Transaction Exposure

43
Fundamentals of Multinational Finance, 3e (Moffett) Chapter 9 Transaction Exposure 9.1 Multiple Choice and True/False Questions 1) ________ exposure deals with cash flows that result from existing contractual obligations. A) Operating B) Transaction C) Translation D) Economic Answer : B Topic: Transaction Exposure Skill: Recognition 2) ________ exposure measures the change in the present value of the firm resulting from unexpected changes in exchange rates. 1

Transcript of Transaction Exposure

Page 1: Transaction Exposure

Fundamentals of Multinational Finance, 3e (Moffett) Chapter 9

Transaction Exposure

9.1

Multiple Choice and True/False Questions

1)

________ exposure deals with cash flows that result from existing contractual obligations. A)

Operating B)

Transaction C)

Translation D)

Economic Answer:

B Topic:

Transaction Exposure Skill:

Recognition

2)

________ exposure measures the change in the present value of the firm resulting from unexpected changes in exchange rates.

A)

Operating B)

Transaction C)

1

Page 2: Transaction Exposure

Translation D)

Accounting Answer:

A Topic:

Operating Exposure Skill:

Recognition

3)

Each of the following is another name for operating exposure EXCEPT ________. A)

economic exposure B)

strategic exposure C)

accounting exposure D)

competitive exposure Answer:

C Topic:

Accounting Exposure Skill:

Recognition

4)

Transaction exposure and operating exposure exist because of unexpected changes in future cash flows. The difference between the two is that ________ exposure deals with cash flows already contracted for, while ________ exposure deals with future cash flows that might change because of changes in exchange rates.

A)

2

Page 3: Transaction Exposure

transaction; operating B)

operating; transaction C)

operating; accounting D)

none of the above Answer:

A Topic:

Transaction and Operating Exposure Skill:

Recognition

3

Page 4: Transaction Exposure

5)

________ exposure is the potential for accounting-derived changes in owner's equity to occur because of the need to translate foreign currency financial statements into a single reporting currency.

A)

Transaction B)

Operating C)

Economic D)

Accounting Answer:

D Topic:

Accounting Exposure Skill:

Recognition

6)

Losses from ________ exposure generally reduce taxable income in the year they are realized. ________ exposure losses may reduce taxes over a series of years.

A)

accounting; Operating B)

operating; Transaction C)

transaction; Operating D)

transaction; Accounting Answer:

C

4

Page 5: Transaction Exposure

Topic:

Transaction and Accounting Exposure Skill:

Recognition

7)

Losses from ________ exposure generally reduce taxable income in the year they are realized. ________ exposure losses are not cash losses and therefore, are not tax deductible.

A)

transaction; Operating B)

accounting; Operating C)

accounting; Transaction D)

transaction; Translation Answer:

D Topic:

Transaction and Accounting Exposure Skill:

Recognition

8)

MNE cash flows may be sensitive to changes in which of the following? A)

exchange rates B)

interest rates C)

commodity prices D)

5

Page 6: Transaction Exposure

all of the above Answer:

D Topic:

MNE Cash Flow Risk Skill:

Recognition

9)

________ is a technique used by MNEs to deal with currency exposure. A)

Do nothing B)

Speculation C)

Hedging D)

All are techniques MNEs could use. Answer:

D Topic:

MNE Cash Flow Risk Skill:

Recognition

6

Page 7: Transaction Exposure

10)

Hedging, or reducing risk, is the same as adding value or return to the firm. Answer:

FALSE Topic:

MNE Cash Flow Risk Skill:

Conceptual

11)

Assuming no transaction costs (i.e., hedging is "free"), hedging currency exposures should ________ the variability of expected cash flows to a firm and at the same time, the expected value of the cash flows should ________.

A)

increase; not change B)

decrease; not change C)

not change; increase D)

not change; not change Answer:

B Topic:

Hedging Skill:

Conceptual

12)

Which of the following is NOT cited as a good reason for hedging currency exposures? A)

Reduced risk of future cash flows is a good planning tool. B)

7

Page 8: Transaction Exposure

Reduced risk of future cash flows reduces the probability that the firm may not meet required cash flows.

