Deck 9: Transaction Exposure

Question 1

________ exposure deals with cash flows that result from existing contractual obligations.

A) Operating
B) Transaction
C) Translation
D) Economic

Answer 1

Transaction

Question 2

Assuming no transaction costs (i.e., hedging is "free"), hedging currency exposures should ________ the variability of expected cash flows to a firm and at the same time, the expected value of the cash flows should ________.

A) increase; not change
B) decrease; not change
C) not change; increase
D) not change; not change

Answer 2

decrease; not change

Question 3

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 heding 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

Answer 3

gain; $2000

Question 4

________ is a technique used by MNEs to deal with currency exposure.

A) Do nothing
B) Speculation
C) Hedging
D) All are techniques MNEs could use.

Question 5

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. The U.S. firm is at risk today of a loss if

A) the exchange rate changes to $2.00/£.
B) the exchange rate changes to $2.05/£.
C) the exchange rate doesn't change.
D) all of the above.

Question 6

Losses from ________ exposure generally reduce taxable income in the year they are realized. ________ exposure losses may reduce taxes over a series of years.

A) accounting; Operating
B) operating; Transaction
C) transaction; Operating
D) transaction; Accounting

Question 7

Each of the following is another name for operating exposure EXCEPT ________.

A) economic exposure
B) strategic exposure
C) accounting exposure
D) competitive exposure

Question 8

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

Question 9

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.

A) transaction; Operating
B) accounting; Operating
C) accounting; Transaction
D) transaction; Translation

Question 10

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 heding 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 ________.

A) loss; $2,000
B) gain; $2,000
C) loss; £2000
D) gain; £2000

Question 11

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

Question 12

________ exposure may result from a firm having a payable in a foreign currency.

A) Transaction
B) Accounting
C) Operating
D) None of the above

Question 13

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.

A) transaction; operating
B) operating; transaction
C) operating; accounting
D) none of the above

Question 14

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

A) Shareholders are more capable of diversifying risk than management.
B) Currency risk management through hedging does not increase expected cash flows.
C) Hedging activities are often of greater benefit to management than to shareholders.
D) All of the above are cited as reasons NOT to hedge.

Question 15

________ 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.

A) Transaction
B) Operating
C) Economic
D) Accounting

Question 16

________ exposure measures the change in the present value of the firm resulting from unexpected changes in exchange rates.

A) Operating
B) Transaction
C) Translation
D) Accounting

Question 17

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

A) exchange rates
B) interest rates
C) commodity prices
D) all of the above

Question 18

The stages in the life of a transaction exposure can be broken into three distinct time periods. The first time period is the time between quoting a price and reaching an actual sale agreement or contract. The next time period is the time lag between taking an order and actually filling or delivering it. Finally, the time it takes to get paid after delivering the product. In order, these stages of transaction exposure may be identified as,

A) backlog, quotation, and billing exposure.
B) billing, backlog, and quotation exposure.
C) quotation, backlog, and billing exposure.
D) quotation, billing, and backlog exposure.

Question 19

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

A) Reduced risk of future cash flows is a good planning tool.
B) Reduced risk of future cash flows reduces the probability that the firm may not meet required cash flows.
C) Currency risk management increases the expected cash flows to the firm.
D) Management is in a better position to assess firm currency risk than individual investors.

Question 20

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

Question 21

A ________ hedge refers to an offsetting operating cash flow such as a payable arising from the conduct of business.

A) financial
B) natural
C) contractual
D) futures

Question 22

A ________ hedge and a ________ hedge guarantee fixed payoffs but a ________ hedge or ________ hedge offer uncertain outcomes.

A) money market; currency option; forward; no hedge at all
B) no hedge at all; currency option; forward; money market
C) money market; forward; currency option; no hedge at all
D) forward; no hedge at all; money market; currency option

Question 23

Instruction 9.1:
Use the information for following problem(s).
Plains States Manufacturing has just signed a contract to sell agricultural equipment to Boschin, a German firm, for euro 1,250,000. The sale 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, Plains States 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
∙ Plains States' 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 put options for euro 625,000; strike price $1.42, premium price is 1.5%
∙ Plains States' forecast for 6-month spot rates is $1.43/euro
∙ The budget rate, or the lowest acceptable sales price for this project, is $1,075,000 or $1.35/euro
Refer to Instruction 9.1. If Plains States chooses to hedge its transaction exposure in the forward market, it will ________ euro 1,250,000 forward at a rate of ________.

