BEC Final Review Aug 2023

Question 1

According to the COSO Enterprise Risk Management Framework, uncertainty in enterprise risk management refers to

A. The impact of events or the time it would take to recover.
B. The possibility that events will occur and affect the achievement of objectives.
C. The boundaries of acceptable variation in performance related to achieving business objectives.
D. The state of not knowing how or if potential events may manifest.

Answer 1

D. The state of not knowing how or if potential events may manifest.

The term “uncertainty” refers to the inability of an entity to know in advance the likelihood or impact of future events on achieving objectives.

Question 2

When risk is evaluated, which of the following risk responses is generally considered a sharing response?

A. Reallocating capital among operating units.
B. Diversifying product offerings.
C. Entering into syndication agreements.
D. Rebalancing the asset portfolio to reduce exposure to certain types of losses.

Answer 2

C. Entering into syndication agreements.

Risk sharing is action taken to reduce the severity of the risk by transferring a portion of the risk to another party. Examples include insurance, hedging, joint ventures, and outsourcing. A syndication agreement is a contract between the arranger and the other participants that shares risk among all parties.

Question 3

Inherent risk is

A. A potential event that may affect the achievement of strategy and business objectives.
B. The risk when management has not taken action to reduce the impact or likelihood of an adverse event.
C. A risk response.
D. The risk after management takes action to alter its severity.

Answer 3

B. The risk when management has not taken action to reduce the impact or likelihood of an adverse event.

Inherent risk is the risk when management does not act to alter its severity. Severity commonly is measured as a combination of impact and likelihood.

Question 4

Enterprise Risk Management (ERM) is closely aligned with corporate governance because it

A. Identifies and isolates the silos in which risk exists.
B. Focuses management’s attention on the risks mitigated.
C. Reduces the level of acceptable risks to be taken.
D. Identifies which of the organizations’ objectives is at greatest risk.

Answer 4

D. Identifies which of the organizations’ objectives is at greatest risk.

ERM recognizes risk management across the entire enterprise, so it identifies and responds to the organization’s greatest risks. Managing the risks of an organization is one of the goals of corporate governance.

Question 5

Even though a company implements an enterprise risk management program, it still is likely to have risk. This risk is considered

A. Tolerable risks.
B. Uninsurable risks.
C. Actual residual risks.
D. Inherent risks.

Answer 5

C. Actual residual risks.

Actual residual risk is the risk that remains after management has taken actions to alter the original (inherent) risk. By implementing an enterprise risk management program, management has taken action to alter the inherent risk. The risk that remains after the program’s implementation is residual risk.

Question 6

The components of enterprise risk management (ERM) should be present and functioning. What does “present” mean?

A. I only.
B. II only.
C. I, II, and III.
D. I and II.

Answer 6

D. I and II.

The components and principles of ERM, and their related controls, should be present and functioning to help the entity achieve its strategy and business objective. “Present” means such components, principles, and controls exist in the design and implementation of ERM.

Question 7

A decrease in the price of a complementary good will

A. Shift the demand curve of the other commodity to the right.
B. Shift the demand curve of the other commodity to the left.
C. Shift the supply curve of the other commodity to the left.
D. Increase the price paid for a substitute good.

Answer 7

A. Shift the demand curve of the other commodity to the right.

A decrease in the price of a good (e.g., gasoline) will cause the demand curve of a complementary good (e.g., automobiles) to shift to the right (increase). The lower price of the first good results in greater demand for the complementary good at each price level.

Question 8

The amounts paid to laborers are

A. Nominal wages.
B. Real wages.
C. Productivity wages.
D. Minimum wages.

Answer 8

A. Nominal wages.

Nominal wages are the amounts actually paid (and received), while real wages represent the purchasing power of goods and services that can be acquired by the nominal wages. The level of real wages is determined by the productivity of labor. As productivity increases, the demand for labor also increases.

Question 9

The change in total product resulting from the use of one unit more of the variable factor is known as

A. The point of diminishing average productivity.
B. Marginal product.
C. Marginal cost.
D. The point of diminishing marginal productivity.

