Question 1

​According to the text, currency volatility levels ____ perfectly stable over time, and currency correlations ____ perfectly stable over time.
A) ​are; are not
B) ​are; are
C) ​are not; are not
D) ​are not; are

Accepted Answer

Currency volatility levels and currency correlations are not perfectly stable over time due to various economic, political, and market factors that can influence exchange rates and the relationships between different currencies.

Question 2

Assume that your firm is an importer of Mexican chairs denominated in pesos. Your competition is mainly U.S. producers of chairs. You wish to assess the relationship between the percentage change in the firm's stock price (SP_t) and the percentage change in the peso's value relative to the dollar (PESO_t). SP_t is the dependent variable. You apply the regression model to an earlier subperiod and a more recent subperiod. In the recent subperiod, you increased your importing volume. You should expect that the regression coefficient in the PESO_t variable would be ____ in the first subperiod and ____ in the second subperiod. A) negative; positive B) positive; positive C) positive; negative D) negative; negative

Accepted Answer

The regression coefficient in the PESO_t variable would likely be negative in both subperiods because as the value of the peso increases relative to the dollar, the cost of importing chairs from Mexico in dollar terms increases, potentially reducing the firm's profitability and thus negatively impacting its stock price. This relationship is expected to hold regardless of the volume of imports, although the magnitude of the effect might change.

Question 3

Jenco Co. imports raw materials from Japan, invoiced in U.S. dollars. The price it pays is not expected to change for the next several years. If the Japanese yen appreciates, Jenco's imports from Japan will probably ____ and if the Japanese yen depreciates, its imports from Japan will probably ____.
A) increase; decrease
B) decrease; increase
C) increase; stay the same
D) stay the same; stay the same

Accepted Answer

Since Jenco's imports are invoiced in U.S. dollars and the price is not expected to change, fluctuations in the value of the yen will not affect the cost of imports, meaning the volume of imports is likely to remain constant regardless of currency value changes.

Question 4

Generally, MNCs with less foreign costs than foreign revenues will ____ affected by a ____ foreign currency.
A) be favorably; stronger
B) not be; stronger
C) be favorably; weaker
D) not be; weaker
E) not be; stronger AND not be; weaker

Accepted Answer

MNCs with less foreign costs than foreign revenues will be favorably affected by a stronger foreign currency because it will increase the value of their foreign revenues relative to their foreign costs.

Question 5

Exhibit 10-2
Volusia, Inc. is a U.S.-based exporting firm that expects to receive payments denominated in both euros and Canadian dollars in one month. Based on today's spot rates, the dollar value of the funds to be received is estimated at $500,000 for the euros and $300,000 for the Canadian dollars. Based on data for the last 50 months, Volusia estimates the standard deviation of monthly percentage changes to be 8 percent for the euro and 3 percent for the Canadian dollar. The correlation coefficient between the euro and the Canadian dollar is 0.30.
-Refer to Exhibit 10-2. What is the portfolio standard deviation?
A) 3.00 percent
B) 5.44 percent
C) 17.98 percent
D) None of these are correct.

Accepted Answer

To calculate the portfolio standard deviation, we need to use the following formula:

σp = √[(w1^2 × σ1^2) + (w2^2 × σ2^2) + (2 × w1 × w2 × σ1 × σ2 × ρ)]

where:
σ1 = standard deviation of euro
σ2 = standard deviation of Canadian dollar
w1 = weight of euro in the portfolio (in dollar terms)
w2 = weight of Canadian dollar in the portfolio (in dollar terms)
ρ = correlation coefficient between the euro and Canadian dollar

Here, we can assume that the weights are equal (i.e., 0.5 for each currency).

So, plugging in the given values, we get:

σp = √[(0.5^2 × 0.08^2) + (0.5^2 × 0.03^2) + (2 × 0.5 × 0.5 × 0.08 × 0.03 × 0.30)]
   = 0.0544 or 5.44%

Therefore, the portfolio standard deviation is 5.44%. The answer is B.

Question 6

​Assume that the British pound and Swiss franc are highly correlated. A U.S. firm anticipates the equivalent of $1 million cash outflows in francs and the equivalent of $1 million cash outflows in pounds. During a ____ cycle, the firm is ____ affected by its exposure.
A) ​strong dollar; favorably
B) ​weak dollar; not
C) ​strong dollar; not
D) ​weak dollar; favorably

Accepted Answer

During a strong dollar cycle, the value of foreign currencies like the British pound and Swiss franc decreases relative to the dollar. This means the firm would need fewer dollars to meet its obligations in these currencies, thus being favorably affected by its exposure.

