FIN 312- Exam 2 (section 16-21)

Question 1

The current exchange rates at which specific currencies can be bought or sold on currency exchange markets

Answer 1

Spot rates
(normally between 2 countries)

Question 2

The rate at which one currency will be exchanged for another

Answer 2

exchange rate
(includes factors such as commissions and other costs associated with exchanging one currency for another)

Question 3

• change in the differential between U.S. inflation and the foreign country’s inflation
• change in the differential between the U.S. interest rate and the foreign country’s interest rate
• change in the differential between the U.S. income level and the foreign country’s income level
• change in government controls
• change in expectations of future exchange rates
• Percentage change in the spot rate

Answer 3

factors that can influence a currency’s spot rate

Question 4

methods available for forecasting exchange rates (4)

Answer 4

• technical forecasting
• fundamental forecasting
• market-based forecasting
• mixed forecasting

Question 5

Involves the use of historical exchange rates data to predict future variables

Answer 5

Technical forecasting

Question 6

Is based on relationships between economic variables and exchange rates

Answer 6

Fundamental forecasting

Question 7

Uses market indicators and it is usually based on either 1) the spot rate or 2) the forward rate

Answer 7

Market-based forecasting

Question 8

Because no single technique has been found to be consistently superior, it uses a combination of techniques

Answer 8

Mixed forecasting

Question 9

forms of exchange rate exposure (3)

Answer 9

• transaction exposure
• economic exposure
• translation exposure

Question 10

Sensitivity of the firm’s contractual transactions in foreign currencies to exchange rate movements

Answer 10

Transaction exposure

Question 11

Sensitivity of the firm’s cash flows to exchange rate movements

Answer 11

Economic exposure

Question 12

The exposure of the MNC’s consolidated financial statements to exchange rate fluctuations

Answer 12

Translation exposure

Question 13

What does MNCs degree of translation exposure depend on?

Answer 13

• Proportion of business by foreign subsidiaries
• Locations of foreign subsidiaries
• Accounting methods

Question 14

Hedging exposure to ____:

___: Forward and future contracts allow MNC to lock in a specific exchange rate at which it can purchase a specific currency

Answer 14

payables; Forward hedge

Question 15

Hedging exposure to ____:

____: Future contracts are standardized and can be purchased on an exchange

Answer 15

payables; Future hedge

Question 16

_____: The MNC borrows its home currency and convert the proceeds into the foreign currency that will be needed in the future

Answer 16

Money market hedge
(Hedging exposure to payables)

Question 17

_____: it provides the right to buy a specified amount of currency at a specified price within a given period of time

Answer 17

Currency option hedge
(Hedging exposure to payables)

Question 18

Hedging exposure to ____:

_____: Forward and future contracts allow MNC to lock in a specific exchange rate at which it can sell a specific currency

Answer 18

receivables; Forward hedge

Question 19

Hedging exposure to ____:

_____: Future contracts are standardized and can be sold on an exchange

Answer 19

receivables; Future hedge

Question 20

______: The MNC borrows the currency to be received and converts the funds into its home currency; receivables pay off the loan

Answer 20

Money market hedge
(Hedging exposure to receivables)

Question 21

____: it provides the right to sell a specified amount of currency at a specified price within a given period of time

Answer 21

Currency option hedge
(Hedging exposure to receivables)

Question 22

MNC’s management of its exposure to exchange rate movements can increase its value:

1) It may be able to increase its cash inflows or reduce its cash outflows by properly managing its exposure.
2) it may be able to reduce its _____, which lowers its cost of capital.
3) it may be able to stabilize its ___, which can reduce its ____ and therefore reduce its ____

Answer 22

financing costs; earnings; risk; cost of capital

Question 23

They are any investment that falls beyond traditional long-only investments, such as stock and bonds
- primarily used to diversify an investment portfolio

Answer 23

alternative investments

Question 24

• Low correlation to traditional investments like stocks and bonds
• Higher return potential than traditional investments
• More esoteric and oftentimes illiquid assets
• Longer lock-up of periods, meaning shares or interests may not be able to be redeemed/sold on a daily basis. This helps allow for exposure to less liquid assets
• Often complex investment structures and risk-return profiles Typically, higher minimum investment requirements
• Unique risk profile that should be understood prior to investing

Answer 24

key characteristics of alternative investments

Question 25

What are the types of investors who may be suited to alternative investments?

Answer 25

most attractive and more suitable for more sophisticated and higher-net-worth investors

Question 26

are natural resources or agricultural products that are grown, mined or processed and are critical inputs in the production of food, energy and clothing.