Answer 9

B. Marginal product.

Marginal product is the output obtained by adding one extra unit of a variable input factor. If the cost of the input factor is constant, a rising marginal product will result in a declining marginal cost of output. If marginal product is falling, marginal cost is rising. Hence, marginal cost is at a minimum when marginal product is at a maximum.

Question 10

The price elasticity of demand for a good is 2.0, and the quantity demanded is 5,000 units. The price increases by 10%. What is the new quantity demanded?

A. 4,000
B. 6,000
C. 1,000
D. 4,500

Answer 10

A. 4,000

Based on the law of supply and demand, quantity demanded generally decreases when price increases. Therefore, a 10% price increase will decrease the demand for the goods by 20% (2.0 price elasticity of demand × 10% increase in prices). Accordingly, the new quantity demanded is 4,000 [5,000 × (100% – 20%)].

Question 11

If a rent control law in a competitive housing market establishes a maximum or ceiling rent that is above the market or equilibrium rent,

A. A surplus of rental housing units will result.
B. Demand will increase as price increases.
C. Supply will decrease as price increases.
D. The law has no effect on the rental market.

Answer 11

D. The law has no effect on the rental market.

If the market equilibrium price is less than the maximum rent allowed, a rent control law will have no effect on the market.

Question 12

Because of economies of scale, as output from production expands,

A. The long-run average cost of production increases.
B. The short-run average cost of production decreases.
C. The slope of the demand curve increases.
D. The long-run total cost decreases.

Answer 12

B. The short-run average cost of production decreases.

When a firm experiences economies of scale, the average unit cost of production decreases as production increases. This phenomenon is attributable to spreading fixed costs over a greater number of units of output. Both the short-run and long-run average costs are lower because of economies of scale.

Question 13

The demand curve for a product reflects which of the following?

A. The impact that price has on the purchase amount of two related products.
B. The impact of prices on the amount of the product offered.
C. The impact that price has on the amount of a product purchased.
D. The willingness of producers to offer a product at alternative prices.

Answer 13

C. The impact that price has on the amount of a product purchased.

Demand is a schedule of the amounts of a good or service that consumers are willing and able to purchase at various prices during a period of time. Quantity demanded is the amount that will be purchased at a specific price during a period of time. The demand curve graphically depicts these relationships.

Question 14

The graph above depicts a relationship between the price and the quantity of a good. The movement depicted by the arrow can be described as

A. An increase in supply.
B. An increase in quantity demanded of a normal good.
C. An increase in demand for a normal good.
D. An increase in quantity supplied.

Answer 14

D. An increase in quantity supplied.

An upward-sloping curve relating price to quantity depicts a supply schedule. As prices rise, suppliers are willing to offer more of the product in the marketplace.

Question 15

The price of a commodity has decreased from $6 to $2, and the quantity supplied has decreased from 100 units to 50 units. If the midpoint method is used in the calculation, the price elasticity of supply is

A. .50
B. 2.00
C. .75
D. .667

Answer 15

D. .667

Question 16

Falser Co. increases all of its input factors by 100%, resulting in increased output of 90%. Which of the following statements identifies the effect of this change?

A. Marginal costs decrease.
B. Returns to scale increase.
C. Returns to scale decrease.
D. Marginal returns rise.

Answer 16

C. Returns to scale decrease.

Diseconomies of scale, also called decreasing returns to scale, occurs when the marginal cost of production increases as firms expand their output. Falser’s output expanded by 90%, but it required a 100% increase in inputs. Hence, the marginal amount of required inputs increased as Falser expanded its output. This change is therefore classified as a returns to scale decrease.

Question 17

The situation depicted in the graph below could be caused by

A. An improvement in manufacturers’ productivity.
B. A price hike by all producers.
C. A rise in the country’s population.
D. A price cut by all producers.

Answer 17

C. A rise in the country’s population.

A downward-sloping curve relating price to quantity depicts the demand schedule for a normal good. When a country’s population grows, producers can sell more of their products at every price level. This is depicted as a rightward shift in the demand curve.

Question 18

The activities of the user entity and the service organization have a high degree of interaction. The user auditor

A. Should obtain absolute assurance that the service organization’s internal control will prevent or detect fraud or error.
B. Is not required to evaluate the service organization’s controls.
C. Need not test the service organization’s internal control if the user entity has effective controls related to service organization processing.
D. Should not consider weaknesses in the service organization’s internal control to be weaknesses in the user entity’s system.