Question 7

Vada, Inc. exports computers to Australia, invoiced in U.S. dollars. Its main competitor is located in Japan. Vada is subject to:
A) economic exposure.
B) transaction exposure.
C) translation exposure.
D) economic exposure AND transaction exposure.

Accepted Answer

Economic exposure refers to the risk that a company's cash flow, earnings, or future cash flows will be affected by changes in exchange rates. Since Vada, Inc. is competing with a company in Japan while exporting to Australia and invoicing in U.S. dollars, changes in the exchange rate could affect its competitive position and pricing, leading to economic exposure. Transaction exposure, on the other hand, relates to losses or gains arising from the settlement of existing financial obligations whose terms are stated in a foreign currency. Since the question does not mention any obligations to be settled in foreign currency, transaction exposure is not the primary concern here. Translation exposure involves the impact of currency exchange rate changes on the reported financial statements of a company, which is not indicated as a concern in the scenario provided.

Question 8

​Translation exposure reflects:
A) ​the exposure of a firm's international transactions to exchange rate fluctuations.
B) ​the exposure of a firm's local currency value to transactions between foreign exchange traders.
C) ​the exposure of a firm's financial statements to exchange rate fluctuations.
D) ​the exposure of a firm's cash flows to exchange rate fluctuations.

Accepted Answer

Translation exposure refers to the impact of exchange rate fluctuations on a company's financial statements. This arises when a company has foreign subsidiaries or assets and liabilities denominated in a foreign currency that need to be translated into the company's reporting currency for accounting purposes. The translation of these items can result in gains or losses due to fluctuations in exchange rates. Option A is incorrect as it refers to transaction exposure, which involves the impact of exchange rate fluctuations on a company's transactions with foreign customers, suppliers, or creditors. Option B is incorrect as it is a reference to market exposure or market risk, which is the risk associated with changes in the market value of a company's assets or liabilities. Option D is incorrect as it refers to operating exposure or economic exposure, which is the impact of exchange rate fluctuations on a company's future cash flows and profits.

Question 9

​If a U.S. firm's sales in Australia are much greater than its cost of goods sold in Australia, the appreciation of the Australian dollar has a ____ impact on the firm's ____.
A) ​positive; interest expenses
B) ​positive; gross profit
C) ​negative; interest expenses
D) ​negative; gross profit

Accepted Answer

If the U.S. firm's sales in Australia are much greater than its cost of goods sold in Australia, then an appreciation of the Australian dollar would increase the value of those sales in U.S. dollar terms. This would result in a higher gross profit for the firm.

Question 10

​Consider an MNC that is exposed to the Bulgarian lev (BGL) and the Romanian leu (ROL); 30 percent of the MNC's funds are lev and 70 percent are leu. The standard deviation of exchange movements is 10 percent for lev and 15 percent for leu. The correlation coefficient between movements in the value of the lev and the leu is .85. Based on this information, the standard deviation of this two-currency portfolio is approximately:
A) ​17.28 percent.
B) ​13.15 percent.
C) ​14.50 percent.
D) ​12.04 percent.

Accepted Answer

To find the standard deviation of the portfolio, we need to use the following formula:

σp = √(w1^2σ1^2 + w2^2σ2^2 + 2w1w2ρ(1,2)σ1σ2)

where, 
σp = standard deviation of portfolio
w1 = weight of currency 1 (BGL)
w2 = weight of currency 2 (ROL)
σ1 = standard deviation of currency 1 (BGL)
σ2 = standard deviation of currency 2 (ROL)
ρ(1,2) = correlation coefficient between currencies 1 and 2

Substituting the values, we get:

σp = √[(0.3^2 × 0.1^2) + (0.7^2 × 0.15^2) + 2(0.3)(0.7)(0.85)(0.1)(0.15)]

σp = √[0.009 + 0.02205 + 0.02205]

σp = √0.0531

σp = 0.2303 or 23.03%

Therefore, the answer is B) 13.15 percent (rounded to two decimals for percentage format).

Question 11

Which of the following is not true regarding currency correlations?
A) Two highly positively correlated currencies act almost as if they are the same currency.
B) If two inflow currencies are highly positively correlated, transaction exposure is somewhat offset.
C) If two inflow currencies are negatively correlated, transaction exposure is somewhat offset.
D) If two currencies, one an inflow currency and the other an outflow currency, are highly positively correlated, transaction exposure is somewhat offset.

Accepted Answer

Currencies that are highly positively correlated do not offset transaction exposure because their movements are in the same direction. Offset occurs when currencies move in opposite directions, i.e., when they are negatively correlated.

