International Financial Mgmt Exam 3

Futures, forward, and money market hedges all lock into a certain price to be received from hedging a receivable. For a currency option hedge with a put option, however, the exact amount received is not known until the option is (or is not) exercised.

True

The price at which a currency put option allows the holder to sell a currency is called the settlement price.

False

MNCs generally do not need to hedge because shareholders can hedge their own risk.

False

When comparing the forward hedge to the options hedge, the MNC can easily determine which hedge is more desirable, because the cost of each hedge can be determined with certainty.

False

When comparing the forward hedge to the money market hedge, the MNC can easily determine which hedge is more desirable, because the cost of each hedge can be determined with certainty.

False

To hedge a payable position with a currency option hedge, an MNC would buy a call option.

True

To hedge a payable position with a currency option hedge, an MNC would buy a put option.

False

Which of the following reflects a hedge of net receivables in British pounds by a U.S. firm?

purchase a currency put option in British pounds.

sell pounds forward.

borrow U.S. dollars, convert them to pounds, and invest them in a British pound deposit.

A and B

FAI Corporation will be receiving 300,000 Canadian dollars (C$) in 90 days. Currently, a 90-day call option with an exercise price of $0.75 and a premium of $0.01 is available. Also, a 90-day put option with an exercise price of $0.73 and a premium of $0.01 is available. FAI plans to purchase options to hedge its receivable position. Assuming that the spot rate in 90 days is $0.71, what is the net amount received from the currency option hedge?

$216,000

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.

($1.60 − $.02) × £700,000 = $1,106,000

If interest rate parity exists and transactions costs are zero, the hedging of payables in euros with a forward hedge will ____.

have the same result as a money market hedge on payables

To hedge a ____ in a foreign currency, a firm may ____ a currency futures contract for that currency.

payable; purchase

The ____ does not represent an obligation.

currency option

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
$0.54

0.57

0.58

0.59

Probability

15%

25%

35%

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?

Since Lorre locks into the $.575 with a forward contract, the first two cases would have been cheaper had Lorre not hedged (15% + 25% = 40%).

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 ____.

negative; negative

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:

sell euros forward.

Which of the following reflects a hedge of net payables on British pounds by a U.S. firm?

borrow U.S. dollars, convert them to pounds, and invest them in a British pound deposit.

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.

($1.68 + $.04) × £200,000 = $344,000

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.

360-day borrowing rate

7%
360-day deposit rate

5%

Switzerland

360-day borrowing rate

6%
360-day deposit rate

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:

1. Need to invest SF192,308 (SF200,000/1.04) = SF192,308.

2. Need to borrow $92,308 to exchange for SF192,308 (SF192,308 × $.48) = $92,308.

3. At the end of 360 days, need $98,769 to repay the loan ($92,308 × 1.07) = $98,770.

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?

($.71 + $.01) × 200,000 = $144,000. Note: the call option is not exercised since the spot rate is less than the exercise price.

Johnson Co. has 1,000,000 euros as payables due in 30 days, and is certain that euro is going to appreciate substantially over time. Assuming the firm is correct, the ideal strategy is to:

purchase euros forward.

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?

($.73 − $.01) × 300,000 = $216,000. Subtract put option by premium for receivables

Transaction exposure results when an MNC translates each subsidiary's financial data to its home currency for consolidated financial statements.

False

A foreign subsidiary with more revenue than expenses denominated in a foreign currency will be favorably affected by appreciation of the foreign currency.

True

A foreign subsidiary with more susceptible expenses than revenue to exchange rate movements will be favorably affected by an appreciation of the foreign currency.

False

Although forward contracts may reduce translation exposure at the expense of increasing transaction exposure, they are sometimes used to hedge translation exposure.

True

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.

False

In general, it is more difficult to effectively hedge economic or translation exposure than to hedge transaction exposure.

True (transaction, translation, economic)

It is generally least difficult to effectively hedge various types of:

transaction exposure

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:

producing more automobiles in the U.S.