Answer 18

C. Need not test the service organization’s internal control if the user entity has effective controls related to service organization processing.

The significance of controls at the service organization depends on the degree of interaction between its activities and those of the user entity. The degree of interaction is the extent to which the user entity can, and chooses to, implement effective controls over service organization processing. In these circumstances, the user auditor may be able to obtain an understanding from the user entity of the service organization’s services that suffices to assess the RMMs. Accordingly, the user auditor need not obtain a type 1 or type 2 report.

Question 19

An issuer’s audit committee has established procedures on submissions by employees of questionable accounting and auditing matters. Those procedures require the following:

Which of the above procedures will likely result in a violation of the Sarbanes-Oxley Act of 2002?

A. I only.
B. I, II and III.
C. I and II only.
D. II only.

Answer 19

C. I and II only.

The procedure requiring employees to identify themselves will likely violate the Sarbanes-Oxley Act because submissions should be made anonymously. Additionally, the procedure requiring that all submissions be presented to senior management will likely violate the Sarbanes-Oxley Act because submission should be confidential.

Question 20

In the processing of sales orders, which of the following documents authorizes the warehouse to send goods to the shipping department?

A. Customer purchase order.
B. Picking ticket.
C. Packing slip.
D. Sales order.

Answer 20

B. Picking ticket.

A picking ticket is an efficient means of gathering items to fill customer orders. The ticket is a hard copy or digital record of items to be selected for shipment from warehouse inventory. It states the (1) identifying item number and description, (2) location code, (3) quantity, (4) customer order number, and (5) number of units actually picked.

Question 21

Which of the following describes the most effective preventive control to ensure proper handling of cash receipt transactions?

A. The employee who receives customer mail receipts prepares the daily bank deposit, which is then deposited by another employee.
B. Use predetermined totals (hash totals) of cash receipts to control posting routines.
C. One employee issues a prenumbered receipt for all cash collections; another employee reconciles the daily total of prenumbered receipts to the bank deposits.
D. Have bank reconciliations prepared by an employee not involved with cash collections and then have them reviewed by a supervisor.

Answer 21

C. One employee issues a prenumbered receipt for all cash collections; another employee reconciles the daily total of prenumbered receipts to the bank deposits.

Sequentially numbered receipts should be issued to maintain accountability for cash collected. Such accountability should be established as soon as possible because cash has a high inherent risk. Daily cash receipts should be deposited intact so that receipts and bank deposits can be reconciled. The reconciliation should be performed by someone independent of the cash custody function.

Question 22

A service auditor’s report on internal control may be issued on management’s description of a service organization system and the suitability of the design of controls or management’s description of a service organization system and the suitability and operating effectiveness of controls. Which of the following is true about a type 1 report?

A. It should include an opinion about the design of internal control as well as conclusions about tests of controls.
B. It should state that the auditor did not test the effectiveness of the controls.
C. It need not be restricted in its use and may be made available to any third party.
D. It will include a list of all fraud and error discovered.

Answer 22

B. It should state that the auditor did not test the effectiveness of the controls.

A service auditor’s type 1 report should contain a statement that the auditor did not test the effectiveness of the controls.
The AICPA has issued additional guidance on service auditor reports. The term System and Organization Controls (SOC) report is used in this guidance. The reports obtained by the user auditor in an audit are called SOC 1 reports (type 1 or type 2). Service auditors also may prepare SOC 2 and SOC 3 reports to provide assurance on more than internal controls over financial reporting (e.g., security, availability, processing integrity, confidentiality, or privacy). SOC 2 reports are to be used by those identified in the report, and SOC 3 reports may be used by any user.

Question 23

An internal auditor is considering a client’s organizational structure as it affects the ethical climate established by company management. Each of the following considerations is valid in this regard except

A. A highly structured organization with formal reporting lines may be appropriate regardless of entity size.
B. The appropriateness of an entity’s organizational structure depends in part on the nature of its activities.
C. A company that is highly centralized will have a more diverse ethical culture than a company that is decentralized.
D. A decentralized environment may increase the risk that unethical decisions could be made by unit managers.

