Deck 11: Managing Transaction Exposure

Question 1

$$\begin{array} { l l r } \text { U.S. deposit rate for 1 year } & = & 11 \% \\\text { U.S. borrowing rate for 1 year } & = & 12 \% \\\text { New Zealand deposit rate for 1 year } & = & 8 \% \\\text { New Zealand borrowing rate for 1 year } & = & 10 \% \\\text { New Zealand dollar forward rate for 1 year } & = & \$ .40 \\\text { New Zealand dollar spot rate } & = & \$ .39\end{array}$$
Also assume that a U.S. exporter denominates its New Zealand exports in NZ$ and expects to receive NZ$600,000 in 1 year. You are a consultant for this firm.
Using the information above, what will be the approximate value of these exports in 1 year in U.S. dollars given that the firm executes a money market hedge?

A) $238,584.
B) $240,000.
C) $234,000.
D) $236,127.

Answer 1

$236,127.

Question 2

13)Assume that Cooper Co. will not use its cash balances in a money market hedge. When deciding between a forward hedge and a money market hedge, it ____ determine which hedge is preferable before implementing the hedge. It ____ determine whether either hedge will outperform an unhedged strategy before implementing the hedge.

A) can; can
B) can; cannot
C) cannot; can
D) cannot; cannot

Answer 2

B

Question 3

6)Which of the following reflects a hedge of net receivables in British pounds by a U.S. firm?

A) purchase a currency put option in British pounds.
B) sell pounds forward.
C) borrow U.S. dollars, convert them to pounds, and invest them in a British pound deposit.
D) A and B

Answer 3

D

Question 4

2)Assume zero transaction costs. If the 180-day forward rate overestimates the spot rate 180 days from now, then the real cost of hedging payables will be:

A) positive.
B) negative.
C) positive if the forward rate exhibits a premium, and negative if the forward rate exhibits a discount.
D) zero.

Question 5

12)Use the following information to calculate the dollar cost of using a money market hedge to hedge 200,000 pounds of payables due in 180 days. Assume the firm has no excess cash. Assume the spot rate of the pound is $2.02, the 180-day forward rate is $2.00. The British interest rate is 5%, and the U.S. interest rate is 4% over the 180-day period.

A) $391,210.
B) $396,190.
C) $388,210.
D) $384,761.
E) none of the above

Question 6

20)Your company will receive C$600,000 in 90 days. The 90-day forward rate in the Canadian dollar is $.80. If you use a forward hedge, you will:

A) receive $750,000 today.
B) receive $750,000 in 90 days.
C) pay $750,000 in 90 days.
D) receive $480,000 today.
E) receive $480,000 in 90 days.

Question 7

3)Assume the following information:

Also assume that a U.S. exporter denominates its Swiss exports in Swiss francs and expects to receive SF600,000 in 1 year.
Using the information above, what will be the approximate value of these exports in 1 year in U.S. dollars given that the firm executes a forward hedge?

A) $234,000.
B) $238,584.
C) $240,000.
D) $236,127.

Question 8

15)Spears Co. will receive SF1,000,000 in 30 days. Use the following information to determine the total dollar amount received (after accounting for the option premium) if the firm purchases and exercises a put option:

A) $630,000.
B) $610,000.
C) $600,000.
D) $590,000.
E) $580,000.

Question 9

5)An example of cross-hedging is:

A) find two currencies that are highly positively correlated; match the payables of the one currency to the receivables of the other currency.
B) use the forward market to sell forward whatever currencies you will receive.
C) use the forward market to buy forward whatever currencies you will receive.
D) B and C

Question 10

11)From the perspective of Detroit Co., which has payables in Mexican pesos and receivables in Canadian dollars, hedging the payables would be most desirable if the expected real cost of hedging payables is ____, and hedging the receivables would be most desirable if the expected real cost of hedging receivables is ____.

A) negative; positive
B) zero; positive
C) zero; zero
D) positive; negative
E) negative; negative

Question 11

10)The real cost of hedging payables with a forward contract equals:

A) the nominal cost of hedging minus the nominal cost of not hedging.
B) the nominal cost of not hedging minus the nominal cost of hedging.
C) the nominal cost of hedging divided by the nominal cost of not hedging.
D) the nominal cost of not hedging divided by the nominal cost of hedging.

