Assignment 2

Question 1

Q1) Transaction exposure is defined as

A) the extent to which the value of the firm would be affected by unanticipated changes in exchange rate.
B) the sensitivity of realized domestic currency values of the firm’s contractual cash flows denominated in foreign currencies to unexpected exchange rate changes.
C) ex post and ex ante currency exposures.
D) the potential that the firm’s consolidated financial statement can be affected by changes in exchange rates.

Answer 1

1) B

Question 2

Q2) The most direct and popular way of hedging transaction exposure is by

A) currency forward contracts.
B) exchange-traded futures options.
C) foreign currency warrants.
D) borrowing and lending in the domestic and foreign money markets.

Answer 2

2) A

Question 3

Q3) If you have a long position in a foreign currency, you can hedge with

A) a short position in a currency forward contract.
B) borrowing in the domestic and foreign money markets.
C) a short position in an exchange-traded futures option.
D) a short position in foreign currency warrants.

Answer 3

3) A

Question 4

Q4) If you owe a foreign currency denominated debt, you can hedge with

A) a long position in a currency forward contract, or buying the foreign currency today and investing it in the foreign country.
B) a long position in a currency forward contract.
C) buying the foreign currency today and investing it in the foreign country.
D) a long position in an exchange-traded futures option.

Answer 4

4) A

Question 5

Q5) The extent to which the value of the firm would be affected by unexpected changes in the exchange rate is

A) transaction exposure.
B) economic exposure.
C) translation exposure.
D) none of the options

Answer 5

5) B

Question 6

Q6) The choice between a forward market hedge and a money market hedge often comes down to

A) flexibility and availability.
B) interest rate parity.
C) option pricing.
D) none of the options

Answer 6

6) B

Question 7

Q7) Exchange rate risk of a foreign currency payable is an example of

A) economic exposure.
B) translation exposure.
C) transaction exposure.
D) none of the options

Answer 7

7) C

Question 8

Q14) Buying a currency option provides

A) a right, but not an obligation, to buy or sell a currency.
B) limits the downside risk while preserving the upside potential.
C) a flexible hedge against exchange exposure.
D) all of the options

Answer 8

14) D

Question 9

Q15) XYZ Corporation, located in the United States, has an accounts payable obligation of ¥750 million payable in one year to a bank in Tokyo. Which of the following is not part of a money market hedge?

A) Buy yen at the spot exchange rate.
B) Invest in risk-free Japanese securities with the same maturity as the accounts payable obligation.
C) Buy the ¥750 million at the forward exchange rate.
D) Find the present value of ¥750 million at the Japanese interest rate.

Answer 9

15) C

Question 10

Q17) A call option to buy £10,000 at a strike price of $1.80 = £1.00 is equivalent to

A) a put option on £10,000 at a strike price of $1.80 = £1.00.
B) a call option on $18,000 at a strike price of $1.80 = £1.00.
C) a put option to sell $18,000 at a strike price of $1 = £0.5556.
D) none of the options

Answer 10

17) C

Question 11

Q18) Your U.S. firm has a £100,000 payable with a 3-month maturity. Which of the following will hedge your liability?

A) Buy the present value of £100,000 today at the spot exchange rate, invest in the U.K. at i£.
B) Take a long position in a forward contract on £100,000 with a 3-month maturity.
C) Buy a call option on £100,000 with a strike price in dollars.
D) all of the options

Answer 11

18) D

Question 12

Q19) Contingent exposure can best be hedged with

A) money market hedging.
B) options.
C) futures.
D) all of the options

Answer 12

19) B

Question 13

Q20) An exporter can shift exchange rate risk to their customers by

A) invoicing in their customer’s local currency.
B) splitting the difference, and invoicing half of sales in local currency and half of sales in home currency.
C) invoicing in their home currency.
D) invoicing sales in a currency basket such as the SDR as the invoice currency.

Answer 13

20) C

Question 14

Q21) In evaluating the pros and cons of corporate risk management, “market imperfections” refer to

A) management costs, corporate costs, liquidity costs, and trading costs.
B) information asymmetry, differential transaction costs, default costs, and progressive corporate taxes.
C) economic costs, noneconomic costs, arbitrage costs, and hedging costs.
D) leading and lagging, receivables and payables, and diversification costs.

Answer 14

21) B

Question 15

Q22) Suppose the U.S. dollar substantially depreciates against the Japanese yen. The change in exchange rate

A) will tend to strengthen the competitive position of Japanese car makers at the expense of U.S. makers.
B) will tend to strengthen the competitive position of import-competing U.S. car makers.
C) will tend to weaken the competitive position of import-competing U.S. car makers.
D) none of the options

Answer 15

22) B

Question 16

Q23) When exchange rates change,

A) U.S. firms that produce domestically and sell only to domestic customers can be affected if they compete against imports.
B) U.S. firms that produce domestically and sell only to domestic customers will be affected, but only if they borrow in foreign currency to finance their domestic operations.
C) U.S. firms that produce domestically and sell only to domestic customers will be unaffected.
D) U.S. firms that produce domestically and sell only to domestic customers will be unaffected, and U.S. firms that produce domestically and sell only to domestic customers can be affected if they compete against imports.

