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Answers to End of Chapter Questions
1. Transaction versus Economic Exposure. Compare and contrast transaction exposure and economic
exposure. Why would an MNC consider examining only its “net” cash flows in each currency when
assessing its transaction exposure?
ANSWER: Transaction exposure is due only to international transactions by a firm. Economic
exposure includes any form by which the firm’s cash flow will be affected. Foreign competition may
2. Assessing Transaction Exposure. Your employer, a large MNC, has asked you to assess its
transaction exposure. Its projected cash flows are as follows for the next year:
Currency Total Inflow Total Outflow
Current Exchange
Rate in U.S. Dollars
Danish krone (DK) DK50,000,000 DK40,000,000 $.15
British pound (£) £2,000,000 £1,000,000 $1.50
Assume that the movements in the Danish krone and the pound are highly correlated. Provide your
assessment as to your firm’s degree of transaction exposure (as to whether the exposure is high or
low). Substantiate your answer.
Foreign Currency
Net Inflows in
Foreign Currency
Current
Exchange Rate Value of Exposure
Danish krone (DK) +DK10,000,000 $.15 $1,500,000
3. Factors That Affect a Firm’s Transaction Exposure. What factors affect a firm’s degree of
transaction exposure in a particular currency? For each factor, explain the desirable characteristics
that would reduce transaction exposure.
ANSWER: Currency variability—low level is desirable.
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Measuring Exposure to Exchange Rate Fluctuations 2
4. Currency Correlations. Kopetsky Co. has net receivables in several currencies that are highly
correlated with each other. What does this imply about the firm’s overall degree of transaction
exposure? Are currency correlations perfectly stable over time? What does your answer imply about
Kopetsky Co. or any other firm using past data on correlations as an indicator for the future?
ANSWER: Its exposure is high since all currencies move in tandem—no offsetting effect is likely. If
5. Currency Effects on Cash Flows. How should appreciation of a firm’s home currency generally
affect its cash inflows? How should depreciation of a firm’s home currency generally affect its cash
outflows?
ANSWER: Appreciation of the firm’s home currency reduces inflows since the foreign demand for
6. Transaction Exposure. Fischer Inc., exports products from Florida to Europe. It obtains supplies
and borrows funds locally. How would appreciation of the euro likely affect its net cash flows?
Why?
ANSWER: Fischer Inc. should benefit from the appreciation of the euro, because it should
7. Exposure of Domestic Firms. Why are the cash flows of a purely domestic firm exposed to
exchange rate fluctuations?
ANSWER: If the firm competes with foreign firms that also sell in a given market, the consumers
8. Measuring Economic Exposure. Memphis Co. hires you as a consultant to assess its degree of
economic exposure to exchange rate fluctuations. How would you handle this task? Be specific.
ANSWER: Regression analysis can be used to determine the relationship between the firm’s value
and exchange rate fluctuations. Stock returns can be used as a proxy for the change in the firm’s
9. Factors That Affect a Firm’s Translation Exposure. What factors affect a firm’s degree of
translation exposure? Explain how each factor influences translation exposure.
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Measuring Exposure to Exchange Rate Fluctuations 3
ANSWER: The greater the percentage of business conducted by subsidiaries, the greater is the
translation exposure. The greater the variability of each relevant foreign currency relative to the
10. Translation Exposure. Consider a period in which the U.S. dollar weakens against the euro. How
will this affect the reported earnings of a U.S.-based MNC with European subsidiaries? Consider a
period in which the U.S. dollar strengthens against most foreign currencies. How will this affect the
reported earnings of a U.S.-based MNC with subsidiaries all over the world?
ANSWER: The consolidated earnings will be increased due to the strength of the subsidiaries’ local
11. Transaction Exposure. Aggie Co. produces chemicals. It is a major exporter to Europe, where its
main competition is from other U.S. exporters. All of these companies invoice the products in U.S.
dollars. Is Aggie’s transaction exposure likely to be significantly affected if the euro strengthens or
weakens? Explain. If the euro weakens for several years, can you think of any change that might
occur in the global chemicals market?