Question 12

1)Assume zero transaction costs. If the 90-day forward rate of the euro is an accurate estimate of the spot rate 90 days from now, then the real cost of hedging payables will be:

A) positive.
B) negative.
C) positive if the forward rate exhibits a premium, and negative if the forward rate exhibits a discount.
D) zero.

Question 13

8)If Lazer Co. desired to lock in the maximum it would have to pay for its net payables in euros but wanted to be able to capitalize if the euro depreciates substantially against the dollar by the time payment is to be made, the most appropriate hedge would be:

A) a money market hedge.
B) purchasing euro put options.
C) a forward purchase of euros.
D) purchasing euro call options.
E) selling euro call options.

Question 14

17)If interest rate parity exists and transactions costs are zero, the hedging of payables in euros with a forward hedge will ____.

A) have the same result as a call option hedge on payables
B) have the same result as a put option hedge on payables
C) have the same result as a money market hedge on payables
D) require more dollars than a money market hedge
E) A and D

Question 15

Assume that Parker Company will receive SF200,000 in 360 days. Assume the following interest rates:
$$\begin{array} { l c c } & \text { U.S. } & \text { Switzerland } \\ \text { 360-day borrowing rate } & 6 \% & 5 \% \\\text { 360-day deposit rate } & 6 \% & 4 \%\end{array}$$
Assume the forward rate of the Swiss franc is $.50 and the spot rate of the Swiss franc is $.48. If Parker Company uses a money market hedge, it will receive ____ in 360 days.

A) $101,904
B) $101,923
C) $98,769
D) $96,914
E) $92,307

Question 16

14)Foghat Co. has 1,000,000 euros as receivables due in 30 days, and is certain that the euro will depreciate substantially over time. Assuming that the firm is correct, the ideal strategy is to:

A) sell euros forward.
B) purchase euro currency put options.
C) purchase euro currency call options.
D) purchase euros forward.
E) remain unhedged.

Question 17

9)If Salerno Inc. desired to lock in a minimum rate at which it could sell its net receivables in Japanese yen but wanted to be able to capitalize if the yen appreciates substantially against the dollar by the time payment arrives, the most appropriate hedge would be:

A) a money market hedge.
B) a forward sale of yen.
C) purchasing yen call options.
D) purchasing yen put options.
E) selling yen put options.

Question 18

7)Which of the following reflects a hedge of net payables on British pounds by a U.S. firm?

A) purchase a currency put option in British pounds.
B) sell pounds forward.
C) sell a currency call option in British pounds.
D) borrow U.S. dollars, convert them to pounds, and invest them in a British pound deposit.
E) A and B

Question 19

16)A ____ involves an exchange of currencies between two parties, with a promise to re-exchange currencies at a specified exchange rate and future date.

A) long-term forward contract
B) currency option contract
C) parallel loan
D) money market hedge

Question 20

The forward rate of the Swiss franc is $.50. The spot rate of the Swiss franc is $.48. The following interest rates exist:
$$\begin{array} { l c c } & \text { U.S. } & \text { Switzerland } \\\text { 360-day borrowing rate } & 7 \% & 5 \% \\\text { 360-day deposit rate } & 6 \% & 4 \%\end{array}$$
You need to purchase SF200,000 in 360 days. If you use a money market hedge, the amount of dollars you need in 360 days is:

A) $101,904.
B) $101,923.
C) $98,770.
D) $96,914.
E) $92,307.

Question 21

33)FAB Corporation will need 200,000 Canadian dollars (C$) in 90 days to cover a payable position. Currently, a 90-day call option with an exercise price of $.75 and a premium of $.01 is available. Also, a 90-day put option with an exercise price of $.73 and a premium of $.01 is available. FAB plans to purchase options to hedge its payable position. Assuming that the spot rate in 90 days is $.71, what is the net amount paid, assuming FAB wishes to minimize its cost?

A) $144,000.
B) $148,000.
C) $152,000.
D) $150,000.