Answer 23

C. A company that is highly centralized will have a more diverse ethical culture than a company that is decentralized.

A company that is highly centralized will have a less diverse ethical culture than a company that is decentralized. In a highly centralized company, policies and procedures are delivered from the top down. In a decentralized company, each individual unit likely has its own ethical culture, so the company itself has a more diverse ethical culture.

Question 24

When a service auditor conducts an audit of a service organization, what should the user auditor consider in the planning stages regarding internal controls of the service organization?

A. Determining whether management has adequately described complementary user controls.
B. Performing agreed-upon procedures.
C. Assessing risks of material misstatement before obtaining an understanding of internal controls.
D. Obtaining an understanding of the entity’s internal controls after performing substantive procedures.

Answer 24

A. Determining whether management has adequately described complementary user controls.

The user auditor should obtain an understanding of the nature and significance of the services provided by the service organization and their effect on the user entity’s controls relevant to the audit. Understanding controls at the service organization requires evaluating management’s description of the service organization’s system, including complementary user entity controls (CUEC). The service organization builds CUEC into the design of its own control structure. They will be implemented by user entities to achieve the control objectives of the service organization and the user. CUECs therefore are the responsibility of the user entity.

Question 25

Fact Pattern:
This flowchart depicts the processing of daily cash receipts for Rockmart Manufacturing. Please note that some procedures are not shown in this flowchart.

The appropriate description that should be placed in symbol B is

A. Collation of remittance advices.
B. Keying and verifying.
C. Error correction.
D. Batch processing.

Answer 25

B. Keying and verifying.

The figure below symbol B signifies a hard drive used for input or output, so the operation represented by symbol B must be keying the information onto the hard drive. Verifying the keyed data also should occur at this step.

Question 26

The initiation of the purchase of materials and supplies would be the responsibility of the

A. Inventory control department.
B. Production department.
C. Stores control department.
D. Purchasing department.

Answer 26

A. Inventory control department.

The inventory control department would be responsible for initiating a purchase. It has access to the inventory records and would therefore know when stocks were getting low.

Question 27

A hospital is comparing last year’s emergency rescue services expenditures to those from 10 years ago. Last year’s expenditures were $100,500. Ten years ago, the expenditures were $72,800. The CPI for last year is 168.5, as compared to 10 years ago when it was 121.3. After adjusting for inflation, what percentage change occurred in expenditures for emergency rescue services?

A. 18.1% decrease.
B. 0.6% decrease.
C. 13.8% increase.
D. 38.0% increase.

Answer 27

B. 0.6% decrease.

To compare monetary amounts in constant dollars, both amounts must first be deflated using the appropriate price index.

Last year’s expenditures in constant dollars equal $59,644 ($100,500 ÷ 1.685). Those from 10 years ago equal $60,016 ($72,800 ÷ 1.213), for a net decrease of $372 ($59,644 – $60,016). Thus, after adjusting for inflation, expenditures decreased by 0.6% ($372 ÷ $60,016).

Question 28

The elasticity of resource demand tends to be high when

A. The elasticity of product demand is low.
B. The elasticity of product demand is high.
C. Substitutes are not available.
D. The resource cost is a lesser percentage of total cost.

Answer 28

B. The elasticity of product demand is high.

The elasticity of resource demand tends to be high when the elasticity of product demand is high, substitutes are available, the elasticity of the product demand is also high, and the resource is a greater percentage of total cost.

Question 29

Import restrictions for purposes of creating domestic employment

A. May lead to lower prices for consumers.
B. Will lead to lower sales tax collections.
C. May lead to retaliation by other countries.
D. Are likely to increase the number of export jobs.

Answer 29

C. May lead to retaliation by other countries.

Protectionism in the form of import restrictions can lead to a variety of economic and social costs, including higher prices to consumers for both domestic and imported goods, higher taxes, and retaliation by other countries.

Question 30

All other things being equal, what is the most likely impact of imposing import tariffs?

A. Overallocation of resources to relatively efficient industries.
B. Underallocation of resources to relatively inefficient industries.
C. Contraction of relatively efficient industries.
D. Increase in exports of domestically produced goods.

