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International Finance Midterm > Final > Flashcards

Final Flashcards

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1
Q

what is a hard currency

A

currency likliky to appreciate

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2
Q

Covariance

A
  • measure of the degree to which the two variables move together
  • positive: move together
  • negative: move opposite
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3
Q

What is the home currency invoicing strategy

A
  • invoice exports in strong currencies, imports in weak currenies
  • can only “win” if not dealing with informed customers or suppliers
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4
Q

Managing transaction exposure

A
  • forward contract
  • price adjustment clauses
  • currency options
  • HC invoicing
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5
Q

How to account for inflation and exchange rate projection

A
  1. convert each nominal foreign CF into nominal domestic, then discount using a rate that reflects domestic inflation + risk premium
  2. discount each nominal foreign CF at rate reflects foreign inflation and apposite risk premium. su up foreign PV and convert to domestic using spot exchange rate
    * THESE SHOULD BOTH PRODUCE THE SAME RESULT
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6
Q

when does transaction exposure occur

A
  • from time of agreement to time of payment
  • Fixed foreign currency inflows or outflows in the future
  • Arises from possibility of exchange rate changes between transaction date and settlement date
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7
Q

Features of futures (Currency)

A
  • Contract size standardized by amount of foreign currency
  • transaction costs:commision
  • Leverage is high
  • Max price movements
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8
Q

International diversification

A
  • Better risk-return trade off
  • diversify across nations in different stages of the economic cycle
  • international investments push out the efficient frontier
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9
Q

Currency risk sharing

A
  • develop custom hedge contract
  • Price adjustment clause
  • share currency risk outside a neutral band
  • neutral zone range in which risk is NOT shared
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10
Q

Steps in futures

A
  1. initial margin
  2. daily fluctuations flow to margin account
  3. maintenance margin breached, margin call is issued
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11
Q

Differences between forwards and futures

A
  • trading location
  • trading hours
  • regulation
  • delivery date and frequency
  • costs
  • margins
  • market value at origniation
  • credit risk
  • cash flows
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12
Q

What are the components of Economic exposure

A

Transaction exposure + operating exposure

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13
Q

Circumstance in which firms face economic exposure

A
  1. enter purchase/sale agreement in foreign currency
  2. selling or buying abroad or face domestic competition from imports
  3. operating in foreign country where govt. taxes nominal rather than real income
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14
Q

What is transaction exposure

A

results from changes the in value of foreign currency contracts due to exchange rate changes

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15
Q

True cost of hedging

A

opportunity cost depends upon future spot rate at settlement

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16
Q

How to think about measuring translation exposure

A
  • some assets held at historical rate (not exposed)
  • some held at current : exposed
  • Translation exposure = “exposed assets” - “exposed liabilities”
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17
Q

Options on currencies

A
  • foreign (non-US currency) is asset, state prices in USD
  • call : right to buy asset
  • Put; right to sell asset
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18
Q

Economic impact of changes in foreign exchange

A

look at real, see if inflation has offset currency rate changes

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19
Q

Limits to international diversifiaction

A
  • correlation between markets is time-varying
  • correlation appears to increase during period of high vol
  • markets move together during bear markets
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20
Q

Currency future

A

agreement to buy/sell a standard quantity of an available currency at a fixed exchange rate at a set delivery price

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21
Q

Basic translation methods

A
  1. Current/non current
    - only CA, CL, exposed
  2. monetary/non monetary
    - only monetary assets are exposed
  3. temporal
    - current costs are exposed, historical aren’t
  4. current rate
    - all CA, CL exposed
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22
Q

Currency likely to depreciate

A

soft currency

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23
Q

Currency collars

A
  • contract bought to protect against currency moves outside the neutral zone
  • firm convert its foreign currency denominated receivable at zone forward rate
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24
Q

Which risk can be eliminated by diversification

A

non-systematic risk

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25
Q

Regression

A

INPUT

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26
Q

Why use derivatives

A
  • income opportunities/speculation
  • risk management
  • Finanical Engineering
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27
Q

Political risks

A
  • adjust either discount rate or CF, easier to do CF
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28
Q

3 options to manage translation exposure

A
  • adjust fund flows
  • forward contracts
  • exposure netting
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29
Q

What is meant by increasing soft-currency liabilities

A
  • devaluation likely
    • tighten credit to reduce AR
    • reduce level of cash
    • increase LC borriwn
    • delay AP
    • sell weak currency forward
  • SUMMARY: increase cash cycle
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30
Q

What is hedging currency exposure

A
  • creating offsetting currency position
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31
Q

How to create a currency collar

A
  • long put on FC, sell call on FC
  • Long put to hedge downside
  • short call to reduce cost of hedge
32
Q

How to measure transaction exposure

A
  • currency by currency

* equals difference between the contractually fixed future cash inflow and outflows in each currency

33
Q

arises because exchange rate changes alter the value of future revenues and costs

A

Operating exposure

34
Q

Currency swap

A

exchange of debt-service obligations denominated in one currency for the service on an agreed-upon principal amount of debt denominated in another currency

35
Q

Cross -hedging

A
  • use when forward contract not available
  • futures/forward on related currency
  • use regression
36
Q

Impact depends on pricing flexibility

A
  • price elasticity of demand
  • product differentiation
  • ability to shift produciton
  • substitution on inputs
37
Q

Accounting vs. economic exposure

A
  • accounting: reflects past decisions of the firm
  • economic: focus on future impact of exchange rate changes
  • SHOULD FOCUS ON ECONOMIC: true CF expected to firm, max SH value
38
Q

