Chapter 12: Managing Economic Exposure and Translation Exposure
1. Depreciation of the euro relative to the U.S. dollar will cause a U.S.-based MNC’s reported earnings (from the
consolidated income statement) to ____. If a firm 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
2. Springfield Co., based in the United States, has costs from orders of foreign material that exceed its foreign revenue.
All foreign transactions are denominated in the foreign currency of concern. This firm would ____ a stronger dollar and
would ____ a weaker dollar.
a.
b.
c.
d.
e.
3. Whitewater Co. is a U.S. 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. Based on these
exact figures, the dollar value of Whitewater’s “earnings before interest and taxes” would ____ if the Canadian dollar
appreciates; the 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
4. Sycamore (a U.S. firm) 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 U.S. suppliers, it could reduce peso-denominated expenses by MXP12 million and increase dollar-denominated
expenses by $800,000. This strategy would ____ Sycamore’s exposure to changes in the peso’s movements against the
U.S. dollar. Regardless of whether the firm shifts expenses, it is likely to perform better when the peso is valued ____
relative to the dollar.
a.
reduce; high
b.
reduce; low
c.
increase; low
d.
increase; high
5. Which of the following is an example of economic exposure but not an example of transaction exposure?
a.
An increase in the dollar’s value hurts a U.S. firm’s domestic sales because foreign competitors are able to
increase their sales to U.S. customers.
b.
An increase in the pound’s value increases a U.S. firm‘s cost of British pound payables.
c.
A decrease in the peso’s value decreases a U.S. firm’s dollar value of peso receivables.
d.
A decrease in the Swiss franc’s value decreases the dollar value of interest payments on a Swiss deposit sent to
a U.S. firm by a Swiss bank.
6. Rockford Co. is a U.S. manufacturing firm that produces products in the United States and sells all the products to retail
stores in the United Kingdom; the sales 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 dollar value of sales is higher if the pound depreciates against the dollar.
b.
The dollar value of sales is unaffected by the pound’s exchange rate.
c.
A and B
d.
None of the above
7. If a U.S. firm’s expenses are more susceptible to exchange rate movements than its revenue is, the firm will ____ if the
dollar ____.
a.
benefit; weakens
b.
be unaffected; weakens
c.
be unaffected; strengthens
d.
benefit; strengthens
8. Laketown Co. has some expenses and revenue in euros. If its expenses are more sensitive to exchange rate movements
than its revenue is, it could reduce economic exposure by ____. If its revenues are more sensitive than its 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
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
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
11. With regard to hedging translation exposure, translation losses ____, and gains on forward contracts used to hedge
translation exposure ____.
a.
are not tax deductible; are taxed
b.
are tax deductible; are taxed
c.
are not tax deductible; are not taxed
d.
are tax deductible; are not taxed
12. If a firm does not have foreign subsidiaries, it is not subject to ____.
a.
transaction exposure
b.
economic exposure
c.
A and B
d.
translation exposure
13. If the Singapore dollar appreciates against the U.S. dollar over this year, the consolidated earnings of a U.S. company
Chapter 12: Managing Economic Exposure and Translation Exposure
with a subsidiary in Singapore will be ____ as a result of the exchange rate movement.
a.
negative
b.
adversely affected
c.
favorably affected
d.
unaffected
14. Assume a U.S. firm uses a forward contract to hedge all of its translation exposure. Also assume that the firm
underestimated what its foreign earnings would be. Assume that the foreign currency depreciated over the year. The firm
would generate a translation ____, which would be ____ than the gain generated by the forward contract.
a.
loss; smaller
b.
loss; larger
c.
gain; larger
d.
gain; smaller
15. A perfect hedge (full coverage) on translation exposure can usually be achieved when:
a.
using a money market hedge.
b.
using a forward hedge.
c.
using a futures hedge.
d.
none of the above, since a perfect hedge is nearly impossible.
16. Assume that a Japanese car manufacturer exports cars that are priced in yen to U.S. dealerships. The demand for those
cars declines when the yen is strong. The manufacturer also produces some cars in the United States with U.S. materials,
and those cars are priced in dollars. The manufacturer could reduce its economic exposure by:
a.
closing down most of its plants in the United States.
Chapter 12: Managing Economic Exposure and Translation Exposure
b.
producing more automobiles in the United States.
c.
relying completely on Japanese suppliers for its parts.
d.
pricing its exports in dollars.
17. Wisconsin, Inc. conducts business in Zambia. Years ago, Wisconsin established a subsidiary in Zambia that has
consistently generated very large profits denominated in Zambian kwacha. Wisconsin wishes to restructure its operations
to reduce economic exposure. Which of the following is not a feasible way of accomplishing this?
a.
increase Zambian supply orders
b.
increase Zambian sales
c.
restructure debt to increase debt payments in Zambia
d.
reduce Zambian sales
18. Which of the following firms is not exposed to translation exposure?
a.
