8.4 Exchange Rates - Factors and Risk Mitigation Flashcards
When the U.S. dollar is expected to rise in value against foreign currencies, a U.S. company with foreign currency denominated receivables and payables should
A. Speed up collections and slow down payments.
B. Slow down collections and speed up payments.
C. Speed up collections and speed up payments.
D. Slow down collections and slow down payments.
A. Speed up collections and slow down payments.
The proper action would be to increase collections and decrease payments. Collections should be made quickly and converted into dollars to sustain the increase in their value as the dollar appreciates. Decreasing payments would be profitable because, as the company exchanges dollars for foreign currency at a later date, it will receive more of the foreign currency, thus lowering its real cost.
A shift of the demand curve for a country’s currency to the right could be caused by which of the following?
A. A foreign government placing restrictions on the importation of the country’s goods.
B. A fall in the country’s interest rates.
C. Domestic inflation worsens.
D. A rise in consumer incomes in another country.
D. A rise in consumer incomes in another country.
Citizens with higher incomes look for new consumption opportunities in other countries, driving up the demand for those currencies. Thus, as incomes rise in one country, the prices of foreign currencies rise as well.
A publicly-traded company based in Japan is planning on expanding its operations into Germany. The expansion is estimated to cost ¥500 million, but the company needs euros to implement the expansion. The company is not well known in Germany and therefore hesitant to issue a euro-denominated bond in the German marketplace. If the company were to issue a yen-denominated 20-year bond in Japan, which one of the following contracts should the company use?
A. Currency forward.
B. Currency futures.
C. Currency options.
D. Currency swap.
D. Currency swap.
A currency swap is when two parties would like to hedge exchange rate risks by swapping cash flows in each other’s currency. If the Japanese company engages in a currency swap with a European country, it will have access to euros.
A fall in the demand for a country’s currency can be caused by any of the following except:
A. A foreign government places restrictions on the importation of the country’s goods.
B. The country’s government raises barriers to the cross-border flow of capital.
C. The country’s inflation rate decreases.
D. Interest rates in the country fall.
C. The country’s inflation rate decreases.
The currency of a country with a falling inflation rate retains more purchasing power than a currency with high inflation. Demand for a currency with increasing purchasing power will tend to rise.
An electronics manufacturer has subsidiaries in several international locations and is concerned about its exposure to foreign exchange risk. In countries where currency values are likely to fall, the manufacturer should encourage all of the following policies except
A. Granting trade credit whenever possible.
B. Borrowing local currency funds if an appropriate interest rate can be obtained.
C. Investing excess cash in inventory or other real assets.
D. Purchasing materials and supplies on a trade credit basis.
A. Granting trade credit whenever possible.
Extension of credit in a foreign currency would result in receiving payment in less valuable dollars if the foreign currency became less valuable. Thus one would not want to encourage granting trade credit in a foreign country when the country’s currency is expected to loss value.
An American importer of English clothing has contracted to pay an amount fixed in British pounds 3 months from now. If the importer worries that the U.S. dollar may depreciate sharply against the British pound in the interim, it would be well advised to
A. Buy dollars in the futures market.
B. Sell dollars in the futures market.
C. Buy pounds in the forward exchange market.
D. Sell pounds in the forward exchange market.
C. Buy pounds in the forward exchange market.
The American importer should buy pounds now. If the dollar depreciates against the pound in the next 90 days, the gain on the forward exchange contract would offset the loss from having to pay more dollars to satisfy the liability.
If the central bank of a country raises interest rates sharply, the country’s currency will likely
A. Remain unchanged in value.
B. Decrease sharply in value at first and then return to its initial value.
C. Increase in relative value.
D. Decrease in relative value.
C. Increase in relative value.
If the interest rates in a given country rise, money will pour in from all over the world in pursuit of that country’s higher returns. This increase in demand for the country’s currency will boost its purchasing power.
