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Exam 11: Transaction Exposure

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Question 1

Multiple Choice

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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. If the exchange rate changes to $2.05/£ the U.S. firm will realize a ________ of ________.

A) loss; $2000
B) gain; $2000
C) loss; £2000
D) gain; £2000

E) A) and B)
F) C) and D)

Correct Answer

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B

Question 2

Multiple Choice

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Instruction 11.2:Use the information for the 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 -Refer to Instruction 11.2. 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; €50,000.
C) gain; $50,000.
D) gain; €50,000.

E) A) and B)
F) A) and D)

Correct Answer

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C

Question 3

Multiple Choice

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________ 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.

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

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.

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

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

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.

When attempting to manage an account payable denominated in a foreign currency, the firm's only choice is to remain unhedged.

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

Many MNE s manage foreign exchange exposure centrally, thus gains or losses are always matched with the country of origin.

Instruction 11.2:Use the information for the 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 -Refer to Instruction 11.2. 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 ________.

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.

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

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

Instruction 11.2:Use the information for the 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 -Refer to Instruction 11.2. 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.)

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.

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. If the exchange rate changes to $2.01/£ the U.S. firm will realize a ________ of ________.

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

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