Question 1

Consider an MNC that is exposed to the Taiwan dollar (TWD) and the Egyptian pound (EGP). 25% of the MNC's funds are Taiwan dollars and 75% are pounds. The standard deviation of exchange movements is 7% for Taiwan dollars and 5% for pounds. The correlation coefficient between movements in the value of the Taiwan dollar and the pound is 0.7. Based on this information, the standard deviation of this two-currency portfolio is approximately:

Accepted Answer

The correct answer is A. The standard deviation of the portfolio is calculated as the square root of the variance, which is the sum of the variances of the individual currencies weighted by their proportions in the portfolio, plus the covariance between the currencies. The variance of the Taiwan dollar is (0.07)^2 = 0.0049, and the variance of the pound is (0.05)^2 = 0.0025. The covariance between the currencies is 0.7 * 0.07 * 0.05 = 0.00245. Therefore, the variance of the portfolio is 0.0049 * 0.25 + 0.0025 * 0.75 + 0.00245 = 0.003675, and the standard deviation is the square root of this, which is 0.0513, or 5.13%.

Question 2

Which of the following operations benefits from depreciation of the firm's local currency?

Accepted Answer

Investing in foreign bank accounts denominated in foreign currencies prior to the depreciation of the local currency benefits because the value of the foreign currency holdings increases relative to the depreciated local currency.

Question 3

Transaction exposure reflects:

Accepted Answer

Transaction exposure refers to the risk that a company's financial obligations or receivables that are denominated in a foreign currency will be affected by fluctuations in exchange rates. It arises from ongoing international transactions such as imports, exports, and foreign investments. Therefore, option A best explains transaction exposure.

Question 4

A high correlation between two currencies would be desirable for achieving low exchange rate risk if one is an inflow currency and the other is an outflow currency.

Accepted Answer

A high correlation between two currencies would mean that their values tend to move in the same direction, which reduces the risk of exchange rate fluctuations. If one currency is an inflow currency (i.e. used for investments or purchases in the other country), and the other is an outflow currency (i.e. used for investments or purchases outside of the home country), then a high correlation would be desirable for minimizing exchange rate risk in those transactions.

Question 5

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

Accepted Answer

The answer of A firm produces goods for which substitute...

Question 6

Translation exposure is less of a concern when earnings are not remitted by the subsidiary to the parent.

Accepted Answer

Translation exposure arises when there are fluctuations in exchange rates that impact the translation of foreign subsidiary financial statements into the parent company's reporting currency. If earnings are not remitted to the parent, then the impact of translation exposure on the parent's financial statements is minimized as there is no need for translation of the subsidiary's earnings.

Question 7

Economic exposure can affect:

Accepted Answer

The answer of Economic exposure can affect:
...

Question 8

If an MNC expects cash inflows of equal amounts in two currencies, and the two currencies are ____ correlated, the MNC's transaction exposure is relatively ____.

Accepted Answer

If the two currencies are negatively correlated, it means that when one currency strengthens, the other weakens. In this case, the MNC's transaction exposure is relatively low because the losses from one currency will be offset by the gains in the other currency.

Question 9

One argument for exchange rate irrelevance is that:

Accepted Answer

The answer of One argument for exchange rate irrelevance is...

Question 10

If the pound appreciates:

Accepted Answer

When the pound appreciates, UK exports become more expensive for foreign buyers, likely decreasing sales for a UK MNC.

Question 11

Subsidiary A of Mega plc has net inflows in Australian dollars of A$1,000,000, while Subsidiary B has net outflows in Australian dollars of A$1,500,000. The expected exchange rate of the Australian dollar is £0.30. What is the net inflow or outflow as measured in pounds?

Accepted Answer

Subsidiary A has an inflow of A$1,000,000, which converts to £300,000 (A$1,000,000 * £0.30). Subsidiary B has an outflow of A$1,500,000, which converts to £450,000 (A$1,500,000 * £0.30). The net effect is an outflow of £150,000 (£300,000 - £450,000).

Question 12

A firm's transaction exposure in any foreign currency is based solely on the size of its open position in that currency.

Accepted Answer

Transaction exposure also depends on the timing of the cash flows, the volatility of the currency exchange rate, and the firm's ability to adjust its market operations in response to exchange rate changes, not just the size of its open position.

Question 13

Magent ltd. is a UK company that has exposure to the Swiss franc (SF) and Danish kroner (DK). It has net inflows of SF 200 million and net outflows of DK 500 million. The present exchange rate of the SF is about £0.22 while the present exchange rate of the DK is £0.05. Magent ltd. has not hedged these positions. The SF and DK are highly correlated in their movements against the pound. If the pound weakens, then Magent ltd. will:

Accepted Answer

Magent ltd. will benefit because the pound value of its SF inflows (200 million * £0.22 = £44 million) exceeds the pound value of its DK outflows (500 million * £0.05 = £25 million). If the pound weakens, the value of the SF inflows in pounds will increase more than the DK outflows, resulting in a net gain.

Question 14

Regression analysis cannot be used to assess the sensitivity of a company's performance to economic conditions because economic conditions are unpredictable.

Accepted Answer

The answer of Regression analysis cannot be used to assess...

Question 15

When the euro strengthens, the reported consolidated earnings of euro-based MNCs are ____ affected by translation exposure. When the euro weakens, the reported consolidated earnings are ____ affected.

Accepted Answer

The answer of When the euro strengthens, the reported consolidated...

Question 16

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

Accepted Answer

The answer of Generally, MNCs with less foreign costs than...

Question 17

UK exporters may not necessarily benefit from weak-dollar periods if foreign competitors are willing to reduce their profit margin.

Accepted Answer

If foreign competitors reduce their profit margins, they can maintain competitive pricing, negating the advantage UK exporters might gain from a weak dollar.

Question 18

Cerra ltd. expects to receive 5 million euros tomorrow as a result of selling goods to the Netherlands. Cerra estimates the standard deviation of daily percentage changes of the euro to be 1 percent over the last 100 days. Assume that these percentage changes are normally distributed. Using the value-at-risk (VAR) method based on a 95% confidence level, what is the maximum one-day loss if the expected percentage change of the euro tomorrow is 0.5%?

Accepted Answer

The maximum one-day loss at a 95% confidence level is calculated as the expected change minus 1.65 times the standard deviation. Thus, 0.5% - 1.65 * 1% = -1.15%, which rounds to -1.2%.

Question 19

Cerra ltd. expects to receive 5 million euros tomorrow as a result of selling goods to the Netherlands. Cerra estimates the standard deviation of daily percentage changes of the euro to be 1 percent over the last 100 days. Assume that these percentage changes are normally distributed. Using the value-at-risk (VAR) method based on a 95% confidence level, what is the maximum one-day loss in dollars if the expected percentage change of the euro tomorrow is 0.5%? The current spot rate of the euro (before considering the maximum one-day loss) is £0.67.

Accepted Answer

The answer of Cerra ltd. expects to receive 5 million...

Question 20

The Canadian dollar consistently appears to move almost independently of other currencies. That is it exhibits low correlations with the other currencies.

Accepted Answer

The statement is true. The Canadian dollar has exhibited low correlations with other currencies, meaning its movements are not strongly influenced by other global economic factors.

Quiz 10: Measuring Exposure to Exchange Rate Fluctuations