A firm involved in major international market trading can best minimize foreign exchange risk by
A. Entering into a forward rate contract.
B. Factoring in the cost of interest in the commodity price.
C. Requiring collect on delivery payment from customers to avoid exchange rate fluctuations.
D. Having customers use the spot rate.
A. Entering into a forward rate contract.
A forward rate contract minimizes risk because the firm knows exactly what amount it will be able to exchange its currency for at a definitive date in the future.
A Bangladeshi wholesale export company publishes a price list in euros for the products sold by its European Union business unit. The management of the export company has determined that even if there are fluctuations in exchange rates between the Bangladeshi Taka and European euro, it is not practical for it to change its product prices every six months. Which one of the following is the most appropriate solution available to the export company to managing this risk?
A. Hedging the risk through financial instruments.
B. Disposing of the business unit.
C. Diversifying its product offerings.
D. Establishing operational sales limits.
A. Hedging the risk through financial instruments.
Foreign exchange rates can have a significant impact on accounts receivable. A firm can reduce its exchange rate risk by hedging the risk through financial instruments. When the downside risk is that the foreign currency will depreciate by the settlement date, the hedge is to sell the foreign currency forward to lock in a definite price.
Consider a world consisting of only two countries, Canada and Ruritania. Inflation in Canada in 1 year was 5%, and in Ruritania 10%. Which one of the following statements about the Canadian exchange rate (rounded) during that year will be true?
A. The Canadian dollar will appreciate by 5%.
B. Inflation has no effect on the exchange rates.
C. The Canadian dollar will depreciate by 5%.
D. The Canadian dollar will depreciate by 15%.
A. The Canadian dollar will appreciate by 5%.
Ruritanian inflation is worse than Canadian inflation, so the Canadian dollar will experience a net appreciation. Dividing the Ruritanian inflation factor of 1.10 by the Canadian factor of 1.05 and subtracting 1 results in a net gain of Canadian purchasing power of 4.76%.
A company has a foreign-currency-denominated trade payable, due in 60 days. In order to eliminate the foreign currency exchange-rate risk associated with the payable, the company could
A. Borrow foreign currency today, convert it to domestic currency on the spot market, and invest the funds in a domestic bank deposit until the invoice payment date.
B. Wait 60 days and pay the invoice by purchasing foreign currency in the spot market at that time.
C. Buy foreign currency forward today.
D. Sell foreign currency forward today.
C. Buy foreign currency forward today.
The company can arrange to purchase the foreign currency today rather than in 60 days by buying the currency in the forward market. This hedging transaction will eliminate the exchange-rate risk associated with the trade payable.
The accompanying graph depicts the supply of and demand for U.S. dollars in terms of euros at a point in time, i.e., the euro is the domestic currency. Currently, the equilibrium exchange rate is $1 to €0.65. If inflation of other dollar exceeds that of the euro, the new equilibrium exchange rate would most likely settle at
Quantity, Price
A. Indeterminate, €0.70
B. Lower than Qe, €0.70
C. Indeterminate, €0.60
D. Higher than Qe, €0.60
C. Indeterminate, €0.60
When the rate of inflation in a given country rises relative to the rates of other countries, the demand for that country’s currency falls. This inward shift of the demand curve results from the lowered desirability of that currency, a result of its falling purchasing power. As investors unload this currency, there is more of it available, reflected in an outward shift of the supply curve. A new equilibrium point will be reached at a lower price in terms of investor’s domestic currencies. Also, the new equilibrium quantity could be either higher or lower than the old quantity.
If an annual U.S. inflation rate is expected to be 5% while the euro is expected to depreciate against the U.S. dollar by 10%, an Italian firm importing from its U.S. parent can expect its euro costs for these imports to
A. Decrease by about 5%
B. Increase by about 5%
C. Increase by about 16.7%
D. Decrease by about 10%
C. Increase by about 16.7%
Inflation in the U.S. means that $1.05 now has the purchasing power formerly enjoyed by $1.00. The 10% depreciation of the euro means that its purchasing power in dollars has declined to 90%. Dividing the U.S. inflation factor of 1.05 by the new euro value of .90 and subtracting 1 results in a net loss of euro purchasing power against the dollar of 16.67%.
