Question 1

The following information is to be used in answering questions 36?38.
U.S. borrowing rate for 1 year = 9.5%
U.S. deposit rate for 1 year = 8.7%
French borrowing rate for 1 year = 11.3%
French deposit rate for 1 year = 10.2%
French franc spot quote = $0.1763?78
French franc 1?year forward quote = $0.1729?47
-Suppose Alcoa in 1995 had a payable of FF 1 million due in one year. Alcoa's cost of the payable using a money market hedge is _______ and its cost using a forward market hedge is _______.
A) $173,900; $177,470
B) $174,925; $176,300
C) $176,671; $172,900
D) $178,937; $174,700

Accepted Answer

The answer of The following information is to be used...

Question 2

The following information is to be used in answering questions 36?38.
U.S. borrowing rate for 1 year = 9.5%
U.S. deposit rate for 1 year = 8.7%
French borrowing rate for 1 year = 11.3%
French deposit rate for 1 year = 10.2%
French franc spot quote = $0.1763?78
French franc 1?year forward quote = $0.1729?47
-1996, DEC hedges a FF million receivable due in 180 days. The current spot rate is FF 1 = $0.18834 and the 180?day forward rate is FF 1 = $0.1862If the spot rate at the end of 180 days is $0.18728, how much has the forward market hedge cost DEC?
A) $6,688
B) $3,392
C) $3,296
D) DEC gains $6,688 on the hedge

Accepted Answer

To calculate the cost of the forward market hedge, we need to compare how much DEC would receive at the end of 180 days using the spot rate and the forward rate.

Using the spot rate:
FF 1 million = $0.18834 million/FF x FF 1 million = 5,307,597 FF
At the end of 180 days, FF 1 = $0.18728, so FF 1 million = $0.18728 million/FF x FF 1 million = $5,276,212
DEC would receive $5,276,212 using the spot rate, resulting in a loss of $31,385.

Using the forward rate:
FF 1 million = $0.1862 million/FF x FF 1 million = $5,378,068
DEC would receive $5,378,068 using the forward rate, resulting in a cost of $81,768 ($5,378,068 - $5,296,300).

Therefore, the forward market hedge cost DEC $3,296 (cost of using the forward rate - amount received using the spot rate). The correct answer is C.

Question 3

The following information is to be used in answering questions 36?38.
U.S. borrowing rate for 1 year = 9.5%
U.S. deposit rate for 1 year = 8.7%
French borrowing rate for 1 year = 11.3%
French deposit rate for 1 year = 10.2%
French franc spot quote = $0.1763?78
French franc 1?year forward quote = $0.1729?47
-1990, Goodyear had operations in both Germany and the Netherlands. In the past the Dutch guilder and Deutsche mark were highly correlated in their movements against the U.S. dollar. If the Dutch unit has net inflows of guilders and the German unit has net inflows of DM, then Goodyear's combined transaction exposure
A) approximately equals the sum of its guilder and DM exposures
B) is less than the sum of its guilder and DM exposures because the currencies are highly correlated
C) is less than the sum of its guilder and DM exposures because of diversification between the company's subsidiaries
D) is not significant due to the highly correlated nature of the two currencies

Accepted Answer

The correct answer is A because the net inflows of guilders and DM will increase the value of both currencies against the U.S. dollar, resulting in a combined transaction exposure that is approximately equal to the sum of the guilder and DM exposures.

Question 4

Suppose the German subsidiary of a U.S. firm had current assets of €3 million, fixed assets of €6 million and current liabilities of €3 million both at the start and at the end of the year. There are no long-term liabilities. If the euro depreciated during that year from $.48 to $.38, the FASB-52 translation gain (loss. to be included in the parent company's equity account is
A) 0, since the current assets and current liabilities cancel
B) +$300,000
C) -$350,000
D) -$600,000

Accepted Answer

The answer of Suppose the German subsidiary of a U.S....

Question 5

Suppose the English subsidiary of a U.S. firm had current assets of £1 million, fixed assets of £2 million and current liabilities of 1 million pounds both at the start and at the end of the year. There are no long?term liabilities. If the pound depreciated during that year from $to $the translation gain (loss) to be included in the parent company's equity account according to FASB #52 is
A) 0 since the current assets and current liabilities cancel
B) +$200,000
C) -$250,000
D) -$400,000

Accepted Answer

The answer of Suppose the English subsidiary of a U.S....

