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FIN 436 > FINAL EXAM > Flashcards

FINAL EXAM Flashcards

1
Q

a measure of the potential for a firm’s profitability, net cash flow, and market value to change because of a change in exchange rates

A

Foreign exchange exposure

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2
Q

What is the goal of management for foreign exchange exposure?

A

To measure foreign exchange exposure and to manage it so as to maximize the profitability, net cash flow, and market value of the firm

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3
Q

What are the two categories of foreign exchange exposure?

A
  • Accounting exposure
  • Economic exposure
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4
Q

Arise from contracts and accounts being denominated in foreign currency

A

Accounting exposures

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5
Q

the potential change in the value of the firm from its changing global competitiveness

A

Economic exposure

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6
Q

What are the 3 types of foreign exchange exposure

A
  • Transaction exposure
  • Translation exposure
  • Operating exposure
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7
Q

Transaction exposure changes in expected cash flows resulting from _______ __________ _________

A

existing contractual obligations

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8
Q

the potential for accounting-derived changes in owner’s equity to occur because of the need to “translate” foreign currency financial statements of foreign subsidiaries into a single reporting currency to prepare worldwide consolidated financial statements.

A

Translation exposure

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9
Q

measures the change in the present value of the firm resulting from any change in future operating cash flows of the firm caused by an unexpected change in exchange rates.

A

Operating exposure

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10
Q

What is the similarities between transaction and operating exposure?

A

Both deal with unexpected changes in future cash flows

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11
Q

What is the difference between transaction exposure and operating exposure?

A

-transaction exposure is concerned with future cash flows already contracted for

-operating exposure focuses on expected (not yet contracted for) future cash flows

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12
Q

the taking of a position — an asset, a contract, or a derivative — that will rise (fall) in value and offset a fall (rise) in the value of an existing position

A

Hedging

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13
Q

Hedging can protect the owner of an asset from a ____;
however, it also eliminates any ____ from an increase in the value of the asset hedged.

A

loss; gain

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14
Q

Opponents of hedging:

A

Shareholders are much more capable of diversifying currency risk than the management of the firm

Currency risk management does not increase the expected cash flows of the firm

Management incentives

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14
Q

Proponents of Hedging

A
  • Reduction in risk in future cash flows improves the planning capability of the firm
  • Reduction of risk in future cash flows reduces the likelihood that the firm’s cash flows will fall below a necessary minimum (the point of financial distress)
  • Management has a comparative advantage over the individual shareholder in knowing the actual currency risk of the firm
  • Management is in better position to take advantage of disequilibrium conditions in the market with selective hedging.
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15
Q

measures gains or losses that arise from the settlement of existing financial obligations whose terms are stated in a foreign currency

A

Transaction exposure

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16
Q

Transaction exposure arise from a variety of business activities:

A
  • Purchasing or selling goods or services with settlement in foreign currencies
  • Borrowing and lending funds with repayment in a foreign currency
  • Other causes: Being a party to an unperformed forward contract
17
Q

Operating exposure is also called…

A
  • Economic exposure
  • Competitive exposure
  • Strategic exposure
18
Q

arise from intercompany (between unrelated companies) and intracompany (between units of the same company) receivables and payables, such as rent and lease payments, royalty and license fees and assorted management fees.

A

Operating cash flows

19
Q

payments for the use of intercompany and intracompany loans (principal and interest) and stockholder equity (new equity and dividends).

A

Financing cash flows

20
Q

Operating exposure is far more important for the ____ ___ health of a business than changes caused by transaction or translation exposure.

A

Long run

21
Q

What are the challenges of operating exposure?

A
  • Operating exposure is subjective - it depends on estimates of future cash flow changes over an arbitrary time horizon.
  • Planning for operating exposure depends on the interaction of strategies in finance, marketing, purchasing, and production.
22
Q

Only _________ changes in exchange rates, or an inefficient foreign exchange market, should cause market value to change.

A

unexpected

23
Q

The objective of both operating and transaction exposure management is

A

to anticipate and influence the effect of unexpected changes in exchange rates on a firm’s future cash flows

24
Q

adopt operating or financing policies that offset anticipated foreign exchange exposures.

A

Proactive management of operating exposure

25
Q

The most commonly employed proactive policies include:

A
  1. Matching currency cash flows
  2. Risk-sharing agreements
  3. Back-to-back or parallel loans
  4. Cross-currency swaps
  5. Contractual approaches
26
Q

The particular strategy of trying to offset stable inflows of cash from one country with outflows of cash in the same currency is known​ as:

A

Matching

27
Q

seek out potential suppliers in Canada as a substitute for sourcing from U.S. or other foreign firms.
Hedge an operational cash inflow with an operational cash outflow

A

Natural hedge

28
Q

pay foreign suppliers with Canadian dollars.

A

Currency switching

29
Q

This is a contractual arrangement in which the buyer and seller agree to “share” or split currency movement impacts on payments between them.

A

Risk-Sharing Agreements

30
Q

two business firms in separate countries arrange to borrow each other’s currency for a specific period.

A

Back-to-Back or Parallel Loans

31
Q

A firm and a swap dealer (or swap bank) agree to exchange an equivalent amount of two different currencies for a specified amount of time

A

Currency swap

32
Q

A currency swap resembles a back-to-back loan excepts that it does not appear on a firm’s ________ _____

A

Balance sheet

33
Q

When financial statements are consolidated into one currency, accounts…

A

do not balance

34
Q

What are the two methods of translation?

A
  • Current rate method
  • Temporal method
35
Q

all financial statement items are translated at the “current” exchange rate (the rate of exchange in effect on the balance sheet date)

A

Current Rate Method

36
Q

Under this method, specific assets and liabilities are translated at exchange rates consistent with the timing of the item’s creation

A

Temporal Method

37
Q

Under the temporal method, any gains or losses from remeasurement are carried directly to…

A

current consolidated income and not to equity reserves

38
Q

Under the current rate method, any gain or loss from re-measurement is closed to…

A

an equity reserve account entitled the cumulative translation adjustment, rather than through the company’s consolidated income statement

39
Q

The US differentiates foreign subsidiaries on the basis of functional currency, not subsidiary characterization
For the financial statements maintained in local currency:
If the functional currency is the Local currency
The US primarily uses the __________
If the functional currency is the US dollar
The US primarily uses the _____________

A

Current rate method; Temporal method

40
Q

this requires an equal amount of exposed foreign currency assets and liabilities on a firm’s consolidated balance sheet

A

Balance sheet hedge

41
Q

As a general matter, firms seeking to reduce both types of exposures typically go with ____________ ___________ first

A

Transaction exposure

FIN 436 (14 decks)

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