro currency put options.
C) purchase euro currency call options.
D) purchase euros forward.
E) remain unhedged.

Question 22

The trade-off when considering alternative call options to hedge a currency position is that an MNC can obtain a call option with a higher exercise price, but would have to pay a higher premium.

Question 23

Hedging the position of individual subsidiaries is generally necessary, even if the overall performance of the MNC is already insulated by the offsetting positions between subsidiaries.
​

Question 24

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.

Question 25

FAB Corp. will need 200,000 Canadian dollars (C$) in 90 days to cover a payables position. Currently, a 90-day call option with an exercise price of $.75 and a premium of $.01 is available. Also, a 90-day put option with an exercise price of $.73 and a premium of $.01 is available. FAB plans to purchase options to hedge its payables position. Assuming that the spot rate in 90 days is $.71, what is the net amount paid, assuming FAB wishes to minimize its cost?​

A) ​$144,000
B) ​$148,000
C) ​$152,000
D) ​$150,000

Question 26

Most MNCs can completely hedge all of their transactions.

Question 27

Sometimes the overall performance of an MNC may already be insulated by offsetting effects between subsidiaries, and it may not be necessary to hedge the position of each individual subsidiary.

Question 28

A ____ is not normally used for hedging long-term transaction exposure.​

A) ​long-term forward contact
B) ​futures contract
C) ​currency swap
D) ​parallel loan

Question 29

The price at which a currency put option allows the holder to sell a currency is called the settlement price.

Question 30

Since forward contracts are easy to use for hedging, any exposure to exchange rate movements should be hedged.

Question 31

To hedge payables with futures, an MNC would sell futures; to hedge receivables with futures, an MNC would buy futures.

Question 32

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

Question 33

Since the results of both a money market hedge and a forward hedge are known beforehand, an MNC can implement the one that is more feasible.

Question 34

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

Question 35

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

Question 36

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

Question 37

In a forward hedge, if the forward rate is an accurate predictor of the future spot rate, the real cost of hedging payables will be:

A) highly positive.
B) highly negative.
C) zero.
D) None of these are correct.

Question 38

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.

Question 39

A put option essentially represents two swaps of currencies: one swap at the inception of the loan contract and another swap at a specified date in the future.

Question 40

If interest rate parity (IRP) exists, then the money market hedge will yield the same result as the options hedge.

Question 41

Samson Inc. needs €1,000,000 in 30 days. Samson can earn 5 percent annualized on a German security. The current spot rate for the euro is $1.00. Samson can borrow funds in the United States at an annualized interest rate of 6 percent. If Samson uses a money market hedge, how much should it borrow in the United States?​

A) ​$952,381
B) ​$995,851
C) ​$943,396
D) ​$995,025

Question 42

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) sell euros forward.
B) purchase euro currency put options.
C) purchase euro currency call options.
D) purchase euros forward.
E) remain unhedged.

Question 43

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)?

A) $330,000
B) $325,000
C) $320,000
D) $340,000

Question 44

If interest rate parity exists and transaction costs are zero, the hedging of payables in euros with a forward hedge will:

A) have the same result as a call option hedge on payables.
B) have the same result as a put option hedge on payables.
C) have the same result as a money market hedge on payables.
D) require more dollars than a money market hedge.
E) have the same result as a call option hedge on payables AND require more dollars than a money market hedge.

Question 45

Your company will receive C$600,000 in 90 days. The 90-day forward rate in the Canadian dollar is $.80. If you use a forward hedge, you will:

A) receive $750,000 today.
B) receive $750,000 in 90 days.
C) pay $750,000 in 90 days.
D) receive $480,000 today.
E) receive $480,000 in 90 days.

Question 46

An example of cross-hedging is:

A) obtain a forward contract to purchase a currency that is highly correlated with the currency in which the payables are due.
B) use the forward market to sell forward whatever currencies you will receive.
C) use the forward market to buy forward whatever currencies you will pay.
D) use the forward market to sell forward whatever currencies you will receive AND use the forward market to buy forward whatever currencies you will pay.

Question 47

Which of the following reflects a hedge of net payables in British pounds by a U.S. firm?

A) Purchase a currency put option in British pounds.
B) Sell pounds forward.
C) Sell a currency call option in British pounds.
D) Borrow U.S. dollars, convert them to pounds, and invest them in a British pound deposit.
E) Purchase a currency put option in British pounds AND sell pounds forward.

