Chapter 8

Your firm is bidding on a large construction contract in a foreign country. This contingent exposure could best be hedged with futures contracts. both with put and call options on the foreign currency, depending upon the specifics ("the rest of the story"). with call options on the foreign currency. with put options on the foreign currency.

both with put and call options on the foreign currency, depending upon the specifics ("the rest of the story").

The extent to which the value of the firm would be affected by unexpected changes in the exchange rate is Multiple Choice translation exposure. none of the options economic exposure. transaction exposure.

economic exposure.

A financial subsidiary used for centralizing exposure management functions is also referred to as a(an) Multiple Choice none of the options reinvoice center invoice center affiliate

reinvoice center

Check my work Check My Work button is now disabledItem 38 Item 38 1 points ABC Inc., an exporting firm, expects to earn $20 million if the dollar depreciates, but only $10 million if the dollar appreciates. Assume that the dollar has an equal chance of appreciating or depreciating. Step one: calculate the expected tax of ABC if it is operating in a foreign country that has progressive corporate taxes as shown. Corporate income tax rate = 15% for the first $7,500,000. Corporate income tax rate = 30% for earnings exceeding $7,500,000. Step two: ABC is considering implementing a hedging program that will eliminate their exchange rate risk: they will make a certain $15 million whether or not the dollar appreciates or depreciates. How much will they save in taxes if they implement the program? Multiple Choice $1,500,000 $0 $4,500,000 $3,375,000

$0

Your firm has a British customer that is willing to place a $1 million order, but wants to pay in pounds instead of dollars. The spot exchange rate is $1.85 = £1.00 and the one-year forward rate is $1.90 = £1.00. The lead time on the order is such that payment is due in one year. What is the fairest exchange rate to use? $1.8750 = £1.00 $1.85 = £1.00 $1.90 = £1.00 none of the options

$1.90 = £1.00

ABC Inc., an exporting firm, expects to earn $20 million if the dollar depreciates, but only $10 million if the dollar appreciates. Assume that the dollar has an equal chance of appreciating or depreciating. Calculate the expected tax of ABC if it is operating in a foreign country that has progressive corporate taxes as shown. Corporate income tax rate = 15% for the first $7,500,000. Corporate income tax rate = 30% for earnings exceeding $7,500,000. $6,000,000 $4,500,000 $3,375,000 $1,500,000

$3,375,000

XYZ Corporation, located in the United States, has an accounts payable obligation of ¥750 million payable in one year to a bank in Tokyo. The current spot rate is ¥116/$1.00 and the one year forward rate is ¥109/$1.00. The annual interest rate is 3 percent in Japan and 6 percent in the United States. XYZ can also buy a one-year call option on yen at the strike price of $0.0086 per yen for a premium of 0.012 cent per yen. The future dollar cost of meeting this obligation using the money market hedge is $6,880,734. $6,450,000. $6,545,400. $6,653,833.

$6,653,833.

XYZ Corporation, located in the United States, has an accounts payable obligation of ¥750 million payable in one year to a bank in Tokyo. The current spot rate is ¥116/$1.00 and the one year forward rate is ¥109/$1.00. The annual interest rate is 3 percent in Japan and 6 percent in the United States. XYZ can also buy a one-year call option on yen at the strike price of $0.0086 per yen for a premium of 0.012 cent per yen. The future dollar cost of meeting this obligation using the forward hedge is $6,880,734. $6,545,400. $6,450,000. $6,653,833.

$6,880,734.

Suppose that Boeing Corporation exported a Boeing 747 to Lufthansa and billed €10 million payable in one year. The money market interest rates and foreign exchange rates are given as follows: The U.S. one-year interest rate: 6.10 % per annum The euro zone one-year interest rate: 9.00 % per annum The spot exchange rate: $ 1.50 /€ The one-year forward exchange rate $ 1.46 /€ Assume that Boeing sells a currency forward contract of €10 million for delivery in one year, in exchange for a predetermined amount of U.S. dollars. Which of the following is/are true? On the maturity date of the contract Boeing will (i) have to deliver €10 million to the bank (the counter party of the forward contract). (ii) take delivery of $14.6 million (iii) have a zero net euro exposure (iv) have a profit, or a loss, depending on the future changes in the exchange rate, from this British sale. Multiple Choice (ii) and (iv) (i) and (iv) (i), (ii), and (iii) (ii), (iii), and (iv)

(i), (ii), and (iii)

