Topic 6 Exposure Types and Hedging strategies

Question 1

Depreciation of the euro relative to the Australian dollar will cause a Australian-based multinational
company’s reported earnings (from the consolidated income statement) to ____. If a company desired
to protect against this possibility, it could stabilize its reported earnings by ____ euros forward in the
foreign exchange market.
a. be reduced; purchasing
b. be reduced; selling
c. increase; selling
d. increase; purchasing

Answer 1

b)

Question 2

Springfield Co., based in Australia, has a cost from orders of foreign material that exceeds its foreign
revenue. All foreign transactions are denominated in the foreign currency of concern. This company
would ____ a stronger Australian dollar and would ____ a weaker Australian dollar.
a. benefit from; be unaffected by
b. benefit from; be adversely affected by
c. be unaffected by; be adversely affected by
d. be unaffected by; benefit from
e. benefit from; benefit from

Answer 2

b)

Question 3

Whitewater Co. is an Australian company with sales to Canada amounting to C$8 million. Its cost of
materials attributable to the purchase of Canadian goods is C$6 million. Its interest expense on
Canadian loans is C$4 million. Given these exact figures above, the Australian dollar value of
Whitewater’s “earnings before interest and taxes” would ____ if the Canadian dollar appreciates; the
Australian dollar value of Whitewater’s cash flows would ____ if the Canadian dollar appreciates.
a. increase; increase
b. decrease; increase
c. decrease; decrease
d. increase; decrease
e. increase; be unaffected

Answer 3

d)

Question 4

Sycamore (an Australian company) has no subsidiaries and presently has sales to Mexican customers
amounting to MXP98 million, while its peso-denominated expenses amount to MXP41 million. If it
shifts its material orders from its Mexican suppliers to Australian suppliers, it could reduce pesodenominated expenses by MXP12 million and increase dollar-denominated expenses by A$800,000.
This strategy would ____ the Sycamore’s exposure to changes in the peso’s movements against the
Australian dollar. Regardless of whether the company shifts expenses, it is likely to perform better
when the peso is valued ____ relative to the Australian dollar.
a. reduce; high
b. reduce; low
c. increase; low
d. increase; high

Answer 4

d)

Question 5

Which of the following is an example of economic exposure but not an example of transaction
exposure?
a. An increase in the Australian dollar’s value hurts an Australian company’s domestic sales
because foreign competitors are able to increase their sales to Australian customers.
b. An increase in the pound’s value increases the Australian company’s cost of British pound
payables.
c. A decrease in the peso’s value decreases an Australian company’s Australian dollar value
of peso receivables.
d. A decrease in the Swiss franc’s value decreases the Australian dollar value of interest
payments on a Swiss deposit sent to an Australian company by a Swiss bank.

Answer 5

a)

Question 6

Rockford Co. is an Australian manufacturing company that produces goods in Australia and sells all
products to retail stores in the U.K.; the goods are denominated in pounds. It finances a small portion
of its business with pound-denominated loans from British banks. Which of the following is true?
(Assume that the amount of products to be sold is guaranteed by contracts.)
a. The Australian dollar value of sales is higher if the pound depreciates against the
Australian dollar.
b. The Australian dollar value of sales is unaffected by the pound’s exchange rate.
c. A and B
d. None of the above

Answer 6

d)

Question 7

If an Australian company’s expenses are more susceptible to exchange rate movements than revenue,
the company will ____ if the Australian dollar ____.
a. benefit; weakens
b. be unaffected; weakens
c. be unaffected; strengthens
d. benefit; strengthens

Answer 7

d)

Question 8

Laketown Co. has some expenses and revenue in euros. If its expenses are more sensitive to exchange
rate movements than revenue, it could reduce economic exposure by ____. If its revenues are more
sensitive than expenses, it could reduce economic exposure by ____.
a. decreasing foreign revenues; decreasing foreign expenses
b. decreasing foreign revenues; increasing foreign expenses
c. increasing foreign revenues; decreasing foreign revenues
d. decreasing foreign expenses; increasing foreign revenues

Answer 8

d)

Question 9

Any restructuring of operations that ____ the difference between a foreign currency’s inflows and
outflows may ____ economic exposure.
a. reduces; increase
b. increases; reduce
c. reduces; reduce
d. A and B
e. none of the above

Answer 9

c)

Question 10

It is generally least difficult to effectively hedge various types of:
a. translation exposure.
b. transaction exposure.
c. economic exposure.
d. A and C

Answer 10

b)

Question 11

Assume zero transaction costs. If the 90-day forward rate of the euro is an accurate estimate of the spot
rate 90 days from now, then the real cost of hedging payables will be:
a. positive.
b. negative.
c. positive if the forward rate exhibits a premium, and negative if the forward rate exhibits a
discount.
d. zero.

