1. ________exposure deals with cash flows that result from existing contractual obligations.
a. Operating
b. Transaction
c. Translation
d. Economic
2. Each of the following is another name for operating exposure EXCEPT ________.
a. economic exposure
b. strategic exposure
c. accounting exposure
d. competitive exposure
3. 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. accounting; operating
4. 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 ________ as compared with the current exchange rate.
a. loss; $2,000 b. gain; $2,000 c. loss; £2,000 d. gain; £2,000
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. 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; £2,000 d. gain; £2,000
6. ______ is NOT a commonly used contractual hedge against foreign exchange transaction exposure.
a. Forward market hedge
b. Money market hedge
c. Options market hedge
d. Natural hedge
Refer to the following information for Questions 7 to 9:
Oregon Transportation Inc. (OTI), an American company, has just signed a contract to purchase light rail cars from a manufacturer in Germany for €2,500,000. The purchase was made in June with payment due six months later in December. 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 annualized Euro 6-month borrowing rate is 9% (or 4.5% for 6 months)
• The annualized Euro 6-month lending rate is 7% (or 3.5% for 6 months)
• The annualized U.S. 6-month borrowing rate is 8% (or 4% for 6 months)
• The annualized 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
7. 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
8. 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.
9. What is the cost of a call option hedge for OTI's euro payable 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. $52,500.00 b. $55,387.50 c. $56,125.00 d. $58,275.00
Refer to the following information for Questions 10 to 13.
Plains States Manufacturing has just signed a contract to buy agricultural equipment from Boschin, a German firm, for €1,250,000. The contract was signed in June with payment due six months later in December. The firm is considering several hedging alternatives to reduce the exchange rate risk arising from the transaction. To help the firm make a hedging decision you have gathered the following information.
The spot exchange rate is $0.8924/€ The six month forward rate is $0.8750/€
The annualized Euro 6-month borrowing rate is 9% (or 4.5% for 6 months)
The annualized Euro 6-month lending rate is 7% (or 3.5% for 6 months)
The annualized U.S. 6-month borrowing rate is 8% (or 4% for 6 months)
The annualized U.S. 6-month lending rate is 6% (or 3% for 6 months)
10. If Plains States chooses to hedge its transaction exposure in the forward market, it will €1,250,000 forward at a rate of .
a. sell; $0.8750/€ b. sell; $0.8924/€ c. buy; $0.8750/€ d. buy; $0.8924/€
11. Plains States chooses to hedge its transaction exposure in the forward market at the available forward rate. The payment in 6 months will be .
a. €1,428571.43 b. $1,428571.43 c. €1,093,750.00 d. $1,093,750.00
12. Plains States could hedge the Euro payables in the money market. Using the information given, how much would the firm pay in six months through money market hedge?
a. $1,120,888.89 b. $1,110,162.68 c. $1,110,111.11 d. $1,099,488.04
13. Given the information, which of the following is correct about a possible arbitrage opportunity?
a. Borrow $, convert to euro, invest in euro, sell euro investment proceeds forward.
b. Borrow euro, convert to $, invest in $, sell $ investment proceeds forward.
c. Don't bother - there is no arbitrage opportunity.
14. Under the U.S. method of translation procedures, if the financial statements of the foreign subsidiary of a U.S. company are maintained in the local currency, and the local currency is the functional currency, then
a. the translation method to be used is not obvious.
b. translation is accomplished through the temporal method.
c. translation is not required.
d. translation is accomplished through the current rate method.
15. If the European subsidiary of a U.S. firm has net exposed assets of €500,000, and the euro drops in value from $1.40/euro to $1.30/€ the U.S. firm has a translation .
a. gain of $50,000
b. loss of $50,000
c. gain of $450,000
d. loss of €450,000
16. If the British subsidiary of a Eurozone firm has net exposed liability of £500,000, and the pound increases in value from €1.40/£ to €1.45/£, the Eurozone firm has a translation.
a. gain of €25,000
b. loss of €25,000
c. gain of £25,000
d. loss of £25,000
Refer to the information below for Questions 17 to 20.
Assume that Total SA, a world leading oil and gas company headquartered in in La defense, France, borrows SFr 100,000,000 for ten years commencing January 1, 2015 for its new exploration project. According to the terms of the loan, Total SA pays interest at the end of each year and pays back the principle at the end of ten years. On the borrowing date, the relevant financial information is:
Spot = SFr1.20/€
i€ = 5.0%
iSFr = 3.0%
Suppose that on December 31, 2015, the spot rate is SFr1.00/€.
17. What is Total's interest expense for the Swiss franc debt for year 2015, measured in €?
(Keep two decimals; Do not include currency symbols in your answer)
18. When Total's Swiss franc debt is translated to € at the end of 2015, how much is the translation gain or loss (do not consider the interest expense; if it is a loss, put a negative sign "-" in your answer)?
(Keep two decimals; Do not include currency symbols in your answer; Do include the negative sign, "-" in your answer if your answer is a negative number)
19. Suppose Total has an operation in Switzerland with a total Swiss franc denominated asset of SFr 200,000,000 at the beginning of 2015. At the end of 2015, how much is Total's translation gain or loss for its assets and liabilities (i.e. SFr 100,000,000) (do not consider the interest expense; if it is a loss, put a negative sign "-" in your answer)?
(Keep two decimals; Do not include currency symbols in your answer; Do include the negative sign, "-" in your answer if your answer is a negative number)
20. Suppose Total's Swiss franc assets generate a 5% return on assets in Swiss francs each year for the next year starting from January 1, 2015. Ignoring any tax complications, what is Total's net Swiss franc cash flow each year that is exposed to exchange rate changes (include the negative sign "-" in your answer if the net Swiss franc cash flow is a negative number)?
(Keep two decimals; Do not include currency symbols in your answer; Do include the negative sign, "-" in your answer if your answer is a negative number)