FIN 4604 Final Exam

Prof. Wiendl says that the percentage change in an exchange rate can be best expressed and calculated as:

"tomorrow's rate minus today's rate, over today's rate"

Bid/ask spread (in percentage terms) =

(Ask rate - Bid rate) / Ask rate

The correct expression of the 90-day forward premium or discount is:

(forward rate - spot rate) / spot rate * 4

The most correct presentation of a currency's appreciation or depreciation is found or expressed in percentage terms by:

(new rate - old rate) / old rate (new-old)/old (tomorrow-today)/today (today-yesterday)/yesterday

VaR Analysis assumes: --exchange rate movement probabilities have a normal distribution --standard deviation of exchange rate movements is stable over time --use of only a one-tailed probability distribution --(all of the above / other answers are correct) --(none of the other answers are correct)

--(all of the above / other answers are correct)

T/F: In Fundamental forecasting, if regression analysis is used to try to find statistically significant input variables and their coefficients....those coefficients can be counted on to remain constant over time.

False

T/F: When currency A appreciates against the dollar by a greater degree than does currency B, then currency A depreciates against B

False

T/F: When the currency denominating international money market securities differs from the home currency of the investors in the market, the primary risk to investors who provide capital to that market (i.e., by buying short-term corporate and government bonds) is credit risk.

False

a. Discuss the development of a probability distribution of effective financing rates when financing in a foreign currency. How is this distribution developed? b. Once the probability distribution of effective financing rates from financing in a foreign currency is developed, how can this distribution be used in deciding whether to finance in the foreign currency or the home currency?

First, a probability distribution of exchange rate changes is created. Using this along with the foreign currency's quoted interest rate, the probability distribution of effective financing rates can be developed. A distribution of effective financing rates can be used to determine the probability that foreign financing will be more costly than domestic financing. Then, the final decision will depend on the firm's degree of risk aversion.

The relationship between real interest rates, nominal interest rates, and inflation is known as or expressed as:

Fisher Effect

GATT accord

General Agreement on Tariffs and Trade called for reduction or elimination of trade restrictions on specified imported goods over a ten year period across 117 countries

. How can a U.S. firm finance in euros and not necessarily be exposed to exchange rate risk?

How can a U.S. firm finance in euros and not necessarily be exposed to exchange rate risk?

T/F: Forward rates are frequently not available in financial newspapers. However, an analyst can use interest rate parity and the published risk-free (or near risk-free) debt instruments issued by various governments (of similar length to maturity) to determine what the forward rates "should" be for those similar time periods.

TRUE

T/F: A put option premium will be very cheap if the prevailing exchange rate is high above the strike price.

True

T/F: ADR's are intended to track their home country stock by formula, and any temporary differences are quickly arbitraged away by the market.

True

T/F: If a bank begins to experience a shortage of a particular foreign currency, it can purchase that currency from other banks. This trading between banks occurs in what is often referred to as the interbank market.

True

Part 1: Fill in the blank from the text: "...the focus in this text is the U.S. perspective. So unless specified otherwise, the "exchange rate" of any currency is the rate at which it can be exchanged for ______." Part 2: the above quote is an allusion to _______.

U.S. dollars; a direct style quotation

Which agency or organization provides a forum for multilateral trade negotiations and to settle trade disputes related to the GATT accord ?

World Trade Organization

Agency costs are normally larger for MNC's. Large MNC agency costs can be increased by / include:

a high number of distant subsidiaries

notional value

a valuation to which interest rates can be applied on a periodic basis to determine the net interest that will be paid by one party to another party

letter of credit (L/C)

an instrument issued by a bank on behalf of the importer (buyer) promising to pay the exporter (beneficiary) upon presentation of shipping documents in compliance with the terms stipulated therein

The textbook's valuation model that values a U.S. MNC's cash flows requires a special step. What is it?:

apply an exchange rate(s) to the foreign currency cash flow(s)

An effective graphical means by which the textbook consistently evaluates hedging analysis outcomes side-by-side is:

bar charts

Which is not a securities derivative: put option future forward swap bond

bond

Eurobonds

bonds that are sold in countries other than the country whose currency is used to denominate the bonds

What hedging instruments can be used to manage translation exposure ?