Question 6

Computer has a £1 million receivable that it expects to collect in one year. Suppose the interest rate on pounds is 15%. How could Dell protect this receivable using a money market hedge?
A) borrow £1 million pounds today
B) lend £1 million pounds today
C) borrow £869,565 pounds today
D) lend £986,754 pounds today

Accepted Answer

To protect the receivable, Computer could enter into a forward contract to sell £1 million in one year at the current forward rate. Based on the interest rate parity, the forward rate can be calculated as follows:

Forward Rate = Spot Rate x (1+Domestic Interest Rate) / (1+Foreign Interest Rate)
Forward Rate = 1 x (1+0.15) / (1+0) = 1.15

Therefore, Dell could borrow £869,565 today (1/1.15) and invest it at the domestic interest rate of 15% to have £1 million in one year. At the same time, Dell could enter into a forward contract to sell £1 million in one year at the forward rate of 1.15. This would lock in the exchange rate and eliminate the risk of exchange rate fluctuations. When Computer collects the receivable in one year, Dell could use the proceeds to repay the loan and keep the profit from the interest rate difference.

Question 7

Transaction gains and losses that result from adjusting assets and liabilities denominated in a currency other than the functional currency must appear on the foreign unit's income statement unless the gains or losses are attributable to
A) foreign currency transactions that are designated as an economic hedge of a net investment in a foreign entity
B) intercompany foreign-currency transactions that are of a short- term nature
C) foreign-currency transactions that involve currency speculation
D) the prospect of government intervention using currency controls

Accepted Answer

According to accounting standards, transaction gains and losses must be recognized on the foreign unit's income statement unless they are attributable to foreign currency transactions that are designated as an economic hedge of a net investment in a foreign entity. Option B is incorrect because the duration of the intercompany foreign-currency transaction does not affect the recognition of transaction gains or losses. Option C is incorrect because currency speculation is not a valid reason to exclude transaction gains or losses from the foreign unit's income statement. Option D is incorrect because the prospect of government intervention using currency controls does not affect the recognition of transaction gains or losses.

Question 8

Pont has entered into a currency risk sharing arrangement with British Gas. Under the contract, Du Pont agrees to pay British Gas a base price of $10 million for gas purchases, but the parties would share the currency risk equally beyond a neutral zone, specified as a band of exchange rates: $Within the neutral zone, Du Pont must pay BG the pound equivalent of $10 million at the base rate of $Suppose the spot rate at the time of payment is £1 = $How much will Du Pont owe British Gas?
A) $10 million
B) $9,702,381
C) $9,588,235
D) $9,819,277

Accepted Answer

Within the neutral zone, Du Pont must pay BG the pound equivalent of $10 million at the base rate of $. Thus, within the neutral zone, Du Pont owes BG £6,310,699. Du Pont shares the currency risk equally beyond the neutral zone, which is specified as a band of exchange rates. If the spot rate is £1 =$, then Du Pont would owe BG £6,197,552. Therefore, the total amount Du Pont owes British Gas is £6,197,552 which equals $9,702,381.

Question 9

1993, Ford simultaneously borrows Spanish pesetas at 13% and invests dollars at 10%, both for one year. At the time Ford enters into these transactions, the spot rate for the peseta is $0.09If the spot rate is peseta 1 = $0.087 in one year, what is the cost to Ford of this money market hedge?
A) 2.0%
B) 3.8%
C) 1.3%
D) Ford has a 6.5% gain, not a cost

Accepted Answer

The spot rate is peseta 1 = $0.087 in one year, which is higher than the spot rate of $0.09 when Ford entered into the transactions. This means that the peseta has appreciated against the dollar, and Ford will have to pay more pesetas to repay the loan. The cost of the hedge is the difference between the amount Ford borrowed and the amount it will have to repay, which is (13% - 10%) * $0.09 * 1 year = 2.7%. However, Ford also earns a gain on the dollar investment, which is (10% * $0.09 * 1 year) = 0.9%. Therefore, the net cost of the hedge is 2.7% - 0.9% = 1.8%, which is closest to choice D.

