Deck 12: Managing Economic Exposure and Translation Exposure

Question 1

Rockington ltd. is a UK manufacturing firm that produces goods in the UK and sells all products to retail stores in the US; the goods are denominated in dollars. It finances a small portion of its business with dollar-denominated loans from US banks. Which of the following is true? (Assume that the amount of products to be sold is guaranteed by contracts.)

A) The pound value of sales is higher if the dollar depreciates against the pound.
B) The pound value of sales is unaffected by the dollar's exchange rate.
C) A and B
D) None of the above

Answer 1

D

Question 2

Managing economic exposure is generally perceived to be ____ managing transaction exposure.

A) more difficult than
B) less difficult than
C) just as difficult as
D) None of the above

Answer 2

A

Question 3

Sycamore (a UK firm) has no subsidiaries and presently has sales to Mexican customers amounting to MXP 98 million, while its peso-denominated expenses amount to MXP 41 million. If it shifts its material orders from its Mexican suppliers to UK suppliers, it could reduce peso-denominated expenses by MXP 12 million and increase pound-denominated expenses by £400,000. This strategy would ____ the Sycamore's exposure to changes in the peso's movements against the pound. Regardless of whether the firm shifts expenses, it is likely to perform better when the peso value is ____ relative to the pound.

A) reduce; high
B) reduce; low
C) increase; low
D) increase; high

Answer 3

D

Question 4

Transaction exposure results when an MNC translates each subsidiary's financial data to its home currency for consolidated financial statements.

Question 5

In general, it is more difficult to effectively hedge economic or translation exposure than to hedge transaction exposure.

Question 6

UK-based MNCs invoicing in Asian currencies and incurring expenses in Asian currencies were probably less affected by weakness of Asian currencies than UK-based MNCs that invoice in Asian currencies but do not incur expenses in those currencies.

Question 7

A foreign subsidiary with more susceptible expenses than revenue to exchange rate movements will be favourably affected by an appreciation of the foreign currency.

Question 8

If a firm is subject to ____, then it must be subject to translation exposure.

A) transaction exposure
B) economic exposure
C) A and B
D) None of the above

Question 9

____ represents any impact of exchange rate fluctuations on a firm's future cash flows.

A) Translation exposure
B) Economic exposure
C) Transaction exposure
D) None of the above

Question 10

Any restructuring of operations that ____ the difference between a foreign currency's inflows and outflows may ____ economic exposure.

A) reduces; increase
B) increases; reduce
C) reduces; reduce
D) A and B
E) None of the above

Question 11

It is generally least difficult to effectively hedge various types of:

A) translation exposure.
B) transaction exposure.
C) economic exposure.
D) A and C

Question 12

____ exposure occurs when an MNC translates each subsidiary's financial data to its home currency for consolidated financial statements.

A) Translation
B) Transaction
C) Economic
D) None of the above

Question 13

As opposed to transaction exposure, managing economic exposure involves developing a ____ solution.

A) short-term
B) long-term
C) immediate
D) None of the above

Question 14

Depreciation of the pound relative to the US dollar will cause a US-based multinational firm's reported earnings (from the consolidated income statement) to ____. If a firm desired to protect against this possibility, it could stabilize its reported earnings by ____ pounds forward in the foreign exchange market.

A) be reduced; purchasing
B) be reduced; selling
C) increase; selling
D) increase; purchasing

Question 15

An MNC expects to sell fixed assets it utilizes in the US in the distant future. In order to hedge the sale of these assets in the distant future, the MNC could create a(n) ____ that ____ the expected value of the assets in the future.

A) asset; matches
B) asset; exceeds
C) liability; matches
D) liability; is less than

Question 16

Which of the following is an example of economic exposure but not an example of transaction exposure?

A) An increase in the pound's value hurts a UK firm's domestic sales because foreign competitors are able to increase their sales to UK customers.
B) An increase in the dollar's value increases the UK firm's cost of US payables.
C) A decrease in the euro's value decreases a UK firm's pound value of euro receivables.
D) A decrease in the Swiss franc's value decreases the pound value of interest payments on a Swiss deposit sent to a UK firm by a Swiss bank.

Question 17

Although forward contracts may reduce translation exposure at the expense of increasing transaction exposure, they are sometimes used to hedge translation exposure.

Question 18

A limitation of hedging translation exposure is that translation losses are not tax deductible, whereas gains on forward contracts used to hedge translation exposure are taxed.

Question 19

Springfield plc, based in the UK, has a cost of goods sold attributable to foreign material orders that exceeds its foreign revenue. All foreign transactions are denominated in the foreign currency of concern. This firm would ____ a stronger pound and would ____ a weaker pound.