Variance

A

a measure of the degree to which a variable deviates from its average

39
Q

3 steps approach to simplify project evaluation

A
  • estimate project cf from the project’s standpoint
  • forecast the amount, timing and form of transfers to parents, taxes etc
  • consider indirect benefits and costs
40
Q

Selective hedging

A
  • hedging only when a currency change is expected, going unhedged otherwise
  • not much different from speculation
41
Q

increase in the real value of a currency

A
  • tax on exports

* subsidy on imports

42
Q

Key questions to ask in identifying economic exposure

A
  • Where is the company selling?
  • Who are the company’s key competitors?
  • How sensitive is demand to price?
  • Where is the company producing?
  • Where are the company’s inputs coming from?
  • How are the company’s inputs and outputs priced?
43
Q

Advantages of international investing

A
  1. offers more opportunities

2. diversification (side benifit of 1 )

44
Q

What is translation exposure

A

arises when reporting and consolidating financial statements requires conversion from local to home currency

45
Q

Why to we care about foreign currency accounting

A

CF is basis for valuation

46
Q

Systematic risk:

A
  • risk present in all investment opportunities

* cannot be eliminated

47
Q

How can a domestic company with no accounting exposure be exposed to currency risk?

A

eg. skiing in aspen

48
Q

Basic hedging strategy for reducing translation expsoure

A
  • increase hard currency asset
  • decrease soft currency assets
  • increase soft currency libaility
  • decrease hard currency liability
49
Q

Hedging methods

A
  • Forward market hedge
  • Money market hedge
  • Risk shifting
  • Pricing decisions
  • Exposure netting
  • Currency risk sharing
  • Currency collars
  • Cross-hedging
  • Foreign currency options
50
Q

Foreign currency options

A
  • good for when quantity of FX is uncertain
  • call option valuable when offered to buy a foreign asset at fixed price (limit downside to premium if bid is rejected)
  • put: insure profit margin
    • hedge anticipated sales or purchase
    • hard to chard in FC
    • protect margins in HC
51
Q

Money market hedge

A
  • Simultaneous borrowing and lending activities in two different currencies to lock in the dollar value of a future foreign currency cash flow
  • “Homemade” forward contract
52
Q

Risk shifting

A
  • home currency invoicing
  • zero sum game
  • common for global businesses
53
Q

Methods of international investing

A
  • ADR
  • GDR
  • ETF
  • Internationally diversified MFs
  • MNCs
  • Bonds
54
Q

Foreign Exchange Exposure

A

– the degree to which a company is affected by exchange rate changes

55
Q

Important aspects of hedging

A
  • degree of centralization

* responsibility for developing and implementing the hedging strategy

56
Q

Option value

A
  • intrinsic + time value
  • affected by volatility of exchange rate, time to expiration and interest rate differential
    • when domestic r > foreign r, calls higher, puts lower
57
Q

production management options

A
  • input mix (shop the world)
  • shift production among plants
  • plant location
  • raising productivity
58
Q

Pricing decisions

A
  • general rule on credit sales overseas
    • conver foreign price to home price using forward, not spot rate
    • use weighted average w. multiple payments
59
Q

Example: Bombardier to receive NFr 50M from Norden Airlines in 6 months: Borrow PV(NFr 50M), NFr → C$, lend C$

A

This is an example of a money market hedge

60
Q

Quoting futures and forwards

A
  1. Future
    • American ($/FC)
  2. Forward
    • Euro (FC/$)
61
Q

Salient difference between futures, forwards and options

A

Futures/forwards must take delivery,

-options have no obligation

62
Q

What is the objective a hedge

A
  • reduce/ eliminate vol of CF as a result of exchange rate changes
  • not a profit centre
  • should be evaluated as a purchase of insurance
63
Q

Total risk

A

= systematic + nonsystematic

64
Q

If international fischer effect holds

A

firms face no exposure on foreign currency denominated transactions

65
Q

How to manage exposure

A

hedge

66
Q

Factors that can distort the base for incremental cf

A
  • Cannibalization
  • Sales creation
  • Opportunity cost
  • Transfer pricing
  • Fees and royalties
  • Getting the base case right
  • Accounting for intangible benefits
67
Q

What is a forward market hedge

A
  • Consists of offsetting a receivable (or payable) in a foreign currency using a forward contract:
  • eliminate downside risk at expense of upside potential
68
Q

Three types of exposure

A
  1. Translation
  2. Transaction
  3. Operating
69
Q

Higher the price elasticity of demand

A
  • more currency risk the firm faces by product substituion

* eg. lower end of car market in the US

70
Q

When and how does Exposure netting work

A
  • offset positively correlated currencies, (offset long with short)
  • Offset negatively correlate currencies with another short
71
Q

disadvantages of futures

A
  • limited number of currencies
  • rigid contract size (eliminated from emicro)
  • create CF problems
  • limited delivery date (not really an issue, explain why )
72
Q

Option price influenced by interest rates

A

if domestic > foreign, calls are higher, puts a

73
Q

what affects the price of a currency option

A
  • volatility of exchange rate
  • time to expiration
  • interest rate differential between 2 currencies
74
Q

put call parity

A

(St / 1+rf) + P - x/(1+rh) = C

75
Q

Convert then discount method

A

((0.9 x 1.03 ) - (0.65x1.3) x 0.27 x 1.03/1.3) / (1.05x1.03) -1 -0.03

International Finance Midterm (3 decks)

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