Question 48

A ____ does not represent an obligation.​

A) ​long-term forward contract
B) ​currency swap
C) ​parallel loan
D) ​currency option

Question 49

Celine Co. will need €500,000 in 90 days to pay for German imports. Today's 90-day forward rate of the euro is $1.07. The spot rate of the euro in 90 days is forecasted to be $1.02. Based on this information, the expected value of the real cost of hedging payables is $____.

A) -25,000
B) 25,000
C) -107,000
D) 10,700

Question 50

Foghat Co. has 1,000,000 euros as receivables due in 30 days, and is certain that the euro will depreciate substantially over time. Assuming that the firm is correct, the ideal strategy is to:​

A) ​sell euros forward.
B) ​purchase euro currency put options.
C) ​purchase euro currency call options.
D) ​purchase euros forward.
E) ​remain unhedged.

Question 51

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

A) ​the foreign currency; United States
B) ​the foreign currency; foreign country
C) ​dollars; foreign country
D) ​dollars; United States

Question 52

​The real cost of hedging payables with a forward contract equals:

A) ​the dollar cost of hedging minus the dollar cost of not hedging.
B) ​the dollar cost of not hedging minus the dollar cost of hedging.
C) ​the dollar cost of hedging divided by the dollar cost of not hedging.
D) ​the dollar cost of not hedging divided by the dollar cost of hedging.

Question 53

From the perspective of Detroit Co., which has payables in Mexican pesos, hedging the payables is especially beneficial if the expected real cost of hedging the payables is:

A) negative.
B) zero.
C) positive and large.
D) positive and small.

Question 54

Assume zero transaction costs. If the 90-day forward rate of the euro is an accurate estimate of the spot rate 90 days from now, then the real cost of hedging payables will be:

A) ​positive.
B) ​negative.
C) ​positive if the forward rate exhibits a premium, and negative if the forward rate exhibits a discount.
D) ​zero.

Question 55

To hedge a ____ in a foreign currency, a firm may ____ a currency futures contract for that currency.

A) receivable; purchase
B) payable; sell
C) payable; purchase
D) None of these are correct.

Question 56

An MNC wants to hedge against the potential risk that the euro denominating its payables appreciates against the dollar. Yet, it also wants flexibility to benefit by buying euros at the spot rate when payables are due if the euro depreciates by that time. The appropriate hedge for this MNC would be a(n) ____ hedge.

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

Question 57

The ____ hedge is not a technique to eliminate transaction exposure discussed in your text.​

A) ​index
B) ​futures
C) ​forward
D) ​money market
E) ​currency option

Question 58

Assume the following information: U.S. deposit rate for 1 year
=
11%
U)S. borrowing rate for 1 year
=
12%
Swiss deposit rate for 1 year
=
8%
Swiss borrowing rate for 1 year
=
10%
Swiss forward rate for 1 year
=
$)40
Swiss franc spot rate
=
$)39
​
Also assume that a U.S. exporter denominates its Swiss exports in Swiss francs and expects to receive SF600,000 in 1 year.
​
Using the information above, what will be the approximate value of these exports in 1 year in U.S. dollars given that the firm executes a forward hedge?

A) $234,000
B) $238,584
C) $240,000
D) $236,127

Question 59

Assume zero transaction costs. If the 180-day forward rate overestimates the spot rate 180 days from now, then the real cost of hedging payables will be:​

A) ​positive.
B) ​negative.
C) ​positive if the forward rate exhibits a premium, and negative if the forward rate exhibits a discount.
D) ​zero.

Question 60

A forward contract hedge is very similar to a futures contract hedge, except that ____ contracts are commonly used for ____ transactions.

A) forward; small
B) futures; large
C) forward; large
D) None of these are correct.

Question 61

Assume zero transaction costs. If the 90-day forward rate of the euro underestimates the spot rate 90 days from now, then the real cost of hedging payables will be:​

A) ​positive.
B) ​negative.
C) ​positive if the forward rate exhibits a premium, and negative if the forward rate exhibits a discount.
D) ​zero.

Question 62

​A ____ involves an exchange of currencies between two parties, with a promise to re-exchange currencies at a specified exchange rate and future date.

A) ​long-term forward contract
B) ​currency option contract
C) ​parallel loan
D) ​money market hedge

Question 63

If interest rate parity exists, and transaction costs do not exist, the money market hedge will yield the same result as the ____ hedge.