Answer 16

23) A

Question 17

Q24) Two studies found a link between exchange rates and the stock prices of U.S. firms;

A) this suggests that exchange rate changes can systematically affect the value of the firm by influencing its operating cash flows, as well influencing the domestic currency values of its assets and liabilities.
B) this suggests that exchange rate changes can systematically affect the value of the firm by influencing its operating cash flows.
C) this suggests that exchange rate changes can systematically affect the value of the firm by influencing the domestic currency values of its assets and liabilities.
D) none of the options

Answer 17

24) A

Question 18

Q25) Exposure to currency risk can be measured by the sensitivities of

A) the future home currency values of the firm’s assets and liabilities, as well as the firm’s operating cash flows to random changes in exchange rates.
B) the future home currency values of the firm’s assets and liabilities.
C) the firm’s operating cash flows to random changes in exchange rates.
D) none of the options

Answer 18

25) A

Question 19

Q26) Economic exposure refers to

A) the sensitivity of realized domestic currency values of the firm’s contractual cash flows denominated in foreign currencies to unexpected exchange rate changes.
B) ex post and ex ante currency exposures.
C) the potential that the firm’s consolidated financial statement can be affected by changes in exchange rates.
D) the extent to which the value of the firm would be affected by unanticipated changes in exchange rate.

Answer 19

26) D

Question 20

Q27) Before you can use the hedging strategies such as a forward market hedge, options market hedge, and so on, you should consider running a regression of the form P = a + b × S + e . When reviewing the output, you should initially focus on

A) the slope coefficient b.
B) the intercept a.
C) R2.
D) mean square error, MSE.

Answer 20

27) A

Question 21

Q28) The link between the home currency value of a firm’s assets and liabilities and exchange rate fluctuations is

A) asset exposure.
B) asset exposure and operating exposure.
C) operating exposure.
D) none of the options

Answer 21

28) A

Question 22

Q29) In recent years, the U.S. dollar has depreciated substantially against most major currencies of the world, especially against the euro.

A) The stronger euro has made many American products less expensive in euro terms, boosting sales of U.S. products in Europe.
B) The stronger euro has made many European products more expensive in dollar terms, hurting sales of these products in the United States. Additionally, the stronger euro has made many American products less expensive in euro terms, boosting sales of U.S. products in Europe.
C) The stronger euro has made many European products more expensive in dollar terms, hurting sales of these products in the United States.
D) none of the options

Answer 22

29) B

Question 23

Q30) From the perspective of the U.S. firm that owns an asset in Britain, the exposure that can be measured by the coefficient b in regressing the dollar value P of the British asset on the dollar/pound exchange rate S using regression equation P = a + b × S + e is

A) asset exposure.
B) accounting exposure.
C) operating exposure.
D) none of the options

Answer 23

30) A

Question 24

Q31) On the basis of regression equation P = a + b × S + e, we can decompose the variability of the dollar value of the asset, VAR(P), into two separate components: VAR(P) = b2 × VAR(S) + VAR(e). The first term in the right-hand side of the equation, b2 × VAR(S) represents

A) the part of the variability of the dollar value of the asset that is related to random changes in the exchange rate, as well as the residual part of the dollar value variability that is independent of exchange rate movements.
B) the part of the variability of the dollar value of the asset that is related to random changes in the exchange rate.
C) the residual part of the dollar value variability that is independent of exchange rate movements.
D) none of the options

Answer 24

31) B

Question 25

Q32) On the basis of regression equation P = a + b × S + e, we can decompose the variability of the dollar value of the asset, VAR(P), into two separate components: VAR(P) = b2 × VAR(S) + VAR(e). The second term in the right-hand side of the equation, VAR(e) represents

A) the part of the variability of the dollar value of the asset that is related to random changes in the exchange rate.
B) the part of the variability of the dollar value of the asset that is related to random changes in the exchange rate, as well as the residual part of the dollar value variability that is independent of exchange rate movements.
C) the residual part of the dollar value variability that is independent of exchange rate movements.
D) none of the options

Answer 25

32) C

Question 26

Q33) Consider a U.S. MNC who owns a foreign asset. If the foreign currency value of the asset is inversely related to changes in the dollar–foreign currency exchange rate,

A) the dollar value variability is independent of exchange rate movements.
B) the company has a built-in hedge.
C) the company has a built-in hedge and the dollar value variability that is independent of exchange rate movements.
D) none of the options