Answer 11

d)

Question 12

Assume zero transaction costs. If the 180-day forward rate overestimates the spot rate 180 days from
now, then the real cost of hedging payables will be:
a. positive.
b. negative.
c. positive if the forward rate exhibits a premium, and negative if the forward rate exhibits a
discount.
d. zero.

Answer 12

a)

Question 13

Assume the following information:
Australian deposit rate for 1 year = 11%
Australian borrowing rate for 1 year = 12%
Swiss deposit rate for 1 year = 8%
Swiss borrowing rate for 1 year = 10%
Swiss forward rate for 1 year = A$.40
Swiss franc spot rate = A$.39
Also assume that an Australian exporter denominates its Swiss exports in Swiss francs and expects to
receive SF600,000 in 1 year.
Using the information above, what will be the approximate value of these exports in 1 year in
Australian dollars given that the company executes a forward hedge?
a. A$234,000.
b. A$238,584.
c. A$240,000.
d. A$236,127.

Answer 13

3C
SOLUTION: SF600,000 x A$.40 = A$240,000

Question 14

Assume the following information:
Australian deposit rate for 1 year = 11%
Australian borrowing rate for 1 year = 12%
New Zealand deposit rate for 1 year = 8%
New Zealand borrowing rate for 1 year = 10%
New Zealand dollar forward rate for 1 year = A$.40
New Zealand dollar spot rate = A$.39

Also assume that an Australian exporter denominates its New Zealand exports in NZ$ and expects to
receive NZ$600,000 in 1 year. You are a consultant for this company.
Using the information above, what will be the approximate value of these exports in 1 year in
Australian dollars given that the company executes a money market hedge?
a. A$238,584.
b. A$240,000.
c. A$234,000.
d. A$236,127.

Answer 14

1. Borrow NZ$545,455 (NZ$600,000/1.1) = NZ$545,455.
2. Convert NZ$545,455 to $212,727 (at A$.39 per NZ$).
3. Invest A$212,727 to accumulate A$236,127 (A$212,727  1.11) = A$236,127

Question 15

An example of cross-hedging is:
a. find two currencies that are highly positively correlated; match the payables of the one
currency to the receivables of the other currency.
b. use the forward market to sell forward whatever currencies you will receive.
c. use the forward market to buy forward whatever currencies you will receive.
d. B and C

Answer 15

a)

Question 16

Which of the following reflects a hedge of net receivables in British pounds by an Australian
company?
a. purchase a currency put option in British pounds.
b. sell pounds forward.
c. borrow Australian dollars, convert them to pounds, and invest them in a British pound
deposit.
d. A and B

Answer 16

d)

Question 17

Which of the following reflects a hedge of net payables on British pounds by a Australian company?
a. purchase a currency put option in British pounds.
b. sell pounds forward.
c. sell a currency call option in British pounds.
d. borrow Australian dollars, convert them to pounds, and invest them in a British pound
deposit.
e. A and B

Answer 17

d)

Question 18

If Lazer Co. desired to lock in the maximum it would have to pay for its net payables in euros but
wanted to be able to capitalize if the euro depreciates substantially against the Australian dollar by the
time payment is to be made, the most appropriate hedge would be:
a. a money market hedge.
b. purchasing euro put options.
c. a forward purchase of euros.
d. purchasing euro call options.
e. selling euro call options.

Answer 18

d)

Question 19

If Salerno Inc. desired to lock in a minimum rate at which it could sell its net receivables in Japanese
yen but wanted to be able to capitalize if the yen appreciates substantially against the dollar by the
time payment arrives, the most appropriate hedge would be:
a. a money market hedge.
b. a forward sale of yen.
c. purchasing yen call options.
d. purchasing yen put options.
e. selling yen put options.

Answer 19

a)

Question 20

The real cost of hedging payables with a forward contract equals:
a. the nominal cost of hedging minus the nominal cost of not hedging.
b. the nominal cost of not hedging minus the nominal cost of hedging.
c. the nominal cost of hedging divided by the nominal cost of not hedging.
d. the nominal cost of not hedging divided by the nominal cost of hedging.

