Final Exam Flashcards
(227 cards)
1
Q
If interest rate parity exists, then ____ is not feasible. (LO 6.2)
A. locational arbitrage
B. triangular arbitrage
C. covered interest arbitrage
D. forward realignment arbitrage
A
C. covered interest arbitrage
2
Q
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. (LO 6.1)
A. forward realignment arbitrage
B. locational arbitrage
C. covered interest arbitrage
D. triangular arbitrage
A
D. triangular arbitrage
3
Q
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. (LO 6.1)
A. forward realignment arbitrage
B. covered interest arbitrage
C. triangular arbitrage
D. locational arbitrage
A
B. covered interest arbitrage
4
Q
Based on interest rate parity, the larger the degree by which the foreign interest rate exceeds the U.S. interest rate, the: (LO 6.2, 6.3)
A. smaller will be the forward discount of the foreign currency.
B. larger will be the forward discount of the foreign currency.
C. smaller will be the forward premium of the foreign currency.
D. larger will be the forward premium of the foreign currency.
A
B. larger will be the forward discount of the foreign currency.
5
Q
Assume the bid rate of a New Zealand dollar is $.33 while the ask rate is $.335 at Bank X. Assume the bid rate of the New Zealand dollar is $.32 while the ask rate is $.325 at Bank Y. Given this information, what would be your gain if you use $1,000,000 and execute locational arbitrage? That is, how much will you end up with over and above the $1,000,000 you started with? (LO 6.1)
A. $22,136
B. $15,385
C. $31,250
D. $15,625
A
B. $15,385
6
Q
If a U.S. firm’s cost of goods sold exposure is much greater than its sales (revenue) exposure in Switzerland, there is a ____ overall impact of the Swiss franc’s depreciation against the dollar on ____. (LO 8.3)
Hint: Think about the example in the lecture where we measured the economic exposure of the U.S. based Multinational Corporation that purchased most of the materials, and generated some sales, from Canada
A. positive; profits
B. negative; expenses
C. negative; profits
A
A. positive; profits
7
Q
If the U.S. dollar appreciates, an MNC’s: (LO 8.1)
A. U.S. sales (exports) will probably decrease.
B. exports denominated in U.S. dollars will probably increase.
C. interest owed on foreign funds borrowed will probably increase.
D. All of these are correct.
A
A. U.S. sales (exports) will probably decrease.
8
Q
____ is (are) not a determinant of translation exposure. (LO 8.4)
A. The local (domestic) earnings of the MNC
B. The proportion of business by foreign subsidiaries
C. The locations of foreign subsidiaries
D. The accounting methods used
A
A. The local (domestic) earnings of the MNC
9
Q
Transaction exposure reflects: (LO 8.2)
A. the exposure of a firm’s international contractual transactions to exchange rate movements.
B. the exposure of a firm’s local currency value to transactions between foreign exchange traders.
C. the exposure of a firm’s financial statements to exchange rate movements.
D. the exposure of a firm’s cash flows to exchange rate movements.
A
A. the exposure of a firm’s international contractual transactions to exchange rate movements.
10
Q
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 South Korea that produces computers and sells them there. Lazer also has competitors in different countries. Lazer Co. is subject to: (LO 8.1)
A. All of these are correct.
B. transaction exposure
C. economic exposure
D. translation exposure
A
A. All of these are correct.
11
Q
To hedge a ____ in a foreign currency, a firm may ____ a currency futures contract for that currency. (LO 9.1, 9.2)
A. payable; sell
B. receivable; purchase
C. None of these are correct.
D. payable; purchase
A
D. payable; purchase
12
Q
The ____ hedge is not a technique to eliminate transaction exposure discussed in your text. (LO 9.1-9.2)
A. currency option
B. forward
C. index
D. money market
A
C. index
13
Q
Quasik Corp. 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 receivables position. Assuming that the spot rate in 90 days is $.71, what is the net amount received from the currency option hedge? (LO 9.2)
A. $213,000
B. $216,000
C. $222,000
D. $219,000
A
B. $216,000
14
Q
When a perfect hedge is not available to eliminate transaction exposure, the firm may consider methods to at least reduce exposure, such as: (LO 9.4)