A) benefit from; be unaffected by
B) benefit from; be adversely affected by
C) be unaffected by; be adversely affected by
D) be unaffected by; benefit from
E) benefit from; benefit from

Question 20

All MNCs are subject to translation exposure.

Question 21

US firms can attempt to hedge their translation exposure of their European subsidiaries with a forward purchase of euros.

Question 22

In practice, a perfect hedge (full coverage) on translation exposure can usually be achieved when:

A) using the money market hedge.
B) using the forward hedge.
C) using the futures hedge.
D) none of the above, since a perfect hedge is nearly impossible.

Question 23

Long-term forward contracts are a possible way to hedge the distant sale of fixed assets in foreign countries, but they may not be available for many emerging market currencies.

Question 24

The translation gain (or loss) is simply a paper gain (or loss). Conversely, the gain (or loss) resulting from a hedge strategy is a real gain (or loss).

Question 25

With regard to hedging translation exposure, translation losses ____; and gains on forward contracts used to hedge translation exposure ____.

A) are not tax deductible; are taxed
B) are tax deductible; are taxed
C) are not tax deductible; are not taxed
D) are tax deductible; are not taxed

Question 26

An effective way for an MNC to assess its economic exposure is to look at the firm's:

A) income statement.
B) liquidity.
C) retained earnings.
D) level of stockholder's equity.

Question 27

If the Singapore dollar appreciates against the euro over this year, the consolidated earnings of a euro company with a subsidiary in Singapore will be ____ as a result of the exchange rate movement.

A) negative
B) adversely affected
C) favourably affected
D) unaffected

Question 28

Whitewater ltd. is a UK company with sales to Canada amounting to C$8 million. Its cost of goods sold attributable to the purchase of Canadian goods is C$6 million. Its interest expense on Canadian loans is C$4 million. Given these exact figures above, the pound value of Whitewater's 'earnings before interest and taxes' would ____ if the Canadian dollar appreciates; the pound value of Whitewater's "earnings before taxes" would ____ if the Canadian dollar appreciates.

A) increase; increase
B) decrease; increase
C) decrease; decrease
D) increase; decrease
E) increase; be unaffected

Question 29

Wisbeech ltd conducts business in Zambia. Years ago, Wisbeech established a subsidiary in Zambia that has consistently generated very large profits denominated in Zambian kwacha. Wisbeech wishes to restructure its operations to reduce economic exposure. Which of the following is not a feasible way of accomplishing this?

A) Increase Zambian supply orders.
B) Increase Zambian sales.
C) Restructure debt to increase debt payments in Zambia.
D) Reduce Zambian sales.

Question 30

The management of economic exposure is normally focused completely on transactions that will occur in the next three months.

Question 31

Hedging translation exposure with forward contracts can backfire if the currency being hedged depreciates.

Question 32

Assume a UK firm uses a forward contract to hedge all of its translation exposure. Also assume that the firm underestimated what its foreign earnings would be. Assume that the foreign currency depreciated over the year. The firm would generate a translation ____, which would be ____ than the gain generated by the forward contract.

A) loss; smaller
B) loss; larger
C) gain; larger
D) gain; smaller

Question 33

Cierra ltd is attempting to assess its degree of economic exposure in euros. In order to do so, it has applied regression analysis to determine whether the percentage change in its total cash flow is related to the percentage change in the euro. A ____ and statistically significant slope coefficient resulting from this analysis implies that the cash flows are ____ related to the percentage changes in the euro.

A) positive; positively
B) positive; negatively
C) negative; positively
D) B and C
E) none of the above

Question 34

Assume that a Japanese car manufacturer exports cars to UK dealerships, which are priced in yen. The demand for those cars declines when the yen is strong. The manufacturer also produces some cars in the UK with UK materials and those cars are priced in pounds. The manufacturer could reduce its economic exposure by:

A) closing down most of its plants in the UK.
B) producing more automobiles in the UK.
C) relying completely on Japanese suppliers for its parts.
D) pricing its exports in pounds.

Question 35

Which of the following firms is not exposed to translation exposure?

A) Firm X, with a fully owned subsidiary that periodically remits earnings generated in Great Britain to the euro-based parent.
B) Firm Y, with a fully owned subsidiary that periodically generates foreign losses in Sweden; the parent covers at least some of these losses.
C) Firm Z, with a fully owned subsidiary that generates substantial earnings in Germany; the subsidiary never remits earnings but reinvests them in Germany.
D) All of the above firms are exposed to translation exposure.

Question 36

If revenues and costs are equally sensitive to exchange rate movements, MNCs may reduce their economic exposure by restructuring their operations to shift the sources of costs or revenues to other locations so that:

A) cash inflows exceed cash outflows in each foreign currency.
B) cash outflows exceed cash inflows in each foreign currency.
C) cash inflows match cash outflows in each foreign currency.
D) none of the above.