ANSWER: If the euro strengthens, European customers can purchase Aggie’s goods with fewer
euros. Since Aggie’s competitors also invoice their exports in dollars, Aggie Company will not gain a
If the euro remained weak for several years, some companies in Europe may begin to produce the
chemicals, so that customers could avoid purchasing dollars with weak euros. That is, the U.S.
12. Economic Exposure. Longhorn Co. produces hospital equipment. Most of its revenues are in the
United States. About half of its expenses require outflows in Philippine pesos (to pay for Philippine
materials). Most of Longhorn’s competition is from U.S. firms that have no international business at
all. How will Longhorn Co. be affected if the peso strengthens?
ANSWER: If the peso strengthens, Longhorn will incur higher expenses when paying for the
13. Economic Exposure. Lubbock, Inc., produces furniture and has no international business. Its major
competitors import most of their furniture from Brazil and then sell it out of retail stores in the United
States. How will Lubbock, Inc., be affected if Brazil’s currency (the real) strengthens over time?
ANSWER: If the Brazilian real strengthens, U.S. retail stores will likely have to pay higher prices for
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Measuring Exposure to Exchange Rate Fluctuations 4
14. Economic Exposure. Sooner Co. is a U.S. wholesale company that imports expensive high-quality
luggage and sells it to retail stores around the United States. Its main competitors also import
high-quality luggage and sell it to retail stores. None of these competitors hedge their exposure to
exchange rate movements. Why might Sooner’s market share be more volatile over time if it hedges
its exposure?
ANSWER: If Sooner Company hedged its imports, then it would have an advantage over the
competition when the dollar weakened (since its competitors would pay higher prices for the
When Sooner Company does not hedge, the amount paid for imports would depend on exchange rate
15. PPP and Economic Exposure. Boulder, Inc., exports chairs to Europe (invoiced in U.S. dollars) and
competes against local European companies. If purchasing power parity exists, why would Boulder
not benefit from a stronger euro?
ANSWER: If purchasing power parity exists, a stronger euro would occur only because the U.S.
inflation is higher than European inflation. Thus, the European demand for Boulder’s chairs may not
16. Measuring Changes in Economic Exposure. Toyota Motor Corp. measures the sensitivity of its
exports to the yen exchange rate (relative to the U.S. dollar). Explain how regression analysis could
be used for such a task. Identify the expected sign of the regression coefficient if Toyota primarily
exports to the United States. If Toyota established plants in the United States, how might the
regression coefficient on the exchange rate variable change?
ANSWER: The dependent variable is a percentage change (from one period to the next) in Toyota’s
export volume to the U.S. The independent variables are (1) the percentage change in the yen’s value
17. Impact of Exchange Rates on Earnings. Cieplak, Inc., is a U.S.-based MNC that has expanded into
Asia. Its U.S. parent exports to some Asian countries, with its exports denominated in the Asian
currencies. It also has a large subsidiary in Malaysia that serves that market. Offer at least two
reasons related to exposure to exchange rates why Cieplak's earnings were reduced during the Asian
crisis.
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Measuring Exposure to Exchange Rate Fluctuations 5
ANSWER: First, its receivables from its exports were converted to fewer dollars due to the
depreciation of the Asian currencies. Second, any funds remitted by the Malaysian subsidiary
Advanced Questions
18. Speculating Based on Exposure. Periodically, there are rumors that China will weaken its
currency (the yuan) against the U.S. dollar and many European currencies. This causes
investors to sell stocks in Asian countries such as Japan, Taiwan, and Singapore. Offer an
intuitive explanation for such an effect. What types of Asian firms would be affected the
most?
ANSWER: If China weakened its currency, importers of Asian products may purchase more Chinese
19. Comparing Transaction and Economic Exposure. Erie Co. has most of its business in the U.S.,
except that it exports to Belgium. Its exports were invoiced in euros (Belgium’s currency) last year. It
has no other economic exposure to exchange rate risk. Its main competition when selling to
Belgium’s customers is a company in Belgium that sells similar products, denominated in euros.