A. All of these are correct.
B. cross-hedging.
C. lagging.
D. leading.
A
A. All of these are correct.
15
Q
Overhedging refers to hedging a smaller amount of the currency than the actual transaction amount. (LO 9.3)
True
False
A
False
16
Q
A MNC has fixed assets in Europe that it expects to sell in the distant future. In order to hedge the sale of these assets in the distant future, the MNC could create a(n) ____ that ____ the expected value of the assets in the future. (LO 10.1)
A. liability; matches
B. asset; matches
C. asset; exceeds
A
A. liability; matches
17
Q
Any restructuring of operations that ____ the difference between a foreign currency’s inflows and outflows may ____ economic exposure. (LO 10.1)
A. increases; reduce
B. reduces; increase
C. reduces; reduce
A
C. reduces; reduce
18
Q
Assume that a Japanese car manufacturer exports cars that are priced in yen to U.S. dealerships. The demand for those cars declines when the yen is strong. The manufacturer also produces some cars in the United States with U.S. materials, and those cars are priced in dollars. The manufacturer could reduce its economic exposure by: (LO 10.1)
A. producing more automobiles in the United States.
B. closing down most of its plants in the United States.
C. relying completely on Japanese suppliers for its parts.
A
A. producing more automobiles in the United States.
19
Q
Depreciation of the euro relative to the U.S. dollar will cause a U.S.-based MNC’s reported earnings (from the consolidated income statement) to ____. If a firm desired to protect against this possibility, it could stabilize its reported earnings by ____ euros forward in the foreign exchange market. (LO 10.2)
A. increase; selling
B. be reduced; selling
C. be reduced; purchasing
A
B. be reduced; selling
20
Q
____ exposure occurs when an MNC translates each subsidiary’s financial data to its home currency for consolidated financial statements. (LO 10.1, 10.2)
A. Translation
B. Economic
C. Transaction
D. None of these are correct.
A
A. Translation
21
Q
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.
a. forward realignment arbitrage
b. triangular arbitrage
c. covered interest arbitrage
d. locational arbitrage
A
c. covered interest arbitrage
22
Q
Due to ____, market forces should realign the spot rate of a currency among banks.
a. forward realignment arbitrage
b. triangular arbitrage
c. covered interest arbitrage
d. locational arbitrage
A
d. locational arbitrage
23
Q
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.
a. forward realignment arbitrage
b. triangular arbitrage
c. covered interest arbitrage
d. locational arbitrage
A
b. triangular arbitrage
24
Q
If interest rate parity exists, then ____ is not feasible.
a. forward realignment arbitrage
b. triangular arbitrage
c. covered interest arbitrage
d. locational arbitrage
A
c. covered interest arbitrage
25
In which case will locational arbitrage most likely be feasible?
a. One banks ask price for a currency is greater than another banks bid price for the currency.
b. One banks bid price for a currency is greater than another banks ask price for the currency.
c. One banks ask price for a currency is less than another banks ask price for the currency.
d. One banks bid price for a currency is less than another banks bid price for the currency.
b. One banks bid price for a currency is greater than another banks ask price for the currency.
26
When using ____, funds are not tied up for any length of time.
a. covered interest arbitrage
b. locational arbitrage
c. triangular arbitrage
d. locational arbitrage AND triangular arbitrage
d. locational arbitrage AND triangular arbitrage
27
When using ____, funds are typically tied up for a significant period of time.
a. covered interest arbitrage
b. locational arbitrage
c. triangular arbitrage
d. locational arbitrage AND triangular arbitrage
a. covered interest arbitrage
28
Assume that the interest rate in the home country of Currency X is much higher than the U.S. interest rate. According to interest rate parity, the forward rate of Currency X:
a. should exhibit a discount
b. should exhibit a premium
c. should be zero (i.e., it should equal its spot rate)
d. should exhibit a premium AND should be zero (i.e., it should equal its spot rate)
a. should exhibit a discount
29
If the interest rate is higher in the United States 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:
a. U.S. investors could possibly benefit from covered interest arbitrage.
b. British investors could possibly benefit from covered interest arbitrage.
c. neither U.S. nor British investors could benefit from covered interest arbitrage.
d. U.S. investors could possibly benefit from covered interest arbitrage AND British investors could possibly benefit from covered interest arbitrage.
b. British investors could possibly benefit from covered interest arbitrage.
30
If the interest rate is lower in the United States than in the United Kingdom, and if the forward rate of the British pound is the same as its spot rate:
a. U.S. investors could possibly benefit from covered interest arbitrage
b. British investors could possibly benefit from covered interest arbitrage.
c. neither U.S. nor British investors could benefit from covered interest arbitrage.
d. U.S. investors could possibly benefit from covered interest arbitrage AND British investors could possibly benefit from covered interest arbitrage.
a. U.S. investors could possibly benefit from covered interest arbitrage
31
Assume that U.S. investors are benefiting from covered interest arbitrage due to high interest rates on euros. Which of the following forces should result from this covered interest arbitrage activity?