both forwards and futures

current account

broad measure of a country's international trade in goods and services

Where in the U.S.'s Balance of Payments does the following event get recorded?: U.S. MNC in Texas relocates a large fleet of vehicles from the U.S. to an office in Mexico

capital account

Investors attempt to capitalize on the differential in interest rates between two countries. This is known as:

carry trade

The strategy of borrowing a currency with a low interest rate and investing the funds in a currency in a high interest rate for periods as short as a day or as long as several months ?

carry trade

All of the following are factors that influence exchange rates except: change in experience levels change in government controls change in inflation differential change in income level differential change in interest rate differential

change in experience levels

Which of the following is not a factor affecting international trade flows ? changes in relative interest rate differentials cost of labor inflation national income government policies exchange rates

changes in relative interest rate differentials

Firms may invest time forecasting exchange rates for all of the following reasons except: predict or estimate earnings long-term financing decisions confirm forward rate market pricing to incorporate into hedging strategies capital investment allocation problem / budgeting

confirm forward rate market pricing

When one country experiences weak economic conditions, its consumers tend to reduce their demand for both local and foreign products. Credit risk of local firms increases because economic weakness reduces revenue and earnings, making it harder to repay loans. As a country's consumers reduce their demand for foreign products & services, the producers in those countries may have similar problems repaying their loans in their own foreign country. This domino effect is called....?

credit contagion

The contractual right to sell a currency at a particular exchange rate, by or before a specific expiration date...such right typically being used/purchased by its holder to hedge against currency risk of/on future receivables (i.e., receivables in a foreign currency)...is called a:

currency put option

A U.S. investor receives an interest payment from an investment in a French corporate bond. Which balance of payments account includes this activity?

current account

Where in the U.S.'s Balance of Payments does the following event get recorded?: A hedge fund manager in London receives a cash dividend on the stock of a U.S. MNC

current account

To access debt capital in Europe for terms >1 year, MNC's or governments have the option of borrowing from financial institutions. This kind of activity is generally called:

eurocredits

T/F: Currency correlations change over time; previous correlations cannot predict future correlations; and some general relationships / correlation patterns do not tend to hold over time and should therefore be disregarded.

false

T/F: If the firm does not have excess cash in the prior example, then it cannot due a money market hedge

false

T/F: The concept of economic exposure to exchange rates is defined as the sensitivity of the firm's contractual transactions in foreign currencies

false

T/F: Translation exposure can hurt earnings performance because it can depress cash flows from a subsidiary

false

T/F: We can directly observe the inflation rate in a country.

false

T/F: an MNC can assess its complete economic exposure to exchange rate movements by determining the sensitivity of its revenues to various possible exchange rate scenarios

false

T/F: if we assume that IRP holds and there are no transaction costs, then a money market hedge will perform better generally than a forward hedge.

false

T/F: in theory, IRP is affected by real interest rates.

false

Direct foreign investment (DFI) activity is accounted for in what balance of payments account ?

financial account

The concept that suggests that forecast errors are typically much larger for forecasts 12 months out than (for example) forecasts 3 months out is:

forecast errors among time horizons

indirect quotation

foreign/home number of units of a foreign currency per dollar

Fill in the blank: A _______ contract is an agreement between (e.g.) an MNC and a FOREX dealer that specifies the currencies to be exchanged, the exchange rate, and the date of delivery.

forward

Standard ways by which an Non-U.S. MNC (e.g., based in Mexico) may issue securities and access the international capital markets include all of the following except: forwards and futures eurobonds foreign bonds yankee stock offerings American depository receipts

forwards and futures

Futures markets differ from forward markets by all of the following except: futures typically based on the euro futures offer greater liquidity futures commonly traded on the CME futures traded in standard unit sizes

futures typically based on the euro

If U.S. income levels are rising relative to those in the U.K., the supply/demand effects will include:

greater U.S. demand for British pounds

A characteristic of a futures contract is: heavily traded tailor made executed on the phone customized delivery date

heavily traded

Firms use currency call options for all of the following except: hedge costs of creation of subsidiaries hedge payables hedge project bidding (protect expenditures) hedge FDI acquisition bids

hedge costs of creation of subsidiaries

The implications of currency correlations for a particular MNC depend on its cash flow characteristics. If an MNC has positive net cash flows in various currencies that are highly correlated, it may be exposed to a relatively ____ level of exchange rate risk...because there are no offsetting exchange rate effects. To the extent that there are offsetting cash flows in highly-correlated currencies, the overall risk is ___.