Starting today, Erie Co. plans to adjust its pricing strategy to invoice its exports in U.S. dollars instead
of euros. Based on the new strategy, will Erie Co. be subject to economic exposure to exchange rate
risk in the future? Briefly explain.
ANSWER: Economic exposure still exists because a weak euro would encourage Belgian customers
20. Using Regression Analysis to Measure Exposure.
a. How can a U.S. company use regression analysis to assess its economic exposure to fluctuations
in the British pound?
ANSWER: A U.S. company could quantify its performance by measuring the percentage change in
b. In using regression analysis to assess the sensitivity of cash flows to exchange rate movements,
what is the purpose of breaking the database into subperiods?
ANSWER: Breaking the database into subperiods enables one to understand how the impact of the
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Measuring Exposure to Exchange Rate Fluctuations 6
c. Assume the regression coefficient based on assessing economic exposure was much higher in
the second sub period than in the first sub period. What does this tell you about the firm’s
degree of economic exposure over time? Why might such results occur?
ANSWER: The firm is more exposed to change in currency values. This could occur if the firm
21. Transaction Exposure. Vegas Corp. is a U.S. firm that exports most of its products to Canada. It
historically invoiced its products in Canadian dollars to accommodate the importers. However, it was
adversely affected when the Canadian dollar weakened against the U.S. dollar. Since Vegas did not
hedge, its Canadian dollar receivables were converted into a relatively small amount of U.S. dollars.
After a few more years of continual concern about possible exchange rate movements, Vegas called
its customers and requested that they pay for future orders with U.S. dollars instead of Canadian
dollars. At this time, the Canadian dollar was valued at $.81. The customers decided to oblige, since
the number of Canadian dollars to be converted into U.S. dollars when importing the goods from
Vegas was still slightly smaller than the number of Canadian dollars that would be needed to buy the
product from a Canadian manufacturer. Based on this situation, has transaction exposure changed for
Vegas Corp.? Has economic exposure changed? Explain.
ANSWER: Transaction exposure is reduced since Vegas will have less receivables in Canadian
22. Measuring Economic Exposure. Using the following cost and revenue information shown for
DeKalb, Inc., determine how the costs, revenue, and cash flow would be affected by three possible
exchange rate scenarios for the New Zealand dollar (NZ$): (1) NZ$ = $.50, (2) NZ$ = $.55, and (3)
NZ$ = $.60. (Assume U.S. sales will be unaffected by the exchange rate.) Assume that NZ$ earnings
will be remitted to the U.S. parent at the end of the period. Ignore possible tax effects.
Forecasted Net Cash Flows: DeKalb Inc.
(in millions of U.S. dollars and New Zealand dollars)
New Zealand
U.S. Business Business
Sales $800 NZ$800
Cost of Materials 500 100
Operating Expenses 300 0
Interest Expense 100 0
Cash Flow –$100 NZ$700
ANSWER:
(Figures are in millions)
NZ$=$.50 NZ$=$.55 NZ$=$.60
Sales
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Measuring Exposure to Exchange Rate Fluctuations 7
Cash flow $250 $285 $320
The preceding table shows that DeKalb Inc. is adversely affected by a weaker New Zealand dollar
value. This should not be surprising since the New Zealand business has relatively high NZ$ revenue
compared to NZ$ expenses. This analysis assumes that the NZ$ received are converted to U.S.
dollars at the end of the period.
23. Changes in Economic Exposure. Walt Disney World built an amusement park in France that opened
in 1992. How do you think this project has affected Disney’s economic exposure to exchange rate
movements? Think carefully before you give your final answer. There is more than one way in which
Disney’s cash flows may be affected. Explain.