Suppose that Boeing Corporation exported a Boeing 747 to Lufthansa and billed €10 million payable in one year. The money market interest rates and foreign exchange rates are given as follows: The U.S. one-year interest rate: 6.10 % per annum The euro zone one-year interest rate: 9.00 % per annum The spot exchange rate: $ 1.50 /€ The one-year forward exchange rate $ 1.46 /€ Assume that Boeing sells a currency forward contract of €10 million for delivery in one year, in exchange for a predetermined amount of U.S. dollars. Suppose that on the maturity date of the forward contract, the spot rate turns out to be $1.40/€ (i.e. less than the forward rate of $1.46/€). Which of the following is true? Multiple Choice Boeing would have received only $14.0 million, rather than $14.6 million, had it not entered into the forward contract. Boeing would have received only $14.0 million, rather than $14.6 million, had it not entered into the forward contract. Additionally, Boeing gained $0.6 million from forward hedging. none of the options Boeing gained $0.6 million from forward hedging.

Boeing would have received only $14.0 million, rather than $14.6 million, had it not entered into the forward contract. Additionally, Boeing gained $0.6 million from forward hedging.

A US-firm has receivables of EUR 5 million in 9 months from a German customer. The spot and forward (EURUSD) rates are 1.55 and 1.52 respectively. Assume that the firm can borrow as well as lend at the following Eurocurrency rates: 2% (USD) and 4% (EUR). How can the firm use money market hedge to manage this transaction exposure? Borrow $7,600,000 and invest in Germany Borrow EUR 4,854,369 and invest in the US None of the above Borrow $7,750,000 and invest in Germany

Borrow EUR 4,854,369 and invest in the US

Your U.S. firm has a £100,000 payable with a 3-month maturity. Which of the following will hedge your liability? Multiple Choice Buy a call option on £100,000 with a strike price in dollars. Buy a call option on £100,000 with a strike price in euro. Buy a put option on £100,000 with a strike price in dollars. none of the options

Buy a call option on £100,000 with a strike price in dollars.

XYZ Corporation, located in the United States, has an accounts payable obligation of ¥750 million payable in one year to a bank in Tokyo. Which of the following is not part of a money market hedge? Multiple Choice Buy the ¥750 million at the forward exchange rate. Buy that much yen at the spot exchange rate. Find the present value of ¥750 million at the Japanese interest rate. Invest in risk-free Japanese securities with the same maturity as the accounts payable obligation.

Buy the ¥750 million at the forward exchange rate.

A Japanese importer has a $1,250,000 payable due in one year. Spot $1 = Y100, 1 year forward $1 = Y120 , Contract size Y12,500,000 Detail a strategy using forward contracts that will hedge his exchange rate risk. Multiple Choice Go short in 12 yen forward contracts. none of the options Go long in 12 yen forward contracts. Go short in 16 yen forward contracts.

Go short in 12 yen forward contracts.

Which of the following firm type is most likely to hedge currency exchange rate risk Multiple Choice Large firms Medium firms None of the above; Large, medium, and small firms are equally likely to hedge Small firms

Large firms

Generally speaking, a firm with recurrent exposure can best hedge using which product? Multiple Choice Futures all of the options Options Swaps

Swaps

The current exchange rate is €1.25 = £1.00 and a British firm offers a French customer the choice of paying a £10,000 bill due in 90 days with either £10,000 or €12,500. The seller has given the buyer an at-the-money put option on pounds with a strike in euro. The seller has given the buyer an at-the-money put option on euro with a strike in pounds. The seller has given the buyer an at-the-money call option on euro with a strike in pounds. none of the options

The seller has given the buyer an at-the-money put option on euro with a strike in pounds.

The current exchange rate is €1.25 = £1.00 and a British firm offers a French customer the choice of paying a £10,000 bill due in 90 days with either £10,000 or €12,500. The seller has given the buyer an at-the-money call option. The seller has given the buyer an at-the-money put option. none of the options The seller has given the buyer both an at-the-money put option, as well as an at-the-money call option.

The seller has given the buyer both an at-the-money put option, as well as an at-the-money call option.

Boeing imported a Rolls-Royce jet engine for £5 million in one year. Which of the following is true, given the market conditions of i$=6%, i£ = 6.5%, S0 = $1.80/£, F1 = $1.75/£? To hedge this FX exposure using forward contracts, Boeing should invest $5 million today in the US If S1 = $1.70/£, Boeing would have lost $0.25 million from forward hedging To hedge this FX exposure using forward contracts, Boeing should buy £5 million forward in exchange for $8,750,000 None of the above

To hedge this FX exposure using forward contracts, Boeing should buy £5 million forward in exchange for $8,750,000

Your firm is bidding on a large construction contract in a foreign country. This contingent exposure could best be hedged Multiple Choice with futures contracts. with put options on the foreign currency. with call options on the foreign currency. both with put and call options on the foreign currency, depending upon the specifics ("the rest of the story").

