Question 1

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 fiFS1U1B1tS1U1B0y 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. Assuming an expected percentage change of 0 percent for each currency during the next month, what is the maximum one-month loss of the currency portfolio? Use a 95 percent confidence level and assume the monthly percentage changes for each currency are normally distributed.
A)-9.00 percent
B)-30.00 percent.
C)-5.00 percent
D)none of the above

Accepted Answer

The maximum one-month loss of the currency portfolio is -9.00 percent. This is calculated using the formula:Maximum loss = -Z * sqrt(variance of portfolio)where:Z = the z-score for the desired confidence level (95% in this case)variance of portfolio = the variance of the portfolio, which is calculated as:variance of portfolio = w1^2 * variance of currency 1 + w2^2 * variance of currency 2 + 2 * w1 * w2 * correlation coefficient * standard deviation of currency 1 * standard deviation of currency 2In this case, w1 = 500,000 / (500,000 + 300,000) = 0.625, w2 = 300,000 / (500,000 + 300,000) = 0.375, variance of currency 1 = 0.08^2, variance of currency 2 = 0.03^2, and correlation coefficient = 0.30.Plugging these values into the formula, we get:variance of portfolio = 0.625^2 * 0.08^2 + 0.375^2 * 0.03^2 + 2 * 0.625 * 0.375 * 0.30 * 0.08 * 0.03 = 0.0036Maximum loss = -1.96 * sqrt(0.0036) = -9.00%

Question 2

The maximum one-day loss computed for the value-at-risk (VaR) method does not depend on:
A)the expected percentage change in the currency for the next day.
B)the standard deviation of the daily percentage changes in the currency over a previous period.
C)the current level of interest rates.
D)the confidence level used.

Accepted Answer

The maximum one-day loss computed for the value-at-risk (VaR) method is based on the historical volatility of the currency's daily percentage changes over a specified time period and the confidence level used, but it does not depend on the current level of interest rates.

Question 3

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

The standard deviation of a two-currency portfolio can be calculated using the formula: $\sqrt{w_1^2\sigma_1^2 + w_2^2\sigma_2^2 + 2w_1w_2\sigma_1\sigma_2\rho}$, where $w_1$ and $w_2$ are the weights of the currencies in the portfolio, $\sigma_1$ and $\sigma_2$ are the standard deviations of the currencies, and $\rho$ is the correlation coefficient between the currencies. Plugging in the given values: $\sqrt{0.3^2 \times 0.1^2 + 0.7^2 \times 0.15^2 + 2 \times 0.3 \times 0.7 \times 0.1 \times 0.15 \times 0.85}$ gives approximately 13.15 percent.

Question 4

Assume that Mill Corp., a U.S.-based MNC, has applied the following regression model to estimate the sensitivity of its cash flows to exchange rate movements:
$ \mathrm{PCF}_{t}=a_{0}+a_{1} e_{t}+\mu t $where the term on the leFt-hand side is the percentage change in inflation-adjusted cash flows measured in the firm's home currency over period t, and et is the percentage change in the exchange rate of the currency over period t. The regression model estimates a coefficient of a₁ of 2. This indicates that:
A)if the foreign currency appreciates by 1%, Mill's cash flows will decline by 2%.
B)if the foreign currency appreciates by 1%, Mill's cash flows will decline by .2%.
C)if the foreign currency depreciates by 1%, Mill's cash flows will increase by 2%.
D)if the foreign currency depreciates by 1%, Mill's cash flows will decline by 2%.
E)none of the above

Accepted Answer

The answer of Assume that Mill Corp., a U.S.-based MNC,...

Question 5

The following regression model was run by a U.S.-based MNC to determine its degree of economic exposure as it relates to the Australian dollar and Sudanese dinar (SDD):
 where the term on the leFt-hand side is the percentage change in inflation-adjusted cash flows measured in the firm's home currency over period t, and et is the percentage change in the exchange rate of the currency over period t. The regression was run over two subperiods for each of the two currencies, with the following results:
Based on these results, which of the following statements is probably not true?

A)The MNC was more sensitive to movements in the Australian dollar than in the dinar in the earlier subperiod.
B)The MNC was more sensitive to movements in the dinar than in the Australian dollar in the more recent subperiod.
C)The MNC probably had more outflows than inflows in Australian dollars in the earlier subperiod.
D)The MNC probably had more inflows than outflows denominated in dinar in the more recent subperiod.
E)All of the above are true.

Accepted Answer

The answer of The following regression model was run by...

Question 6

Because creditors may prefer that firms maintain low exposure to exchange rate risk, and because investors may prefer corporations to perform hedging for them, exchange rate risk is probably relevant.

Accepted Answer

Creditors and investors both have an interest in minimizing the negative effects of exchange rate fluctuations on a corporation's financial performance. Therefore, exchange rate risk is relevant in terms of corporate financial management.

Question 7

The transaction exposure of two inflow currencies is offset when the correlation between the currencies is high.

Accepted Answer

Transaction exposure is better offset when the correlation between the inflow currencies is low, as adverse movements in one currency are likely to be offset by favorable movements in the other.

Question 8

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 the above

Accepted Answer

The answer of In general, a firm that concentrates on...