ANSWER: This is a good question for class discussion. The typical first reaction is that Walt Disney
24. Lagged Effects of Exchange Rate Movements. Cornhusker Co. is an exporter of products to
Singapore. It wants to know how its stock price is affected by changes in the Singapore dollar’s
exchange rate. It believes that the impact may occur with a lag of one to three quarters. How could
regression analysis be used to assess the impact?
ANSWER: A possible regression model for this task is to regress percentage change in its stock price
where ut is an error term.
25. Potential Effects if the United Kingdom Adopted the Euro. The U.K. still has its own currency, the
pound. The pound’s interest rate has historically been higher than the euros interest rate. The U.K. has
considered adopting the euro as its currency. There have been many arguments about whether it
should do so.
Use your knowledge and intuition to discuss the likely effects if the United Kingdom adopts the euro.
For each of the 10 statements below, insert either INCREASE or DECREASE and complete the
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Measuring Exposure to Exchange Rate Fluctuations 8
statement by adding a clear short explanation (perhaps one to three sentences) of why the U.K.’s
adoption of the euro would have that effect.
To help you narrow your focus, follow these guidelines. Assume that the pound is more volatile than
the euro. Do not base your answer on whether the pound would have been stronger than the euro in
the future. Also, do not base your answer on an unusual change in economic growth in the U.K. or in
the euro zone if the euro is adopted.
ANSWERS:
a. The economic exposure of British firms that are heavy exporters to the euro zone would decrease
b. The translation exposure of firms based in the euro zone that have British subsidiaries would
c. The economic exposure of U.S. firms that conduct substantial business in the U.K. and have no
h. Assume that the Swiss franc is more highly correlated with the British pound than with the euro.
A U.S. firm has substantial monthly exports to the U.K. denominated in the British currency, and also
has substantial monthly imports of Swiss supplies (denominated in Swiss francs). The economic
26. Invoicing Policy to Reduce Exposure. Celtic Co. is a U.S. firm that exports its products to England.
It faces competition from many firms in England. Its price to customers in England has generally
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Measuring Exposure to Exchange Rate Fluctuations 9
been lower than those of the competitors, primarily because the British pound has been strong. It has
priced its exports in pounds, and then converts the pound receivables into dollars. All of its expenses
are in the U.S. and are paid with dollars. It is concerned about its economic exposure. It considers a
change in its pricing policy, in which it will price its products in dollars instead of pounds. Offer your
opinion on why this will or will not significantly reduce its economic exposure.
ANSWER: If the pound weakens, demand for exports of Celtic Co. will decline as customers shift to
27. Exposure to Cash Flows. Raton Co. is a U.S. company that has net inflows of 100 million Swiss
francs and net outflows of 100 million British pounds. The present exchange rate of the Swiss franc
is about $.70 while the present exchange rate of the pound is $1.90. Raton Co. has not hedged these
positions. The Swiss franc and British pound are highly correlated in their movements against the
dollar. Explain whether Raton will be favorably or adversely affected if the dollar weakens against
foreign currencies over time.
ANSWER: Raton Co. will be favorably affected because dollar outflows and inflows will be
28. Assessing Exchange Rate Risk. Washington Co. and Vermont Co. have no domestic business.
They have a similar dollar equivalent amount of international exporting business. Washington Co.
exports all of its products to Canada. Vermont Co. exports its products to Poland and Mexico, with
about half of its business in each of these 2 countries. Each firm receives the currency of the country
where it sends its exports. You obtain the end-of-month spot exchange rates of the currencies
mentioned above during the end of each of the last 6 months.
End of Month Canadian Dollar Mexican Peso Polish Zloty
1 $0.8142 $.09334 $.29914
2 0.8176 .09437 .29829
3 0.8395 .09241 .30187
4 0.8542 .09263 .3088
5 0.8501 .09251 .30274
6 0.8556 .09448 .30312
You want to assess the data in a logical manner to determine which firm has a higher degree of
exchange rate risk. Show your work and write your conclusion. [HINT: The percentage change in the
portfolio of currencies is a weighted average of the percentage change in each currency in the
portfolio.]