Answer 20

b)

Question 21

Assume that Suffolk Co. negotiated a forward contract to purchase 200,000 British pounds in 90 days. The 90 day forward rate was $1.40 per British pound. The pounds to be purchased were to be used to purchase British supplies. On the day the pounds were delivered in accordance with the forward contract, the spot rate of the Real Cost of Hedging Payables. Assume that Suffolk Co. negotiated a forward contract to purchase 200,000 British pounds in 90 days. The 90 day forward rate was $1.40 per British pound. The pounds to be purchased were to be used to purchase British supplies. On the day the pounds were delivered in accordance with the forward contract, the spot rate of the British pound was $1.44. What was the real cost of hedging the payables for this U.S. firm? What was the real cost of hedging the payables for this U.S. firm if the spot rate of the British pound was $1.34?

Answer 21

To determine the real cost of hedging payables for Suffolk Co, we need to compare the cost of the forward contract with the cost if the company had not hedged and used the spot rate instead.

When the spot rate is $1.44:
Forward contract cost: 200,000 pounds * $1.40 = $280,000
Spot rate cost: 200,000 pounds * $1.44 = $288,000
Real cost of hedging: $280,000 (forward contract) - $288,000 (spot rate) = -$8,000
Suffolk Co. saved $8,000 by using the forward contract.
When the spot rate is $1.34:
Forward contract cost: 200,000 pounds * $1.40 = $280,000
Spot rate cost: 200,000 pounds * $1.34 = $268,000
Real cost of hedging: $280,000 (forward contract) - $268,000 (spot rate) = $12,000
Suffolk Co. incurred an additional cost of $12,000 by using the forward contract.
In summary, the real cost of hedging payables for Suffolk Co. was a savings of $8,000 when the spot rate was $1.44, and an additional cost of $12,000 when the spot rate was $1.34

Question 22

Coleman Co. is a us based MNC that will need 100K AUD in one year. It could obtain a forward contract to purchase one year from now The one year forward rate is 0.75c. If it purchases AUD one year forward, its US dollar cost in one year is?

Answer 22

Cost in $ = payables x forward rate
=A$100.000 x $0.7500 = $75,000USD

Question 23

Which of the following forecasting techniques would best represent the use of today’s forward
exchange rate to forecast the future exchange rate?
a. fundamental forecasting.
b. market-based forecasting.
c. technical forecasting.
d. mixed forecasting.

Answer 23

b)

Question 24

Which of the following forecasting techniques would best represent sole use of today’s spot exchange
rate of the euro to forecast the euro’s future exchange rate?
a. fundamental forecasting.
b. market-based forecasting.
c. technical forecasting.
d. mixed forecasting.

Answer 24

b)

Question 25

Which of the following forecasting techniques would best represent the use of relationships between
economic factors and exchange rate movements to forecast the future exchange rate?
a. fundamental forecasting.
b. market-based forecasting.
c. technical forecasting.
d. mixed forecasting.

Answer 25

a)

Question 26

Which of the following forecasting techniques would best represent the sole use of the pattern of
historical currency values of the euro to predict the euro’s future currency value?
a. fundamental forecasting.
b. market-based forecasting.
c. technical forecasting.
d. mixed forecasting.

Answer 26

c)

Question 27

According to the text, the analysis of currencies forecasted with use of the forward rate suggests that:
a. currencies exhibited about the same mean forecast errors as a percent of the realized value.
b. the Canadian dollar can be forecasted by U.S. companies with greater accuracy than other
currencies.
c. the Swiss franc can be forecasted by U.S. companies with greater accuracy than other
currencies.
d. none of the above

Answer 27

b)

Question 27

If a particular currency is consistently declining substantially over time, then a market-based forecast
will usually have:
a. underestimated the future exchange rates over time.
b. overestimated the future exchange rates over time.
c. forecasted future exchange rates accurately.
d. forecasted future exchange rates inaccurately but without any bias toward consistent
underestimating or overestimating.

Answer 27

b)

Question 28

Assume the following information:
Predicted Value of Realized Value of
Period New Zealand Dollar New Zealand Dollar
1 A$.52 A$.50
2 A$.54 A$.60
3 A$.44 A$.40
4 A$.51 A$.50
Given this information, the mean absolute forecast error as a percentage of the realized value is about:
a. 1.5%.
b. 26%.
c. 6%.
d. 6.5%.
e. none of the above

Answer 28

[|A$.52 − A$.50|/A$.50 + |A$.54 − A$.60|/A$.60 + |A$.44 − A$.40|/A$.40 +
|A$.51 − A$.50|/A$.50)]/4
= [.04 + .10 + .10 + .02]/4
= .065 = 6.50%

d)

Question 29

If it was determined that the movement of exchange rates was not related to previous exchange rate
values, this implies that a ____ is not valuable for speculating on expected exchange rate movements.
a. technical forecast technique
b. fundamental forecast technique
c. all of the above
d. none of the above

Answer 29

a)

Question 30

Which of the following is true?
a. Forecast errors cannot be negative.
b. Forecast errors are negative when the forecasted rate exceeds the realized rate.
c. Absolute forecast errors are negative when the forecasted rate exceeds the realized rate.
d. None of the above.

