Transaction exposure is defined as:
a) the sensitivity of realized domestic currency values of the firm’s contractual cash
flows denominated in foreign currencies to unexpected exchange rate changes
b) the extent to which the value of the firm would be affected by unanticipated
changes in exchange rate
c) the potential that the firm’s consolidated financial statement can be affected by
changes in exchange rates
d) ex post and ex ante currency exposures
Answer: a)
The most direct and popular way of hedging transaction exposure is by:
a) exchange-traded futures options
b) currency forward contracts
c) foreign currency warrants
d) borrowing and lending in the domestic and foreign money markets
Answer: b)
If you have a long position in a foreign currency, you can hedge with:
a) A short position in an exchange-traded futures option
b) A short position in a currency forward contract
c) A short position in foreign currency warrants
d) borrowing (not lending) in the domestic and foreign money markets
If you a foreign currency denominated debt, you can hedge with:
a) A long position in a currency forward contract
b) A long position in an exchange-traded futures option
c) Buying the foreign currency today and investing it in the foreign county.
d) Both a) and c)
Answer: d)
The sensitivity of “realized” domestic currency values of the firm’s contractual cash
flows denominated in foreign currency to unexpected changes in the exchange rate is:
a) Transaction exposure
b) Translation exposure
c) Economic exposure
d) None of the above
The sensitivity of the firm’s consolidated financial statements to unexpected changes in
the exchange rate is:
With any hedge
a) Your losses on one side should about equal your gains on the other side.
b) You should try to make money on both sides of the transaction: that way you
make money coming and going.
c) You should spend at least as much time working the hedge as working the
underlying deal itself.
d) You should agree to anything your banker puts in front of your face.
The extent to which the value of the firm would be affected by unexpected changes in
Answer: c)
Buying a currency option provides
a) a flexible hedge against exchange exposure
b) limits the downside risk while preserving the upside potential
c) a right, but not an obligation, to buy or sell a currency
d) all of the above
Which of the following options strategies are internally consistent?
a) Sell puts and buy calls
b) Buy puts and sell calls
c) Buy puts and buy calls
d) Both a) and b)
Rationale. Both strategies a) and b) have internally consistent beliefs about the future asset
price. For example, if you sell puts, you hope the price stays the same or goes up; if you
buy calls, you hope the price goes up.
XYZ Corporation, located in the United States, has an accounts payable obligation of
¥750 million payable in one year to a bank in Tokyo. Which of the following is NOT
part of a money market hedge?
a) Buy the ¥750 million at the forward exchange rate.
b) Find the present value of ¥750 million at the Japanese interest rate.
c) Buy that much yen at the spot exchange rate.
d) Invest in risk-free Japanese securities with the same maturity as the accounts
payable obligation.
To hedge a foreign currency payable,
a) Buy call options on the foreign currency
b) Buy put options on the foreign currency
c) Sell call options on the foreign currency
d) Sell put options on the foreign currency
Rationale: d) is wrong because while you have a risk of unlimited losses from a foreign
currency appreciation, you can’t hedge that with finite gains from foreign currency
depreciation.
To hedge a foreign currency receivable,
A call option to buy £10,000 at a strike price of $1.80 = £1.00 is equivalent to
a) A put option to sell $18,000 at a strike price of $1.80 = £1.00.
b) A call option on $18,000 at a strike price of $1.80 = £1.00
c) A put option on £10,000 at a strike price of $1.80 = £1.00.
A minor currency is
a) Anything other than the “big six”: U.S. dollar, British pound, Japanese yen, euro,
Canadian dollar, and Swiss franc.
b) Any currency that trades at less than one U.S. dollar
c) Any currency that is less than a $20 denomination.
A U.S.-based MNC with exposure to the Swedish krona could best cross-hedge with
a) Forward contracts on the euro
b) Forward contracts on the ruble
c) Forward contracts on the pound
d) Forward contracts on the yen
When cross-hedging,
a) Try to find one asset that has a positive correlation with another asset.
b) The main thing is to find one asset that covaries with another asset in some
predictable way.
c) Try to find one asset that has a negative correlation with another asset.
Your firm is bidding on a large construction contract in a foreign country. This
contingent exposure could best be hedged
a) With put options on the foreign currency
b) With call options on the foreign currency
c) Both a) and b), depending upon the specifics (“the rest of the story”)
d) With futures contracts.