Answer 26

Commodities

Question 27

Commodities are bought and sold in ___ ___ ___ in the same way as stocks and shares.

Answer 27

bulk on exchanges

Question 28

two primary reasons for investing in commodities, particularly in times of economic volatility and high inflation:

Answer 28

1) A hedge against inflation 2) Portfolio diversification

Question 29

- Inflation reduces the ‘real’ value of a currency over time - Commodity returns have historically been positively correlated with high inflation, in other words, returns increase when inflation is high. This is not entirely surprising given that inflation measures incorporate the cost of commodities such as petrol and electricity in their ‘basket of representative items’

Answer 29

A hedge against inflation

Question 30

Along with cash, shares, bonds and property, commodities are another form of asset that can help investors to ....... Diversification offers a form of protection against one asset class under-performing and may help smooth the overall volatility of your portfolio

Answer 30

Portfolio diversification

Question 31

a basket of securities you buy or sell through a brokerage firm on a stock exchange

Answer 31

Exchange-traded fund (ETF)

Question 32

- index ETFs - Fixed-income ETFs - Sector and industry ETFs - Commodity ETFs - style ETFs - Foreign market ETFs - Inverse ETFs - Leveraged ETFs - Actively managed ETFs - Exchange-traded notes (ETNs) - Alternative investment ETFs

Answer 32

types of ETFs

Question 33

how do ETFs work

Answer 33

ETF are bought and sold like a company stock during the day when the stock exchanges are open.

Question 34

- Easy to trade - Transparency - More tax efficient - Trading transactions

Answer 34

Advantages of ETFs

Question 35

- trading costs - liquidity - tracking error - settlement dates

Answer 35

disadvantages of ETFs

Question 36

a way to measure the performance of an investment by taking risk into account. It can be used to evaluate a single security or an entire investment portfolio.

Answer 36

sharpe ratio

Question 37

Sharpe Ratio = ___ (equation)

Answer 37

(Rp – Rf) / Standard deviation Rp: expected return Rf: risk-free rate Standard deviation: a measure of risk based on volatility (Rp - Rf): market risk premium

Question 38

the ___ the sharpe ratio, the better the investment in terms of risk-adjusted returns. What are the ratings?

Answer 38

higher; - a ratio between 1 and 2 = good - a ratio between 2 and 3 = very good - any result higher than 3 = excellent

Question 39

- Sharpe ratio assumes that an investment’s average returns are normally distributed on a curve - If standard deviation fails to accurately represent the risk assumed → sharpe ratio can be higher or lower than it should be - The use of leverage increases the downside risks in an investment.... if SD rises too significantly, sharpe ratio will decline

Answer 39

The limitation to the sharpe ratio

Question 40

debt an investor takes on to increase the potential return from an investment

Answer 40

leverage

Question 41

the higher the Sharpe Ratio → the more attractive the _____ is relative to the risk taken, thus the more attractive the ______

Answer 41

return; investment

Question 42

The alternation of economic expansion and contraction in business activities

Answer 42

Business cycle

Question 43

business cycle stages: ___: strong consumer demand and confidence lead the economy to overheat and overproduce ____: represents the bleak reality of economic contraction and slowdown

Answer 43

peak; trough

Question 44

business cycle stages: ____: marked by growing business activities and strong consumer confidence after a trough. The economic recovery and optimism lead companies to hire more workers and create more jobs. With more jobs, consumers have more money to spend. ____: business activities slow and profitability falls. Companies are forced to let go of their employees to cut costs. Many who can’t survive will file for bankruptcies, leading the economy to bottom at a trough

Answer 44

expansion; contraction

Question 45

During expansion → technology stocks __ utilities During contraction → technology stocks ____ utilities

Answer 45

outperform; decline more quickly than (Investing in tech stocks during an expansion will provide higher returns than investing in sectors such as utilities)

Question 46

____, such as utilities and consumer staples, have more steady performances across different stages of a business cycle

Answer 46

Defensive stocks

Question 47

Stocks during ____ → have poor performances (bc businesses suffer lower demand and have to scale back their operations) Bonds during ____ → outperform with its stable and predictable cash flow During expansion → ___ rise quickly but ___ are less favored (due to its lack of growth potentials)

Answer 47

contractions; recession; stocks; bonds

Question 48

When the market is ____ and the economy is at a ___, you might want to take a break before putting your hard-earned money into the market.

Answer 48

overheated; peak

Question 49

- External shocks that are completely unforeseeable can affect a business cycle (COVID led to a recession) - Assessing which stage of the business cycle we are in is not straightforward (most economic indicators like GDP is reported quarterly)

Answer 49

Limitations of business cycle investing