International Test 2

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.

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.

T or F: A company may become more exposed or sensitive to an individual currency's movements over time for several reasons, including a reduction in hedging, a greater involvement in the foreign country, or an increased use of the foreign currency.

True

TRUE or FALSE: If the international Fisher effect (IFE) holds, the local investors are expected to earn the same return from investing internationally as they would from investing in their local markets.

True

TRUE or False: Research indicates that deviations from purchasing power parity (PPP) are reduced over the long run.

True

If the interest rate is lower in the U.S. than in the United Kingdom, and if the forward rate of the British pound is the same as its spot rate:

U.S. investors could possibly benefit from covered interest arbitrage.

Assume the U.S. interest rate is 2% higher than the Swiss rate, and the forward rate of the Swiss franc has a 4% premium. Given this information:

U.S. investors who attempt covered interest arbitrage earn a higher rate of return than if they invested in the U.S.

Assume that the U.S. interest rate is 10%, while the British interest rate is 15%. If interest rate parity exists, then:

U.S. investors will earn 10% whether they use covered interest arbitrage or invest in the U.S.

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.

benefit; appreciation

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

benefit; strengthens

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.

If Lazer Co. desired to lock in the maximum it would have to pay for its net payables in euros but wanted to be able to capitalize if the euro depreciates substantially against the dollar by the time payment is to be made, the most appropriate hedge would be:

purchasing euro call options.

Which theory suggests that the percentage change in spot exchange rate of a currency should be equal to the inflation differential between two countries?

purchasing power parity (PPP).

Latin American countries have historically experienced relatively high inflation, and their currencies have weakened. This information is somewhat consistent with the concept of:

purchasing power parity.

The Fisher effect is used to determine the:

real interest rate

Because there are a variety of factors in addition to inflation that affect exchange rates, this will:

reduce the probability that PPP shall hold.

Because there are sometimes no substitutes for traded goods, this will:

reduce the probability that PPP shall hold.

Assume that the New Zealand inflation rate is higher than the U.S. inflation rate. This will cause U.S. consumers to ____ their imports from New Zealand and New Zealand consumers to ____ their imports from the U.S. According to purchasing power parity (PPP), this will result in a(n) ____ of the New Zealand dollar (NZ$).

reduce; increase; depreciation

Any restructuring of operations that ____ the difference between a foreign currency's inflows and outflows may ____ economic exposure.

reduces; reduce

Linden Co. has 1,000,000 euros as payables due in 90 days, and is certain that euro is going to depreciate substantially over time. Assuming the firm is correct, the ideal strategy is to:

remain unhedged

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.

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.

sell the currency forward

If Salerno Inc. desired to lock in a minimum rate at which it could sell its net receivables in Japanese yen but wanted to be able to capitalize if the yen appreciates substantially against the dollar by the time payment arrives, the most appropriate hedge would be:

selling yen put options.

A fundamental forecast that uses multiple values of the influential factors is an example of:

sensitivity analysis.

If the international Fisher effect (IFE) did not hold based on historical data, then this suggests that:

some corporations with excess cash could have generated higher profits on average from foreign short-term investments than from domestic short-term investments.

Assume that a U.S. firm can invest funds for one year in the U.S. at 12% or invest funds in Mexico at 14%. The spot rate of the peso is $.10 while the one-year forward rate of the peso is $.10. If U.S. firms attempt to use covered interest arbitrage, what forces should occur? Spot rate increase/decrease? Forward rate increase/decrease?

spot rate of peso increases; forward rate of peso decreases.

Translation losses are ____, while gains on forward contracts used to hedge translation exposure are ____.

tax deductible; taxed

If it was determined that the movement of exchange rates was not related to previous exchange rate values, this implies that a ____ is not valuable for speculating on expected exchange rate movements.

technical forecast technique

Which technique would best represent the sole use of the pattern of historical currency values of the euro to predict the euro's future currency value?

technical forecasting.

According to the IFE, if British interest rates exceed U.S. interest rates:

the British pound will depreciate against the dollar.

According to the international Fisher effect (IFE):

the exchange rate adjusted rate of return on a foreign investment should be equal to the interest rate on a local money market investment.

Economic exposure refers to:

the exposure of a firm's cash flows to exchange rate fluctuations

Translation exposure reflects:

the exposure of a firm's financial statements to exchange rate fluctuations.

Transaction exposure reflects:

the exposure of a firm's international contractual transactions to exchange rate fluctuations.

According to interest rate parity (IRP):

the forward rate differs from the spot rate by a sufficient amount to offset the interest rate differential between two currencies.

If the forward rate was expected to be an unbiased estimate of the future spot rate, and interest rate parity holds, then:

the international Fisher effect (IFE) is supported.

The real cost of hedging payables with a forward contract equals:

the nominal cost of hedging minus the nominal cost of not hedging.