On a recent sale, Boeing allowed British Airways to pay either $18 million or £10
million.
a) At the due date, British airways will be indifferent between paying dollars or
pounds since they would of course have hedged their exposure either way.
b) Boeing has provided British Airways with a free option to buy $18 million with an
exercise price of £10 million.
c) Boeing has provided British Airways with a free option to sell up to £10 million
with an exercise price of $18 million.
d) All of the above
Contingent exposure can best be hedged with
a) Options
b) Money market hedging
c) Futures.
Generally speaking, a firm with recurrent exposure can best hedge using which
product?
b) Swaps
An exporter can shift exchange rate risk to their customers by
a) Invoicing in their home currency
b) Invoicing in their customer’s local currency
c) Splitting the difference, and invoicing half of sales in local currency and half of
sales in home currency.
d) Invoicing sales in a currency basket such as the SDR as the invoice currency.
An exporter can share exchange rate risk with their customers by
a) Invoicing in their customer’s local currency
b) Splitting the difference, and invoicing half of sales in local currency and half of
c) Invoicing sales in a currency basket such as the SDR as the invoice currency.
d) b) and c)
Answer: b) or d)
An exporter faced with exposure to a depreciating currency can reduce transaction
exposure with a strategy of
a) Paying or collecting early
b) Paying or collecting late
c) Paying late, collecting early.
d) Paying early, collecting late
An exporter faced with exposure to an appreciating currency can reduce transaction
A MNC seeking to reduce transaction exposure with a strategy of leading and lagging
a) Can probably employ the strategy more effectively with intrafirm payables and
receivables than with customers or outside suppliers.
b) Can employ the strategy most easily with customers, regardless of market
structure.
c) Can employ the strategy most easily with suppliers, regardless of market structure.
In evaluating the pros and cons of corporate risk management, one argument against
hedging is
a) If the corporate guys were good at forecasting exchange rates, they would make
more money on Wall Street, so only incompetent managers are left at corporations
to hedge.
b) Shareholders who are diversified have already managed their exchange rate risk.
c) The hedging costs go into someone else’s pocket.
If a firm faces progressive tax rates
a) They should spread income out across time and subsidiaries
b) They should focus on maximizing income in one division or subsidiary
c) They should manage their income recognition without regard to their taxes
In evaluating the pros and cons of corporate risk management, “market imperfections”
refer to:
a) information asymmetry, differential transaction costs, default costs, and
progressive corporate taxes
b) leading and lagging, receivables and payables, and diversification costs
c) economic costs, noneconomic costs, arbitrage costs, and hedging costs
d) management costs, corporate costs, liquidity costs, and trading costs
Answer: A
A study of Fortune 500 firms hedging practices shows that
a) Over 90 percent of Fortune 500 firms use forward contracts.
b) Over 90 percent of Fortune 500 firms use options contracts.
c) a) and b)
d
c
13. Your firm has a British customer that is willing to place a $1 million order, but wants to pay in pounds instead of dollars. The spot exchange rate is $1.85 = £1.00 and the one-year forward rate is $1.90 = £1.00. The lead time on the order is such that payment is due in one year. What is the fairest exchange rate to use?
a) $1.85 = £1.00
b) $1.8750 = £1.00
c) $1.90 = £1.00
d) none of the above
Rationale: Payment is due in one year. If they have to pay in dollars, they can hedge with a forward contract at the rate of $1.90 = £1.00
18 A U.S. firm has sold an Italian firm €1,000,000 worth of product. In one year they get paid. To hedge, the U.S. firm bought put options on the euro with a strike price of $1.15. They paid an option premium $0.01 per euro. If at maturity, the exchange rate is $1.10,
a) The firm will realize $1,145,000 on the sale net of the cost of hedging.
b) The firm will realize $1,150,000 on the sale net of the cost of hedging.
c) The firm will realize $1,140,000 on the sale net of the cost of hedging. d) None of the above
26 XYZ Corporation, located in the United States, has an accounts payable obligation of ¥750 million payable in one year to a bank in Tokyo. The current spot rate is ¥116/$1.00 and the one year forward rate is ¥109/$1.00. The annual interest rate is 3 percent in Japan and 6 percent in the United States. XYZ can also buy a one-year call option on yen at the strike price of $0.0086 per yen for a premium of 0.012 cent per yen. The future dollar cost of meeting this obligation using the money market hedge is:
a) $6,450,000
b) $6,545,400
c) $6,653,833
d) $6,880,734
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