C)

Currency risk management increases the expected cash flows to the firm. D)

Management is in a better position to assess firm currency risk than individual investors. Answer:

C Topic:

Hedging Skill:

Recognition

13)

There is considerable question among investors and managers about whether hedging is a good and necessary tool.

Answer:

TRUE Topic:

Hedging Skill:

Recognition

14)

Which of the following is cited as a good reason for NOT hedging currency exposures? A)

Shareholders are more capable of diversifying risk than management. B)

Currency risk management through hedging does not increase expected cash flows. C)

Hedging activities are often of greater benefit to management than to shareholders. D)

All of the above are cited as reasons NOT to hedge. 8

Page 9: Transaction Exposure

Answer:

D Topic:

Hedging Skill:

Recognition

15)

The key arguments in opposition to currency hedging such as market efficiency, agency theory, and diversification do not have financial theory at their core.

Answer:

FALSE Topic:

Hedging Skill:

Conceptual

9

Page 10: Transaction Exposure

16)

________ exposure may result from a firm having a payable in a foreign currency. A)

Transaction B)

Accounting C)

Operating D)

None of the above Answer:

A Topic:

Hedging Skill:

Conceptual

17)

The stages in the life of a transaction exposure can be broken into three distinct time periods. The first time period is the time between quoting a price and reaching an actual sale agreement or contract. The next time period is the time lag between taking an order and actually filling or delivering it. Finally, the time it takes to get paid after delivering the product. In order, these stages of transaction exposure may be identified as,

A)

backlog, quotation, and billing exposure. B)

billing, backlog, and quotation exposure. C)

quotation, backlog, and billing exposure. D)

quotation, billing, and backlog exposure. Answer:

10

Page 11: Transaction Exposure

C Topic:

Transaction Exposure Skill:

Recognition

18)

A U.S. firm sells merchandise today to a British company for £100,000. The current exchange rate is $2.03/£ , the account is payable in three months, and the firm chooses to avoid any hedging techniques designed to reduce or eliminate the risk of changes in the exchange rate. The U.S. firm is at risk today of a loss if

A)

the exchange rate changes to $2.00/£. B)

the exchange rate changes to $2.05/£. C)

the exchange rate doesn't change. D)

all of the above. Answer:

D Topic:

Transaction Exposure Skill:

Analytical

19)

A U.S. firm sells merchandise today to a British company for £100,000. The current exchange rate is $2.03/£ , the account is payable in three months, and the firm chooses to avoid any heding techniques designed to reduce or eliminate the risk of changes in the exchange rate. If the exchange rate changes to $2.05/£ the U.S. firm will realize a ________ of ________.

A)

loss; $2000 B)

11

Page 12: Transaction Exposure

gain; $2000 C)

loss; £2000 D)

gain; £2000 Answer:

B Topic:

Transaction Exposure Skill:

Analytical

12

Page 13: Transaction Exposure

20)

A U.S. firm sells merchandise today to a British company for £100,000. The current exchange rate is $2.03/£ , the account is payable in three months, and the firm chooses to avoid any heding techniques designed to reduce or eliminate the risk of changes in the exchange rate. If the exchange rate changes to $2.01/£ the U.S. firm will realize a ________ of ________.

A)

loss; $2,000 B)

gain; $2,000 C)

loss; £2000 D)

gain; £2000 Answer:

A Topic:

Transaction Exposure Skill:

Analytical

21)

________ is NOT a popular contractual hedge against foreign exchange transaction exposure.

A)

Forward market hedge B)

Money market hedge C)

Options market hedge D)

All of the above are contractual hedges. Answer:

13

Page 14: Transaction Exposure

D Topic:

Contractual Hedges Skill:

Recognition

22)

A ________ hedge refers to an offsetting operating cash flow such as a payable arising from the conduct of business.

A)

financial B)

natural C)

contractual D)

futures Answer:

B Topic:

Natural Hedge Skill:

Recognition

14

Page 15: Transaction Exposure

Instruction 9.1: Use the information for following problem(s).