Answer 30

C. Contraction of relatively efficient industries.

As a result of import quotas and tariffs, domestic consumers pay higher prices and consume fewer goods. However, the domestic producers are able to sell more goods. Thus, domestic consumers pay a subsidy to domestic producers, and workers are shifted from relatively efficient export industries into less efficient, protected industries.

Question 31

One consequence of the imposition of tariffs or quotas on imported products is

A. Additional consumption of the affected imported products.
B. Domestic industry opposition to protection from imports.
C. Lower prices for domestic products that compete with affected imports.
D. Higher prices for the affected imported products.

Answer 31

D. Higher prices for the affected imported products.

Tariffs lead to higher prices on imported products. Similarly, the imposition of quotas leads to higher prices through an artificial limitation on supply.

Question 32

A direct effect of imposing a protective tariff on an item for which there are both foreign and domestic producers is that domestic producers will sell <List> of the item while domestic consumers consume <List> of the item.</List></List>

Answer 32

List A = More
List B = Less

Domestic producers are not subject to the tariff and will therefore have a price advantage over their foreign competitors. However, absent such competition, the domestic price of the item will be higher. Domestic producers will sell more at a higher price, and domestic consumers will consume less following the price increase.

Question 33

Protectionism has been justified using the strategic trade policy argument. Its premise is that

A. The risk of domestic product development should be reduced.
B. Exports of certain technology should be prohibited on national security grounds.
C. Special interest lobbying tends to be effective because the costs of cheaper imports are direct and concentrated.
D. Displaced worker programs can reduce the effects of foreign competition.

Answer 33

A. The risk of domestic product development should be reduced.

An extension of the infant-industry argument is the “strategic trade policy argument.” It contends that a government should use trade barriers strategically to reduce the risk of product development borne by domestic firms. It applies particularly to products involving advanced technology.

Question 34

The value of money varies

A. Inversely with the general level of prices.
B. Directly with investment.
C. Directly with the tax rates.
D. Directly with government spending.

Answer 34

A. Inversely with the general level of prices.

As prices rise, the purchasing power of a stock of money held diminishes. Accordingly, the value of money and the general level of prices must be inversely related.

Question 35

Domestic content rules

A. Restrict demand for affected products.
B. Tend to be imposed by capital-intensive countries.
C. Tend to be imposed by labor-intensive countries.
D. Exclude products not made domestically.

Answer 35

B. Tend to be imposed by capital-intensive countries.

Domestic content rules require that at least a portion of any imported product be constructed from parts manufactured in the importing nation. This rule sometimes is used by capital-intensive nations. Parts can be produced using idle capacity and then sent to a labor-intensive country for final assembly.

Question 36

Which of the following pricing policies results in establishment of a price to external customers higher than the competitive price for a given industry?

A. Transfer pricing.
B. Predatory pricing.
C. Collusive pricing.
D. Dual pricing.

Answer 36

C. Collusive pricing.

Collusion involves competitive businesses working together to gain advantage in the market. Inflating the price of a good or service higher than the competitive price to realize higher profits is indicative of collusive behavior.

Question 37

Demand-pull inflation occurs when

A. There are excessive wage increases.
B. Incomes rise suddenly.
C. There are rapid increases in raw materials prices.
D. There are substantial changes in energy prices.

Answer 37

B. Incomes rise suddenly.

When incomes rise suddenly, consumers demand more of everything, driving up the price level.

Question 38

Governments most likely restrict trade in the form of tariffs and import quotas to

A. I only.
B. I, II, and IV only.
C. I and II only.
D. II and III only.

Answer 38

C. I and II only.

Trade restrictions are generally imposed for the announced purpose of protecting domestic jobs, developing new industries, and protecting declining industries. Both tariffs and import quotas increase the prices of imported goods. Import quotas decrease the quantity of imports.

Question 39

Increased demand for Product A increases the demand for resources used to produce Product A. What is the best explanation for the increase in the demand for resources?

A. Product A is in an expanding industry.
B. The demand for Product A is highly elastic.
C. The theory of derived demand is working.
D. The theory of the “invisible hand” is working.

Answer 39

C. The theory of derived demand is working.

Derived demand is the demand for the inputs to production (factors) derived from the demand for the outputs (final goods).

