Chapter 11—Managing Transaction Exposure
1. 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.
2. 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.
3. Assume the following information:
U.S. deposit rate for 1 year
=
11%
U.S. 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
=
$.40
Swiss franc spot rate
=
$.39
Also assume that a U.S. 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 U.S.
dollars given that the firm executes a forward hedge?
a.
$234,000.
b.
$238,584.
c.
$240,000.
d.
$236,127.
SF600,000 $.40 = $240,000
4. Assume the following information:
U.S. deposit rate for 1 year
=
U.S. borrowing rate for 1 year
=
New Zealand deposit rate for 1 year
=
New Zealand borrowing rate for 1 year
=
New Zealand dollar forward rate for 1 year
=
New Zealand dollar spot rate
=
Also assume that a U.S. exporter denominates its New Zealand exports in NZ$ and expects to receive
NZ$600,000 in 1 year. You are a consultant for this firm.
Using the information above, what will be the approximate value of these exports in 1 year in U.S.
dollars given that the firm executes a money market hedge?
a.
$238,584.
b.
$240,000.
c.
$234,000.
d.
$236,127.
1.
Borrow NZ$545,455 (NZ$600,000/1.1) = NZ$545,455.
2.
Convert NZ$545,455 to $212,727 (at $.39 per NZ$).
Invest $212,727 to accumulate $236,127 ($212,727 1.11) = $236,127.
5. 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
6. Which of the following reflects a hedge of net receivables in British pounds by a U.S. firm?
a.
purchase a currency put option in British pounds.
b.
sell pounds forward.
c.
borrow U.S. dollars, convert them to pounds, and invest them in a British pound deposit.
d.
A and B
7. Which of the following reflects a hedge of net payables on British pounds by a U.S. firm?
a.
purchase a currency put option in British pounds.
b.
sell pounds forward.
c.
sell a currency call option in British pounds.
d.
borrow U.S. dollars, convert them to pounds, and invest them in a British pound deposit.
e.
A and B
8. 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 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.
9. 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.
10. 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.
11. From the perspective of Detroit Co., which has payables in Mexican pesos and receivables in Canadian
dollars, hedging the payables would be most desirable if the expected real cost of hedging payables is
____, and hedging the receivables would be most desirable if the expected real cost of hedging
receivables is ____.
a.
negative; positive
b.
zero; positive
c.
zero; zero
d.
positive; negative
e.
negative; negative
12. Use the following information to calculate the dollar cost of using a money market hedge to hedge
200,000 pounds of payables due in 180 days. Assume the firm has no excess cash. Assume the spot
rate of the pound is $2.02, the 180-day forward rate is $2.00. The British interest rate is 5%, and the
U.S. interest rate is 4% over the 180-day period.
a.
$391,210.
b.
$396,190.
c.
$388,210.
d.
$384,761.
e.
none of the above
1.
Need to invest £190,476 (£200,000/1.05) = £190,476.
Need to exchange $384,762 to obtain the £190,476 (£190,476 $2.02) = $384,762.
13. Assume that Cooper Co. will not use its cash balances in a money market hedge. When deciding
between a forward hedge and a money market hedge, it ____ determine which hedge is preferable
before implementing the hedge. It ____ determine whether either hedge will outperform an unhedged
strategy before implementing the hedge.
a.
can; can
b.
can; cannot
c.
cannot; can
d.
cannot; cannot
14. Foghat Co. has 1,000,000 euros as receivables due in 30 days, and is certain that the euro will
depreciate substantially over time. Assuming that the firm is correct, the ideal strategy is to:
a.
sell euros forward.
b.
purchase euro currency put options.
c.
purchase euro currency call options.
d.
purchase euros forward.
e.
remain unhedged.
