Chapter 11

Question 1

Financial risk is the risk arising

Answer 1

Where financial conditions are different than expected

Gearing is a type of financial risk

Question 2

Actions accompany could take to manage credit credit risk

Answer 2

Ensure credit check is undertaken for all new customers

Monitor receivables balances in relation to a customers credit limits.

Obtain an export credit guarantee

Question 3

Impact on margins from imports due to home currency depreciation

Answer 3

Lower margins

Question 4

Economic risk

Answer 4

Relates to long-term impacts on cash flows 

Question 5

Transaction risk

Answer 5

When entering into a short term transaction involving Credit in a non-native country

Question 6

Translation risk

Answer 6

The danger of a business generating accounting losses when translating the value of a foreign asset or liability into the functional currency of the business at the end of the accounting period

Question 7

Factors likely to cause movement in the countries exchange rate

Answer 7

Speculative activity by currency traders

Political stability of the country.

The balance of payments

The countries debt rating

Capital movements between economies

The governments monetary policy

Question 8

Factors influencing the demand for a countries currency

Answer 8

The demand for its goods and services

The purchasing requirements of its central bank

Overseas investors undertaking investment in the country

Question 9

Cross rate

Answer 9

An exchange rate between two countries computed by reference to a third currency, usually the US dollar

Question 10

Purchasing power, parity formula

Answer 10

Uses inflation rate between two countries to calculate the future exchange rate 

Question 11

Interest rate parity theory

Answer 11

The a fair forward, exchange rate can be determined using the current spot rate and the nominal interest rates in the two countries

Question 12

Impact on imports and exports of the strengthening exchange rate

Answer 12

Imports will increase

Exports will decrease

Question 13

Factors influencing exchange rates

Answer 13

Supply and demand

Interest rates

Inflation rates

Question 14

Meaning when a currency is quoted as a premium in relation to a spot rate

Answer 14

Implies the currency is expected to strengthen

Per interest rate parity. The interest rate of the strengthened company must be lower than others.

Question 15

The international Fisher effect

Answer 15

Assumes that

The only reason the nominal interest rates in two different countries are different is due to differing levels of inflation.

Hence the forward rate (using interest rate parity) is an unbiased predictor of the future expected spot rate (using purchasing power parity). This is known as expectations theory.

Question 16

Limitation of interest rate parity theory

Answer 16

In practice, exchange rates are influenced by speculative activity in foreign exchange markets

Question 17

Limitations of inflation rate parity theory

Answer 17

It assumes free trade and the absence of exchange controls

Question 18

Determining forward rates

Answer 18

Use interest rate parity theory

Question 19

Determining future spot rates

Answer 19

Use purchasing power, parity theory

Question 20

Difference between forward, contracts and options

Answer 20

Forward contracts is an agreement under which business agrees to buy or sell a certain amount of foreign currency on a specific future date

Currency options give the company, the right, not the obligation to buy or sell currency at a specific rate or a specific date

Question 21

Asset and liability management

Answer 21

A process of managing the use of assets and cash flows to reduce the firms risk of loss from not paying a liability on time. Well managed assets and liabilities increased business profits.

It also involves the economic value of equity.