A firm in Australia imports chairs from Bangladesh and resells them in Australia for A$45 per unit. The firm placed an order for 1,000 chairs with the supplier in Bangladesh at a cost of B$60 per unit. As per the terms of the agreement, payment is not required until the goods arrive in 30 days. The current exchange rate is B$1.5753 for A$1. The firm expects the exchange rate to decline to B$1.5500 for A$1. In order to manage short-term exchange rate risk, the firm decides to hedge and lock in an exchange rate of B$1.5650 for A$1. What would be the pre-tax profit from the sale of chairs?
A. A$6,290
B. A$6,910
C. A$6,660
D. A$9,585
C. A$6,660
The firm can buy the chairs for A$38,340 since the costs of the chairs are B$60,000. B$1 is equal to A$0.639. Thus, the firm can purchase the chairs with A$38,340 using A$.639 multiplied by the B$60,000 cost (A$1 ÷ 1.565). Since the firm’s sales will be A$45,000 (1,000 chairs × A$45 per chair), the firm would have a profit of A$6,660 (A$45,000 – A$38,340 cost).
Assuming exchange rates are allowed to fluctuate freely, which one of the following factors would likely cause a nation’s currency to appreciate on the foreign exchange market?
A. A high rate of inflation relative to other countries.
B. Domestic real interest rates that are lower than real interest rates abroad.
C. A slower rate of growth in income than in other countries, which causes imports to lag behind exports.
D. A relatively rapid rate of growth in income that stimulates imports.
C. A slower rate of growth in income than in other countries, which causes imports to lag behind exports.
Assuming that exchange rates are allowed to fluctuate freely, a nation’s currency will appreciate if the demand for it is constant or increasing while supply is decreasing. For example, if the nation decreases its imports relative to exports, less of its currency will be used to buy foreign currencies for import transactions and more of its currency will be demanded for export transactions. Thus, the supply of the nation’s currency available in foreign currency markets decreases. If the demand for the currency increases or does not change, the result is an increase in (appreciation of) the value of the currency.
Two countries have flexible exchange rate systems and an active trading relationship. If incomes <List> in Country 1, everything else being equal, then the currency of Country 1 will tend to <List> relative to the currency of Country 2.</List></List>
A. Rise / Remain constant
B. Fall / Depreciate
C. Remain constant / Appreciate
D. Rise / Depreciate
D. Rise / Depreciate
Citizens with higher incomes look for new consumption opportunities in other countries, driving up the demand for those currencies and shifting the demand curve to the right. Thus, as incomes rise in one country, the prices of foreign currencies rise as well, and the local currency will depreciate.
The product manager for a U.S. computer manufacturer is being asked to quote prices of desktop computers to be used in Kuwait. The Kuwaiti government wants the price in British pounds, for delivery next year. The product manager knows that the general price level in the United States will increase by 3%. The product manager’s banker forecasts that the British pound will depreciate about 5% this year with respect to the U.S. dollar. If the product manager is able to quote £700 for immediate delivery, the price that should be quoted for delivery to Kuwait next year is about
A. £721
B. £737
C. £759
D. £700
C. £759
Expected inflation in the U.S. means that it will take $1.03 to have the same purchasing power currently enjoyed by $1.00. At the same time, the pound is expected to fall to 95% of its current value against the dollar. The net effect is a loss of purchasing power for the pound against the dollar of 8.42% [(1.03 ÷ .95) – 1.0]. Next year’s price will therefore be £758.94 (£700 × 1.0842).
If risk is purposely undertaken in the foreign currency market, the investor in foreign currency then becomes
A. An arbitrageur.
B. A speculator.
C. Involved in hedging.
D. An exporter.
B. A speculator.
An individual who purposely accepts exchange rate risk is a speculator. Speculators buy and sell foreign currencies in anticipation of favorable changes in rates.