high; reduced

direct quotation

home/foreign value of foreign currency in dollars

The idea that a country's distinct factors of production characteristics may be relatively immobile is an observation used in what theory of why companies will pursue international business?:

imperfect markets

All of the following are goals of managing economic exposure, except... increasing interest earned stabilizing earnings reducing cost of capital increaasing MNC value improving cash flow reducing risk

increasing interest earned

Alternative methods of hedging that Prof. Wiendl wants you to be aware of include all of the following except: cross-hedging currency diversification leading lagging indifference

indifference

The most fundamental manner in which MNC's engage in international business is:

international trade

Pick the best combination of two methods of participating in international business described below: a) first method: "capital light," low risk, transactional, short-term, few human resource or monetary entanglements b) second method: capital intensive, difficult to withdraw investment, longer term, transactional

international trade AND acquisitions

Methods of indirect government intervention include all of the following except: non-sterilized intervention changing interest rates restrictions on the exchange of currency warnings and policy announcements

non-sterilized intervention

For a call option on a foreign currency, if the strike price is greater that the spot rate, then the option is:

out of the money

A situation in which an MNC creates a hedge for a larger number of transaction units (i.e., sales or purchases) than it really needs is called....

overhedging

Which is not a factor that can influence a currency's spot rate: --change in the differential between the US interest rate and the foreign country's interest rate --change in the differential between the US income level and the foreign country's income level --change in government controls --percentage change in the spot rate

percentage change in the spot rate

Value-at-risk (VaR):

pg 331 method for assessing exposure measures the maximum possible (one-day) loss on the value of positions held by an MNC that is exposed to exchange rate movements

An U.S. MNC's foreign cash flows are subject to which of the following distinctive risks:

political risk

Fill in blank: The international Money Market consists of the market of ________.

public (govt.) and private debt securities (i.e., notes) with maturities one year or less

Which of the following techniques is most likely to be part of an analyst's / forecaster's fundamental forecasting approach ?

regression analysis

capital account

represents a summary of the flow of funds between one specified country and all other countries due to purchases of goods and services or to the cash flows generated by income-producing financial assets

Which is NOT a factor that affects international trade flows?:

risk-free interest rate

The practice that some MNC's frequently employ in which hedging is considered for each transaction individually is called...

selective hedging

Fundamental forecasting technique may include analysis of which of the following:

shifts in expectations of currency exchange rates

A fourth factor governing exchange rates is government controls. Which of the following is not an example of how a foreign government can affect its U.S. exchange rate ?

speculating in the futures market

A forward contract will specify all of the following except... date of delivery denomination of currency given denomination of currency received forward rate spot rate

spot rate

Options for hedging exposure to a single payable includes all of the following except... international money market hedge forward hedge currency option hedge strategic hedging futures hedge

strategic hedging

All else equal, an increase in inflation in the U.K. will have what effect on supply and demand or FOREX market equilibrium point of the $US relative to the British pound:

supply of $US will decrease

Rising U.S. Inflation would have what effect on the supply of British pounds available for exchange to $US ?

supply of British pounds decreases

Fill in the blank: when the value of a foreign currency "X" is high, consumers of country X are more willing to ______ X for exchange for ________ in order to ____ U.S. goods...

supply; U.S. dollars; buy

imperfect market

the condition where, due to the costs to transfer labor and other resources used for production, firms may attempt to use foreign factors of production when they are less costly than local factors

Market-based forecasting depends heavily on the use of market quotes in:

the forward market

FOREX Market Analysts at an MNC or elsewhere spend a significant amount of time building models based on historical data, and then try to apply those models to the future to make predictions. A key means by which analysts come to understand the relative strength of their models or process, or how accurate they are (or are not), requires a study of (best answer):

the model's/process's forecast errors

product cycle theory

theory suggesting that a firm initially establishes itself locally and expands into foreign markets in response to foreign demand for its product; over time, the MNC will grow in foreign markets; after some point, its foreign business may decline unless it can differentiate its product from competitors

comparative advantage

theory suggesting that specialization by countries can increase worldwide production