Plains States Manufacturing has just signed a contract to sell agricultural equipment to Boschin, a German firm, for euro 1,250,000. The sale was made in June with payment due six months later in December. Because this is a sizable contract for the firm and because the contract is in euros rather than dollars, Plains States is considering several hedging alternatives to reduce the exchange rate risk arising from the sale. To help the firm make a hedging decision you have gathered the following information.

∙ The spot exchange rate is $1.40/euro∙ The six month forward rate is $1.38/euro∙ Plains States' cost of capital is 11%∙ The Euro zone 6-month borrowing rate is 9% (or 4.5% for 6 months)∙ The Euro zone 6-month lending rate is 7% (or 3.5% for 6 months)∙ The U.S. 6-month borrowing rate is 8% (or 4% for 6 months)∙ The U.S. 6-month lending rate is 6% (or 3% for 6 months)∙ December put options for euro 625,000; strike price $1.42, premium price is 1.5%∙ Plains States' forecast for 6-month spot rates is $1.43/euro∙ The budget rate, or the lowest acceptable sales price for this project, is $1,075,000 or $1.35/euro

23)

Refer to Instruction 9.1. If Plains States chooses not to hedge their euro receivable, the amount they receive in six months will be ________.

A)

$1,750,000 B)

$1,250,000 C)

$892,857 D)

undeterminable today Answer:

D Topic:

Forward Hedge Computation Skill:

Analytical

24)

15

Page 16: Transaction Exposure

Refer to Instruction 9.1. If Plains States chooses to hedge its transaction exposure in the forward market, it will ________ euro 1,250,000 forward at a rate of ________.

A)

sell; $1.38/euro B)

sell; $1.40/euro C)

buy; $1.38/euro D)

buy; $1.40/euro Answer:

A Topic:

Forward Hedge Computation Skill:

Analytical

25)

Refer to Instruction 9.1. Plains States chooses to hedge its transaction exposure in the forward market at the available forward rate. The payoff in 6 months will be ________.

A)

$1,750,000 B)

$1250,000 C)

$1,725,000 D)

$1787,500 Answer:

C Topic:

16

Page 17: Transaction Exposure

Forward Hedge Computation Skill:

Analytical

26)

Refer to Instruction 9.1. If Plains States locks in the forward hedge at $1.38/euro, and the spot rate when the transaction was recorded on the books was $1.40/euro, this will result in a "foreign exchange loss" accounting transaction of ________.

A)

$0 B)

$25,000 C)

This was not a loss; it was a gain of $25,000. D)

There is not enough information to answer this question. Answer:

B Topic:

Forward Hedge Computation Skill:

Analytical

27)

Refer to Instruction 9.1. Plains States would be ________ by an amount equal to ________ with a forward hedge than if they had not hedged and their predicted exchange rate for 6 months had been correct.

A)

better off; $43,750 B)

better off; $62,500 C)

worse off; $43,750 D)

17

Page 18: Transaction Exposure

worse off; $62,500 Answer:

D Topic:

Forward Hedge Computation Skill:

Analytical

28)

The structure of a money market hedge is similar to a forward hedge. The difference is the cost of the money market hedge is determined by the differential interest rates, while the forward hedge is a function of the forward rates quotation.

Answer:

TRUE Topic:

Money Market Hedge Skill:

Conceptual

29)

In efficient markets, interest rate parity should assure that the costs of a forward hedge and money market hedge should be approximately the same.

Answer:

TRUE Topic:

Money Market Hedge Skill:

Conceptual

18

Page 19: Transaction Exposure

Instruction 9.1: Use the information for following problem(s).

Plains States Manufacturing has just signed a contract to sell agricultural equipment to Boschin, a German firm, for euro 1,250,000. The sale was made in June with payment due six months later in December. Because this is a sizable contract for the firm and because the contract is in euros rather than dollars, Plains States is considering several hedging alternatives to reduce the exchange rate risk arising from the sale. To help the firm make a hedging decision you have gathered the following information.