Question 9

If the U.S. dollar appreciates, an MNC's:
A)U.S. sales will probably decrease.
B)exports denominated in U.S. dollars will probably increase.
C)interest owed on foreign funds borrowed will probably increase.
D)exports denominated in foreign currencies will probably increase.
E)all of the above

Accepted Answer

When the U.S. dollar appreciates, U.S. goods become more expensive for foreign buyers, likely leading to a decrease in U.S. sales for an MNC.

Question 10

Appreciation in a firm's local currency causes a(n) ____ in cash inflows and a(n) ____ in cash outflows.
A)reduction; reduction
B)increase; increase
C)increase; reduction
D)reduction; increase

Accepted Answer

The answer of Appreciation in a firm's local currency causes...

Question 11

Under FASB 52, consolidated earnings are sensitive to the functional currency's weighted average exchange rate.

Accepted Answer

Under FASB 52, consolidated earnings are sensitive to the functional currency's weighted average exchange rate, as it affects the translation of foreign subsidiary financial statements into the reporting currency of the parent company.

Question 12

Which of the following is not a form of exposure to exchange rate fluctuations?
A)transaction exposure
B)credit exposure
C)economic exposure
D)translation exposure

Accepted Answer

Credit exposure refers to the risk of loss resulting from a counterparty defaulting on a payment obligation, and is not related to exchange rate fluctuations. The other options - transaction, economic, and translation exposure - all relate to different forms of risk related to exchange rate fluctuations.

Question 13

The maximum one-day loss computed for the value-at-risk (VaR) method does not depend on:
A)the expected percentage change in the currency for the next day.
B)the standard deviation of the daily percentage changes in the currency over a previous period.
C)the current level of interest rates.
D)the confidence level used.

Accepted Answer

The maximum one-day loss computed for the value-at-risk (VaR) method does not depend on the current level of interest rates. It is calculated based on the expected percentage change and standard deviation of the daily percentage changes in the currency over a previous period, as well as the confidence level used.

Question 14

One argument why exchange rate risk is irrelevant to corporations is that shareholders may be able to hedge this risk individually.

Accepted Answer

Shareholders have the ability to manage or hedge their own exposure to exchange rate risk through various financial instruments or by diversifying their investment portfolios, making the management of this risk by corporations less critical.

Question 15

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 the above

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 influenced by changes in foreign exchange rates.

Question 16

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 currency's volatility, and contractual obligations, not just the size of the open position.

Question 17

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 answer of Consider an MNC that is exposed to...

Question 18

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 fiFS1U1B1tS1U1B0y 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%
B)5.44 percent
C)17.98 percent
D)none of the above

Accepted Answer

To calculate the portfolio standard deviation, we need to use the formula:
Portfolio SD = sqrt [(w1^2 x SD1^2) + (w2^2 x SD2^2) + 2(w1 x w2 x Corr x SD1 x SD2)]
Where w1 and w2 are the weights of euros and Canadian dollars in the portfolio, SD1 and SD2 are the standard deviations of the percentage changes in euros and Canadian dollars, and Corr is the correlation coefficient between the two currencies.

Given:
- w1 = 500,000 / (500,000 + 300,000) = 0.625 (the proportion of the portfolio in euros)
- w2 = 1 - w1 = 0.375 (the proportion of the portfolio in Canadian dollars)
- SD1 = 8%
- SD2 = 3%
- Corr = 0.30

Applying the formula, we get:
Portfolio SD = sqrt [(0.625^2 x 0.08^2) + (0.375^2 x 0.03^2) + 2(0.625 x 0.375 x 0.30 x 0.08 x 0.03)]
Portfolio SD = sqrt [0.0039 + 0.000421875 + 0.0003375]
Portfolio SD = sqrt(0.004659375)
Portfolio SD = 0.06823 or 6.823%

Thus, the portfolio standard deviation is 6.823%, which is closest to option B, 5.44%.

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 subsidiaries' financial statements 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 relates to foreign operations and their translation into the parent company's currency.

Question 20

Two highly negatively correlated currencies move in tandem almost as if they are the same currency.

Accepted Answer

Highly negatively correlated currencies move in opposite directions, so they would not move in tandem as if they are the same currency.

Quiz 10: Measuring Exposure to Exchange Rate Fluctuations

The maximum one-day loss computed for the value-at-risk (VaR) method does not depend on:

Because creditors may prefer that firms maintain low exposure to exchange rate risk, and because investors may prefer corporations to perform hedging for them, exchange rate risk is probably relevant.

The transaction exposure of two inflow currencies is offset when the correlation between the currencies is high.

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.

If the U.S. dollar appreciates, an MNC's:

Appreciation in a firm's local currency causes a(n) in cash inflows and a(n) in cash outflows.

Under FASB 52, consolidated earnings are sensitive to the functional currency's weighted average exchange rate.

Which of the following is not a form of exposure to exchange rate fluctuations?

The maximum one-day loss computed for the value-at-risk (VaR) method does not depend on:

One argument why exchange rate risk is irrelevant to corporations is that shareholders may be able to hedge this risk individually.

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

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

Two highly negatively correlated currencies move in tandem almost as if they are the same currency.