The balance of payments formula includes all of the following components except: transfer account current account capital account financial account

transfer account

Capitalizing on discrepancies in cross exchange rates is called:

triangular arbitrage

Forecasting techniques that analysts may employ include all of the following except: triangular arbitrage fundamental / "absolute" mixed / composite market-based / "relative" technical (chartists)

triangular arbitrage

T/F: A major tenet of PPP theory is that as soon as prices become relatively higher in the home country (e.g., the USA), consumers in the foreign country (e.g., the UK) will stop buying US goods and instead purchase UK goods. This shift affects the exchange rate. This assumes that SUBSTITUTES are available.

true

T/F: A money market hedge on payables involves taking a money market position to cover a future payables position. ***If a firm has excess cash,*** then it can create a simple money market hedge by (i) converting just enough cash ($US) at the current spot rate to the currency payable, and then (ii) put that foreign currency to work in the international spot market at a known interest rate such that the total principal and accrued interest equals the payable amount on the payable due date.

true

T/F: An MNC can hedge exposure to fixed assets by matching opposing cash flows with a long-term hedge or on a long-term loan to the expected sale and value of the asset.

true

T/F: Changes in demand and supply schedules of a foreign currency force a change in the equilibrium exchange rate in the foreign exchange market.

true

T/F: In using the Fisher Effect to predict exchange rate movements, the derivation suggests that you must first know the nominal interest rates, assume that real interest rates are the same in both countries, then deduce the EXPECTED inflation rates, and then apply PPP to predict the effect on exchange rates.

true

T/F: The guidelines for accounting translations are set by FASB 52. AQn MNC's degree of exposure is strongly affected by accounting procedures used to translate accounting information from overseas operations when consolidated financial statements are presented.

true

T/F: the PPP theory suggests that the exchange rate will not remain constant but will adjust to maintain the parity in purchasing power

true

Euronotes

unsecured debt securities issued by MNCs for short-term financing

Which factor that affects the bid-ask spread results from/with currencies that have highly liquid markets with numerous buyers and numerous sellers at any time? volume order costs competition currency risk inventory costs

volume

interest rate parity

when market forces cause interest rates and exchange rates to adjust such that covered interest arbitrage is no longer feasible, equilibrium state; forward rate differs from the spot rate by a sufficient amount to offset the interest rate differential between two currencies

Giving someone the right to buy a specific currency at a designated strike price within a specific period of time is:

writing a call option

IFE Theory is inconsistent with which of the following: --Chapter 4 arguments re: how a country wit high interest rates can attract capital flows and strengthen the currency --Chapter 6 arguments re: how a central bank can may purposefully raise interest rates in order to attract funds and strengthen the local currency --Higher interest rates seen in a foreign market are attributable to changes in income levels or government controls --All of the other responses are correct

--All of the other responses are correct

Factors Affecting International Trade Flows

--cost of labor --inflation --national income --credit conditions --government policies --exchange rates

B/L usually includes the following provisions:

--description of the merchandise --identification marks on the merchandise --evidence of loading (receiving) ports --name of the exporter (shipper) --name of the importer --status of freight charges (prepaid or collect) --date of shipment

financial account components:

--direct foreign investment --portfolio investment --other capital investment

Currency's spot rate is influenced by:

--inflation differential --interest rate differential --income level differential --change in government controls --change in expectations of future exchange rates

An MNC must consider the following criteria when it decides which currency to borrow:

--interest rate parity --the forward rate as a forecast --exchange rate forecasts

Methods to conduct international business:

--international trade --licensing --franchising --joint ventures --acquisitions of existing operations --establishment of new foreign subsidiaries

Commercial invoice normally contains the following information:

--name and address of seller --name and address of buyer --date --terms of payment --price (including freight, handling, and insurance if applicable) --quantity, weight, packaging, etc. --shipping information

Methods available for forecasting exchange rates:

--technical --fundamental --market-based --mixed

Reasons for government intervention may include all of the following except: --to slow the velocity of money --to smooth exchange rate movements --to establish exchange rate boundaries implicitly or explicitly --to respond to shocks

--to slow the velocity of money

Central banks commonly manage exchange rates for three reasons:

--to smooth exchange rate movements --to establish implicit exchange rate boundaries --to respond to temporary disturbances

The notion that specialization by countries can increase production efficiency is supported by which theory of international business?