a. downward pressure on the euros spot rate
b. downward pressure on the euros forward rate
c. downward pressure on the U.S. interest rate
d. upward pressure on the euros interest rate
b. downward pressure on the euro's forward rate
32
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 this covered interest arbitrage activity?
a. upward pressure on the Swiss francs spot rate
b. upward pressure on the U.S. interest rate
c. downward pressure on the Swiss interest rate
d. upward pressure on the Swiss francs forward rate
d. upward pressure on the Swiss franc's forward rate
33
Assume that a U.S. firm can invest funds for one year in the United States at 12 percent or invest funds in Mexico at 14 percent. 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?
a. spot rate of peso increases; forward rate of peso decreases
b. spot rate of peso decreases; forward rate of peso increases
c. spot rate of peso decreases; forward rate of peso decreases
d. spot rate of peso increases; forward rate of peso increases
a. spot rate of peso increases; forward rate of peso decreases
34
Based on interest rate parity, the larger the degree by which the foreign interest rate exceeds the U.S. interest rate, the:
a. larger will be the forward discount of the foreign currency.
b. larger will be the forward premium of the foreign currency.
c. smaller will be the forward premium of the foreign currency.
d. smaller will be the forward discount of the foreign currency.
a. larger will be the forward discount of the foreign currency.
35
Assume that the U.S. interest rate is 10 percent, while the British interest rate is 15 percent. If interest rate parity exists, then:
a. British investors who invest in the United Kingdom will achieve the same return as U.S. investors who invest in the United States.
b. U.S. investors will earn a higher rate of return when using covered interest arbitrage than what they would earn in the United States.
c. U.S. investors will earn 15 percent whether they use covered interest arbitrage or invest in the United States.
d. U.S. investors will earn 10 percent whether they use covered interest arbitrage or invest in the United States.
d. U.S. investors will earn 10 percent whether they use covered interest arbitrage or invest in the United States.
36
Based on interest rate parity, the larger the degree by which the U.S. interest rate exceeds the foreign interest rate, the:
a. larger will be the forward discount of the foreign currency.
b. larger will be the forward premium of the foreign currency.
c. smaller will be the forward premium of the foreign currency.
d. smaller will be the forward discount of the foreign currency.
b. larger will be the forward premium of the foreign currency.
37
Assume the following exchange rates: $1 = NZ$3, NZ$1 = MXP2, and $1 = MXP5. Given this information, as you and others perform triangular arbitrage, the exchange rate of the New Zealand dollar (NZ) with respect to the U.S. dollar should ____, and the exchange rate of the Mexican peso (MXP) with respect to the U.S. dollar should ____.
a. appreciate; depreciate
b. depreciate; appreciate
c. depreciate; depreciate
d. appreciate; appreciate
e. remain stable; appreciate
a. appreciate; depreciate
38
Assume that the euro's interest rates are higher than U.S. interest rates, and that interest rate parity exists. Which of the following is true?
a. Americans using covered interest arbitrage earn the same rate of return as Germans who attempt covered interest arbitrage.
b. Americans who invest in the United States earn the same rate of return as Germans who attempt covered interest arbitrage.
c. Americans who invest in the United States earn the same rate of return as Germans who invest in Germany.
d. Americans using covered interest arbitrage earn the same rate of return as Germans who attempt covered interest arbitrage AND Americans who invest in the United States earn the same rate of return as Germans who attempt covered interest arbitrage.
e. None of these are correct.
e. None of these are correct.
39
Assume the U.S. interest rate is 2 percentage points higher than the Swiss rate, and the forward rate of the Swiss franc has a 4 percent premium. Given this information:
a. Swiss investors who attempt covered interest arbitrage earn the same rate of return as if they invested in Switzerland.
b. U.S. investors who attempt covered interest arbitrage earn a higher rate of return than if they invested in the United States.
c. Swiss investors who attempt covered interest arbitrage earn the same rate of return as if they invested in Switzerland AND U.S. investors who attempt covered interest arbitrage earn a higher rate of return than if they invested in the United States.
d. None of these are correct.
b. U.S. investors who attempt covered interest arbitrage earn a higher rate of return than if they invested in the United States.