Question 22

Exhibit 11-1
$\begin{array}{lll} & \text { U.S. } & \text { Jordan } \\360 \text {-day borrowing rate } & 6 \% & 5 \% \\360 \text {-day deposit rate } & 5 \% & 4 \%\end{array}$


-Refer to Exhibit 11-1. Pablo Corp. will need 150,000 Jordanian dinar (JOD) in 360 days. The current spot rate of the dinar is $1.48, while the 360-day forward rate is $1.46. What is Pablo's cost from implementing a money market hedge (assume Pablo does not have any excess cash)?

A) $224,135.
B) $226,269.
C) $224,114.
D) $223,212.

Question 23

40)A forward contract hedge is very similar to a futures contract hedge, except that ____ contracts are commonly used for ____ transactions.

A) forward; small
B) futures; large
C) forward; large
D) none of the above

Question 24

You are the treasurer of Arizona Corporation and must decide how to hedge (if at all) future receivables of 350,000 Australian dollars (A$) 180 days from now. Put options are available for a premium of $.02 per unit and an exercise price of $.50 per Australian dollar. The forecasted spot rate of the Australian dollar in 180 days is:
$\begin{array}{cc}\text { Future Spot Rate } & \text { Probability } \\\$ .46 & 20 \% \\\$ .48 & 30 \% \\\$ .52 & 50 \%\end{array}$

The 90-day forward rate of the Australian dollar is $.50.
What is the probability that the put option will be exercised (assuming Arizona purchased it)?

A) 0%.
B) 80%.
C) 50%.
D) none of the above

Question 25

Assume that Kramer Co. will receive SF800,000 in 90 days. Today's spot rate of the Swiss franc is $.62, and the 90-day forward rate is $.635. Kramer has developed the following probability distribution for the spot rate in 90 days:
$$\begin{array}{l}\text { Passible spot Fate }\\\begin{array} { c c } \text { in 90 D.4 } & \text { Probabilit } \\ .61 & 10 \% \\\$ .63 & 20 \% \\\$ .64 & 40 \% \\\$ .65 & 30 \%\end{array}\end{array}$$
The probability that the forward hedge will result in more dollars received than not hedging is:

A) 10%.
B) 20%.
C) 30%.
D) 50%.
E) 70%.

Question 26

27)Money Corp. frequently uses a forward hedge to hedge its Malaysian ringgit (MYR) receivables. For the next month, Money has identified its net exposure to the ringgit as being MYR1,500,000. The 30-day forward rate is $.23. Furthermore, Money's financial center has indicated that the possible values of the Malaysian ringgit at the end of next month are $.20 and $.25, with probabilities of .30 and .70, respectively. Based on this information, the revenue from hedging minus the revenue from not hedging receivables is____.

A) $0.
B) -$7,500.
C) $7,500.
D) none of the above

Question 27

37)When a perfect hedge is not available to eliminate transaction exposure, the firm may consider methods to at least reduce exposure, such as ____.

A) leading
B) lagging
C) cross-hedging
D) currency diversification
E) all of the above

Question 28

Assume that Patton Co. will receive 100,000 New Zealand dollars (NZ$) in 180 days. Today's spot rate of the NZ$ is $.50, and the 180-day forward rate is $.51. A call option on NZ$ exists, with an exercise price of $.52, a premium of $.02, and a 180-day expiration date. A put option on NZ$ exists with an exercise price of $.51, a premium of $.02, and a 180-day expiration date. Patton Co. has developed the following probability distribution for the spot rate in 180 days:
$$\begin{array}{l}\text { Passible spot Fate }\\\begin{array} { c c } \text { in 90 Days } & \text { Probraility } \\\$ 48 & 10 \% \\\$ 49 & 60 \% \\\$.55 & 30 \%\end{array}\end{array}$$
The probability that the forward hedge will result in more U.S. dollars received than the options hedge is ____ (deduct the amount paid for the premium when estimating the U.S. dollars received on the options hedge).

A) 10%
B) 30%
C) 40%
D) 70%
E) none of the above

Question 29

39)To hedge a ____ in a foreign currency, a firm may ____ a currency futures contract for that currency.

