Deck 10: Measuring Exposure to Exchange Rate Fluctuations

Question 1

Consider an MNC that is exposed to the Taiwan dollar (TWD) and the Egyptian pound (EGP). 25% of the MNC's funds are Taiwan dollars and 75% are pounds. The standard deviation of exchange movements is 7% for Taiwan dollars and 5% for pounds. The correlation coefficient between movements in the value of the Taiwan dollar and the pound is 0.7. Based on this information, the standard deviation of this two-currency portfolio is approximately:

A) 5.13%
B) 2.63%
C) 4.33%
D) 5.55%

Answer 1

A

Question 2

Which of the following operations benefits from depreciation of the firm's local currency?

A) Borrowing in a foreign country and converting the funds to the local currency prior to the depreciation.
B) Purchasing foreign supplies.
C) Investing in foreign bank accounts denominated in foreign currencies prior to depreciation of the local currency.
D) A and B

Answer 2

C

Question 3

Transaction exposure reflects:

A) the exposure of a firm's ongoing international transactions to exchange rate fluctuations.
B) the exposure of a firm's local currency value to transactions between foreign exchange traders.
C) the exposure of a firm's financial statements to exchange rate fluctuations.
D) the exposure of a firm's cash flows to exchange rate fluctuations.

Answer 3

A

Question 4

A high correlation between two currencies would be desirable for achieving low exchange rate risk if one is an inflow currency and the other is an outflow currency.

Question 5

A firm produces goods for which substitute goods are produced in all countries. Depreciation of the firm's local currency should:

A) decrease local sales as foreign competition in local markets is reduced.
B) decrease the firm's exports denominated in the local currency.
C) decrease the returns earned on the firm's foreign bank deposits.
D) decrease the firm's cash outflow required to pay for imported supplies denominated in a foreign currency.
E) none of the above

Question 6

Translation exposure is less of a concern when earnings are not remitted by the subsidiary to the parent.

Question 7

Economic exposure can affect:

A) MNCs only.
B) purely domestic firms only.
C) A and B
D) none of the above.

Question 8

If an MNC expects cash inflows of equal amounts in two currencies, and the two currencies are ____ correlated, the MNC's transaction exposure is relatively ____.

A) negatively; high
B) negatively; low
C) positively; low
D) none of the above

Question 9

One argument for exchange rate irrelevance is that:

A) MNCs can hedge exchange rate exposure much more effectively than individual investors.
B) diversified stakeholders will not be affected by exchange rate movements because of offsetting effects.
C) purchasing power parity does not hold very well.
D) MNCs are typically not diversified across numerous countries.

Question 10

If the pound appreciates:

A) a UK MNC's sales will probably decrease.
B) an MNC's exports denominated in pounds will probably increase.
C) an MNC's interest owed on foreign funds borrowed will probably increase.
D) an MNC's exports denominated in foreign currencies will probably increase.
E) all of the above.

Question 11

Subsidiary A of Mega plc has net inflows in Australian dollars of A$1,000,000, while Subsidiary B has net outflows in Australian dollars of A$1,500,000. The expected exchange rate of the Australian dollar is £0.30. What is the net inflow or outflow as measured in pounds?

A) £150,000 outflow
B) £150,000 inflow
C) £1,666,000 inflow
D) £1,666,000 outflow

Question 12

A firm's transaction exposure in any foreign currency is based solely on the size of its open position in that currency.

Question 13

Magent ltd. is a UK company that has exposure to the Swiss franc (SF) and Danish kroner (DK). It has net inflows of SF 200 million and net outflows of DK 500 million. The present exchange rate of the SF is about £0.22 while the present exchange rate of the DK is £0.05. Magent ltd. has not hedged these positions. The SF and DK are highly correlated in their movements against the pound. If the pound weakens, then Magent ltd. will:

A) benefit, because the pound value of its SF position exceeds the pound value of its DK position.
B) benefit, because the pound value of its DK position exceeds the pound value of its SF position.
C) be adversely affected, because the pound value of its SF position exceeds the pound value of its DK position.
D) be adversely affected, because the pound value of its DK position exceeds the pound value of its SF position.

Question 14

Regression analysis cannot be used to assess the sensitivity of a company's performance to economic conditions because economic conditions are unpredictable.

Question 15

When the euro strengthens, the reported consolidated earnings of euro-based MNCs are ____ affected by translation exposure. When the euro weakens, the reported consolidated earnings are ____ affected.

A) favourably; favourably affected but by a smaller degree
B) favourably; favourably affected by a higher degree
C) unfavourably; favourably affected
D) favourably; unfavourably affected

Question 16

Generally, MNCs with less foreign costs than foreign revenue will be ____ affected by a ____ foreign currency.

A) favourably; stronger
B) not; stronger
C) favourably; weaker
D) not; weaker
E) B and D

Question 17

UK exporters may not necessarily benefit from weak-dollar periods if foreign competitors are willing to reduce their profit margin.