40
Assume that British interest rates are higher than U.S. rates, and that the spot rate equals the forward rate. Covered interest arbitrage puts ____ pressure on the pound's spot rate and ____ pressure on the pound's forward rate.
a. downward; downward
b. downward; upward
c. upward; downward
d. upward; upward
c. upward; downward
41
Assume that interest rate parity holds, and the euro's interest rate is 9 percent while the U.S. interest rate is 12 percent. Then the euro's interest rate increases to 11 percent while the U.S. interest rate remains the same. As a result of the increase in the interest rate on euros, the euro's forward ____ will ____ in order to maintain interest rate parity.
a. discount; increase
b. discount; decrease
c. premium; increase
d. premium; decrease
d. premium; decrease
42
Which of the following is an example of triangular arbitrage initiation?
a. buying a currency at one banks ask and selling at another banks bid, which is higher than the former banks ask
b. buying Singapore dollars from a bank (quoted at $.55) that has quoted the South African rand (SAR)/Singapore dollar (S$) exchange rate at SAR2.50 when the spot rate for the rand is $.20
c. buying Singapore dollars from a bank (quoted at $.55) that has quoted the South African rand/Singapore dollar exchange rate at SAR3.00 when the spot rate for the rand is $.20
d. converting funds to a foreign currency and investing the funds overseas
c. buying Singapore dollars from a bank (quoted at $.55) that has quoted the South African rand/Singapore dollar exchange rate at SAR3.00 when the spot rate for the rand is $.20
43
According to interest rate parity (IRP):
a. the forward rate differs from the spot rate by a sufficient amount to offset the inflation differential between two currencies.
b. the future spot rate differs from the current spot rate by a sufficient amount to offset the interest rate differential between two currencies.
c. the future spot rate differs from the current spot rate by a sufficient amount to offset the inflation differential between two currencies.
d. the forward rate differs from the spot rate by a sufficient amount to offset the interest rate differential between two currencies.
d. the forward rate differs from the spot rate by a sufficient amount to offset the interest rate differential between two currencies.
44
Assume that interest rate parity holds. The Mexican interest rate is 50 percent, and the U.S. interest rate is 8 percent. Subsequently, the U.S. interest rate decreases to 7 percent. According to interest rate parity, the peso's forward ____ will ____.
a. premium; increase
b. discount; decrease
c. discount; increase
d. premium; decrease
c. discount; increase
45
If the cross exchange rate of two nondollar currencies implied by their individual spot rates with respect to the dollar is less than the cross exchange rate quoted by a bank, locational arbitrage is possible.
a. True
b. False
b. False
46
For locational arbitrage to be possible, one bank's ask rate must be higher than another bank's bid rate for a currency.
a. True
b. False
b. False
47
Assume locational arbitrage is possible and involves two different banks. The realignment that would occur due to market forces would increase one bank's ask rate and would decrease the other bank's bid rate.
a. True
b. False
a. True
48
Triangular arbitrage tends to force a relationship between the interest rates of two countries and their forward exchange rate premium or discount.
a. True
b. False
b. False
49
The interest rate on euros is 8 percent. The interest rate in the United States is 5 percent. The euro's forward rate should exhibit a premium of about 3 percent.
a. True
b. False
b. False
50
Capitalizing on discrepancies in quoted prices involving no risk and no investment of funds is referred to as interest rate parity.
a. True
b. False
b. False
51
Realignment in the exchange rates of banks will eliminate locational arbitrage. More specifically, market forces will increase the ask rate of the bank from which the currency was bought to conduct locational arbitrage and will decrease the bid rate of the bank to which the currency was sold to conduct locational arbitrage.
a. True
b. False
a. True
52
Locational arbitrage involves investing in a foreign country and covering against exchange rate risk by engaging in forward contracts.
a. True
b. False
b. False
53
To capitalize on high foreign interest rates using covered interest arbitrage, a U.S. investor would convert dollars to the foreign currency, invest in the foreign country, and simultaneously sell the foreign currency forward.
a. True
b. False
a. True
54
If interest rate parity (IRP) exists, then the rate of return achieved from covered interest arbitrage should be equal to the rate available in the foreign country.
a. True
b. False
b. False
55
If interest rate parity (IRP) exists, then triangular arbitrage will not be possible.
a. True
b. False
b. False
56
Forward rates are driven by the government rather than market forces.
a. True
b. False
b. False
57
Arbitrage involves capitalizing on a discrepancy in quoted prices in an attempt to make a profit, but it entails substantial risk.
a. True
b. False
b. False
58
The yield curve of every country has its own unique shape.
a. True
b. False
a. True
59
If quoted exchange rates are the same across different locations, then ____ is not feasible.
a. triangular arbitrage
b. covered interest arbitrage
c. locational arbitrage
d. triangular arbitrage AND covered interest arbitrage
d. triangular arbitrage AND covered interest arbitrage
60
Points above the IRP line represent situations where:
a. covered interest arbitrage is feasible from the perspective of domestic investors and results in the same yield as investing domestically.
b. covered interest arbitrage is feasible from the perspective of domestic investors and results in a yield above what is possible domestically.
c. covered interest arbitrage is feasible from the perspective of foreign investors and results in a yield above what is possible in their local markets.
d. covered interest arbitrage is feasible for neither domestic nor foreign investors.
c. covered interest arbitrage is feasible from the perspective of foreign investors and results in a yield above what is possible in their local markets.