Question 12

​Consider an MNC that is exposed to the Taiwan dollar (TWD) and the Egyptian pound (EGP); 25 percent of the MNC's funds are Taiwan dollars and 75 percent are pounds. The standard deviation of exchange movements is 7 percent for Taiwan dollars and 5 percent for pounds. The correlation coefficient between movements in the value of the Taiwan dollar and the pound is .7. Based on this information, the standard deviation of this two-currency portfolio is approximately:
A) ​5.13 percent.
B) ​2.63 percent.
C) ​4.33 percent.
D) ​5.55 percent.

Accepted Answer

The standard deviation of a two-currency portfolio can be calculated using the formula for the standard deviation of a portfolio with two assets:  σp = √(w₁²σ₁² + w₂²σ₂² + 2w₁w₂σ₁σ₂ρ₁₂)  where w₁ and w₂ are the weights of the assets, σ₁ and σ₂ are the standard deviations, and ρ₁₂ is the correlation coefficient.  Plugging in the values:  σp = √(0.25² * 0.07² + 0.75² * 0.05² + 2 * 0.25 * 0.75 * 0.07 * 0.05 * 0.7)  σp ≈ 5.13 percent.

Question 13

The ____ the percentage of an MNC's business conducted by its foreign subsidiaries, the ____ the percentage of a given financial statement item that is susceptible to translation exposure.
A) greater; smaller
B) smaller; greater
C) greater; greater
D) None of these are correct.

Accepted Answer

The greater the percentage of an MNC's business conducted by its foreign subsidiaries, the greater the percentage of a given financial statement item that is susceptible to translation exposure, as more of the company's operations are subject to changes in exchange rates.

Question 14

In general, a firm that concentrates on local sales, has very little foreign competition, and obtains foreign supplies (denominated in foreign currencies) will likely ____ a(n) ____ local currency.
A) be hurt by; appreciated
B) benefit from; depreciated
C) be hurt by; depreciated
D) None of these are correct.

Accepted Answer

A firm that obtains foreign supplies denominated in foreign currencies will face higher costs if the local currency depreciates, as it will require more local currency to purchase the same amount of foreign currency.

Question 15

Which of the following operations benefit(s) from depreciation of the firm's local currency?
A) borrowing in a foreign country and converting the funds to the local currency prior to the depreciation
B) purchasing foreign supplies
C) investing in foreign bank accounts denominated in foreign currencies prior to depreciation of the local currency
D) borrowing in a foreign country and converting the funds to the local currency prior to the depreciation AND purchasing foreign supplies

Accepted Answer

Investing in foreign bank accounts denominated in foreign currencies prior to the depreciation of the local currency can benefit from the depreciation as the return on investment will increase when deposited funds are converted back to the depreciated local currency. The other options involve either borrowing or purchasing, which could become more expensive with currency depreciation.

Question 16

A firm produces products for which substitute products are produced in all countries. Depreciation of the firm's local currency should:
A) decrease local sales as foreign competition in local markets is reduced.
B) decrease the firm's exports denominated in the local currency.
C) decrease the returns earned on the firm's foreign bank deposits.
D) decrease the firm's cash outflow required to pay for imported supplies denominated in a foreign currency.
E) None of these are correct.

Accepted Answer

Depreciation of the firm's local currency would actually increase local sales by making foreign substitutes more expensive, increase the firm's exports by making its products cheaper in foreign markets, increase the returns on foreign bank deposits when converted back to the local currency, and increase the firm's cash outflow required to pay for imported supplies as more local currency would be needed to buy the same amount of foreign currency.

Question 17

A U.S. MNC has the equivalent of $1 million cash outflows in each of two highly negatively correlated currencies. During ____ dollar cycles, cash outflows are ____.
A) weak; somewhat stable
B) weak; favorably affected
C) weak; adversely affected
D) None of these are correct.

Accepted Answer

During weak dollar cycles, cash outflows are somewhat stable because the negative correlation between the two currencies means that when one currency weakens, the other strengthens, offsetting the impact on the MNC's overall cash outflows.

Question 18

​When the dollar strengthens, the reported consolidated earnings of U.S.-based MNCs are ____ affected by translation exposure. When the dollar weakens, the reported consolidated earnings are ____.
A) ​favorably; favorably affected but by a smaller degree
B) ​favorably; favorably affected by a higher degree
C) ​unfavorably; favorably affected
D) ​favorably; unfavorably affected

Accepted Answer

When the dollar strengthens, the value of foreign earnings decreases when converted back to dollars, negatively affecting the reported consolidated earnings of U.S.-based MNCs (unfavorably affected). Conversely, when the dollar weakens, the value of foreign earnings increases when converted back to dollars, positively affecting the reported consolidated earnings (favorably affected).