Answer 30

d)

Question 31

Which of the following is true according to the text?
a. Forecasts in recent years have been very accurate.
b. Use of the absolute forecast error as a percent of the realized value is a good measure to
use in detecting a forecast bias.
c. Forecasting errors are smaller when focused on longer term periods.
d. None of the above.

Answer 31

d)

Question 32

Kalons, Inc. is an Australian-based MNC that frequently imports raw materials from Canada. Kalons
is typically invoiced for these goods in Canadian dollars and is concerned that the Canadian
dollar will appreciate in the near future. Which of the following is not an appropriate hedging
technique under these circumstances?
a. purchase Canadian dollars forward.
b. purchase Canadian dollar futures contracts.
c. purchase Canadian dollar put options.
d. purchase Canadian dollar call options.

Answer 32

c)

Question 33

AME, Inc., based in Perth Western Australia, exports products to a German firm and will receive
payment of €200,000 in three months. On June 1, the spot rate of the euro was A$1.12, and the 3-
month forward rate was A$1.10. On June 1, AME negotiated a forward contract with a bank to sell
€200,000 forward in three months. The spot rate of the euro on September 1 is A$1.15. AME will
receive A$____ for the euros.
a. 224,000
b. 220,000
c. 200,000
d. 230,000

Answer 33

b) €200,000  A$1.10 = A$220,000

Question 34

The one-year forward rate of the British pound is quoted at A$1.60, and the spot rate of the British
pound is quoted at A$1.63. The forward ____ is ____ percent.
a. discount; 1.9
b. discount; 1.8
c. premium; 1.9
d. premium; 1.8

Answer 34

b)
(F/S) − 1 = (A$1.60/A$1.63) − 1 = −1.8 percent

Question 35

The 90-day forward rate for the euro is A$1.07, while the current spot rate of the euro is A$1.05.
What is the annualized forward premium or discount of the euro?
a. 1.9 percent discount.
b. 1.9 percent premium.
c. 7.6 percent premium.
d. 7.6 percent discount.

Answer 35

c) [(F/S) − 1] x 360/90 = 7.6 percent.

Question 36

Thornton, Inc. an Australian company needs to invest five million Nepalese rupees in its Nepalese
subsidiary to support local operations. Thornton would like its subsidiary to repay the rupees in one
year. Thornton would like to engage in a swap transaction. Thus, Thornton would:
a. convert the rupees to Australian dollars in the spot market today and convert rupees to
Australian dollars in one year at today’s forward rate.
b. convert the Australian dollars to rupees in the spot market today and convert dollars to
rupees in one year at the prevailing spot rate.
c. convert the Australian dollars to rupees in the spot market today and convert rupees to
Australian dollars in one year at today’s forward rate.
d. convert the Australian dollars to rupees in the spot market today and convert rupees to
Australian dollars in one year at the prevailing spot rate.

Answer 36

c)

Question 37

In the U.S., the typical currency futures contract is based on a currency value in terms of:
a. euros.
b. U.S. dollars.
c. British pounds.
d. Canadian dollars

Answer 37

b)

Question 38

Currency futures contracts sold on an exchange:
a. contain a commitment to the owner, and are standardized.
b. contain a commitment to the owner, and can be tailored to the desire of the owner.
c. contain a right but not a commitment to the owner, and can be tailored to the desire of the
owner.
d. contain a right but not a commitment to the owner, and are standardized.

Answer 38

a)

Question 39

Currency options sold through an options exchange:
a. contain a commitment to the owner, and are standardized.
b. contain a commitment to the owner, and can be tailored to the desire of the owner.
c. contain a right but not a commitment to the owner, and can be tailored to the desire of the
owner.
d. contain a right but not a commitment to the owner, and are standardized.

Answer 39

d)

Question 40

Currency options are commonly traded through the ____ system.
a. robot
b. Euro
c. GLOBEX
d. Scope

Answer 40

c)

Question 41

Forward contracts:
a. contain a commitment to the owner, and are standardized.
b. contain a commitment to the owner, and can be tailored to the desire of the owner.
c. contain a right but not a commitment to the owner, and can be tailored to the desire of the
owner.
d. contain a right but not a commitment to the owner, and are standardized.

Answer 41

b)