If interest rates on the euro are consistently below U.S. interest rates, then for the international Fisher effect (IFE) to hold:

the value of the euro would often appreciate against the dollar.

Which of the following is not one of the major reasons for MNCs to forecast exchange rates?

to speculate on the exchange rate movements.

Which of the following might discourage covered interest arbitrage even if interest rate parity does not exist?

transaction costs. political risk. differential tax laws.

If a firm does not have foreign subsidiaries, it is not subject to ____.

translation exposure

Due to ____, market forces should realign the cross exchange rate between two foreign currencies based on the spot exchange rates of the two currencies against the U.S. dollar.

triangular arbitrage

Assume that Swiss investors are benefiting from covered interest arbitrage due to a high U.S. interest rate. Which of the following forces results from the act of this covered interest arbitrage? Upward/downward pressure on...?

upward pressure on the Swiss franc's forward rate.

Assume zero transaction costs. If the 90-day forward rate of the euro is an accurate estimate of the spot rate 90 days from now, then the real cost of hedging payables will be:

zero.

Due to ____, market forces should realign the relationship between the interest rate differential of two currencies and the forward premium (or discount) on the forward exchange rate between the two currencies.

covered interest arbitrage

If interest rate parity exists, then ____ is not feasible.

covered interest arbitrage

When using ____, funds are typically tied up for a significant period of time.

covered interest arbitrage

The ____ does not represent an obligation.

currency option

Assume that the U.S. interest rate is 11 percent, while Australia's one-year interest rate is 12 percent. Assume interest rate parity holds. If the one-year forward rate of the Australian dollar was used to forecast the future spot rate, the forecast would reflect an expectation of:

depreciation in the Australian dollar's value over the next year.

Assume that the interest rate in the home country of Currency X is a much higher interest rate than the U.S. interest rate. According to interest rate parity, the forward rate of Currency X: should exhibit a premium or discount?

discount

Assume that the U.S. investors are benefiting from covered interest arbitrage due to high interest rates on euros. Which of the following forces should result from the act of this covered interest arbitrage? Upward/downward pressure on...?

downward pressure on the euro's forward rate.

If interest rate parity exists, and transaction costs do not exist, the money market hedge will yield the same result as the ____ hedge.

forward

Factors such as economic growth, inflation, and interest rates are an integral part of ____ forecasting.

fundamental

Purchasing power parity is used in:

fundamental forecasting.

Which technique would best represent the use of relationships between economic factors and exchange rate movements to forecast the future exchange rate?

fundamental forecasting.

A ____ is not normally used for hedging long-term transaction exposure.

futures contract

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

If speculators expect the spot rate of the yen in 60 days to be ____ than the 60-day forward rate on the yen, they will ____ the yen forward and put ____ pressure on the yen's forward rate. higher, _____ , _____ .

higher; buy; upward

Monson Co., based in the U.S., exports products to Japan denominated in yen. If the forecasted value of the yen is substantially ____ than the forward rate, Monson Co. will likely decide ____ the payments.

higher; not to hedge

According to the international Fisher effect, if Venezuela has a much higher nominal rate than other countries, its inflation rate will likely be ____ than other countries, and its currency will ____.

higher; weaken

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.

Assume that the U.S. inflation rate is higher than the New Zealand inflation rate. This will cause U.S. consumers to ____ their imports from New Zealand and New Zealand consumers to ____ their imports from the U.S. According to purchasing power parity (PPP), this will result in a(n) ____ of the New Zealand dollar (NZ$).

increase; reduce; appreciation

The ____ hedge is not a technique to eliminate transaction exposure discussed in your text.

index

Which theory can be assessed using data that exists at one specific point in time?

interest rate parity (IRP).

Which theory suggests that the percentage difference between the forward rate and the spot rate depends on the interest rate differential between two countries?

interest rate parity (IRP).

Which theory suggests the percentage change in spot exchange rate of a currency should be equal to the interest rate differential between two countries?

international Fisher effect (IFE).

Which of the following operations benefit(s) from depreciation of the firm's local currency?

investing in foreign bank accounts denominated in foreign currencies prior to depreciation of the local currency.

According to the international Fisher effect, if investors in all countries require the same real rate of return, the differential in nominal interest rates between any two countries:

is due to their inflation differentials.

When the value from the prior period of an influential factor affects the forecast in the future period, this is an example of a(n):

lagged input.

Based on interest rate parity, the larger the degree by which the foreign interest rate exceeds the U.S. interest rate, the:

larger will be the forward discount of the foreign currency.

Based on interest rate parity, the larger the degree by which the U.S. interest rate exceeds the foreign interest rate, the:

larger will be the forward premium of the foreign currency.

