Topic 6 Exposure Types and Hedging strategies Flashcards
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
b)
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
b)
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
d)
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
d)
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.
a)
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
d)
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
d)
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
d)
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
c)
It is generally least difficult to effectively hedge various types of:
a. translation exposure.
b. transaction exposure.
c. economic exposure.
d. A and C
b)
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.
d)
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.
a)
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$236,127.
3C
SOLUTION: SF600,000 x A$.40 = A$240,000
Assume the following information:
Australian deposit rate for 1 year = 11%
Australian borrowing rate for 1 year = 12%
New Zealand deposit rate for 1 year = 8%
New Zealand borrowing rate for 1 year = 10%
New Zealand dollar forward rate for 1 year = A$.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.
- Borrow NZ$545,455 (NZ$600,000/1.1) = NZ$545,455.
- Convert NZ$545,455 to $212,727 (at A$.39 per NZ$).
- Invest A$212,727 to accumulate A$236,127 (A$212,727 1.11) = A$236,127
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
a)
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
d)
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
d)
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.
d)
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.
a)
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.
b)
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?
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
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?
Cost in $ = payables x forward rate
=A$100.000 x $0.7500 = $75,000USD
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.
b)
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.
b)