Unlock document.
This document is partially blurred.
Unlock all pages and 1 million more documents.
Get Access
Multinational Business Finance, 14e (Eiteman)
Chapter 10 Transaction Exposure
10.1 Types of Foreign Exchange Exposure
1) ________ exposure deals with cash flows that result from existing contractual obligations.
A) Operating
B) Transaction
C) Translation
D) Economic
2) ________ exposure measures the change in the present value of the firm resulting from
unexpected changes in exchange rates.
A) Operating
B) Transaction
C) Translation
D) Accounting
3) Each of the following is another name for operating exposure EXCEPT:
A) economic exposure.
B) strategic exposure.
C) accounting exposure.
D) competitive exposure.
4) Transaction exposure and operating exposure exist because of unexpected changes in future
cash flows. The difference between the two is that ________ exposure deals with cash flows
already contracted for, while ________ exposure deals with future cash flows that might change
because of changes in exchange rates.
A) transaction; operating
B) operating; transaction
C) operating; accounting
D) none of the above
5) ________ exposure is the potential for accounting-derived changes in owner's equity to occur
because of the need to translate foreign currency financial statements into a single reporting
currency.
A) Transaction
B) Operating
C) Economic
D) Accounting (aka translation)
6) Losses from ________ exposure generally reduce taxable income in the year they are realized.
________ exposure losses may reduce taxes over a series of years.
A) accounting; Operating
B) operating; Transaction
C) transaction; Operating
D) transaction; Accounting
7) Losses from ________ exposure generally reduce taxable income in the year they are realized.
________ exposure losses are not cash losses and therefore, are not tax deductible.
A) transaction; Operating
B) accounting; Operating
C) accounting; Transaction
D) transaction; Translation
8) MNE cash flows may be sensitive to changes in which of the following?
A) exchange rates
B) interest rates
C) commodity prices
D) all of the above
9) Assuming no transaction costs (i.e., hedging is "free"), hedging currency exposures should
________ the variability of expected cash flows to a firm and at the same time, the expected
value of the cash flows should ________.
A) increase; not change
B) decrease; not change
C) not change; increase
D) not change; not change
10) Which of the following is NOT cited as a good reason for hedging currency exposures?
A) Reduced risk of future cash flows is a good planning tool.
B) Reduced risk of future cash flows reduces the probability that the firm may not meet required
cash flows.
C) Currency risk management increases the expected cash flows to the firm.
D) Management is in a better position to assess firm currency risk than individual investors.
11) Which of the following is cited as a good reason for NOT hedging currency exposures?
A) Shareholders are more capable of diversifying risk than management.
B) Currency risk management through hedging does not increase expected cash flows.
C) Hedging activities are often of greater benefit to management than to shareholders.
D) All of the above are cited as reasons NOT to hedge.
12) The stages in the life of a transaction exposure can be broken into three distinct time periods.
The first time period is the time between quoting a price and reaching an actual sale agreement
or contract. The next time period is the time lag between taking an order and actually filling or
delivering it. Finally, the time it takes to get paid after delivering the product. In order, these
stages of transaction exposure may be identified as:
A) backlog, quotation, and billing exposure.
B) billing, backlog, and quotation exposure.
C) quotation, backlog, and billing exposure.
D) quotation, billing, and backlog exposure.
13) A U.S. firm sells merchandise today to a British company for £150,000. The current
exchange rate is $1.55/£ , the account is payable in three months, and the firm chooses to avoid
any hedging techniques designed to reduce or eliminate the risk of changes in the exchange rate.
The U.S. firm is at risk today of a loss if:
A) the exchange rate changes to $1.52/£.
B) the exchange rate changes to $1.58/£.
C) the exchange rate doesn't change.
D) all of the above
14) A U.S. firm sells merchandise today to a British company for £150,000. The current
exchange rate is $1.55/£ , the account is payable in three months, and the firm chooses to avoid
any hedging techniques designed to reduce or eliminate the risk of changes in the exchange rate.
If the exchange rate changes to $1.58/£ the U.S. firm will realize a ________ of ________.
