Financial Risk Management: Part 2

Question 1

Freely fluctuating exchange rates perform which function?

Answer 1

They automatically correct a lack of equilibrium in the balance of payments

Question 2

The balance of payments has two major components. What are they and what do they do to each other?

Answer 2

1. Current account (imports and exports) and Capital account (investments in this country and foreign countries)
2. These accounts generally offset each other

Question 3

Which external factor would increase the risk of a highly leveraged audit client that has closely monitored profit expectations and imports most of its resale inventory from Europe?

Answer 3

An increase in the prime interest rate

Question 4

A highly leveraged client implies what?

Answer 4

That the client is heavily utilizing debt in the capital structure

Question 5

What are prime interest rates?

Answer 5

Rates that banks charge their most creditworthy customers

Question 6

If prime interest rates rise, how will it affect debt and interest?

Answer 6

Debt becomes more more expensive, more debt means higher interest costs which will affect the bottom line

Question 7

What is the cross rate in foreign currency?

Answer 7

It’s the exchange rate between two currencies derived by using two exchange rate quotes that have a common currency

Question 8

One euro will buy U.S. $1.48, and a British pound will buy U.S. $2.06. What is the cross rate of euros per pound?

Answer 8

2.06 / 1.48 = 1.39 euros per pound

Question 9

How does an appreciation of domestic currency affect imports and exports?

Answer 9

Imports become less expensive, which increases inflows.
Exports become more expensive to purchasers overseas, which decreases outflows