`both with put and call options on the foreign currency, depending upon the specifics ("the rest of the story").

If you owe a foreign currency denominated debt, you can hedge with a long position in an exchange-traded futures option. buying the foreign currency today and investing it in the foreign county. a long position in a currency forward contract. a long position in a currency forward contract, or buying the foreign currency today and investing it in the foreign county.

a long position in a currency forward contract, or buying the foreign currency today and investing it in the foreign county.

Buying a currency option provides limits the downside risk while preserving the upside potential. a right, but not an obligation, to buy or sell a currency. a flexible hedge against exchange exposure. all of the options

all of the options

A call option on £1,000 with a strike price of €1,250 is equivalent to a put option on £1,000 with an exercise price of €1,250. both a put option on €1,250 with an exercise price of €1,000 and a portfolio of options: a put on €1,250 with a strike price in dollars plus a call on £1,000 with a strike price in dollars. a put option on €1,250 with an exercise price of £1,000. a portfolio of options: a put on €1,250 with a strike price in dollars plus a call on £1,000 with a strike price in dollars.

a put option on €1,250 with an exercise price of £1,000.

A call option to buy £10,000 at a strike price of $1.80 = £1.00 is equivalent to Multiple Choice a put option on £10,000 at a strike price of $1.80 = £1.00. a put option to sell $18,000 at a strike price of $1.80 = £1.00. none of the options a call option on $18,000 at a strike price of $1.80 = £1.00.

a put option to sell $18,000 at a strike price of $1.80 = £1.00.

If you have a long position in a foreign currency, you can hedge with borrowing (not lending) in the domestic and foreign money markets. a short position in foreign currency warrants. a short position in a currency forward contract. a short position in an exchange-traded futures option.

a short position in a currency forward contract.

If you own a foreign currency denominated bond, you can hedge with buying the foreign currency today and investing it in the foreign county. a long position in an exchange-traded futures option. a long position in a currency forward contract. a swap contract where pay the cash flows of the bond in exchange for dollars.

a swap contract where pay the cash flows of the bond in exchange for dollars.

On a recent sale, Boeing allowed British Airways to pay either $18 million or £10 million. Multiple Choice Boeing has provided British Airways with a free option to sell up to £10 million with an exercise price of $18 million. At the due date, British airways will be indifferent between paying dollars or pounds since they would of course have hedged their exposure either way. all of the options Boeing has provided British Airways with a free option to buy $18 million with an exercise price of £10 million.

all of the options

Your U.S. firm has a £100,000 payable with a 3-month maturity. Which of the following will hedge your liability? Buy the present value of £100,000 today at the spot exchange rate, invest in the U.K. at i£. Take a long position in a forward contract on £100,000 with a 3-month maturity. Buy a call option on £100,000 with a strike price in dollars. all of the options

all of the options

Suppose that the exchange rate is €1.25 = £1.00.Options (calls and puts) are available on the Philadelphia exchange in units of €10,000 with strike prices of $1.60/€1.00.Options (calls and puts) are available on the Philadelphia exchange in units of £10,000 with strike prices of $2.00/£1.00. For a U.S. firm to hedge a €100,000 payable, buy 10 call options on the euro with a strike in dollars. sell 8 put options on the pound with a strike in dollars. sell 10 call options on the euro with a strike in dollars. buy 8 put options on the pound with a strike in dollars.

buy 10 call options on the euro with a strike in dollars.

Suppose that the exchange rate is €1.25 = £1.00.Options (calls and puts) are available on the London exchange in units of €10,000 with strike prices of £0.80 = €1.00. Options (calls and puts) are available on the Frankfurt exchange in units of £10,000 with strike prices of €1.25 = £1.00. For a U.K. firm to hedge a €100,000 receivable, buy 10 call options on the euro with a strike in pounds sterling. buy 10 put options on the euro with a strike in pounds sterling and buy 8 call options on the pound with a strike in euro. buy 10 put options on the euro with a strike in pounds sterling. buy 8 call options on the pound with a strike in euro.

buy 10 put options on the euro with a strike in pounds sterling and buy 8 call options on the pound with a strike in euro.