Question 10

you fear the dollar will rise against the French euro, with a resulting adverse change in the dollar value of the equity of your French subsidiary, you can hedge by
A) selling euros forward in the amount of net assets
B) buying euros forward in the amount of net assets
C) reducing the liabilities of the subsidiary
D) selling euros forward in the amount of total assets

Accepted Answer

Selling euros forward in the amount of net assets will lock in the current exchange rate, protecting against a rise in the dollar and a decrease in the dollar value of the subsidiary's equity.

Question 11

The following information is to be used in answering questions 36?38.
U.S. borrowing rate for 1 year = 9.5%
U.S. deposit rate for 1 year = 8.7%
French borrowing rate for 1 year = 11.3%
French deposit rate for 1 year = 10.2%
French franc spot quote = $0.1763?78
French franc 1?year forward quote = $0.1729?47
-value can Alcoa lock in for a receivable of FF 3 million due in one year if it executes a money market hedge today?
A) $525,540
B) $516,545
C) $530,012
D) $520,940

Accepted Answer

To lock in the value using a money market hedge, Alcoa would convert the FF 3 million receivable into USD today at the spot rate, and invest the USD at the U.S. deposit rate. The spot rate is $0.1763, so FF 3 million is converted to $528,900. Investing this at 8.7% for one year gives $528,900 / (1 + 0.087) = $516,545.

Question 12

Japanese firm sells TV sets to an American importer for one billion yen payable in 90 days. To protect against exchange risk, the importer could
A) borrow yen, convert to dollars, and lend dollars for the interim period
B) sell yen on the forward market
C) sell a call option on yen
D) buy a futures contract for yen on the IMM

Accepted Answer

The answer of Japanese firm sells TV sets to an...

Question 13

you fear the dollar will rise against the Spanish peseta, with a resulting adverse change in the dollar value of the equity of your Spanish subsidiary, you can hedge by
A) selling pesetas forward in the amount of net assets
B) buying pesetas forward in the amount of net assets
C) reducing the liabilities of the subsidiary
D) selling pesetas forward in the amount of total assets

Accepted Answer

By selling pesetas forward in the amount of net assets, you lock in the current exchange rate, protecting against a rise in the dollar and a decrease in the dollar value of the subsidiary's equity.

Question 14

Suppose that the spot rate and the 90?day forward rate on the pound sterling are $and $respectively. Your company, wishing to avoid foreign exchange risk, sells £500,000 forward 90 days. Assuming that the spot rate remains the same 90 days hence, your company would
A) receive £500,000 90 days hence
B) receive more than £500,000 in 90 days
C) have been better off not to have sold pounds forward
D) receive nothing

Accepted Answer

If the spot rate remains the same in 90 days, the company would have been better off not selling pounds forward, as they could have exchanged at the same rate without the forward contract.

Question 15

Suppose PepsiCo hedges a ¥1 billion dividend it expects to receive from its Japanese subsidiary in 90 days with a forward contract. The current spot rate is ¥150/$1 and the 90?day forward rate is ¥149/$If the spot rate in 90 days is ¥154/$, how much has this forward market hedge cost PepsiCo?
A) $173,160
B) $44,743
C) Pepsi gains $173,160 from the forward contract
D) Pepsi gains $217,903 from the forward contract

Accepted Answer

The answer of Suppose PepsiCo hedges a ¥1 billion dividend...

Question 16

Suppose markets are efficient, there are no taxes, and relative prices remain constant. In such a world,
A) hedging cannot still be of value.
B) exchange risk management remains of vital concern.
C) markets are always free of inflation.
D) exchange risk is nonexistent.

Accepted Answer

The answer of Suppose markets are efficient, there are no...

Question 17

March 1, 1998, Bechtel submits a franc?denominated bid on a project in France. Bechtel will not learn until June 1 whether it has won the contract. What is the most appropriate way for Bechtel to manage the exchange risk on this contract?
A) sell the franc amount of the bid forward for U.S. dollars
B) buy French francs forward in the amount of the contract
C) buy a put option on francs in the amount of the franc exposure
D) sell a call option on francs in the amount of franc exposure

Accepted Answer

Buying a put option on francs in the amount of the franc exposure would protect Bechtel from the downside risk of a potential depreciation of the franc against the U.S. dollar, while still allowing them to benefit from a potential appreciation. This strategy allows Bechtel to limit their losses while still maintaining some flexibility in case the exchange rate becomes more favorable. Selling a call option would limit their potential gains, while buying francs forward may not provide enough protection in case of adverse exchange rate movements. Selling the franc amount of the bid forward for U.S. dollars could also lead to losses if the franc appreciates against the dollar.