A) loss; $4,500
B) gain; $4,500
C) loss; £4,500
D) gain; £4,500
15) A U.S. firm sells merchandise today to a British company for £150,000. The current
exchange rate is $1.55/£ , the account is payable in three months, and the firm chooses to avoid
any hedging techniques designed to reduce or eliminate the risk of changes in the exchange rate.
If the exchange rate changes to $1.52/£ the U.S. firm will realize a ________ of ________.
A) loss; $4,500
B) gain; $4,500
C) loss; £4,500
D) gain; £4,500
16) ________ is NOT a commonly used contractual hedge against foreign exchange transaction
exposure.
A) Forward market hedge
B) Money market hedge
C) Options market hedge
D) All of the above are contractual hedges.
17) A ________ hedge refers to an offsetting operating cash flow such as a payable arising from
the conduct of business.
A) financial
B) natural
C) contractual
D) futures
18) As a generalized rule, only realized foreign exchange losses are deductible for tax purposes.
19) Many MNE s manage foreign exchange exposure centrally, thus gains or losses are always
matched with the country of origin.
20) Hedging, or reducing risk, is the same as adding value or return to the firm.
21) There is considerable question among investors and managers about whether hedging is a
good and necessary tool.
22) The key arguments in opposition to currency hedging such as market efficiency, agency
theory, and diversification do not have financial theory at their core.
23) Management often conducts hedging activities that benefit management at the expense of the
shareholders. The field of finance called agency theory frequently argues that management is
generally LESS risk averse than are shareholders.
24) Managers CAN outguess the market. If and when markets are in equilibrium with respect to
parity conditions, the expected net present value of hedging should be POSITIVE.
25) Shareholders are LESS capable of diversifying currency risk than is the management of the
firm.
26) Hedging can be advantageous to shareholders because management is in a better position
than shareholders to recognize disequilibrium conditions and to take advantage of single
opportunities to enhance firm value through selective hedging.
8
27) TRANSACTION exposure measures gains or losses that arise from the settlement of existing
financial obligations whose terms are stated in a foreign currency.
28) Transaction exposure could arise when borrowing or lending funds when repayment is to be
made in the firm's domestic currency.
29) Does foreign currency exchange hedging both reduce risk and increase expected value?
Explain, and list several arguments in favor of currency risk management and several against.
Answer: Foreign exchange currency hedging can reduce the variability of foreign currency
receivables or payables by locking in a specific exchange rate in the future via a forward
10.2 Ganadoʹs Transaction Exposure
Instruction 10.1:
Use the information for the following problem(s).
Central Valley Transit Inc. (CVT) has just signed a contract to purchase light rail cars from a
manufacturer in Germany for euro 3,000,000. The purchase was made in June with payment due
six months later in December. Because this is a sizable contract for the firm and because the
contract is in euros rather than dollars, CVT is considering several hedging alternatives to reduce
the exchange rate risk arising from the sale. To help the firm make a hedging decision you have
gathered the following information.
∙ The spot exchange rate is $1.250/euro
∙ The six month forward rate is $1.22/euro
∙ CVT's cost of capital is 11%
∙ The Euro zone 6-month borrowing rate is 9% (or 4.5% for 6 months)
∙ The Euro zone 6-month lending rate is 7% (or 3.5% for 6 months)
∙ The U.S. 6-month borrowing rate is 8% (or 4% for 6 months)
∙ The U.S. 6-month lending rate is 6% (or 3% for 6 months)
∙ December call options for euro 750,000; strike price $1.28, premium price is 1.5%
∙ CVT's forecast for 6-month spot rates is $1.27/euro
∙ The budget rate, or the highest acceptable purchase price for this project, is $3,900,000 or
$1.30/euro
1) Refer to Instruction 10.1. If CVT chooses NOT to hedge their euro payable, the amount they
pay in six months will be:
A) $3,500,000.
B) $3,900,000.
C) €3,000,000.
D) unknown today
2) Refer to Instruction 10.1. If CVT chooses to hedge its transaction exposure in the forward
market, it will ________ euro 3,000,000 forward at a rate of ________.
A) buy; $1.22
B) buy; $1.25
C) sell; $1.22
D) sell; €1.25