Question 40

A U.S.-based company decides to invest capital in an emerging market operation that has a lower expected return rate compared to the expected return for an alternative domestic operation. Which of the following statements correctly supports this decision?

A. Management expects the U.S. dollar to decline in value relative to the foreign location’s currency.
B. Management expects inflation to increase in the emerging market compared to the U.S. inflation rate.
C. Management expects the U.S. dollar to strengthen in value relative to the foreign location’s currency.
D. Management expects inflation to decrease in the U.S. compared to the foreign location’s inflation rate.

Answer 40

A. Management expects the U.S. dollar to decline in value relative to the foreign location’s currency.

A decline in the U.S. dollar will increase the return on invested capital in the foreign market. Thus, management will invest capital in the emerging foreign market.

Question 41

A firm must pay an invoice denominated in a foreign currency in 30 days. Which one of the following is an appropriate strategy for mitigating the associated exchange rate risk?

A. Sell a put option.
B. Buy a put option.
C. Sell a call option.
D. Buy a call option.

Answer 41

D. Buy a call option.

A call option gives the holder the right to buy (i.e., call for) a specified amount of currency in a future month at a specified price. Call options are used to hedge payables.

Question 42

A significant decline in the exchange rate of the U.S. dollar generally will have which of the following effects?

A. It will hurt all U.S. business.
B. It will benefit U.S. importers.
C. It will benefit U.S. exporters.
D. It will make foreign goods cheaper for U.S. consumers.

Answer 42

C. It will benefit U.S. exporters.

A decline in the exchange rate of the U.S. dollar means that the U.S dollar can be exchanged for fewer units of a foreign currency.
U.S. exporters will benefit because they sell their goods for foreign currency. This foreign currency can now be exchanged for more units of the U.S. dollar because of the dollar’s decline in value.

Question 43

An appreciation of the U.S. dollar against the Japanese yen would

A. Make travel in Japan more expensive for U.S. citizens.
B. Increase the translated earnings of U.S. subsidiaries domiciled in Japan.
C. Increase the cost of buying supplies for U.S. firms in Japan.
D. Make U.S. goods more expensive to Japanese consumers.

Answer 43

D. Make U.S. goods more expensive to Japanese consumers.

When one currency appreciates, other currencies lose buying power.
If the dollar appreciates against the yen, Japanese customers lose buying power when they shop for American goods.

Question 44

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. Slow down collections and slow down payments.
D. Speed up collections and speed up payments.

Answer 44

A. Speed up collections and slow down payments.

The U.S. firm should 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 is 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.

Question 45

Which of the following options is (are) worth exercising?

A. Options A and D.
B. Option D only.
C. Options A and B.
D. Options A, B, and C.

Answer 45

A. Options A and D.

An option is worth exercising if its intrinsic value is positive.
A call option gives the holder the right to purchase (i.e., call for) the underlying asset at a fixed price, called the exercise or strike price. The intrinsic value of a call option is the amount by which the exercise price is less than the market price of the underlying asset. Thus, the intrinsic value of call option D is positive ($24 – $20 = $4).
A put option gives the holder the right to sell (i.e., put onto the market) the underlying asset at a fixed price. The intrinsic value of a put option is the amount by which the exercise price is greater than the price of the underlying asset. Thus, the intrinsic value of put option A is positive ($30 – $27 = $3).

Question 46

Over the past year, Russia’s ruble supply has increased. Today’s spot rate with respect to the U.S. dollar is $1 = 30 rubles. Which one of the following statements is consistent with these facts?

A. The Russian ruble has decreased in value.
B. The dollar has appreciated over the past year.
C. Interest rates in the U.S. are higher than those in Russia.
D. Interest rates in the U.S. are lower than those in Russia.

Answer 46

A. The Russian ruble has decreased in value.

As the supply of the currency increases, its value will decrease (or depreciate). In this situation, the ruble would have depreciated over the past year.

Question 47

The spot rate for one Australian dollar is $0.92685 and the 60-day forward rate is $0.93005. Which one of the following statements is consistent with these facts?