∙ The spot exchange rate is $1.40/euro∙ The six month forward rate is $1.38/euro∙ Plains States' cost of capital is 11%∙ The Euro zone 6-month borrowing rate is 9% (or 4.5% for 6 months)∙ The Euro zone 6-month lending rate is 7% (or 3.5% for 6 months)∙ The U.S. 6-month borrowing rate is 8% (or 4% for 6 months)∙ The U.S. 6-month lending rate is 6% (or 3% for 6 months)∙ December put options for euro 625,000; strike price $1.42, premium price is 1.5%∙ Plains States' forecast for 6-month spot rates is $1.43/euro∙ The budget rate, or the lowest acceptable sales price for this project, is $1,075,000 or $1.35/euro

30)

Refer to Instruction 9.1. Plains States could hedge the Euro receivables in the money market. Using the information provided, how much would the money market hedge return in six months assuming Plains States reinvests the proceeds at the U.S. investment rate?

A)

$1,250,000 B)

$1,724,880 C)

$1,674,641 D)

$1,207,371 Answer:

B Topic:

Money Market Hedge Skill:

Analytical

31) Refer to Instruction 9.1. Money market hedges almost always return more than forward

19

Page 20: Transaction Exposure

hedges because of the greater risk involved. Answer:

FALSE Topic:

Money Market Hedge Skill:

Conceptual

32)

Refer to Instruction 9.1. If Plains States chooses to implement a money market hedge for the Euro receivables, how much money will the firm borrow today?

A)

euro 1,201,923 B)

$1,201,923 C)

euro 1,196,172 D)

$1,196,172 Answer:

C Topic:

Money Market Hedge Skill:

Analytical

20

Page 21: Transaction Exposure

33)

Refer to Instruction 9.1. A ________ hedge allows Plains States to enjoy the benefits of a favorable change in exchange rates for their euro receivables contract while protecting the firm from unfavorable exchange rate changes.

A)

forward B)

call option C)

put option D)

money market Answer:

C Topic:

Put Option Hedge Skill:

Conceptual

34)

Refer to Instruction 9.1. What is the cost of a put option hedge for Plains States' euro receivable contract? (Note: Calculate the cost in future value dollars and assume the firm's cost of capital as the appropriate interest rate for calculating future values.)

A)

$27,694 B)

$26,250 C)

euro 27,694 D)

euro 26,250 Answer:

21

Page 22: Transaction Exposure

A Topic:

Put Option Hedge Skill:

Analytical

35)

Refer to Instruction 9.1. The cost of a call option to Plains States would be ________. A)

$17,653 B)

$16,733 C)

$18,471 D)

There is not enough information to answer this question. Answer:

D Topic:

Put Option Hedge Skill:

Analytical

36)

Refer to Instruction 9.1. If Plains States purchases the put option, and the option expires in six months on the same day that Plains States receives the euro 1,250,000, the firm will exercise the put at that time if the spot rate is $1.43/euro.

Answer:

FALSE Topic:

Put Option Hedge Skill:

Analytical

22

Page 23: Transaction Exposure

37)

A ________ hedge and a ________ hedge guarantee fixed payoffs but a ________ hedge or ________ hedge offer uncertain outcomes.

A)

money market; currency option; forward; no hedge at all B)

no hedge at all; currency option; forward; money market C)

money market; forward; currency option; no hedge at all D)

forward; no hedge at all; money market; currency option Answer:

C Topic:

Multiple Hedges Skill:

Conceptual

23

Page 24: Transaction Exposure

38)

Choosing which transaction exposure hedging strategy is best for a particular transaction depends on which of the following?

A)

the firm's risk tolerance B)

the firm's expectations about changes in currency exchange rates C)

the costs associated with each alternative D)

all of the above Answer:

D Topic:

Transaction Exposure Skill:

Conceptual

39)

Hedging accounts payable foreign currency exchange risk would likely consider the purchase of a ________ option whereas hedging accounts receivable currency exchange risk would be likely be to purchase a ________ option.

A)

put; call B)

put; put C)

call; put D)

call; call Answer:

C

24

Page 25: Transaction Exposure

Topic:

Options Skill:

Conceptual

25

Page 26: Transaction Exposure

Instruction 9.2:Use the information for following problem(s).

Oregon Transportation Inc. (OTI) has just signed a contract to purchase light rail cars from a manufacturer in Germany for euro 2,500,000. The purchase was made in June with payment due six months later in December. Because this is a sizable contract for the firm and because the contract is in euros rather than dollars, OTI is considering several hedging alternatives to reduce the exchange rate risk arising from the sale. To help the firm make a hedging decision you have gathered the following information.