An effective way for an MNC to assess its economic exposure is to review the firm's:

income statement

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?

increase Zambian sales.

If a U.S. firm has much more revenue than expenses denominated in euros, the firm will likely ____ if the euro ____.

benefit; strengthens

____ represents any impact of exchange rate fluctuations on a firm's future cash flows.

economic exposure

Managing economic exposure is generally perceived to be ____ managing transaction exposure.

more difficult than

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?

Thornton has at least some translation exposure.

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.

increase; decrease

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.

benefit from; be adversely affected by (Its in foreign currency)

Since the cost of funds can vary among markets, the MNC's access to the international capital markets may allow it to attract funds at a lower cost than that paid by domestic firms.

True

In general, an MNC's size, its access to international capital markets, and international diversification are unfavorable to an MNC's cost of capital.

False

It is always advantageous to use foreign debt to finance a foreign project, particularly in developing countries.

False

If an MNC's cash flows are more stable, it can probably handle more debt than an MNC with erratic cash flows.

True

Country differences, such as differences in the risk-free interest rate and differences in risk premiums across countries, can cause the cost of capital to vary across countries.

True

The cost of debt:

among countries changes over time, and these changes are positively correlated.

Assume that the risk-free interest rate in the U.S. is the same as that in Country M. Assume that the government of Country M is more likely to rescue local firms that experience financial problems. Other things being equal, Country M's firms are likely to use a ____ degree of financial leverage than U.S. firms. If a firm based in Country M had the same degree of financial leverage and the same operating characteristics as a U.S. firm, its cost of capital would be ____ than that of the U.S. firm.

higher; lower

An argument for MNCs to have a debt-intensive capital structure is:

They are well diversified.

Assume that an MNC has very stable cash flows and uses very little debt. Its cost of debt should be:

lower than its cost of equity

If the parent ____ the debt of the subsidiary, the subsidiary's borrowing capacity might be ____.

does not back; reduced

backs; increased

Which of the following operations benefits from appreciation of the firm's local currency?

borrowing in a foreign currency and converting the funds to the local currency prior to the appreciation.

Some MNCs are subject to economic exposure without being subject to transaction exposure.

True

If an MNC has a net inflow in one currency and a net outflow of about the same amount in another currency, then the MNCs' transaction exposure is ____ if the two currencies are ____ correlated.

high; negatively

A high correlation between two currencies would be desirable for achieving low exchange rate risk if one is an inflow currency and the other is an outflow currency.

True

Economic exposure can affect:

MNCs and purely domestic firms only.

The degree to which a firm's present value of future cash flows can be influenced by exchange rate fluctuations is referred to as transaction exposure.

False

Translation exposure affects an MNC's cash flows.

False

Vada, Inc. exports computers to Australia invoiced in U.S. dollars. Its main competitor is located in Japan. Vada is subject to:

economic exposure

____ is (are) not a determinant of translation exposure.

The local (domestic) earnings of the MNC

Since earnings can affect stock prices, many MNCs are concerned about translation exposure.

True

Lazer Co. is a U.S. firm that exports computers to Belgium invoiced in euros and to Italy invoiced in dollars. Additionally, Lazer Co. has a subsidiary in Korea that produces computers in South Korea and sells them there. Lazer also has competitors in different countries. Lazer Co. is subject to:

transaction, translation, and exposure.

If the net inflow of one currency is about the same amount as a net outflow in another currency, the firm will benefit if these two currencies are negatively correlated because the transaction exposure is offset.

False

If the U.S. dollar appreciates,

an MNC’s US sales will probably decrease

Diz Co. is a U.S.-based MNC with net cash inflows of euros and net cash inflows of Swiss francs. These two currencies are highly correlated in their movements against the dollar. Yanta Co. is a U.S.-based MNC that has the same level of net cash flows in these currencies as Diz Co. except that its euros represent net cash outflows. Which firm has a higher exposure to exchange rate risk?

Diz Co.