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.

less; fewer

Due to ____, market forces should realign the spot rate of a currency among banks.

locational arbitrage

When using ____, funds are not tied up for any length of time.

locational arbitrage; triangular arbitrage

As opposed to transaction exposure, managing economic exposure involves developing a(n) ____ solution.

long-term

Assume that the U.S. and Chile nominal interest rates are equal. Then, the U.S. nominal interest rate decreases while the Chilean nominal interest rate remains stable. According to the international Fisher effect, this implies expectations of ____ than before, and that the Chilean peso should ____ against the dollar.

lower U.S. inflation; depreciate

If speculators expect the spot rate of the Canadian dollar in 30 days to be ____ than the 30-day forward rate on Canadian dollars, they will ____ Canadian dollars forward and put ____ pressure on the Canadian dollar forward rate. _____, sell, ______ .

lower; sell; downward

Which technique would best represent sole use of today's spot exchange rate of the euro to forecast the euro's future exchange rate?

market-based forecasting.

Which technique would best represent the use of today's forward exchange rate to forecast the future exchange rate?

market-based forecasting.

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

more difficult than

Assume zero transaction costs. If the 90-day forward rate of the euro underestimates the spot rate 90 days from now, then the real cost of hedging payables will be:

negative.

To hedge a contingent exposure, in which an MNC's exposure is contingent on a specific event occurring, the appropriate hedge would be a(n) ____ hedge.

options

If a particular currency is consistently declining substantially over time, then a market-based forecast will usually have:

overestimated the future exchange rates over time.

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

payable; purchase

Assume zero transaction costs. If the 180-day forward rate overestimates the spot rate 180 days from now, then the real cost of hedging payables will be:

positive.

Assume that interest rate parity holds. U.S. interest rate is 13% and British interest rate is 10%. The forward rate on British pounds exhibits a premium or discount?

premium

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.

According to the international Fisher effect, if U.S. investors expect a 5% rate of domestic inflation over one year, and a 2% rate of inflation in European countries that use the euro, and require a 3% real return on investments over one year, the nominal interest rate on one-year U.S. Treasury securities would be:

8%.

If the interest rate is higher in the U.S. than in the United Kingdom, and if the forward rate of the British pound (in U.S. dollars) is the same as the pound's spot rate, then:

British investors could possibly benefit from covered interest arbitrage.

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

Economic exposure

TRUE or FALSE: Assume a two-country world: Country A and Country B. If Country B's inflation rate exceeds Country A's inflation rate, Country A's currency will weaken.

FALSE

When is locational arbitrage most likely be feasible?

One bank's bid price for a currency is greater than another bank's ask price for the currency.

Jacko Co. is a U.S.-based MNC with net cash inflows of euros and net cash inflows of Sunland francs. These two currencies are highly negatively correlated in their movements against the dollar. Kriner Co. is a U.S.-based MNC that has the same exposure as Jacko Co. in these currencies, except that its Sunland francs represent cash outflows. Which firm has a high exposure to exchange rate risk?

Kriner Co.

Economic exposure can affect:

MNCs and purely domestic firms

Assume you discovered an opportunity for locational arbitrage involving two banks and have taken advantage of it. Because of your and other arbitrageurs' actions, the following adjustments must take place.

One bank's ask price will rise and the other bank's bid price will fall.

TRUE or FALSE: Assume a two-country world: Country A and Country B. If Country A's inflation rate exceeds Country B's inflation rate, Country A's currency will weaken.

TRUE

Covered interest arbitrage opportunities only exist when...

The foreign interest rate is higher than the interest rate in the home country.

____ exposure is the degree to which the value of contractual transactions can be affected by exchange rate fluctuations.

Transaction

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

Translation

Limitation of fundamental forecasting?

Uncertain timing of impact. Omission of other relevant factors from the model. Possible change in sensitivity of the forecasted variable to each factor over time.

Given a home country and a foreign country, purchasing power parity (PPP) suggests that:

a home currency will depreciate if the current home inflation rate exceeds the current foreign inflation rate.

The international Fisher effect (IFE) suggests that:

a home currency will depreciate if the current home interest rate exceeds the current foreign interest rate.

If an MNC invests excess cash in a foreign county, it would like the foreign currency to ____; if an MNC issues bonds denominated in a foreign currency, it would like the foreign currency to ____.

appreciate; depreciate

With regard to hedging translation exposure, translation losses ____, and gains on forward contracts used to hedge translation exposure ____.

are not tax deductible; are taxed

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.

economic

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.

economic; transaction

If interest rate parity holds, then the one-year forward rate of a currency will be ____ the predicted spot rate of the currency in one year according to the international Fisher effect.

equal to

Purchasing power parity (PPP) does not consistently occur are:

exchange rates are affected by interest rate differentials. exchange rates are affected by national income differentials and government controls. supply and demand may not adjust if no substitutable goods are available.