Firm X, with a fully owned subsidiary that periodically remits earnings generated in Great Britain to the U.S.-
based parent.
b.
Firm Y, with a fully owned subsidiary that periodically generates foreign losses in Sweden. The parent covers
at least some of these losses.
c.
Firm Z, with a fully owned subsidiary that generates substantial earnings in Germany. The subsidiary never
remits earnings but reinvests them in Germany.
d.
All of the above firms are exposed to translation exposure.
19. ____ represents any impact of exchange rate fluctuations on a firm’s future cash flows.
a.
Translation exposure
b.
Economic exposure
Chapter 12: Managing Economic Exposure and Translation Exposure
c.
Transaction exposure
d.
None of the above
20. An effective way for an MNC to assess its economic exposure is to review the firm’s:
a.
income statement
b.
liquidity
c.
retained earnings
d.
level of stockholders’ equity
21. If revenues and costs are equally sensitive to exchange rate movements, MNCs may reduce their economic exposure
by restructuring their operations to shift the sources of costs or revenues to other locations so that:
a.
cash inflows exceed cash outflows in each foreign currency.
b.
cash outflows exceed cash inflows in each foreign currency.
c.
cash inflows match cash outflows in each foreign currency.
d.
none of the above
22. Managing economic exposure is generally perceived to be ____ managing transaction exposure.
a.
more difficult than
b.
less difficult than
c.
just as difficult as
d.
none of the above
23. As opposed to transaction exposure, managing economic exposure involves developing a(n) ____ solution.
a.
short-term
b.
long-term
c.
immediate
d.
none of the above
24. Cierra, Inc. is attempting to assess its degree of economic exposure in euros. In order to do so, it has applied
regression analysis to determine whether the percentage change in its total cash flows is related to the percentage change
in the euro. A ____ and statistically significant slope coefficient resulting from this analysis implies that the cash flows
are ____ related to the percentage changes in the euro.
a.
positive; positively
b.
positive; negatively
c.
negative; positively
d.
B and C
e.
none of the above
25. Assume that an MNC’s cash flows are positively related to the movements in a foreign currency. If the MNC expects
the foreign currency to weaken, it could purchase the currency forward to reduce its degree of economic exposure.
a.
True
b.
False
26. An MNC is attempting to reduce its economic exposure by financing a portion of its business with loans in the foreign
currency. If the foreign currency weakens, the MNC will need ____ of the foreign currency to cover the loan payment,
while the MNC’s foreign currency revenues will convert to ____ dollars.
a.
more; fewer
b.
more; more
c.
less; fewer
d.
less; more
27. An MNC has fixed assets in Europe that it expects to sell in the distant future. In order to hedge the sale of these assets
in the distant future, the MNC could create a(n) ____ that ____ the expected value of the assets in the future.
a.
asset; matches
b.
asset; exceeds
c.
liability; matches
d.
liability; is less than
28. Long-term forward contracts are a possible way to hedge the distant sale of fixed assets in foreign countries, but they
may not be available for many emerging market currencies.
a.
True
b.
False
29. ____ exposure occurs when an MNC translates each subsidiary’s financial data to its home currency for consolidated
Chapter 12: Managing Economic Exposure and Translation Exposure
financial statements.
a.
Translation
b.
Transaction
c.
Economic
d.
None of the above
30. ____ is (are) not a limitation of hedging translation exposure.
a.
Inaccurate stock price forecasts
b.
Inadequate forward contracts for some currencies
c.
Taxation on gains from forward contracts
d.
Increased transaction exposure
31. To hedge translation exposure, MNCs could ____ that their foreign subsidiaries receive as earnings to create a cash
outflow in the currency to offset the earnings received in that currency.
a.
purchase the currency forward
b.
sell the currency forward
c.
purchase futures contracts of the currency
d.
A or C
e.
none of the above
32. Which of the following is a possible strategy for reducing economic exposure?
a.
hedging with forward contracts
b.
purchasing foreign supplies
Chapter 12: Managing Economic Exposure and Translation Exposure
c.
financing with foreign funds
d.
all of the above
33. In general, it is more difficult to effectively hedge economic or translation exposure than to hedge transaction
exposure.
a.
True
b.
False
34. A foreign subsidiary with expenses that are more susceptible to exchange rate movements than its revenue will be
favorably affected by an appreciation of the foreign currency.
a.
True
b.
False
35. U.S. firms can attempt to hedge the translation exposure of their European subsidiaries with a forward purchase of
euros.
a.
True
b.
False
36. Hedging translation exposure with forward contracts can backfire if the currency being hedged depreciates.
a.
True
b.
False
37. A limitation of hedging translation exposure is that translation losses are not tax deductible, whereas gains on forward
contracts used to hedge translation exposure are taxed.
a.
True
b.
False
38. The translation gain (or loss) is simply a paper gain (or loss). Conversely, the gain (or loss) resulting from a hedge
strategy is a real gain (or loss).
a.