Question 18

Cerra ltd. expects to receive 5 million euros tomorrow as a result of selling goods to the Netherlands. Cerra estimates the standard deviation of daily percentage changes of the euro to be 1 percent over the last 100 days. Assume that these percentage changes are normally distributed. Using the value-at-risk (VAR) method based on a 95% confidence level, what is the maximum one-day loss if the expected percentage change of the euro tomorrow is 0.5%?

A) -0.5%
B) -2.2%
C) -1.5%
D) -1.2%

Question 19

Cerra ltd. expects to receive 5 million euros tomorrow as a result of selling goods to the Netherlands. Cerra estimates the standard deviation of daily percentage changes of the euro to be 1 percent over the last 100 days. Assume that these percentage changes are normally distributed. Using the value-at-risk (VAR) method based on a 95% confidence level, what is the maximum one-day loss in dollars if the expected percentage change of the euro tomorrow is 0.5%? The current spot rate of the euro (before considering the maximum one-day loss) is £0.67.

A) -£48,910
B) -£40,200
C) -£41.331
D) -£48,200

Question 20

The Canadian dollar consistently appears to move almost independently of other currencies. That is it exhibits low correlations with the other currencies.

Question 21

In general, translation exposure is more closely monitored when the foreign earnings of the subsidiaries are more likely to be remitted to the parent.

Question 22

One argument why exchange rate risk is irrelevant to corporations is that shareholders can deal with this risk individually.

Question 23

Assume a regression is run of the firm's stock price percentage change on the percentage change in the foreign currency. The coefficient is negative. This implies that the company's stock price increases if the foreign currency appreciates.

Question 24

Because creditors may prefer that firms maintain low exposure to exchange rate risk, exchange rate movements may cause earnings to be more volatile, and because investors may prefer corporations to perform hedging for them, exchange rate risk is probably relevant.

Question 25

The maximum one-day loss computed for the value-at-risk (VAR) method, does not depend on:

A) the expected percentage change in the currency for the next day.
B) the standard deviation of the daily percentage changes in the currency over a previous period.
C) the current level of interest rates.
D) the confidence level used.

Question 26

Jacko plc is a UK-based MNC with net cash inflows of Singapore dollars and net cash inflows of Sunland francs. These two currencies are highly negatively correlated in their movements against the pound. Kriner plc is a UK-based MNC that has the same exposure as Jacko plc in these currencies, except that its Sunland francs represent cash outflows. Which firm has a high exposure to exchange rate risk?

A) Jacko plc
B) Kriner plc
C) The firms have about the same level of exposure.
D) Neither firm has any exposure.

Question 27

____ is(are) not a determinant of translation exposure.

A) The MNC's degree of foreign involvement
B) The locations of foreign subsidiaries
C) The local (domestic) earnings of the MNC
D) The accounting methods used

Question 28

Dubas Co. is a UK-based MNC that has a subsidiary in Germany and another subsidiary in Greece. Both subsidiaries frequently remit their earnings back to the parent company. The German subsidiary generated a net outflow of €2,000,000 this year, while the Greek subsidiary generated a net inflow of €1,500,000. What is the net inflow or outflow as measured in pounds this year? The exchange rate for the euro is £0.58.

A) £1,160,000 outflow
B) £290,000 outflow
C) £8,700,000 inflow
D) £210,000 outflow

Question 29

Translation exposure reflects:

A) the exposure of a firm's ongoing international transactions to exchange rate fluctuations.
B) the exposure of a firm's local currency value to transactions between foreign exchange traders.
C) the exposure of a firm's financial statements to exchange rate fluctuations.
D) the exposure of a firm's cash flows to exchange rate fluctuations.

Question 30

If a UK firm's cost of goods sold exposure is much greater than its sales exposure in Switzerland, there is a ____ overall impact of the Swiss franc's depreciation against the pound on ____.

A) positive; interest expenses
B) positive; gross profit
C) negative; gross profit
D) negative; interest expenses

Question 31

The transaction exposure of two inflow currencies is offset when the correlation between the currencies is high.

Question 32

Consider an MNC that is exposed to the Bulgarian lev (BGL) and the Romanian leu (ROL). 30% of the MNC's funds are lev and 70% are leu. The standard deviation of exchange movements is 10% for lev and 15% for leu. The correlation coefficient between movements in the value of the lev and the leu is 0.85. Based on this information, the standard deviation of this two-currency portfolio is approximately:

A) 17.28%.
B) 13.15%.
C) 14.50%.
D) 12.04%.

Question 33

According to the text, currency variability levels ____ perfectly stable over time, and currency correlations ____ perfectly stable over time.

A) are; are not
B) are; are
C) are not; are not
D) are not; are

Question 34

A company may become more exposed or sensitive to an individual currency's movements over time for several reasons, including a reduction in hedging, a greater involvement in the foreign country, or an increased use of the foreign currency.

Question 35

If the functional currencies for reporting purposes are highly correlated, translation exposure is magnified.

Question 36

Assume that the euro and Swiss franc are highly correlated. A UK firm anticipates the equivalent of £1 million cash outflows in francs and the equivalent of £1 million cash outflows in euros. During a ____ cycle, the firm is ____ affected by its exposure.