15. Spears Co. will receive SF1,000,000 in 30 days. Use the following information to determine the total
dollar amount received (after accounting for the option premium) if the firm purchases and exercises a
put option:
Exercise price
=
$.61
Premium
=
$.02
Spot rate
=
$.60
Expected spot rate in 30 days
=
$.56
30-day forward rate
=
$.62
a.
$630,000.
b.
$610,000.
c.
$600,000.
d.
$590,000.
e.
$580,000.
($.61 − $.02) SF1,000,000 = $590,000
16. A ____ involves an exchange of currencies between two parties, with a promise to re-exchange
currencies at a specified exchange rate and future date.
a.
long-term forward contract
b.
currency option contract
c.
parallel loan
d.
money market hedge
17. If interest rate parity exists and transactions costs are zero, the hedging of payables in euros with a
forward hedge will ____.
a.
have the same result as a call option hedge on payables
b.
have the same result as a put option hedge on payables
c.
have the same result as a money market hedge on payables
d.
require more dollars than a money market hedge
e.
A and D
18. Assume that Parker Company will receive SF200,000 in 360 days. Assume the following interest
rates:
U.S.
Switzerland
360-day borrowing rate
7%
5%
360-day deposit rate
6%
4%
Assume the forward rate of the Swiss franc is $.50 and the spot rate of the Swiss franc is $.48. If
Parker Company uses a money market hedge, it will receive ____ in 360 days.
a.
$101,904
b.
$101,923
c.
$98,769
d.
$96,914
e.
$92,307
1.
Borrow SF190,476 (SF200,000/1.05) = SF190,476.
Convert SF190,476 to $91,428 (SF190,476 $.48) = $91,428.
Invest $91,428 at 6% to accumulate $96,914 ($91,428 1.06) = $96,914.
19. The forward rate of the Swiss franc is $.50. The spot rate of the Swiss franc is $.48. The following
interest rates exist:
U.S.
Switzerland
360-day borrowing rate
7%
5%
360-day deposit rate
6%
4%
You need to purchase SF200,000 in 360 days. If you use a money market hedge, the amount of dollars
you need in 360 days is:
a.
$101,904.
b.
$101,923.
c.
$98,770.
d.
$96,914.
e.
$92,307.
1.
Need to invest SF192,308 (SF200,000/1.04) = SF192,308.
Need to borrow $92,308 to exchange for SF192,308 (SF192,308 $.48) = $92,308.
At the end of 360 days, need $98,769 to repay the loan ($92,308 1.07) = $98,770.
20. Your company will receive C$600,000 in 90 days. The 90-day forward rate in the Canadian dollar is
$.80. If you use a forward hedge, you will:
a.
receive $750,000 today.
b.
receive $750,000 in 90 days.
c.
pay $750,000 in 90 days.
d.
receive $480,000 today.
e.
receive $480,000 in 90 days.
C$600,000 $0.80 = $480,000
21. A call option exists on British pounds with an exercise price of $1.60, a 90-day expiration date, and a
premium of $.03 per unit. A put option exists on British pounds with an exercise price of $1.60, a
90-day expiration date, and a premium of $.02 per unit. You plan to purchase options to cover your
future receivables of 700,000 pounds in 90 days. You will exercise the option in 90 days (if at all).
You expect the spot rate of the pound to be $1.57 in 90 days. Determine the amount of dollars to be
received, after deducting payment for the option premium.
a.
$1,169,000.
b.
$1,099,000.
c.
$1,106,000.
d.
$1,143,100.
e.
$1,134,000.
($1.60 − $.02) £700,000 = $1,106,000
22. Assume that Smith Corporation will need to purchase 200,000 British pounds in 90 days. A call option
exists on British pounds with an exercise price of $1.68, a 90-day expiration date, and a premium of
$.04. A put option exists on British pounds, with an exercise price of $1.69, a 90-day expiration date,
and a premium of $.03. Smith Corporation plans to purchase options to cover its future payables. It
will exercise the option in 90 days (if at all). It expects the spot rate of the pound to be $1.76 in 90
days. Determine the amount of dollars it will pay for the payables, including the amount paid for the
option premium.
a.