A) receivable; purchase
B) payable; sell
C) payable; purchase
D) none of the above

Question 30

Exhibit 11-1
$\begin{array}{lll} & \text { U.S. } & \text { Jordan } \\360 \text {-day borrowing rate } & 6 \% & 5 \% \\360 \text {-day deposit rate } & 5 \% & 4 \%\end{array}$


-Refer to Exhibit 11-1. Perkins Corp. will receive 250,000 Jordanian dinar (JOD) in 360 days. The current spot rate of the dinar is $1.48, while the 360-day forward rate is $1.50. How much will Perkins receive in 360 days from implementing a money market hedge (assume any receipts before the date of the receivable are invested)?

A) $377,115.
B) $373,558.
C) $363,019.
D) $370,000.

Question 31

21)A call option exists on British pounds with an exercise price of $1.60, a 90-day expiration date, and a premium of $.03 per unit. A put option exists on British pounds with an exercise price of $1.60, a 90-day expiration date, and a premium of $.02 per unit. You plan to purchase options to cover your future receivables of 700,000 pounds in 90 days. You will exercise the option in 90 days (if at all). You expect the spot rate of the pound to be $1.57 in 90 days. Determine the amount of dollars to be received, after deducting payment for the option premium.

A) $1,169,000.
B) $1,099,000.
C) $1,106,000.
D) $1,143,100.
E) $1,134,000.

Question 32

22)Assume that Smith Corporation will need to purchase 200,000 British pounds in 90 days. A call option exists on British pounds with an exercise price of $1.68, a 90-day expiration date, and a premium of $.04. A put option exists on British pounds, with an exercise price of $1.69, a 90-day expiration date, and a premium of $.03. Smith Corporation plans to purchase options to cover its future payables. It will exercise the option in 90 days (if at all). It expects the spot rate of the pound to be $1.76 in 90 days. Determine the amount of dollars it will pay for the payables, including the amount paid for the option premium.

A) $360,000.
B) $338,000.
C) $332,000.
D) $336,000.
E) $344,000.

Question 33

31)Lorre Company needs 200,000 Canadian dollars (C$) in 90 days and is trying to determine whether or not to hedge this position. Lorre has developed the following probability distribution for the Canadian dollar:

The 90-day forward rate of the Canadian dollar is $.575, and the expected spot rate of the Canadian dollar in 90 days is $.55. If Lorre implements a forward hedge, what is the probability that hedging will be more costly to the firm than not hedging?

A) 40%.
B) 60%.
C) 15%.
D) 85%.

Question 34

28)Hanson Corp. frequently uses a forward hedge to hedge its British pound (£) payables. For the next quarter, Hanson has identified its net exposure to the pound as being £1,000,000. The 90-day forward rate is $1.50. Furthermore, Hanson's financial center has indicated that the possible values of the British pound at the end of next quarter are $1.57 and $1.59, with probabilities of .50 and .50, respectively. Based on this information, what is the expected real cost of hedging payables?

A) $80,000.
B) -$80,000.
C) $1,570,000.
D) $1,580,000.

Question 35

32)Quasik Corporation will be receiving 300,000 Canadian dollars (C$) in 90 days. Currently, a 90-day call option with an exercise price of $.75 and a premium of $.01 is available. Also, a 90-day put option with an exercise price of $.73 and a premium of $.01 is available. Quasik plans to purchase options to hedge its receivable position. Assuming that the spot rate in 90 days is $.71, what is the net amount received from the currency option hedge?

A) $219,000.
B) $222,000.
C) $216,000.
D) $213,000.

Question 36

35)If interest rate parity exists, and transaction costs do not exist, the money market hedge will yield the same result as the ____ hedge.

A) put option
B) forward
C) call option
D) none of the above

Question 37

26)The ____ hedge is not a technique to eliminate transaction exposure discussed in your text.

A) index
B) futures
C) forward
D) money market
E) currency option

Question 38

38.Sometimes the overall performance of an MNC may already be insulated by offsetting effects between subsidiaries and it may not be necessary to hedge the position of each individual subsidiary.