A) strong pound; favourably
B) weak pound; not
C) strong pound; not
D) weak pound; favourably

Question 37

____ exposure is the degree to which the value of future cash transactions can be affected by exchange rate fluctuations.

A) Transaction
B) Economic
C) Translation
D) None of the above

Question 38

A set of currency cash inflows is more volatile if the correlations are low.

Question 39

A European MNC has the equivalent of 1 million euro cash outflows in each of two highly negatively correlated currencies. During ____ euro cycles, cash outflows are ____.

A) weak; somewhat stable
B) weak; favourably affected
C) weak; adversely affected
D) none of the above

Question 40

Volusia, ltd. is a UK-based exporting firm that expects to receive payments denominated in both euros and Canadian dollars in one month. Based on today's spot rates, the dollar value of the funds to be received is estimated at £500,000 for the euros and £300,000 for the Canadian dollars. Based on data for the last fifty months, Volusia estimates the standard deviation of monthly percentage changes to be 8 percent for the euro and 3 percent for the Canadian dollar. The correlation coefficient between the euro and the Canadian dollar is 0.30. Assuming an expected percentage change of 0 percent for each currency during the next month, what is the maximum one-month loss of the currency portfolio? Use a 95 percent confidence level and assume the monthly percentage changes for each currency are normally distributed.

A) -9.00%
B) -30.00%
C) -5.00%
D) None of the above

Question 41

Two highly negatively correlated currencies act almost as if they are the same currency.

Question 42

Appreciation in a firm's local currency causes a(n) ____ in cash inflows and a(n) ____ in cash outflows.

A) reduction; reduction
B) increase; increase
C) increase; reduction
D) reduction; increase

Question 43

Volusia, plc is a UK-based exporting firm that expects to receive payments denominated in both euros and Canadian dollars in one month. Based on today's spot rates, the pound value of the funds to be received is estimated at £500,000 for the euros and £300,000 for the Canadian dollars. Based on data for the last fifty months, Volusia estimates the standard deviation of monthly percentage changes to be 8 percent for the euro and 3 percent for the Canadian dollar. The correlation coefficient between the euro and the Canadian dollar is 0.30. What is the portfolio standard deviation?

A) 3.00%
B) 5.44%
C) 17.98%
D) None of the above

Question 44

A reduction in hedging will probably reduce transaction exposure.

Question 45

If an MNC has a net inflow in one currency and a net outflow of about the same amount in another currency, then the MNCs' transaction exposure is ____ is the two currencies are ____ correlated.

A) high; positively
B) low; negatively
C) high; negatively
D) none of the above

Question 46

Which of the following is not a form of exposure to exchange rate fluctuations?

A) Transaction exposure
B) Credit exposure
C) Economic exposure
D) Translation exposure

Question 47

A firm produces goods for which substitute goods are produced in all countries. Appreciation of the firm's local currency should:

A) increase local sales as it reduces foreign competition in local markets.
B) increase the firm's exports denominated in the local currency.
C) increase the returns earned on the firm's foreign bank deposits.
D) increase the firm's cash outflow required to pay for imported supplies denominated in a foreign currency.
E) none of the above

Question 48

The exposure of an MNC's consolidated financial statements to exchange rate fluctuations is known as transaction exposure.

Question 49

In general, a firm that concentrates on local sales, has very little foreign competition, and obtains foreign supplies (denominated in foreign currencies) will likely ____ a(n) ____ local currency.

A) be hurt by; appreciated
B) benefit from; depreciated
C) be hurt by; depreciated
D) none of the above

Question 50

Diz ltd is a UK-based MNC with net cash inflows of euros and net cash inflows of Swiss francs. These two currencies are highly correlated in their movements against the dollar. Yanta ltd is a UK-based MNC that has the same level of net cash flows in these currencies as Diz ltd except that its euros represent net cash outflows. Which firm has a higher exposure to exchange rate risk?

A) Diz ltd
B) Yanta ltd
C) The firms have about the same level of exposure.
D) Neither firm has any exposure.

Question 51

Economic exposure refers to:

A) the exposure of a firm's ongoing international transactions to exchange rate fluctuations.
B) the exposure of a firm's local currency value to transactions between foreign exchange traders.
C) the exposure of a firm's financial statements to exchange rate fluctuations.
D) the exposure of a firm's cash flows to exchange rate fluctuations.
E) the exposure of a country's economy (specifically GNP) to exchange rate fluctuations.

Question 52

Which of the following operations benefits from appreciation of the firm's local currency?

A) Borrowing in a foreign currency and converting the funds to the local currency prior to the appreciation.
B) Receiving earnings dividends from foreign subsidiaries.
C) Purchasing supplies locally rather than overseas.
D) Exporting to foreign countries.

Question 53

Firms with more in foreign costs than in foreign revenues will be favourably affected by a stronger foreign currency.

Question 54

The ____ the percentage of an MNC's business conducted by its foreign subsidiaries, the ____ the percentage of a given financial statement item that is susceptible to translation exposure.

A) greater; smaller
B) smaller; greater
C) greater; greater
D) none of the above