M6 Financial Risk Management: Part 2

Question 1

Defined as the potential that an organization could suffer economic loss or experience economic gain upon settlement of individual transactions as a result of changes in the exchange rates

Answer 1

Transaction exposure

Question 2

Defined as the potential that the PV or an organization’s cash flows could increase or decrease as a result of changes in the exchange rates

Answer 2

Economic exposure

Question 3

The risk that assets, liabilities, equity or income of a consolidated organization that includes foreign subs will change as a result of changes in the exchange rates

Answer 3

Translation Exposure (Foreign subs)

Question 4

A financial risk management technique in which an organization, seeking to mitigate the risk of fluctuations in value, acquires a financial instrument that behaves in the opposite manner from the item

Answer 4

Hedging (forward, futures, options, swaps)

Question 5

entitles its holder to either purchase or sell a particular number of currency units of an identified currency for a negotiated price on a state date; denominated in standard amounts and tend to be used for SMALLER transactions

Answer 5

Futures hedge

AP application: Buy calls or future contracts because if FC goes up, you want to use the profit on the derivative to offset the loss

AR application: Buy put options, sell futures contracts because if FC goes down, use the profit to offset the loss

Question 6

similar to a futures hedge; but are private and contracts between businesses and commercial banks and normally for larger transactions

Answer 6

Forward Hedge

Private OTC
Customized

AP application: Buy calls or future/forward contracts because if FC goes up, you want to use the profit on the derivative to offset the loss

AR application: Buy put options, sell futures/forward contracts because if FC goes down, use the profit to offset the loss

Question 7

Uses international markets to plan to meet future currency requirements; uses domestic currency to purchase a foreign currency at current spot rates and invest them in securities timed to mature at the same time as related payables

Answer 7

Money market hedge

Question 8

similar principles to forward and money market hedges however instead of requiring a commitment to a transaction, this hedge give the business the option of executing the option OR settling its originally negotiated transaction without the benefit of the hedge (more favorable option)

Answer 8

Currency option hedge

AP application: Exercise only if the price > strike

AR application: Exercise only if the price < strike

Question 9

alternative hedging technique that represent transactions between subsidiaries or a subsidiary and a parent; the entity that is owed may bill in advance if the exchange rate warrants or possibly waiting until the exchange rate is favorable before settlings

Answer 9

leading and lagging

Question 10

alternative hedging technique that involves hedging one instrument’s risk with a different instrument by taking a position in a related derivatives contracts

Answer 10

Cross-hedging

Question 11

alternative hedging technique the is the simplest hedge that involves diversifying foreign currency holdings over time

Answer 11

Currency diversification