Question 39

Assume that Jones Co. will need to purchase 100,000 Singapore dollars (S$) in 180 days. Today's spot rate of the S$ is $.50, and the 180-day forward rate is $.53. A call option on S$ exists, with an exercise price of $.52, a premium of $.02, and a 180-day expiration date. A put option on S$ exists, with an exercise price of $.51, a premium of $.02, and a 180-day expiration date. Jones has developed the following probability distribution for the spot rate in 180 days:
$$\begin{array}{l}\text { Passible spot Fate }\\\begin{array} { c c } \text { in 90 D.4. } & \text { Probrailit } \\\$ 48 & 10 \% \\\$53 & 60 \% \\\$.55 & 30 \%\end{array}\end{array}$$
The probability that the forward hedge will result in a higher payment than the options hedge is ____ (include the amount paid for the premium when estimating the U.S. dollars required for the options hedge).

A) 0%
B) 10%
C) 30%
D) 40%
E) 70%

Question 40

36)Which of the following is the least effective way of hedging exposure in the long run?

A) long-term forward contract.
B) currency swap.
C) parallel loan.
D) money market hedge.

Question 41

45)Blake Inc. needs €1,000,000 in 30 days. It can earn 5 percent annualized on a German security. The current spot rate for the euro is $1.00. Blake can borrow funds in the U.S. at an annualized interest rate of 6 percent. If Blake uses a money market hedge to hedge the payable, what is the cost of implementing the hedge?

A) $1,000,000.
B) $1,055,602.
C) $1,000,830.
D) $1,045,644.

Question 42

52.If an MNC is extremely risk-averse, it may decide to hedge even though its hedging analysis indicates that remaining unhedged will probably be less costly than hedging.

Question 43

59.A futures hedge involves taking a money market position to cover a future payables or receivables position.

Question 44

51.Hedging the position of individual subsidiaries is generally necessary, even if the overall performance of the MNC is already insulated by the offsetting positions between subsidiaries.

Question 45

50)The ____ does not represent an obligation.

A) long-term forward contract
B) currency swap
C) parallel loan
D) currency option

Question 46

43.If an MNC is hedging various currencies, it should measure the real cost of hedging in each currency as a dollar amount for comparison purposes.

Question 47

57.To hedge payables with futures, an MNC would sell futures; to hedge receivables with futures, an MNC would buy futures.

Question 48

48)To hedge a contingent exposure, in which an MNC's exposure is contingent on a specific event occurring, the appropriate hedge would be a(n) ____ hedge.

A) money market
B) futures
C) forward
D) options

Question 49

53.A money market hedge involves taking a money market position to cover a future payables or receivables position.

Question 50

56.Currency futures are very similar to forward contracts, except that they are standardized and are more appropriate for firms that prefer to hedge in smaller amounts.

Question 51

49)A ____ is not normally used for hedging long-term transaction exposure.

A) long-term forward contact
B) futures contract
C) currency swap
D) parallel loan

Question 52

41)Celine Co. will need €500,000 in 90 days to pay for German imports. Today's 90-day forward rate of the euro is $1.07. There is a 40 percent chance that the spot rate of the euro in 90 days will be $1.02, and a 60 percent chance that the spot rate of the euro in 90 days will be $1.09. Based on this information, the expected value of the real cost of hedging payables is $____.

A) -35,000
B) 25,000
C) -1,000
D) 1,000

Question 53

58.When the real cost of hedging is positive, this implies that hedging was more favorable than not hedging.

Question 54

47.If interest rate parity exists, the forward hedge will always outperform the money market hedge.

Question 55

55.MNCs generally do not need to hedge because shareholders can hedge their own risk.

Question 56

46.Since the results of both a money market hedge and a forward hedge are known beforehand, an MNC can implement the one that is more feasible.

Question 57

44)Samson Inc. needs €1,000,000 in 30 days. Samson can earn 5 percent annualized on a German security. The current spot rate for the euro is $1.00. Samson can borrow funds in the U.S. at an annualized interest rate of 6 percent. If Samson uses a money market hedge, how much should it borrow in the U.S.?

A) $952,381.
B) $995,851.
C) $943,396.
D) $995,025.

Question 58

60.If interest rate parity (IRP) exists, then the money market hedge will yield the same result as the options hedge.

Question 59

42)In a forward hedge, if the forward rate is an accurate predictor of the future spot rate, the real cost of hedging payables will be:

A) highly positive.
B) highly negative.
C) zero.
D) none of the above

Question 60

54.To hedge a payable position with a currency option hedge, an MNC would write a call option.