∙ The spot exchange rate is $1.40/euro∙ The six month forward rate is $1.38/euro∙ OTI's cost of capital is 11%∙ The Euro zone 6-month borrowing rate is 9% (or 4.5% for 6 months)∙ The Euro zone 6-month lending rate is 7% (or 3.5% for 6 months)∙ The U.S. 6-month borrowing rate is 8% (or 4% for 6 months)∙ The U.S. 6-month lending rate is 6% (or 3% for 6 months)∙ December call options for euro 625,000; strike price $1.42, premium price is 1.5%∙ OTI's forecast for 6-month spot rates is $1.43/euro∙ The budget rate, or the highest acceptable purchase price for this project, is

$3,625,000 or $1.45/euro

40)

Refer to Instruction 9.2. If OTI chooses not to hedge their euro payable, the amount they pay in six months will be ________.

A)

$3,500,000 B)

$3,450,000 C)

euro 3,450,000 D)

unknown today Answer:

D Topic:

Transaction Exposure Skill:

Analytical

41)

Refer to Instruction 9.2. If OTI chooses to hedge its transaction exposure in the forward

26

Page 27: Transaction Exposure

market, it will ________ euro 2,500,000 forward at a rate of ________. A)

buy; $1.38 B)

buy; $1.40 C)

sell; $1.38 D)

sell; euro 1.40 Answer:

A Topic:

Forward Hedge Skill:

Analytical

27

Page 28: Transaction Exposure

42)

Refer to Instruction 9.2. OTI chooses to hedge its transaction exposure in the forward market at the available forward rate. The required amount in dollars to pay off the accounts payable in 6 months will be ________.

A)

$2,500,000 B)

$3,450,000 C)

$3,500,000 D)

$3,575,000 Answer:

B Topic:

Forward Hedge Skill:

Analytical

43)

Refer to Instruction 9.2. If OTI locks in the forward hedge at $1.38/euro, and the spot rate when the transaction was recorded on the books was $1.40/euro, this will result in a "foreign exchange accounting transaction ________" of ________.

A)

loss; $50,000 B)

loss; euro 50,000 C)

gain; $50,000 D)

gain; euro 50,000 Answer:

28

Page 29: Transaction Exposure

C Topic:

Forward Hedge Skill:

Analytical

44)

Refer to Instruction 9.2. OTI would be ________ by an amount equal to ________ with a forward hedge than if they had not hedged and their predicted exchange rate for 6 months had been correct.

A)

better off; $125,000 B)

better off; euro 125,000 C)

worse off; $125,000 D)

worse off; euro 125,0000 Answer:

A Topic:

Forward Hedge Skill:

Analytical

45)

Refer to Instruction 9.2. What is the cost of a call option hedge for OTI's euro receivable contract? (Note: Calculate the cost in future value dollars and assume the firm's cost of capital as the appropriate interest rate for calculating future values.)

A)

$52,500 B)

$55,388 C)

29

Page 30: Transaction Exposure

$56,125 D)

$58,275 Answer:

B Topic:

Call Option Skill:

Analytical

30

Page 31: Transaction Exposure

46)

Refer to Instruction 9.2. The cost of a put option to OTI would be ________. A)

$52,500 B)

$55,388 C)

$58,275 D)

There is not enough information to answer this question. Answer:

D Topic:

Put Option Skill:

Analytical

47)

The treasury function of most firms, the group typically responsible for transaction exposure management, is NOT usually considered a profit center.

Answer:

TRUE Topic:

Profit Centers Skill:

Recognition

48)

________ are transactions for which there are, at present, no contracts or agreements between parties.

A)

Backlog exposure B)

31

Page 32: Transaction Exposure

Quotation exposure C)

Anticipated exposure D)

None of the above Answer:

C Topic:

Anticipated Exposure Skill:

Recognition

49)

According to the authors, firms that employ proportional hedges increase the percentage of forward-cover as the maturity of the exposure lengthens.