A) sell; $1.38/euro
B) sell; $1.40/euro
C) buy; $1.38/euro
D) buy; $1.40/euro

Question 24

Choosing which transaction exposure hedging strategy is best for a particular transaction depends on which of the following?

A) the firm's risk tolerance
B) the firm's expectations about changes in currency exchange rates
C) the costs associated with each alternative
D) all of the above

Question 25

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.

Question 26

Instruction 9.1:
Use the information for following problem(s).
Plains States Manufacturing has just signed a contract to sell agricultural equipment to Boschin, a German firm, for euro 1,250,000. The sale 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, Plains States 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
∙ Plains States' 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 put options for euro 625,000; strike price $1.42, premium price is 1.5%
∙ Plains States' forecast for 6-month spot rates is $1.43/euro
∙ The budget rate, or the lowest acceptable sales price for this project, is $1,075,000 or $1.35/euro
Refer to Instruction 9.1. If Plains States purchases the put option, and the option expires in six months on the same day that Plains States receives the euro 1,250,000, the firm will exercise the put at that time if the spot rate is $1.43/euro.

Question 27

Instruction 9.1:
Use the information for following problem(s).
Plains States Manufacturing has just signed a contract to sell agricultural equipment to Boschin, a German firm, for euro 1,250,000. The sale 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, Plains States 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
∙ Plains States' 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 put options for euro 625,000; strike price $1.42, premium price is 1.5%
∙ Plains States' forecast for 6-month spot rates is $1.43/euro
∙ The budget rate, or the lowest acceptable sales price for this project, is $1,075,000 or $1.35/euro
Refer to Instruction 9.1. Plains States would be ________ by an amount equal to ________ with a forward hedge than if they had not hedged and their predicted exchange rate for 6 months had been correct.

A) better off; $43,750
B) better off; $62,500
C) worse off; $43,750
D) worse off; $62,500

Question 28

Instruction 9.1:
Use the information for following problem(s).
Plains States Manufacturing has just signed a contract to sell agricultural equipment to Boschin, a German firm, for euro 1,250,000. The sale 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, Plains States 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
∙ Plains States' 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 put options for euro 625,000; strike price $1.42, premium price is 1.5%
∙ Plains States' forecast for 6-month spot rates is $1.43/euro
∙ The budget rate, or the lowest acceptable sales price for this project, is $1,075,000 or $1.35/euro
Refer to Instruction 9.1. If Plains States chooses to implement a money market hedge for the Euro receivables, how much money will the firm borrow today?

A) euro 1,201,923
B) $1,201,923
C) euro 1,196,172
D) $1,196,172

Question 29

Instruction 9.1:
Use the information for following problem(s).
Plains States Manufacturing has just signed a contract to sell agricultural equipment to Boschin, a German firm, for euro 1,250,000. The sale 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, Plains States 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
∙ Plains States' 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 put options for euro 625,000; strike price $1.42, premium price is 1.5%
∙ Plains States' forecast for 6-month spot rates is $1.43/euro
∙ The budget rate, or the lowest acceptable sales price for this project, is $1,075,000 or $1.35/euro
Refer to Instruction 9.1. If Plains States 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 loss" accounting transaction of ________.

A) $0
B) $25,000
C) This was not a loss; it was a gain of $25,000.
D) There is not enough information to answer this question.

Question 30

Instruction 9.1:
Use the information for following problem(s).
Plains States Manufacturing has just signed a contract to sell agricultural equipment to Boschin, a German firm, for euro 1,250,000. The sale 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, Plains States 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
∙ Plains States' 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 put options for euro 625,000; strike price $1.42, premium price is 1.5%
∙ Plains States' forecast for 6-month spot rates is $1.43/euro
∙ The budget rate, or the lowest acceptable sales price for this project, is $1,075,000 or $1.35/euro
Refer to Instruction 9.1. If Plains States chooses not to hedge their euro receivable, the amount they receive in six months will be ________.

A) $1,750,000
B) $1,250,000
C) $892,857
D) undeterminable today

Question 31

Instruction 9.1:
Use the information for following problem(s).
Plains States Manufacturing has just signed a contract to sell agricultural equipment to Boschin, a German firm, for euro 1,250,000. The sale 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, Plains States 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
∙ Plains States' 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 put options for euro 625,000; strike price $1.42, premium price is 1.5%
∙ Plains States' forecast for 6-month spot rates is $1.43/euro
∙ The budget rate, or the lowest acceptable sales price for this project, is $1,075,000 or $1.35/euro
Refer to Instruction 9.1. Plains States chooses to hedge its transaction exposure in the forward market at the available forward rate. The payoff in 6 months will be ________.

