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 multinational firm’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 U.S., 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 firm would
____ a stronger dollar and would ____ a weaker 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
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. Given these exact figures above, 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 ____ the 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 the 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 goods in the U.S. 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 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 revenue, 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 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
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 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 the money market hedge.
b.
using the forward hedge.
c.
using the futures hedge.
d.
none of the above, since a perfect hedge is nearly impossible.
16. Assume that a Japanese car manufacturer exports cars to U.S. dealerships, which are priced in yen. The
demand for those cars declines when the yen is strong. The manufacturer also produces some cars in
the U.S. 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 U.S.
b.
producing more automobiles in the U.S.
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
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 flow 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 expects to sell fixed assets it utilizes in Europe 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 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. Translation losses are ____, while gains on forward contracts used to hedge translation exposure are
____.
a.
tax deductible; not taxed
b.
not tax deductible; not taxed
c.
not tax deductible; taxed
d.
tax deductible; taxed
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 more susceptible expenses than revenue to exchange rate movements will be
favorably affected by an appreciation of the foreign currency.
a. True
b. False
35. U.S. firms can attempt to hedge their 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 were
probably less affected by the weakness of 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 a firm desired 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. Sarakose Co. is a U.S. company with sales to Canada amounting to C$5 million. Its cost of materials
attributable to the purchase of Canadian goods is C$7 million. Its interest expense on Canadian loans is
C$5 million. The dollar value of Sarakose’s “earnings before interest and taxes” would ____ if the
Canadian dollar appreciates; the dollar value of its cash flows would ____ if the Canadian dollar
appreciates.
a.
increase; increase
b.
decrease; increase
c.
decrease; decrease
d.
increase; decrease
e.
increase; be unaffected
46. 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
47. 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 U.S. 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
48. Orlando Co. produces home appliances and sells them in the U.S. It outsources the production of the
appliances to a Chinese manufacturer, and the imported appliances are priced in dollars. Its major
competitor for appliances is located in Mexico. Based on this information, Orlando Co. is subject to
____ exposure.
a.
economic
b.
transaction
c.
translation
d.
economic and transaction
49. Tennessee Co. conducts business in the U.S. 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 supposed to be $200,000. To reduce 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 U.S.
c.
decrease prices on Canadian goods.
d.
decrease its borrowed funds in Canada.
50. 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
51. All MNCs are subject to transaction exposure.
a. True
b. False
52. 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
53. 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
54. To reduce economic exposure when a foreign currency has a greater impact on cash inflows, 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
55. When a foreign currency has a greater impact on cash outflows than on cash inflows, one possibility in
restructuring operations is to reduce foreign sales.
a. True
b. False
56. Even if translation exposure does not affect cash flows, it is a concern of many MNCs.
a. True
b. False
57. Translation exposure results when an MNC translates each subsidiary’s financial data to its home
currency for consolidated financial statements.
a. True
b. False
58. Implementing a forward or money market hedge to hedge translation exposure may increase
transaction exposure.
a. True
b. False
59. Which of the following statements is incorrect?
a.
Transaction exposure represents only the exchange rate risk when converting net foreign
cash inflows to U.S. dollars or when purchasing foreign currencies to send payments.
b.
Economic exposure represents any impact of exchange rate fluctuations on a firm’s future
cash flows.
c.
Firms can simply focus on hedging their foreign currency payables and/or receivables to
hedge economic exposure.
d.
The management of economic exposure tends to serve as a long-term solution rather than
just a short-term solution.
60. Thornton Corporation has extensive liabilities denominated in Cyprus pounds resulting from imports
from Cyprus. 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 Cyprus pound.
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.
61. 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
62. Campbell Company has a subsidiary located in Jamaica. The subsidiary has generated losses for the
last five years and is expected to generate losses for the next ten years. Campbell is reluctant to divest
of this subsidiary, however. Given this information, Campbell would ____ from a(n) ____ of the
Jamaican dollar.
a.
benefit; appreciation
b.
benefit; depreciation
c.
not benefit; appreciation
d.
not benefit; depreciation
e.
B and C
63. ____ 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