Suppose that the exchange rate is €1.25 = £1.00.Options (calls and puts) are available on the Philadelphia exchange in units of €10,000 with strike prices of $1.60/€1.00.Options (calls and puts) are available on the Philadelphia exchange in units of £10,000 with strike prices of $2.00/£1.00. For a U.S. firm to hedge a €100,000 receivable, sell 8 put options on the pound with a strike in dollars. buy 10 call options on the euro with a strike in dollars. sell 10 call options on the euro with a strike in dollars. buy 10 put options on the pound with a strike in dollars.

buy 10 put options on the pound with a strike in dollars.

Suppose that the exchange rate is €1.25 = £1.00.Options (calls and puts) are available on the London exchange in units of €10,000 with strike prices of £0.80 = €1.00. Options (calls and puts) are available on the Frankfurt exchange in units of £10,000 with strike prices of €1.25 = £1.00. For a French firm to hedge a £100,000 receivable, buy 8 call options on the euro with a strike in pounds. buy 10 put options on the pound with a strike in euro. buy 10 call options on the pound with a strike in euro. buy 10 put options on the pound with a strike in euro and buy 8 call options on the euro with a strike in pounds.

buy 10 put options on the pound with a strike in euro and buy 8 call options on the euro with a strike in pounds.

To hedge a foreign currency payable, Multiple Choice buy put options on the foreign currency. sell put options on the foreign currency. sell call options on the foreign currency. buy call options on the foreign currency.

buy call options on the foreign currency.

To hedge a foreign currency receivable, Multiple Choice buy call options on the foreign currency with a strike in the domestic currency. buy put options on the foreign currency with a strike in the domestic currency. sell call options on the foreign currency with a strike in the domestic currency. sell put options on the foreign currency with a strike in the domestic currency.

buy put options on the foreign currency with a strike in the domestic currency.

Suppose that the exchange rate is €1.25 = £1.00.Options (calls and puts) are available on the London exchange in units of €10,000 with strike prices of £0.80 = €1.00.Options (calls and puts) are available on the Frankfurt exchange in units of £10,000 with strike prices of €1.25 = £1.00. For an Italian firm to hedge a £100,000 payable, none of the options buying 10 call options on the pound with a strike in euro or buying 8 put options on the euro with a strike in pounds will both work. buy 10 call options on the pound with a strike in euro. buy 8 put options on the euro with a strike in pounds.

buying 10 call options on the pound with a strike in euro or buying 8 put options on the euro with a strike in pounds will both work.

An MNC seeking to reduce transaction exposure with a strategy of leading and lagging Multiple Choice can employ the strategy most easily with customers, regardless of market structure. none of the options can probably employ the strategy more effectively with intra firm payables and receivables than with customers or outside suppliers. can employ the strategy most easily with suppliers, regardless of market structure.

can probably employ the strategy more effectively with intra firm payables and receivables than with customers or outside suppliers.

If default costs are significant, Multiple Choice corporate hedging would be unjustifiable because it will increase the probability of default, resulting in a decreased credit rating and higher financing costs. corporate hedging would be justifiable because it will reduce the probability of default. none of the options corporate hedging would be unjustifiable because it will increase the probability of default.`

corporate hedging would be justifiable because it will reduce the probability of default.

The most direct and popular way of hedging transaction exposure is by borrowing and lending in the domestic and foreign money markets. foreign currency warrants. exchange-traded futures options. currency forward contracts.

currency forward contracts.

In evaluating the pros and cons of corporate risk management, "market imperfections" refer to Multiple Choice economic costs, noneconomic costs, arbitrage costs, and hedging costs. information asymmetry, differential transaction costs, default costs, and progressive corporate taxes. management costs, corporate costs, liquidity costs, and trading costs. leading and lagging, receivables and payables, and diversification costs.

information asymmetry, differential transaction costs, default costs, and progressive corporate taxes.

The choice between a forward market hedge and a money market hedge often comes down to Multiple Choice none of the options option pricing. flexibility and availability. interest rate parity.

interest rate parity.

An exporter can shift exchange rate risk to their customers by Multiple Choice splitting the difference, and invoicing half of sales in local currency and half of sales in home currency. invoicing sales in a currency basket such as the SDR as the invoice currency. invoicing in their customer's local currency. invoicing in their home currency.

invoicing in their home currency.