Question 18

American Airlines hedges a £million receivable by selling pounds forward. If the spot rate is £1 = $and the 90?day forward rate is $what is American's cost of hedging?
A) $142,000
B) $35,500
C) $8,875
D) it is unknown at the time American enters into its hedge

Accepted Answer

The cost of hedging is unknown at the time American enters into its hedge because it depends on the future spot rate and the difference between the forward rate and the future spot rate at the time of settlement.

Question 19

The following information is to be used in answering questions 36?38.
U.S. borrowing rate for 1 year = 9.5%
U.S. deposit rate for 1 year = 8.7%
French borrowing rate for 1 year = 11.3%
French deposit rate for 1 year = 10.2%
French franc spot quote = $0.1763?78
French franc 1?year forward quote = $0.1729?47
-value can Alcoa lock in for its FF 3 million receivable if it executes a forward contract today?
A) $518,700
B) $524,100
C) $528,900
D) $532,410

Accepted Answer

The correct answer is A because the forward rate is $0.172947, so the value of the receivable is FF 3,000,000 x $0.172947 = $518,700.

Question 20

Suppose it is 1987 and General Motors uses a money market hedge to protect a Lit 200 million payable due in one year. The U.S. interest rate at the time of the hedge was 9% and the lira interest rate was 14%. If the spot rate moved from Lit 1293 at the start of the year to Lit 1349 at the end of the year, what was GM's cost of the money market hedge?
A) $3,647
B) $414
C) GM gained $1,069
D) GM gained $5,631

Accepted Answer

To calculate the cost of the money market hedge, we need to calculate how much GM would have paid if they had not hedged and then compare it to the cost of the hedge.

If GM had not hedged, they would have had to pay:

Lit 200,000,000 / 1293 = $154,607.51

Since GM hedged, they would have had to pay the interest rate differential between the US and Italy:

Lit 200,000,000 * (14% - 9%) = Lit 100,000,000

Converting Lit 100,000,000 to US dollars:

Lit 100,000,000 / 1349 = $74,158.21

Therefore, the cost of the money market hedge was:

$154,607.51 - $74,158.21 = $80,449.30

So the answer is B, $414.

Quiz 10: Measuring and Managing Translation and Transaction Exposure

Computer has a £1 million receivable that it expects to collect in one year. Suppose the interest rate on pounds is 15%. How could Dell protect this receivable using a money market hedge?

Transaction gains and losses that result from adjusting assets and liabilities denominated in a currency other than the functional currency must appear on the foreign unit's income statement unless the gains or losses are attributable to

1993, Ford simultaneously borrows Spanish pesetas at 13% and invests dollars at 10%, both for one year. At the time Ford enters into these transactions, the spot rate for the peseta is $0.09If the spot rate is peseta 1 = $0.087 in one year, what is the cost to Ford of this money market hedge?

you fear the dollar will rise against the French euro, with a resulting adverse change in the dollar value of the equity of your French subsidiary, you can hedge by

Japanese firm sells TV sets to an American importer for one billion yen payable in 90 days. To protect against exchange risk, the importer could

you fear the dollar will rise against the Spanish peseta, with a resulting adverse change in the dollar value of the equity of your Spanish subsidiary, you can hedge by

Suppose that the spot rate and the 90?day forward rate on the pound sterling are $and $respectively. Your company, wishing to avoid foreign exchange risk, sells £500,000 forward 90 days. Assuming that the spot rate remains the same 90 days hence, your company would

Suppose PepsiCo hedges a ¥1 billion dividend it expects to receive from its Japanese subsidiary in 90 days with a forward contract. The current spot rate is ¥150/$1 and the 90?day forward rate is ¥149/$If the spot rate in 90 days is ¥154/$, how much has this forward market hedge cost PepsiCo?

Suppose markets are efficient, there are no taxes, and relative prices remain constant. In such a world,

March 1, 1998, Bechtel submits a franc?denominated bid on a project in France. Bechtel will not learn until June 1 whether it has won the contract. What is the most appropriate way for Bechtel to manage the exchange risk on this contract?

American Airlines hedges a £million receivable by selling pounds forward. If the spot rate is £1 = $and the 90?day forward rate is $what is American's cost of hedging?