Ch. 2C Flashcards
which one of the following factors would likely cause a nation’s currency to appreciate on the foreign exchange market?
Tip: compared to other countries and causes what?
A slower rate of growth in income relative to other countries,
which causes imports to lag behind exports.
Exchange rates are affected by changes in consumer tastes for products produced in various countries, relative changes in income in various countries, differing inflation rates, and differences in real interest rates.
Company has just acquired a large account and needs to increase its working capital by $100,000. The controller of the company has identified alternative source of funds: Issue $110,000 of 6-month commercial paper to net $100,000. (New paper would be issued every six months.)
Calculate the cost
Increase WC by $100,000
Issue $110,000 every 6 months
To retain $100,000 for a full 12 months requires two issues at $110,000 each.
Issue $110,000 Increase Working capital by $100,000 = $10,000 X 2 (every 6 months) = $20,000.
The cost would be $20,000 ÷ $100,000 = .20 or 20%.
The future value of $100 invested today for three years at an annual interest rate of 8% using the simple interest method is ________ (rounded to whole dollars).
The future or maturity of the $100 invested for three years at 8% is:
$100 Principal
$100 x .08 x 3 years = 24 Interest
$100 + 24= 124
A company manufactures goods in Esland for sale to consumers in Woostland. Currently, the economy of Esland is booming and imports are rising rapidly. Woostland is experiencing an economic recession, and its imports are declining.
The $E will ____ with respect to the $W.
Decline.
The demand for Esland products decreases as imports to Woostland decrease. The decline of interest in purchasing Esland products decreases the demand for that country’s currency. As the demand for Esland currency decreases, the price of Esland currency will depreciate, or decline.
What is a yield curve? A line that plots the interest rate…
A line that plots the interest rate, at a set point in time, with equal credit quality but differing maturity dates
Financial risk management primarily identifies _____ involving the financial markets.
uncertainties
A U.S firm sold $3 million in finished goods to a firm in Thailand for delivery in six months with the contract to be invoiced in dollars. In the ensuing period, the value of the bhat declined by 80%, which meant that Thai firm could not afford to purchase the dollars necessary to fulfill the contract. This is an example of:
Economic exposure
represents any impact of exchange rate fluctuations on a firm’s future cash flow. In this instance, the firm had attempted to protect itself from transactions exposure by invoicing the goods in dollars, but the foreign crisis make it impossible for foreign firms to afford to buy the dollars necessary to fulfill the contract. The firm could have protected itself somewhat from this exposure if some of their expenses had been denominated in bhat.
Name 3 hedges of derivative
___ value hedge,
___ flow hedge,
____ currency hedge
fair value hedge reflects the fair value of an asset or liability.
cash flow hedge reflects cash flows of forecasted transactions.
foreign currency hedge mitigates exposure to fluctuations in the value of foreign currencies.
Financial risk management includes:
3 thing
- assessing financial risk.
- developing and implementing management strategies.
- implementing internal priorities and policies.
What 3 factors are relevant when determining the risk premium on a specific security?
- Length of maturity
- Relative liquidity—> convert to cash
- Relative seniority—> order of repayment in event of bankruptcy
Equity “risk premium” is the excess return that investing in the stock market provides over a risk-free rate, such as the return from government treasury bonds. This excess return compensates investors for taking on the relatively higher risk of equity investing. The size of the premium will vary depending on the level of risk in a particular portfolio (including liquidity and seniority) and will also change over time (i.e., length of maturity) as market risk fluctuates.
small companies have what type of additional risks?
- unable to use broader capital markets
- are often unable to have diversified operations.
- usually have few suppliers.
interest rate risk affects both small and large organizations.
Re-pricing risk
Re-pricing risk occurs when a firm deliberately mismatches in an upsloping yield curve environment by holding assets with a longer duration than that of the liabilities used to fund them.
basis risk
basis risk would be found in the situation where a bank’s interest margins are generally spontaneously enhanced in a period of rising interest rates as loan rates tend to adjust upward more rapidly than the rates on deposits. However, at some point, as interest rate increases peak and rates begin to decline, this process reverses itself and there would be increasing pressure on interest rate margins.
Yield curve risk
Yield curve risk arises when the underlying shape of the yield curve changes (e.g., steepens, flattens, becomes inverted). These changes tend to accentuate any asset-liability mismatches the firm has.
The Bytax Company and the Tytax Company are both members of the same multinational corporation (MNC). The Bytax Company has a home-country 50% tax rate and the Tytax Company has a home-country 20% income tax rate. The Bytax Company desires to purchase a component part from the Tytax Company. An acceptable range for the transfer price has been established to be between $300 and $600 per unit. The following statement is true regarding the optimal transfer price:
The Bytax Company (purchasing subsidiary) will maximize earnings by having the transfer price set at the lowest possible price. The Tytax Company (selling subsidiary) will maximize earning by having the transfer price set at the highest possible price. The multinational corporation (MNC) will benefit by having the higher income shifted to the Company with the lowest home-country tax rate; therefore, the Tytax Company as well as the MNC will maximize earning by setting the transfer price at $600 per unit since the Tytax Company has the lower home-country tax rate of 20%.