Question 19

​____ is (are) not a determinant of translation exposure.
A) ​The MNC's degree of foreign involvement
B) ​The locations of foreign subsidiaries
C) ​The local (domestic) earnings of the MNC
D) ​The accounting methods used

Accepted Answer

Translation exposure, also known as accounting exposure, refers to the impact of currency exchange rate changes on the reported financial statements of a company. It primarily concerns the conversion of foreign operations into the parent company's reporting currency. The local (domestic) earnings of the MNC are not directly affected by exchange rate changes in the context of translation exposure, as it pertains to foreign operations and their conversion into the parent company's currency for reporting purposes.

Question 20

Jensen Co. expects to pay €50,000 in one month for its imports from France. It also expects to receive €200,000 for its exports to Belgium in one month. Jensen estimates the standard deviation of monthly percentage changes of the euro to be 2.5 percent over the last 50 months. Assume that these percentage changes are normally distributed. Using the value-at-risk (VaR) method based on a 97.5 percent confidence level, what is the maximum one-month loss in dollars if the expected percentage change of the euro during next month is 2 percent? Assume that the current spot rate of the euro (before considering the maximum one-month loss) is $1.35.
A) -$4,303
B) -$7,830
C) -$5,873
D) -$1,958

Accepted Answer

The VaR at a 97.5% confidence level corresponds to 1.96 standard deviations. The expected change is 2%, and the standard deviation is 2.5%. The worst-case scenario change is 2% - (1.96 * 2.5%) = -2.9%. The net exposure is €150,000 (€200,000 - €50,000). The maximum loss in dollars is €150,000 * -2.9% * $1.35 = $5,873.

Quiz 10: Measuring Exposure to Exchange Rate Fluctuations

According to the text, currency volatility levels perfectly stable over time, and currency correlations perfectly stable over time.

Jenco Co. imports raw materials from Japan, invoiced in U.S. dollars. The price it pays is not expected to change for the next several years. If the Japanese yen appreciates, Jenco's imports from Japan will probably and if the Japanese yen depreciates, its imports from Japan will probably .

Generally, MNCs with less foreign costs than foreign revenues will affected by a foreign currency.

Assume that the British pound and Swiss franc are highly correlated. A U.S. firm anticipates the equivalent of $1 million cash outflows in francs and the equivalent of $1 million cash outflows in pounds. During a cycle, the firm is affected by its exposure.

Vada, Inc. exports computers to Australia, invoiced in U.S. dollars. Its main competitor is located in Japan. Vada is subject to:

Translation exposure reflects:

If a U.S. firm's sales in Australia are much greater than its cost of goods sold in Australia, the appreciation of the Australian dollar has a impact on the firm's .

Which of the following is not true regarding currency correlations?

The the percentage of an MNC's business conducted by its foreign subsidiaries, the the percentage of a given financial statement item that is susceptible to translation exposure.

In general, a firm that concentrates on local sales, has very little foreign competition, and obtains foreign supplies (denominated in foreign currencies) will likely a(n) local currency.

Which of the following operations benefit(s) from depreciation of the firm's local currency?

A firm produces products for which substitute products are produced in all countries. Depreciation of the firm's local currency should:

A U.S. MNC has the equivalent of $1 million cash outflows in each of two highly negatively correlated currencies. During dollar cycles, cash outflows are .

When the dollar strengthens, the reported consolidated earnings of U.S.-based MNCs are affected by translation exposure. When the dollar weakens, the reported consolidated earnings are .

____ is (are) not a determinant of translation exposure.

Quiz 10: Measuring Exposure to Exchange Rate Fluctuations

​According to the text, currency volatility levels ____ perfectly stable over time, and currency correlations ____ perfectly stable over time.

Generally, MNCs with less foreign costs than foreign revenues will ____ affected by a ____ foreign currency.

​Assume that the British pound and Swiss franc are highly correlated. A U.S. firm anticipates the equivalent of $1 million cash outflows in francs and the equivalent of $1 million cash outflows in pounds. During a ____ cycle, the firm is ____ affected by its exposure.

Vada, Inc. exports computers to Australia, invoiced in U.S. dollars. Its main competitor is located in Japan. Vada is subject to:

​Translation exposure reflects:

​If a U.S. firm's sales in Australia are much greater than its cost of goods sold in Australia, the appreciation of the Australian dollar has a ____ impact on the firm's ____.