With respect to information asymmetry, none of the options management knows about the firm's exposure position much better than stockholders, and therefore should be the ones to manage exchange exposure. regulators know about the firm's exposure position much better than management, and therefore should be the ones to oversee exchange exposure. stockholders know about the firm's exposure position much better than management, and therefore should be the ones to manage exchange exposure.

management knows about the firm's exposure position much better than stockholders, and therefore should be the ones to manage exchange exposure.

With any successful hedge, Multiple Choice you are guaranteed to lose money on one side. you can avoid the accounting ramifications of a loss on one side by keeping it off the books. you are guaranteed to lose money on one side, but you can avoid the accounting ramifications of a loss on one side by keeping it off the books. none of the options

none of the options

Contingent exposure can best be hedged with futures. all of the options money market hedging. options.

options.

A study of Fortune 500 firms hedging practices shows that Multiple Choice over 90 percent of Fortune 500 firms use both forward and options contracts. over 90 percent of Fortune 500 firms use forward contracts. over 90 percent of Fortune 500 firms use options contracts. none of the options

over 90 percent of Fortune 500 firms use forward contracts.

An exporter faced with exposure to an appreciating currency can reduce transaction exposure with a strategy of Multiple Choice paying early, collecting late. paying or collecting early. paying late, collecting early. paying or collecting late.

paying early, collecting late.

An exporter faced with exposure to a depreciating currency can reduce transaction exposure with a strategy of paying late, collecting early. paying early, collecting late. paying or collecting late. paying or collecting early.

paying late, collecting early.

In evaluating the pros and cons of corporate risk management, one argument against hedging is Multiple Choice if the corporate guys were good at forecasting exchange rates, they would make more money on Wall Street, so only incompetent managers are left at corporations to hedge. the hedging costs go into someone else's pocket. none of the options shareholders who are diversified have already managed their exchange rate risk.`

shareholders who are diversified have already managed their exchange rate risk.

An exporter can share exchange rate risk with their customers by Multiple Choice invoicing in their customer's local currency. splitting the difference, and invoicing half of sales in local currency and half of sales in home currency, as well as invoicing sales in a currency basket such as the SDR as the invoice currency. invoicing sales in a currency basket such as the SDR as the invoice currency. splitting the difference, and invoicing half of sales in local currency and half of sales in home currency.

splitting the difference, and invoicing half of sales in local currency and half of sales in home currency, as well as invoicing sales in a currency basket such as the SDR as the invoice currency.

Since a corporation can hedge exchange rate exposure at low cost there is no benefit to the shareholders in an efficient market. none of the options shareholders would benefit from the risk reduction that hedging offers. the corporation's banker would benefit from the risk reduction that hedging offers.

the corporation's banker would benefit from the risk reduction that hedging offers.

A 5-year swap contract can be viewed as a portfolio of 5 forward contracts with maturities of 1, 2, 3, 4 and 5 years. One important exception is that the forward price is the same for the swap contract but not for the forward contracts. none of the options the forward contracts will have resettlement risk. the swap contract will have daily resettlement.

the forward price is the same for the swap contract but not for the forward contracts.

ransaction exposure is defined as Multiple Choice the sensitivity of realized domestic currency values of the firm's contractual cash flows denominated in foreign currencies to unexpected exchange rate changes. ex post and ex ante currency exposures. the extent to which the value of the firm would be affected by unanticipated changes in exchange rate. the potential that the firm's consolidated financial statement can be affected by changes in exchange rates.

the sensitivity of realized domestic currency values of the firm's contractual cash flows denominated in foreign currencies to unexpected exchange rate changes.

If a firm faces progressive tax rates, none of the options they should manage their income recognition without regard to their taxes. they should spread income out across time and subsidiaries. they should focus on maximizing income in one division or subsidiary.

they should spread income out across time and subsidiaries.

The sensitivity of "realized" domestic currency values of the firm's contractual cash flows denominated in foreign currency to unexpected changes in the exchange rate is Multiple Choice transaction exposure. none of the options translation exposure. economic exposure.

transaction exposure.

A CFO should be least worried about Multiple Choice none of the options translation exposure. transaction exposure. economic exposure.

translation exposure.

The sensitivity of the firm's consolidated financial statements to unexpected changes in the exchange rate is transaction exposure. none of the options translation exposure. economic exposure.

translation exposure.

With any hedge, Multiple Choice your losses on one side should about equal your gains on the other side. you should spend at least as much time working the hedge as working the underlying deal itself. you should agree to anything your banker puts in front of your face. you should try to make money on both sides of the transaction; that way you make money coming and going.

your losses on one side should about equal your gains on the other side.