Deck 17: Risk Management and the Foreign Currency Hedging Decision

Question 1

________ are financial contracts whose values depend on the values of some underlying asset price.

A) Margin calls
B) Derivative securities
C) Tax codes
D) Tax shields

Answer 1

B

Question 2

According to some research,firms with higher dividend payouts are more like to

A) generate a tax-loss carry-forward.
B) incur financial distress.
C) hedge.
D) under-report their hedging activities.

Answer 2

C

Question 3

Tax benefits of hedging are greater in which one of the following?

A) when the tax code is more progressive
B) when a firm's pretax income is more stable
C) when more of the firm's income is subject to a flat rate tax
D) when the tax code is more regressive

Answer 3

A

Question 4

When a firm is unprofitable it generates a ________ that allows it to offset the losses that were incurred against future income.

A) tax credit
B) itemized deductions
C) tax-loss carry-forward
D) a write-down

Question 5

Because much of the equity value of a firm ________,hedging the foreign exchange risk is difficult.

A) depends on the indefinite future
B) is affected by nominal exchange rate risk
C) is derived from current and past cash flows only
D) must be discounted a finite period of times

Question 6

Accountants treat many hedges as ________.

A) accrued expenses
B) deferred income
C) near liquid assets
D) off-balance sheet items

Question 7

Regarding the true hedging cost,if the bid-ask spread widens for more distant future contracts,the cost of forward hedging

A) decreases with the maturity of the contract.
B) remains constant with the maturity of the contract.
C) increases with the maturity of the contract.
D) has no direct relationship to the longer term.

Question 8

What does hedging have to do with expected taxes?

A) It creates a tax-loss carry-forward.
B) It separates production costs from headquarters' costs.
C) It provides the firm with additional expenses reducing taxable income.
D) It allows the firm to shift income across different tax jurisdictions in the world.

Question 9

What does it mean when a tax code is convex?

A) It is a flat tax and does not vary as taxable income varies.
B) It is regressive and taxes lower incomes more.
C) Is proportional and the rate always taxes at proportional income equivalents.
D) It imposes a higher rate on higher incomes and a lower rate on lower incomes.

Question 10

Hedging reduces the amount of ________ in earnings data that is not due to actions of the managers.

A) information
B) certainty
C) "noise"
D) investor interest

Question 11

Because only ________ tend to get reported,gathering information that reports the trends in hedging activity must be done in other ways.

A) income statements and balance sheets
B) cash transactions
C) cash and credit transactions
D) local currency expenses

Question 12

What is the name of the accounting convention that allows a firm to offset the losses that were incurred against future income rather than receive a refund of taxes paid?

A) tax credit
B) itemized deductions
C) tax-loss carry-forward
D) a write-down

Question 13

According to the Wharton/CIBC Survey of 1998 on hedging,only when a firm is sufficiently large to overcome the fixed costs of hedging does the firm

A) create an international division responsible for hedging.
B) institute tax shelters using hedging devices.
C) institute a hedging policy.
D) hold only the cash manager responsible for hedging.

Question 14

Modigliani and Miller argued that a corporation's financial policies,such as hedging foreign exchange risk,________ unless they lowered the firm's taxes,affected its investment decisions,or could be done more cheaply than individual investors' transactions could be done.

A) do not change the value of the firm's assets
B) always change the value of the firm's assets
C) were difficult to assess
D) were relevant to a firm's dividend policy

Question 15

A ________ tax code imposes a larger tax rate on a higher income and a smaller tax rate on lower incomes.

A) convex
B) concave
C) proportional
D) flat-rate

Question 16

________ are typically larger in the forward market than in the spot market for currency.

A) Contract sizes
B) Bank fees
C) The bid-ask spreads
D) Employee costs

Question 17

When a firm's pretax income is more volatile,

A) the benefits of hedging currency risk are smaller.
B) the benefits of hedging currency risk are greater.
C) hedging will produce mixed benefits to the firm.
D) it is not possible to determines whether any benefits are greater.

Question 18

It is appropriate for the costs of hedging to be borne by the ________ department of the multinational corporation.

A) marketing
B) treasury
C) legal
D) shipping

Question 19

How can hedging increase the value of a firm?

A) by reducing its liabilities
B) by reducing its future income taxes
C) by increasing its interest expense
D) by increasing its headquarter expense

Question 20

________ is the use of derivative securities to take positions in financial markets that offset the underlying sources of risk that arise in a company's normal course of business.

A) Hedging
B) Risk management
C) Asset securitization
D) Option premium

Question 21

The gains from hedging would be more significant in countries who have a ________ tax jurisdiction.

A) lower
B) higher
C) flat tax
D) proportional

Question 22

If the tax code is convex and the forward rate equals the expected future spot rate,why would a firm prefer to pay taxes on the hedged value of a foreign currency cash flow rather than wait to pay the taxes on the realized foreign currency cash flow?

Question 23

Why is hedging considered a cost center and not a profit center?

Question 24

Which one of the following has a higher likelihood of subsidizing losses?

A) convex tax code
B) flat tax
C) currency board
D) floating exchange rate system

Question 25

Why does hedging reduce the firm's expected taxes and increase its value?

A) It creates a tax-loss carry-forward.
B) It separates production costs from headquarters' costs.
C) It provides the firm with additional expenses reducing taxable income.
D) It allows the firm to shift income across different tax jurisdictions in the world.

Question 26

Suppose that the value of a firm increases when the euro strengthens relative to the dollar,an appropriate hedge would be to

A) find another currency that is highly correlated to sell forward.
B) buy euros forward.
C) liquidate euro liabilities.
D) convert some of the firm's debt into euros.

Question 27

Why would a firm ever forgo a positive NPV project? How can hedging help prevent this situation from arising?

Question 28

If Alpha International Inc.has debt in its capital structure,it may forego a ________ project because too much of the increase in the firm's value may accrue to the creditors rather than the stockholders.

A) negative NPV
B) zero NPV
C) positive NPV
D) negative rate of return

Question 29

What are the gains from hedging foreign exchange risk?

Question 30

You work for a company where the CFO thinks that the value of the firm's assets fluctuate widely with the euro-dollar exchange rate does not want to hedge the firm's exchange rate risk because he thinks it is impossible.How can you convince him to hedge?

Question 31

Why did Miller and Modigliani claim that hedging exchange rate risk was irrelevant to the value of the firm?

Question 32

If a country's corporate tax rate is flat,when does it not make sense for a firm to hedge?