$360,000.
b.
$338,000.
c.
$332,000.
d.
$336,000.
e.
$344,000.
($1.68 + $.04) £200,000 = $344,000
23. Assume that Kramer Co. will receive SF800,000 in 90 days. Today’s spot rate of the Swiss franc is
$.62, and the 90-day forward rate is $.635. Kramer has developed the following probability
distribution for the spot rate in 90 days:
Possible Spot Rate
in 90 Days
Probability
$.61
10%
$.63
20%
$.64
40%
$.65
30%
The probability that the forward hedge will result in more dollars received than not hedging is:
a.
10%.
b.
20%.
c.
30%.
d.
50%.
e.
70%.
forward rate, which is true in the first two cases.
24. Assume that Jones Co. will need to purchase 100,000 Singapore dollars (S$) in 180 days. Today’s spot
rate of the S$ is $.50, and the 180-day forward rate is $.53. A call option on S$ exists, with an exercise
price of $.52, a premium of $.02, and a 180-day expiration date. A put option on S$ exists, with an
exercise price of $.51, a premium of $.02, and a 180-day expiration date. Jones has developed the
following probability distribution for the spot rate in 180 days:
Possible Spot Rate
in 90 Days
Probability
$.48
10%
$.53
60%
$.55
30%
The probability that the forward hedge will result in a higher payment than the options hedge is ____
(include the amount paid for the premium when estimating the U.S. dollars required for the options
hedge).
a.
0%
b.
10%
c.
30%
d.
40%
e.
70%
amount paid with the forward hedge ($.53 S$100,000 = $53,000).
25. Assume that Patton Co. will receive 100,000 New Zealand dollars (NZ$) in 180 days. Today’s spot
rate of the NZ$ is $.50, and the 180-day forward rate is $.51. A call option on NZ$ exists, with an
exercise price of $.52, a premium of $.02, and a 180-day expiration date. A put option on NZ$ exists
with an exercise price of $.51, a premium of $.02, and a 180-day expiration date. Patton Co. has
developed the following probability distribution for the spot rate in 180 days:
Possible Spot Rate
in 90 Days
Probability
$.48
10%
$.49
60%
$.55
30%
The probability that the forward hedge will result in more U.S. dollars received than the options hedge
is ____ (deduct the amount paid for the premium when estimating the U.S. dollars received on the
options hedge).
a.
10%
b.
30%
c.
40%
d.
70%
e.
none of the above
26. The ____ hedge is not a technique to eliminate transaction exposure discussed in your text.
a.
index
b.
futures
c.
forward
d.
money market
e.
currency option
27. Money Corp. frequently uses a forward hedge to hedge its Malaysian ringgit (MYR) receivables. For
the next month, Money has identified its net exposure to the ringgit as being MYR1,500,000. The
30-day forward rate is $.23. Furthermore, Money’s financial center has indicated that the possible
values of the Malaysian ringgit at the end of next month are $.20 and $.25, with probabilities of .30
and .70, respectively. Based on this information, the revenue from hedging minus the revenue from not
hedging receivables is____.
a.
$0.
b.
−$7,500.
c.
$7,500.
d.
none of the above
28. Hanson Corp. frequently uses a forward hedge to hedge its British pound (£) payables. For the next
quarter, Hanson has identified its net exposure to the pound as being £1,000,000. The 90-day forward
rate is $1.50. Furthermore, Hanson’s financial center has indicated that the possible values of the
British pound at the end of next quarter are $1.57 and $1.59, with probabilities of .50 and .50,
respectively. Based on this information, what is the expected real cost of hedging payables?
a.
$80,000.
b.
−$80,000.
c.
$1,570,000.
d.
$1,580,000.
Exhibit 11-1
U.S.