ANSWER: First, use an excel spreadsheet to determine the monthly percentage change in the
exchange rate. The portfolio’s movements are equal to a weighted average of the movements of each
Standard
deviation
Maximum expected loss =
1.65 x Std. Dev.
Canadian $ .0123 2.03%
Mexican peso .0157 2.59%
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Measuring Exposure to Exchange Rate Fluctuations 10
29. Exposure to Pegged Currency System. Assume that the Mexican peso and the Brazilian
currency (called the “real”) have depreciated against the dollar recently, due to the high inflation rates
in those countries. Assume that inflation in these two countries is expected to continue and that it will
have a major effect on these currencies if they are still allowed to float. Assume that the government
of Brazil decides to peg its currency to the dollar and will definitely maintain the peg for the next
year. Milez Co. is based in Mexico. Its main business is to export supplies from Mexico to Brazil. It
invoices its supplies in Mexican pesos. Its main competition is from firms in Brazil that produce
similar supplies and sell them locally. How will the sales volume of Milez Co.be affected (if at all) by
the Brazilian government’s actions? Explain.
ANSWER: Its sales should increase because higher inflation in Mexico will cause the peso to weaken
30. Assessing Currency Volatility. Zemart is a U.S. firm that plans to establish international
business in which it will export to Mexico (these exports will be denominated in pesos) and to Canada
(these exports will be denominated in Canadian dollars) once a month and will therefore receive
payments once a month. It is concerned about exchange rate risk. It wants to compare the standard
deviation of exchange rate movements of these 2 currencies against the dollar on a monthly basis. For
this reason, it asks you to
a. estimate the standard deviation of the monthly movements in the Canadian dollar against
the U.S. dollar over the last 12 months
b. estimate the standard deviation of the monthly movements in the Mexican peso against
the U.S. dollar over the last 12 months.
c. Determine which currency is less volatile
You can use the oanda.com web site (or any legitimate web site that has currency data) to obtain the
end of month direct exchange rate of the peso and the Canadian dollar in order to do your analysis.
Show your work. You can use a calculator or a spreadsheet (like excel) to do the actual computations.
ANSWER: This problem requires students to obtain exchange rates and use an Excel spreadsheet to
31. Exposure of Net Cash Flows. Each of the following U.S. firms is expected to generate $40
million in net cash flows (after including the estimated cash flows from international sales if there are
any) over the next year. Ignore any tax effects. Each firm has the same level of expected earnings.
None of the firms have taken any positions in exchange rate derivatives to hedge their exchange rate
risk. All payments for the international trade by each firm will occur one year from today.
Sunrise Co. has ordered imports from Austria, and its imports are invoiced in euros. The dollar value
of the payables (based on today’s exchange rate) from its imports during this year is $10 million. It
has no international sales.
Copans Co. has ordered imports from Mexico, and its imports are invoiced in U.S. dollars. The dollar
value of the payables from its imports during this year is $15 million. It has no international sales.
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Measuring Exposure to Exchange Rate Fluctuations 11
Yamato Co. ordered imports from Italy, and its imports are invoiced in euros. The dollar value of the
payables (based on today’s exchange rate) from its imports during this year is $12 million. In
addition, Yamato exports to Portugal and its exports are denominated in euros. The dollar value of the
receivables (based on today’s exchange rate) from its exports during this year is $8 million.
Glades Co. ordered imports from Belgium, and these imports are invoiced in euros. The dollar value
of the payables (based on today’s exchange rate) from its imports during this year is $7 million.
Glades also ordered imports from Luxembourg and these imports are denominated in dollars. The
dollar value of these payables is $30 million. Glades has no international sales.
Based on this information, which firm is exposed to the most exchange rate risk? Explain.
ANSWER
Company Amount of Foreign Currency Net
Cash Flows (measured in $)
Sunrise $10 million
Sunrise is exposed to the most exchange rate risk.
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