True
b.
False
39. All MNCs are subject to translation exposure.
a.
True
b.
False
40. U.S.-based MNCs invoicing in Asian currencies and incurring expenses in Asian currencies will probably be less
affected by weakness in Asian currencies than U.S.-based MNCs that invoice in Asian currencies but do not incur
expenses in those currencies.
a.
True
b.
False
41. The management of economic exposure is normally focused completely on transactions that will occur in the next
three months.
a.
True
b.
False
42. Transaction exposure results when an MNC translates each subsidiary’s financial data to its home currency for
consolidated financial statements.
a.
True
b.
False
43. Although forward contracts may reduce translation exposure at the expense of increasing transaction exposure, they
are sometimes used to hedge translation exposure.
a.
True
b.
False
44. Vermont Co. has foreign expenses denominated in euros that exceed foreign revenues. Appreciation of the euro
relative to the U.S. dollar will cause this firm’s reported earnings (from the consolidated income statement) to ____. If the
firm desires to protect against this possibility, it could stabilize its reported earnings by ____ euros forward in the foreign
exchange market.
a.
decrease; purchasing
b.
decrease; selling
c.
increase; selling
d.
increase; purchasing
45. If a U.S. firm has much more revenue than expenses denominated in euros, the firm will likely ____ if the euro ____.
a.
benefit; weakens
b.
be unaffected; weakens
c.
be unaffected; strengthens
d.
benefit; strengthens
46. Assume that Atlanta Co. is producing motorcycles and selling them to U.S. customers. Atlanta Co. obtains all of its
supplies from American firms and has no competition in the United States. It has one major competitor in Japan. Now
assume that Phoenix Co. is producing office furniture and obtains its supplies from a Canadian firm. Based on this
information, Atlanta Co. has ____ exposure and Phoenix Co. has ____ exposure.
a.
transaction; translation
b.
translation; transaction
c.
economic; transaction
d.
economic; translation
47. Tennessee Co. conducts business in the United States and Canada. The net cash flows from Canadian operations are
expected to be C$500,000 next year. The Canadian dollar is valued at about $.90. The net cash flows from U.S. operations
are expected to be $200,000. To reduce the sensitivity of its net cash flows without reducing its volume of business in
Canada, Tennessee Co. could:
a.
purchase Canadian supplies
b.
increase its borrowings in United States.
c.
decrease prices on Canadian goods.
d.
decrease its borrowed funds in Canada.
48. Mercury Co. has a subsidiary based in Italy and is exposed to translation exposure. Mercury forecasts that its earnings
next year will be €10 million. Mercury decides to hedge the expected earnings by selling €10 million forward. During the
next year, the euro appreciated. Mercury’s consolidated earnings were ____ affected by the euro’s movement, and
Mercury’s hedge position was ____ affected by the euro‘s movement.
a.
favorably; favorably
b.
favorably; adversely
c.
adversely; favorably
d.
adversely; adversely
49. All MNCs are subject to transaction exposure.
a.
True
b.
False
50. A foreign subsidiary with more revenue than expenses denominated in a foreign currency will be favorably affected
by appreciation of the foreign currency.
a.
True
b.
False
51. Economic exposure represents any impact of exchange rate fluctuations on a firm’s future cash flows and thus includes
transaction exposure.
a.
True
b.
False
52. To reduce economic exposure when a foreign currency has a greater impact on cash inflows than on cash outflows, an
MNC could reduce its level of foreign sales, increase its foreign supply orders, or restructure debt to increase debt
payments in the foreign currency.
a.
True
b.
False
53. Even if translation exposure does not affect cash flows, it is a concern of many MNCs.
a.
True
b.
False
54. Translation exposure results when an MNC translates each subsidiary’s financial data to its home currency for
consolidated financial statements.
a.
True
b.
False
55. Implementing a forward or money market hedge to hedge translation exposure may increase transaction exposure.
a.
True
b.
False
56. Thornton Corp. is based in the U.S. and has no foreign subsidiaries. It has extensive liabilities denominated in Indian
rupees resulting from imports from India. However, Thornton’s revenues are denominated solely in U.S. dollars. Which of
the following is probably not true?
a.
Thornton would benefit from a depreciation of the Indian rupee.
b.
Thornton has at least some transaction exposure.
c.
Thornton has at least some economic exposure.
d.
Thornton has at least some translation exposure.
e.
All of the above are true.
57. A U.S.-based MNC has a subsidiary in Barbados that generates substantial net cash inflows denominated in Barbados
dollars. Given this information, the MNC would ____ from a(n) ____ of the Barbados dollar.
a.
benefit; appreciation
b.
benefit; depreciation
c.
not benefit; appreciation
d.
none of the above
58. ____ is (are) a limitation of hedging translation exposure.
a.
Inaccurate earnings forecasts
b.
Inadequate forward contracts for some currencies
c.
Accounting distortions
d.
Increased transaction exposure
e.
All of the above