A) $1,750,000
B) $1250,000
C) $1,725,000
D) $1787,500

Question 32

In efficient markets, interest rate parity should assure that the costs of a forward hedge and money market hedge should be approximately the same.

Question 33

Instruction 9.1:
Use the information for following problem(s).
Plains States Manufacturing has just signed a contract to sell agricultural equipment to Boschin, a German firm, for euro 1,250,000. The sale 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, Plains States 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
∙ Plains States' 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 put options for euro 625,000; strike price $1.42, premium price is 1.5%
∙ Plains States' forecast for 6-month spot rates is $1.43/euro
∙ The budget rate, or the lowest acceptable sales price for this project, is $1,075,000 or $1.35/euro
Refer to Instruction 9.1. What is the cost of a put option hedge for Plains States' 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.)

A) $27,694
B) $26,250
C) euro 27,694
D) euro 26,250

Question 34

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

A) Forward market hedge
B) Money market hedge
C) Options market hedge
D) All of the above are contractual hedges.

Question 35

Instruction 9.2:
Use the information for 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 9.2. If OTI chooses not to hedge their euro payable, the amount they pay in six months will be ________.

A) $3,500,000
B) $3,450,000
C) euro 3,450,000
D) unknown today

Question 36

Instruction 9.1:
Use the information for following problem(s).
Plains States Manufacturing has just signed a contract to sell agricultural equipment to Boschin, a German firm, for euro 1,250,000. The sale 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, Plains States 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
∙ Plains States' 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 put options for euro 625,000; strike price $1.42, premium price is 1.5%
∙ Plains States' forecast for 6-month spot rates is $1.43/euro
∙ The budget rate, or the lowest acceptable sales price for this project, is $1,075,000 or $1.35/euro
Refer to Instruction 9.1. Plains States could hedge the Euro receivables in the money market. Using the information provided, how much would the money market hedge return in six months assuming Plains States reinvests the proceeds at the U.S. investment rate?

A) $1,250,000
B) $1,724,880
C) $1,674,641
D) $1,207,371

Question 37

Instruction 9.1:
Use the information for following problem(s).
Plains States Manufacturing has just signed a contract to sell agricultural equipment to Boschin, a German firm, for euro 1,250,000. The sale 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, Plains States 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
∙ Plains States' 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 put options for euro 625,000; strike price $1.42, premium price is 1.5%
∙ Plains States' forecast for 6-month spot rates is $1.43/euro
∙ The budget rate, or the lowest acceptable sales price for this project, is $1,075,000 or $1.35/euro
Refer to Instruction 9.1. The cost of a call option to Plains States would be ________.

A) $17,653
B) $16,733
C) $18,471
D) There is not enough information to answer this question.

Question 38

Instruction 9.1:
Use the information for following problem(s).
Plains States Manufacturing has just signed a contract to sell agricultural equipment to Boschin, a German firm, for euro 1,250,000. The sale 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, Plains States 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
∙ Plains States' 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 put options for euro 625,000; strike price $1.42, premium price is 1.5%
∙ Plains States' forecast for 6-month spot rates is $1.43/euro
∙ The budget rate, or the lowest acceptable sales price for this project, is $1,075,000 or $1.35/euro
Refer to Instruction 9.1. Money market hedges almost always return more than forward hedges because of the greater risk involved.

Question 39

Instruction 9.1:
Use the information for following problem(s).
Plains States Manufacturing has just signed a contract to sell agricultural equipment to Boschin, a German firm, for euro 1,250,000. The sale 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, Plains States 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
∙ Plains States' 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 put options for euro 625,000; strike price $1.42, premium price is 1.5%
∙ Plains States' forecast for 6-month spot rates is $1.43/euro
∙ The budget rate, or the lowest acceptable sales price for this project, is $1,075,000 or $1.35/euro
Refer to Instruction 9.1. A ________ hedge allows Plains States to enjoy the benefits of a favorable change in exchange rates for their euro receivables contract while protecting the firm from unfavorable exchange rate changes.

A) forward
B) call option
C) put option
D) money market

Question 40

Hedging accounts payable foreign currency exchange risk would likely consider the purchase of a ________ option whereas hedging accounts receivable currency exchange risk would be likely be to purchase a ________ option.