Jordan
360-day borrowing rate
6%
5%
360-day deposit rate
5%
4%
29. Refer to Exhibit 11-1. Perkins Corp. will receive 250,000 Jordanian dinar (JOD) in 360 days. The
current spot rate of the dinar is $1.48, while the 360-day forward rate is $1.50. How much will Perkins
receive in 360 days from implementing a money market hedge (assume any receipts before the date of
the receivable are invested)?
a.
$377,115.
b.
$373,558.
c.
$363,019.
d.
$370,000.
1.
Borrow JOD238,095.24 (JOD250,000/1.05) = JOD238,095.24.
Convert JOD238,095.24 to $352,380.95 (JOD238,095.24 $1.48) = $352,380.95.
Invest $352,380.95 at 5% to accumulate $370,000 ($352,280.95 1.05) = $370,000.
30. Refer to Exhibit 11-1. Pablo Corp. will need 150,000 Jordanian dinar (JOD) in 360 days. The current
spot rate of the dinar is $1.48, while the 360-day forward rate is $1.46. What is Pablo’s cost from
implementing a money market hedge (assume Pablo does not have any excess cash)?
a.
$224,135.
b.
$226,269.
c.
$224,114.
d.
$223,212.
1.
Need to invest JOD144,230.76 (JOD150,000/1.04) = JOD144,230.76.
= $213,461.52.
At the end of 360 days, need $226,269.22 ($213,461.52 1.06) = $226,269.21.
31. Lorre Company needs 200,000 Canadian dollars (C$) in 90 days and is trying to determine whether or
not to hedge this position. Lorre has developed the following probability distribution for the Canadian
dollar:
Possible Value of
Canadian Dollar in 90 Days
Probability
$0.54
15%
0.57
25%
0.58
35%
0.59
25%
The 90-day forward rate of the Canadian dollar is $.575, and the expected spot rate of the Canadian
dollar in 90 days is $.55. If Lorre implements a forward hedge, what is the probability that hedging
will be more costly to the firm than not hedging?
a.
40%.
b.
60%.
c.
15%.
d.
85%.
32. Quasik Corporation will be receiving 300,000 Canadian dollars (C$) in 90 days. Currently, a 90-day
call option with an exercise price of $.75 and a premium of $.01 is available. Also, a 90-day put option
with an exercise price of $.73 and a premium of $.01 is available. Quasik plans to purchase options to
hedge its receivable position. Assuming that the spot rate in 90 days is $.71, what is the net amount
received from the currency option hedge?
a.
$219,000.
b.
$222,000.
c.
$216,000.
d.
$213,000.
($.73 − $.01) 300,000 = $216,000.
33. FAB Corporation will need 200,000 Canadian dollars (C$) in 90 days to cover a payable position.
Currently, a 90-day call option with an exercise price of $.75 and a premium of $.01 is available. Also,
a 90-day put option with an exercise price of $.73 and a premium of $.01 is available. FAB plans to
purchase options to hedge its payable position. Assuming that the spot rate in 90 days is $.71, what is
the net amount paid, assuming FAB wishes to minimize its cost?
a.
$144,000.
b.
$148,000.
c.
$152,000.
d.
$150,000.
34. You are the treasurer of Arizona Corporation and must decide how to hedge (if at all) future
receivables of 350,000 Australian dollars (A$) 180 days from now. Put options are available for a
premium of $.02 per unit and an exercise price of $.50 per Australian dollar. The forecasted spot rate
of the Australian dollar in 180 days is:
Future Spot Rate
Probability
$.46
20%
$.48
30%
$.52
50%
The 90-day forward rate of the Australian dollar is $.50.
What is the probability that the put option will be exercised (assuming Arizona purchased it)?
a.
0%.
b.
80%.
c.
50%.
d.
none of the above
35. If interest rate parity exists, and transaction costs do not exist, the money market hedge will yield the
same result as the ____ hedge.
a.
put option
b.
forward
c.
call option
d.
none of the above