A. The U.S. dollar has gained purchasing power with respect to the Australian dollar.
B. The U.S. dollar is trading at a forward discount with respect to the Australian dollar.
C. The U.S. dollar is trading at a forward premium with respect to the Australian dollar.
D. The U.S. dollar has lost purchasing power with respect to the Australian dollar.

Answer 47

B. The U.S. dollar is trading at a forward discount with respect to the Australian dollar.

The exchange rate for the Australian dollar is higher in the forward market than the spot market. The Australian dollar is therefore trading at a forward premium. Accordingly, the U.S. dollar is trading at a forward discount.

Question 48

If the value of the U.S. dollar in foreign currency markets changes from $1 = .75 euros to $1 = .70 euros,

A. Products imported from Europe to the U.S. will become more expensive.
B. U.S. tourists in Europe will find their dollars will buy more European products.
C. U.S. exports to Europe should decrease.
D. The euro has depreciated against the dollar.

Answer 48

A. Products imported from Europe to the U.S. will become more expensive.

The dollar has declined in value relative to the euro. If an American had previously wished to purchase a European product that was priced at 10 euros, the price would have been about $13.33. After the dollar’s decline in value, the price of the item has increased to about $14.29. Thus, imports from Europe should decrease and exports should increase.

Question 49

A massive inflation across the entire economy of one of a firm’s trading partners has benefited the firm greatly by making its fixed amount of payables denominated in that country’s currency much cheaper. This exemplifies exchange rate risk stemming from

A. Economic exposure.
B. Transaction exposure.
C. Transition exposure.
D. Translation exposure.

Answer 49

A. Economic exposure.

Economic exposure is the exposure to fluctuations in exchange rates resulting from overall economic conditions.

Question 50

If risk is purposely undertaken in the foreign currency market, the investor in foreign currency then becomes

A. A speculator.
B. Involved in hedging.
C. An arbitrageur.
D. An exporter.

Answer 50

A. 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.

Question 51

A company has several long-term, floating-rate bonds outstanding. The company’s cash flows have stabilized, and the company is considering hedging interest rate risk. Which of the following derivative instruments is recommended for this purpose?

A. Forward contract on a commodity.
B. Futures contract on a stock.
C. Swap agreement.
D. Structured short-term note.

Answer 51

C. Swap agreement.

An interest rate swap is an agreement to exchange interest payments based on one interest structure (e.g., floating rate charges) for payments based on another structure (e.g., fixed rate charges). These swaps are used to hedge interest rate risk.

Question 52

An exporter enters into a contract to supply goods to a foreign buyer. The contract requires the payment in foreign currency 120 days after delivery. Recently the foreign currency has experienced many fluctuations. The exporter may incur a loss on this contract at the time payment is received due to such fluctuations. Which of the following actions should the exporter take to avoid such loss?

A. Cancel the export contract.
B. Invest the foreign currency in the buyer’s country to avoid short-term fluctuations.
C. Enter into a forward contract with a bank.
C. Wait for the settlement date to see if the foreign currency actually fluctuates.

Answer 52

C. Enter into a forward contract with a bank.

Fluctuations in currency between the contract date and the settlement date may cause a loss on a contract. Hedging is a common way to avoid or reduce such losses. When an exporter is required to pay a foreign currency amount at some time in the future, there is a risk that the foreign currency will appreciate. To hedge against risk, the exporter should purchase a foreign currency forward to fix a definite price.

Question 53

A country’s currency conversion value has recently changed from 1.5 to the U.S. dollar to 1.7 to the U.S. dollar. Which of the following statements about the country is correct?

A. Its imports of U.S. goods are more affordable.
B. Its purchases of the U.S. dollar will cost less.
C. Its currency has appreciated.
D. Its exports are less expensive for the United States.

Answer 53

D. Its exports are less expensive for the United States.

Since the foreign country’s currency has depreciated against the U.S. dollar, U.S. consumers have gained purchasing power, making the foreign country’s goods less expensive for buyers that pay in U.S. dollars.

Question 54

Which one of the following is not a determinant in valuing a call option?

A. Exercise price.
B. Expiration date.
C. Underlying asset price.
D. Forward contract price.

Answer 54

D. Forward contract price.

The price of an option is equal to its intrinsic value (exercise price – underlying asset price) plus the time premium that depends on the expiration date of an option.