3) Refer to Instruction 10.1. CVT chooses to hedge its transaction exposure in the forward
market at the available forward rate. The required amount in dollars to pay off the accounts
payable in 6 months will be:
A) $3,000,000.
B) $3,660,000.
C) $3,750,000.
D) $3,810,000.
4) Refer to Instruction 10.1. If CVT locks in the forward hedge at $1.22/euro, and the spot rate
when the transaction was recorded on the books was $1.25/euro, this will result in a “foreign
exchange accounting transaction ________ of ________.
A) loss; $90,000.
B) loss; €90,000.
C) gain; $90,000.
D) gain; €90,000.
5) Refer to Instruction 10.1. CVT would be ________ by an amount equal to ________ with a
forward hedge than if they had NOT hedged and their predicted exchange rate for 6 months had
been correct.
A) better off; $150,000
B) better off; €150,000
C) worse off; $150,000
D) worse off; €150,000
6) Refer to Instruction 10.1. What is the cost of a call option hedge for CVT’s euro receivable
contract? (Note: Calculate the cost in future value dollars and assume the firm’s cost of capital as
the appropriate interest rate for calculating future values.)
A) $57,600
B) $59,904
C) $62,208
D) $63,936
7) Refer to Instruction 10.1. The cost of a put option to CVT would be:
A) $52,500.
B) $55,388.
C) $58,275.
D) There is not enough information to answer this question.
8) When attempting to manage an account payable denominated in a foreign currency, the firm’s
only choice is to remain unhedged.
9) Remaining unhedged is NOT an option when dealing with foreign exchange transaction
exposure.
10) A forward hedge involves a put or call option contract and a source of funds to fulfill that
contract.
11) Like a forward market hedge, a money market hedge also involves a contract and a source of
funds to fulfill that contract. In this instance, the contract is a loan agreement.
12) Hedging transaction exposure with option contracts allows the firm to benefit if exchange
rates are favorable but protects the firm if exchange rates turn unfavorable.
13) A firm’s risk tolerance is a combination of management’s philosophy toward transaction
exposure and the specific goals of treasury activities.
14) The structure of a money market hedge is similar to a forward hedge. The difference is the
cost of the money market hedge is determined by the differential interest rates, while the forward
hedge is a function of the forward rates quotation.
15) In efficient markets, interest rate parity should assure that the costs of a forward hedge and
money market hedge should be approximately the same.
16) Currency risk management techniques include forward hedges, money market hedges, and
option hedges. Draw a diagram showing the possible outcomes of these hedging alternatives for
a foreign currency receivable contract. In your diagram, be sure to label the X and Y-axis, the put
option strike price, and show the possible results for a money market hedge, a forward hedge, a
put option hedge, and an uncovered position. (Note: Assume the forward currency receivable is
British pounds and the put option strike price is $1.50/£, the price of the option is $0.04 the
forward rate is $1.52/£ and the current spot rate is $1.48/£.)
1) ________ are transactions for which there are, at present, no contracts or agreements between
parties.
A) Backlog exposure
B) Quotation exposure
C) Anticipated exposure
D) none of the above
2) According to a survey by Bank of America, the type of foreign exchange risk most often
hedged by firms is:
A) translation exposure.
B) transaction exposure.
C) contingent exposure.
D) economic exposure.
3) The treasury function of most firms, the group typically responsible for transaction exposure
management, is NOT usually considered a profit center.
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4) According to the authors, firms that employ proportional hedges increase the percentage of
forward-cover as the maturity of the exposure lengthens.
5) Although rarely acknowledged by the firms themselves, selective hedging is essentially
speculation.
6) There are as many different approaches to foreign exchange transaction exposure management
as there are firms and no real consensus exists regarding the best approach. List and discuss three
different exposures you can hedge and three different types of hedges (for example option
hedges versus non-option hedges).
Answer: Foreign exchange exposure is a measure of the potential for a firm’s profitability, net
7) Many MNEs have established rigid transaction exposure risk management policies which
mandate proportional hedging (a percentage of existing transaction exposures). Explain the pros
and cons of proportional hedging.
Answer: First of all, hedging is expensive. These policies generally require the use of forward
10.4 Advanced Topics in Hedging
1) When there is a full forward cover with the spot rate equal to the forward rate all of the
following are true EXCEPT:
A) The hedge is asymmetric.
B) There is no uncovered exposure remaining.
C) The total position is a perfect hedge.
D) The currency hedge ratio is equal to 1.
2) The objective of currency hedging is to eliminate the change in the value of the exposed asset
or cash flow from a change in exchange rates.
3) Hedging is accomplished by combining the exposed asset with a hedge asset to create a two
asset portfolio in which the two assets react in relatively equal directions to an exchange rate
change.
4) With the use of forwards, a perfect hedge is possible.
5) With a perfect hedge, there is no uncovered exposure remaining.
6) A hedge constructed using puts foreign currency options would be symmetric.
7) The commonly used 100% forward contract cover is a symmetric hedge.
8) The effectiveness of a hedge is determined to what degree the change in spot asset’s value is
correlated with the equal change in the hedge asset’s value to a change in the underlying spot
exchange rate.
9) The hedge ratio, β, is an individual exposure’s nominal amount covered by a financial
instrument such as a forward contract or currency option.
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10) A hedge constructed using a put foreign currency option would protect you against value
losses, but allow, at the same time, the possibly reap value increases in the event the exchange
rate moved in your favor.
11) The various hedging alternatives explored (the forward, money market, and purchase option
hedges) only work to protect the value of the exposed asset at the time of maturity.
12) There are as many different approaches to exposure management as there are firms and no
real consensus exists regarding the best approach. Discuss the following theoretical dimensions
to currency hedging: optimal hedge ratio, hedge symmetry, hedge effectiveness and hedge
timing.
Answer: The objective of currency hedging is to minimize the change in the value of the
exposed asset or cash flow from a change in exchange rates. Hedging is accomplished by