Answer 26

33) C

Question 27

Q38) A firm’s operating exposure is

A) determined by the firm’s ability to mitigate the effect of exchange rate changes by adjusting its markets, product mix, and sourcing.
B) defined as the extent to which the firm’s operating cash flows would be affected by the random changes in exchange rates.
C) determined by the structure of the markets in which the firm sources its inputs, such as labor and materials, and sells its products.
D) all of the options

Answer 27

38) D

Question 28

Q39) Generally speaking, when both a firm’s costs and its price are sensitive to exchange rate changes,

A) the firm is subject to high degrees of operating exposure.
B) the firm should hedge.
C) the firm is not subject to high degrees of operating exposure.
D) none of the options

Answer 28

39) C

Question 29

Q40) International banks are different from domestic banks in what way(s)?

A) International banks can assist their clients in hedging exchange rate risk.
B) International banks can arrange for foreign exchange transactions.
C) International banks can arrange trade financing.
D) all of the options

Answer 29

40) D

Question 30

Q41) A domestic bank that follows a multinational client abroad to preserve that banking relationship

A) is pursuing a wholesale defensive strategy.
B) is pursuing a retail defensive strategy.
C) is playing the role of the desperate housewife in this relationship.
D) none of the options

Answer 30

41) A

Question 31

Q42) A bank may establish a multinational operation for the reason of low marginal costs. The underlying rationale being that

A) managerial and marketing knowledge developed at home can be used abroad with low marginal costs.
B) banks follow their multinational customers abroad to prevent the erosion of their clientele to foreign banks seeking to service the multinational’s foreign subsidiaries.
C) multinational banking operations help a bank prevent the erosion of its traveler’s check, tourist, and foreign business markets from foreign bank competition.
D) the foreign bank subsidiary can draw on the parent bank’s knowledge of personal contacts and credit investigations for use in that foreign market.

Answer 31

42) A

Question 32

Q43) A correspondent bank relationship is established when

A) a group of banks form a syndicate to spread out the risk and cost of a large bond offering.
B) two banks write to each other about the credit conditions of their countries.
C) two banks maintain deposits with one another.
D) all of the options

Answer 32

43) C

Question 33

Q44) Consider a U.S. importer desiring to purchase merchandise from a Dutch exporter invoiced in euros, at a cost of €160,000. The U.S. importer will contact his U.S. bank (where, of course, he has an account denominated in U.S. dollars) and inquire about the exchange rate, which the bank quotes as €0.6250/$1.00. The importer accepts this price, so his bank will proceed to ________ the importer’s account in the amount of ________.

A) credit; €512,100
B) credit; $500,000
C) debit; €100,000
D) debit; $256,000

Answer 33

44) D

Question 34

Q45) The primary activities of offshore banks

A) is to seek deposits and grant loans in currencies other than the currency of the host government.
B) include money laundering where banking secrecy laws are strict.
C) involve check clearing of large bags of checks.
D) none of the options

Answer 34

45) A

Question 35

Q46) The core of the international money market is

A) the futures forwards and options markets on foreign exchange.
B) the market for foreign exchange.
C) the Eurocurrency market.
D) none of the options

Answer 35

46) C

Question 36

Q47) In an FRA, the buyer agrees to pay the seller

A) the increased interest cost if interest rates increase above the agreement rate.
B) the increased interest cost on a notional amount if interest rates fall below an agreement rate.
C) the increased interest cost on a notional amount if interest rates rise above an agreement rate.
D) none of the options

Answer 36

47) B

Question 37

Q48) In an FRA, the seller agrees to pay the buyer

A) the increased interest cost on a notional amount if interest rates fall below an agreement rate.
B) the increased interest cost if interest rates fall below the agreement rate.
C) the increased interest cost on a notional amount if interest rates increase above the agreement rate.
D) none of the options

Answer 37

48) C

Question 38

Q49) ABC International has borrowed $4,000,000 at LIBOR plus a lending margin of .65 percent per annum on a three-month rollover basis from Barclays in London. Three month LIBOR is currently 5.5 percent, but ABC is worried about an increase in three-month LIBOR 3 months from now. What could they do to hedge?

A) Buy a 3 × 9 FRA in the amount of $4 million.
B) Buy a 3 × 6 FRA in the amount of $4 million.
C) Sell a 3 × 6 FRA in the amount of $4 million.
D) Buy a 3 × 3 FRA in the amount of $4 million.

Answer 38

49) B

Question 39

Q50) Forward rate agreements can be used for speculative purposes. If one believes rates will be less than the agreement rate,

A) take a long position in the spot market.
B) the purchase of a FRA is the suitable position.
C) take a short position in a forward rate agreement.
D) the sale of a FRA is the suitable position.

Answer 39

50) D