A) put; call
B) put; put
C) call; put
D) call; call

Question 41

Instruction 9.2:
Use the information for 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 9.2. The cost of a put option to OTI would be ________.

A) $52,500
B) $55,388
C) $58,275
D) There is not enough information to answer this question.

Question 42

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

Question 43

Instruction 9.2:
Use the information for 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 9.2. 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.)

A) $52,500
B) $55,388
C) $56,125
D) $58,275

Question 44

Currency risk management techniques include forward hedges, money market hedges, and option hedges. Draw a diagram showing the possible outcomes of these hedging alternatives for a foreign currency receivable contract. In your diagram, be sure to label the X and Y-axis, the put option strike price, and show the possible results for a money market hedge, a forward hedge, a put option hedge, and an uncovered position. (Note: Assume the forward currency receivable is British pounds and the put option strike price is $1.50/£, the price of the option is $0.04 the forward rate is $1.52/£ and the current spot rate is $1.48/£.)

Question 45

Instruction 9.2:
Use the information for 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 9.2. 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 ________.

A) $2,500,000
B) $3,450,000
C) $3,500,000
D) $3,575,000

Question 46

Instruction 9.2:
Use the information for 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 9.2. If OTI chooses to hedge its transaction exposure in the forward market, it will ________ euro 2,500,000 forward at a rate of ________.

A) buy; $1.38
B) buy; $1.40
C) sell; $1.38
D) sell; euro 1.40

Question 47

Instruction 9.2:
Use the information for 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 9.2. OTI would be ________ by an amount equal to ________ with a forward hedge than if they had not hedged and their predicted exchange rate for 6 months had been correct.

A) better off; $125,000
B) better off; euro 125,000
C) worse off; $125,000
D) worse off; euro 125,0000

Question 48

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

A) Backlog exposure
B) Quotation exposure
C) Anticipated exposure
D) None of the above

Question 49

Whohauser is a U.S.-based forest products firm. In June Whohauser delivers a shipment of raw lumber to Japan. The ¥55,000,000 receivable is due in 180 days. The firm's foreign exchange advisors believe the yen will be at about ¥115/$ then. The current spot rate is ¥110/$. Whohauser has received a 180 day forward quote of ¥108/$. If the company does nothing and the exchange rate stays the same as the current spot rate of ¥110/$, how much will the firm receive in dollars in 180 days? Is this cash flow risky or known with certainty today?

A) $509,259 certain
B) $500,000 risky
C) $479,261 certain
D) None of the above

Question 50

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.

Question 51

According to a survey by Bank of America, when firms do hedge, the most common type of hedging instruments are ________.

A) forwards
B) options
C) money markets
D) call and puts

Question 52

The treasury function of most firms, the group typically responsible for transaction exposure management, is NOT usually considered a profit center.

Question 53

Whohauser is a U.S.-based forest products firm. In June Whohauser delivers a shipment of raw lumber to Japan. The ¥55,000,000 receivable is due in 180 days. The firm's foreign exchange advisors believe the yen will be at about ¥115/$ then. The current spot rate is ¥110/$. Whohauser has received a 180 day forward quote of ¥108/$. If the company locks in the forward quote and the exchange rate goes to
¥115 as expected, how much will the firm receive in dollars in 180 days? Is this cash flow risky or known with certainty today?

A) $509,259 certain
B) $500,000 risky
C) $478,261 risky
D) $500,000 certain

Question 54

Instruction 9.2:
Use the information for 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 9.2. 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; euro 50,000
C) gain; $50,000
D) gain; euro 50,000

Question 55

According to a survey by Bank of America, the type of foreign exchange risk most often hedged by firms is ________.

A) translation exposure
B) transaction exposure
C) contingent exposure
D) economic exposure

Question 56

Whohauser is a U.S.-based forest products firm. In June Whohauser delivers a shipment of raw lumber to Japan. The ¥55,000,000 receivable is due in 180 days. The firm's foreign exchange advisors believe the yen will be at about ¥115/$ then. The current spot rate is ¥110/$. Whohauser has received a 180 day forward quote of ¥108/$. If the company does nothing and the exchange rate goes to ¥115 as expected, how much will the firm receive in dollars in 180 days? Is this cash flow risky or known with certainty today?

A) $509,259 certain
B) $500,000 risky
C) $478,261 risky
D) $500,000 certain