Question 61

73.If an MNC assesses net transaction exposure, this refers to the consolidation of all expected inflows for a particular time and currency.

Question 62

You are the treasurer of Montana Corporation and must decide how to hedge (if at all) future payables of 1,000,000 Japanese yen 90 days from now. Call options are available with a premium of $.01 per unit and an exercise price of $.01031 per Japanese yen. The forecasted spot rate of the Japanese yen in 90 days is:
$$\begin{array} { c c } \text { Future Spot Rate } & \text { Probability } \\ \$ .01035 & 20 \% \\\$ .01032 & 20 \% \\\$ .01030 & 30 \% \\\$ .01029 & 30 \%\end{array}$$
The 90-day forward rate of the Japanese yen is $.01033.
What is the probability that the call option will be exercised (assuming Montana purchased it)?

A) 30%
B) 60%
C) 20%
D) 40%

Question 63

69)Johnson Co. has 1,000,000 euros as payables due in 30 days, and is certain that euro is going to appreciate substantially over time. Assuming the firm is correct, the ideal strategy is to:

A) sell euros forward
B) purchase euro currency put options.
C) purchase euro currency call options.
D) purchase euros forward.
E) remain unhedged.

Question 64

78.If interest rate parity exists, and transaction costs do not exist, the option hedge will yield the same results as no hedge.

Question 65

66.When comparing the forward hedge to the options hedge, the MNC can easily determine which hedge is more desirable, because the cost of each hedge can be determined with certainty.

Question 66

62.A put option essentially represents two swaps of currencies, one swap at the inception of the loan contract and another swap at a specified date in the future.

Question 67

64.The exact cost of hedging with call options (as measured in the text) is not known with certainty at the time that the options are purchased.

Question 68

71)Mender Co. will be receiving 500,000 Australian dollars in 180 days. Currently, a 180-day call option with an exercise price of $.68 and a premium of $.02 is available. Also, a 180-day put option with an exercise price of $.66 and a premium of $.02 is available. Mender plans to purchase options to hedge its receivables position. Assuming that the spot rate in 180 days is $.67, what is the amount received from the currency option hedge (after considering the premium paid)?

A) $330,000
B) $325,000
C) $320,000
D) $340,000

Question 69

79.To hedge a payable position with a currency option hedge, an MNC would write a call option.

Question 70

65.The tradeoff when considering alternative call options to hedge a currency position is that an MNC can obtain a call option with a higher exercise price, but would have to pay a higher premium.

Question 71

67.When comparing the forward hedge to the money market hedge, the MNC can easily determine which hedge is more desirable, because the cost of each hedge can be determined with certainty.

Question 72

63.The hedging of a foreign currency for which no forward contract is available with a highly correlated currency for which a forward contract is available is referred to as cross-hedging.

Question 73

77.To hedge a payable position in a foreign currency with a money market hedge, the MNC would borrow the foreign currency, convert it to dollars, and invest that amount in the U.S. until the payable is due.

Question 74

74.Most MNCs do not perceive their foreign exchange management as a profit center. Rather, their main responsibility is to assess potential exposure and determine how and if the exposure should be hedged.

Question 75

68)Assume zero transaction costs. If the 90-day forward rate of the euro underestimates the spot rate 90 days from now, then the real cost of hedging payables will be:

A) positive.
B) negative.
C) positive if the forward rate exhibits a premium, and negative if the forward rate exhibits a discount.
D) zero.

Question 76

80.An advantage of using options to hedge is that the MNC can let the option expire. However, a disadvantage of using options is that a premium must be paid for it.

Question 77

76.A money market hedge involves taking a money market position to cover a future payables or receivables position.

Question 78

61.The price at which a currency put option allows the holder to sell a currency is called the settlement price.

Question 79

70)Linden Co. has 1,000,000 euros as payables due in 90 days, and is certain that euro is going to depreciate substantially over time. Assuming the firm is correct, the ideal strategy is to:

A) sell euros forward
B) purchase euro currency put options.
C) purchase euro currency call options.
D) purchase euros forward.
E) remain unhedged

Question 80

75.If a firm is hedging payables with futures contracts, it may end up paying more for the payable than it would have had it remained unhedged if the foreign currency depreciates.