Answer:

FALSE Topic:

Proportional Hedging Skill:

Recognition

50)

According to a survey by Bank of America, the type of foreign exchange risk most often hedged by firms is ________.

A)

translation exposure B)

transaction exposure C)

contingent exposure D)

economic exposure 32

Page 33: Transaction Exposure

B Topic:

Transaction Exposure Skill:

Recognition

51)

According to a survey by Bank of America, when firms do hedge, the most common type of hedging instruments are ________.

A)

forwards B)

options C)

money markets D)

call and puts Answer:

A Topic:

Forward Hedge Skill:

Recognition

52)

Whohauser is a U.S.-based forest products firm. In June Whohauser delivers a shipment of raw lumber to Japan. The ¥55,000,000 receivable is due in 180 days. The firm's foreign exchange advisors believe the yen will be at about ¥115/$ then. The current spot rate is ¥110/$. Whohauser has received a 180 day forward quote of ¥108/$. If the company does nothing and the exchange rate goes to ¥115 as expected, how much will the firm receive in dollars in 180 days? Is this cash flow risky or known with certainty today?

A)

$509,259 certain B)

$500,000 risky 33

Page 34: Transaction Exposure

C)

$478,261 risky D)

$500,000 certain Answer:

C Topic:

Exchange Rates Skill:

Analytical

53)

Whohauser is a U.S.-based forest products firm. In June Whohauser delivers a shipment of raw lumber to Japan. The ¥55,000,000 receivable is due in 180 days. The firm's foreign exchange advisors believe the yen will be at about ¥115/$ then. The current spot rate is ¥110/$. Whohauser has received a 180 day forward quote of ¥108/$. If the company locks in the forward quote and the exchange rate goes to ¥115 as expected, how much will the firm receive in dollars in 180 days? Is this cash flow risky or known with certainty today?

A)

$509,259 certain B)

$500,000 risky C)

$478,261 risky D)

$500,000 certain Answer:

A Topic:

Exchange Rates Skill:

Analytical

34

Page 35: Transaction Exposure

54)

Whohauser is a U.S.-based forest products firm. In June Whohauser delivers a shipment of raw lumber to Japan. The ¥55,000,000 receivable is due in 180 days. The firm's foreign exchange advisors believe the yen will be at about ¥115/$ then. The current spot rate is ¥110/$. Whohauser has received a 180 day forward quote of ¥108/$. If the company does nothing and the exchange rate stays the same as the current spot rate of ¥110/$, how much will the firm receive in dollars in 180 days? Is this cash flow risky or known with certainty today?

A)

$509,259 certain B)

$500,000 risky C)

$479,261 certain D)

None of the above Answer:

B Topic:

Exchange Rates Skill:

Analytical

35

Page 36: Transaction Exposure

9.2

Essay Questions

1)

Does foreign currency exchange hedging both reduce risk and increase expected value? Explain, and list several arguments in favor of currency risk management and several against.

Answer:

Foreign exchange currency hedging can reduce the variability of foreign currency receivables or payables by locking in a specific exchange rate in the future via a forward contract, converting currency at the current spot rate using a money market hedge, or minimizing unfavorable exchange rate movement with a currency option. None of these hedging techniques, however, increases the expected value of the foreign currency exchange. In fact, expected value should fall by an amount equal to the cost of the hedge.

Generally, those in favor of currency risk management find value in the reduction of variability of uncertain cash flows. Those opposed to currency risk management argue the NPV of such activities are $0 or less and that shareholders can reduce risk themselves more efficiently. For a more complete answer to this question, see page 4 where the author outlines several arguments for and against currency risk management.

2)

Currency risk management techniques include forward hedges, money market hedges, and option hedges. Draw a diagram showing the possible outcomes of these hedging alternatives for a foreign currency receivable contract. In your diagram, be sure to label the X and Y-axis, the put option strike price, and show the possible results for a money market hedge, a forward hedge, a put option hedge, and an uncovered position. (Note: Assume the forward currency receivable is British pounds and the put option strike price is $1.50/£, the price of the option is $0.04 the forward rate is $1.52/£ and the current spot rate is $1.48/£.)

Answer:

The student should draw and label a diagram that looks similar to the one found on page 14.

36