A) put option
B) forward
C) call option
D) None of these are correct.

Question 64

Which of the following might be used to hedge exposure in the long run?

A) long-term forward contract
B) money market hedge
C) parallel loan
D) long-term forward contract AND parallel loan

Question 65

When a perfect hedge is not available to eliminate transaction exposure, the firm may consider methods to at least reduce exposure, such as:

A) leading.
B) lagging.
C) cross-hedging.
D) currency diversification.
E) All of these are correct.
Answer Key

Question 66

Spears Co. will receive SF1,000,000 in 30 days. Use the following information to determine the total dollar amount received (after accounting for the option premium) if the firm purchases and exercises a put option: Exercise price
=
$)61
Premium
=
$)02
Spot rate
=
$)60
Expected spot rate in 30 days
=
$)56
30-day forward rate
=
$)62
​

A) $630,000
B) $610,000
C) $600,000
D) $590,000
E) $580,000

Question 67

Blake Inc. needs €1,000,000 in 30 days. It can earn 5 percent annualized on a German security. The current spot rate for the euro is $1.00. Blake can borrow funds in the United States at an annualized interest rate of 6 percent. If Blake uses a money market hedge to hedge the payable, what is the cost of implementing the hedge?

A) $1,000,000
B) $1,055,602
C) $1,000,830
D) $1,045,644

Question 68

Money Corp. frequently uses a forward hedge to hedge its Malaysian ringgit (MYR) receivables. For the next month, Money has identified its net exposure to the ringgit as being MYR1,500,000. The 30-day forward rate is $.23. Furthermore, Money's financial center has indicated that the possible values of the Malaysian ringgit at the end of next month are $.20 and $.25, with probabilities of .30 and .70, respectively. Based on this information, the revenue from hedging minus the revenue from not hedging receivables is:

A) $0.
B) -$7,500.
C) $7,500.
D) None of these are correct.

Question 69

Assume that Cooper Co. will not use its cash balances in a money market hedge. When deciding between a forward hedge and a money market hedge, it ____ determine which hedge is preferable before implementing the hedge. It ____ determine whether either hedge will outperform an unhedged strategy before implementing the hedge.​

A) ​can; can
B) ​can; cannot
C) ​cannot; can
D) ​cannot; cannot

Question 70

Hanson Corp. frequently uses a forward hedge to hedge its British pound (£) payables. For the next quarter, Hanson has identified its net exposure to the pound as being £1,000,000. The 90-day forward rate is $1.50. Furthermore, Hanson's financial center has indicated that the predicted value of the British pound at the end of the next quarter is $1.57. Based on this information, what is the expected real cost of hedging payables?

A) $70,000
B) -$70,000
C) $0
D) $1,570,000

Question 71

​Assume that Smith Corp. will need to purchase 200,000 British pounds in 90 days. A call option exists on British pounds with an exercise price of $1.68, a 90-day expiration date, and a premium of $.04. A put option exists on British pounds with an exercise price of $1.69, a 90-day expiration date, and a premium of $.03. Smith Corporation plans to purchase options to cover its future payables. It will exercise the option in 90 days (if at all). It expects the spot rate of the pound to be $1.76 in 90 days. Determine the amount of dollars it will pay for the payables, including the amount paid for the option premium.

A) ​$360,000
B) ​$338,000
C) ​$332,000
D) ​$336,000
E) ​$344,000

Question 72

If Salerno Inc. desires to lock in a minimum rate at which it could sell its net receivables in Japanese yen but wants to be able to capitalize if the yen appreciates substantially against the dollar by the time payment arrives, the most appropriate hedge would be:​

A) ​a money market hedge.
B) ​a forward sale of yen.
C) ​purchasing yen call options.
D) ​purchasing yen put options.
E) ​selling yen put options.

Question 73

Quasik Corp. will be receiving 300,000 Canadian dollars (C$) in 90 days. Currently, a 90-day call option with an exercise price of $.75 and a premium of $.01 is available. Also, a 90-day put option with an exercise price of $.73 and a premium of $.01 is available. Quasik plans to purchase options to hedge its receivables position. Assuming that the spot rate in 90 days is $.71, what is the net amount received from the currency option hedge?

A) $219,000
B) $222,000
C) $216,000
D) $213,000