??? Imperfect Markets Theory ??? Theory of Competitive Advantage CORRECT ANSWER SHOULD BE COMPARATIVE ADVANTAGE

A ___ can be used as a forecast of the spot rate that will exist at a future date, because the current exchange rate (and an efficient market) should reflect the expectations of the currency exchange rate movements in the near future.

???? spot rate

Explain why an MNC parent would consider financing from its subsidiaries.

A parent may obtain funds at a lower cost from its subsidiaries than from a bank, since a bank will maintain a spread between what it offers depositors and charges on loans.

Exchange rate systems include all of the following except: Bracketed Fixed Freely Floating Pegged

Bracketed

$US Dollar deposits made in/to European banks in Europe and on other continents by U.S. companies in order to facilitate U.S. trade objectives in Europe...(with the added benefit of those European banks having deposits of U.S. currency that they then lent to European concerns so that they could buy U.S. goods and services) are called _________.

Eurodollars

A factor that does NOT affect a FOREX dealer's bid/ask spread is: Currency risk Order Costs Exchange rate risk Volume Competition Inventory Costs

Exchange rate risk

What is a potential advantage to/for an MNC of operating in a fixed exchange rate system?

MNC's can engage in DFI without currency risk

This is an organization with member countries that have market economics; it facilitate governance in corporations and in governments; is specifically pro-globalization:

OECD

An MNC can restructure its operations to reduce economic exposure. Relevant questions ould include all of the following except: Should we move more sourcing to overseas vendors? Should it build factories overseas? Should it change its product portfolio? Should it reduce sales people overseas?

Should it change its product portfolio?

Even with the wider bands allowed by the _________, governments still had difficulty maintaining exchange rates within the stated boundaries. By year ____, the official boundaries imposed by the above agreement were eliminated.

Smithsonian Agreement; 1973

Firms are exposed to all of the following forms of exchange rate exposure except... accounting transaction economic translation

accounting

What is a method of International business in which an MNC can quickly gain control over foreign operations and quickly acquire a share of the foreign market ?

acquisitions of existing operations

Different types of international business risk include all of the following except: agency risk exchange rate risk political risk foreign economic risk

agency risk

If conditions were to disincentivize British firms, consumers, and government agencies from buying U.S. goods and services, this would result in a _____.

decrease in supply of British pounds

Demand for a currency increases when the value of the currency ______, leading to a downward sloping demand schedule.

decreases

rising U.S. inflation would have what effect on the U.S. demand for British pounds ?

demand for British pounds increases

bill of lading (B/L)

document serving as a receipt for shipment and a summary of freight charges and conveying title to the merchandise

Disadvantages of a freely floating exchange rate system include all of the following except: --does not require central bank to maintain exchange rates within specified boundaries --can adversely affect a country that has high unemployment --can adversely affect a country that has high inflation --MNC's are fully exposed to currency fluctuations --Central banks cannot directly intervene

does not require central bank to maintain exchange rates within specified boundaries

Eurodollars

dollar deposits in banks in Europe (and on other continents)

Scenario: we sell products in the USA to our local customers, and our competitor is in Poland. The euro depreciates. Our currency exposure (if any) is:

economic

Any US-based MNC could require that all international sales transactions be in dollars to avoid transaction exposure. However, they may still may be exposed to exchange rate risk due to:

economic exposure

A weakening U.S. currency may not improve America's balance of trade. After all, a U.S. MNC may have 1.5-to-2 years of foreign transaction commitments that it must complete in the face of the weakening currency, regardless of FOREX rate trends. Therefore down the road, U.S. MNC's may need more US$'s to meet those fixed-value transactional commitments denominated in the foreign currency. Therefore the trade balance may further decline for a while even though the US$ is weakening. The graphical representation of this effect is called:

j-curve

Eurocredit loans

loans of one year or longer that are extended by banks to MNCs or government agencies in Europe

The main goal of an MNC is to:

maximize shareholder wealth

In general, ______ in any particular country vary due to differences in the interaction of (i) the total supply of short-term funds available provided by savers via bank deposits, with (ii) the demand of short-term funds by borrowers.

money market interest rates

The Fisher Effect is named after economist Irving Fisher and suggests that the real rate of interest is defined as the return on investment to savers after an adjustment; it is measured as the ___ minus the ___.

nominal interest rate; expected inflation rate