61
Points below the IRP line represent situations where:
a. covered interest arbitrage is feasible from the perspective of domestic investors and results in the same yield as investing domestically.
b. covered interest arbitrage is feasible from the perspective of domestic investors and results in a yield above what is possible domestically.
c. covered interest arbitrage is feasible from the perspective of foreign investors and results in a yield above what is possible in their local markets.
d. covered interest arbitrage is feasible for neither domestic nor foreign investors.
b. covered interest arbitrage is feasible from the perspective of domestic investors and results in a yield above what is possible domestically.
62
Which of the following might discourage covered interest arbitrage even if interest rate parity does not exist?
a. transaction costs
b. political risk
c. differential tax laws
d. All of these are correct.
d. All of these are correct.
63
The interest rate on yen is 7 percent. The interest rate in the United States is 9 percent. The yen's forward rate should exhibit a premium of about 2 percent.
a. True
b. False
a. True
64
The interest rate on pounds in the United Kingdom is 8 percent. The interest rate in the United States is 5 percent. Interest rate parity exists. U.S. investors will earn a lower return domestically than British investors earn domestically.
a. True
b. False
a. True
65
Assume that the real interest rate in the United States and in the United Kingdom is 3 percent. The expected annual inflation in the United States is 3 percent, while in the United Kingdom it is 4 percent. The forward rate on the pound should exhibit a premium of about 1 percent.
a. True
b. False
b. False
66
Triangular arbitrage involves 3 transactions that must be executed at a single bank.
a. True
b. False
b. False
67
Locational arbitrage is focused on capitalizing on the difference in nominal interest rates in two different locations.
a. True
b. False
b. False
68
Technology enables more consistent prices among banks and reduces the likelihood of significant discrepancies in foreign exchange quotations among locations.
a. True
b. False
a. True
69
The yield curve for the United States normally has an upward slope, meaning that the annualized interest rate is higher for longer terms to maturity.
a. True
b. False
a. True
70
Locational arbitrage explains why spot exchange rates among banks at different locations normally will not differ by a significant amount.
a. True
b. False
a. True
71
From the U.S. perspective, an example of a cross exchange rate is the exchange rate between a non-U.S. country and the U.S..
a. True
b. False
b. False
72
The word “covered” in “covered interest arbitrage” refers to the investors hedging their position to protect against the possibility of default risk.
a. True
b. False
b. False
73
The equilibrium state in which covered interest arbitrage is no longer possible is called interest rate parity (IRP).
a. True
b. False
a. True
74
Interest rate parity suggests that an exchange rate should change over time based on the difference in interest rates between foreign versus domestic risk-free interest-bearing securities as of today.
a. True
b. False
b. False
75
Interest rate parity (IRP) states that the foreign currency's forward rate premium or discount is roughly equal to the interest rate differential between the United States and the foreign country.
a. True
b. False
a. True
76
The interest rate in South Africa is 8 percent. The interest rate in the United States is 5 percent. The South African forward rate should exhibit a premium of about 3 percent.
a. True
b. False
b. False
77
The larger the degree by which the foreign interest rate exceeds the home interest rate, the larger will be the forward discount of the foreign currency specified by the interest rate parity (IRP) formula.
a. True
b. False
a. True
78
For points lying to the left of the interest rate parity (IRP) line, covered interest arbitrage is not possible from a U.S. investor's perspective, but is possible from a foreign investor's perspective.
a. True
b. False
b. False
79
If interest rate parity (IRP) exists, then foreign investors will earn the same returns as U.S. investors.
a. True
b. False
b. False
80
If interest rate parity (IRP) does not hold, there is still the possibility that covered interest arbitrage is not worthwhile because of such factors as transaction costs, currency restrictions, and differential tax laws.
a. True
b. False
a. True
81
Which of the following is NOT mentioned in the text as a form of international arbitrage?
a. Locational arbitrage
b. Triangular arbitrage
c. Transactional arbitrage
d. Covered interest arbitrage
e. All of these are mentioned in the text as forms of international arbitrage.
c. Transactional arbitrage
82
American Bank quotes a bid rate of $0.026 and an ask rate of $0.028 for the Indian rupee (INR); National Bank quotes a bid rate of $0.024 and an ask rate for $0.025. Locational arbitrage would involve:
a. buying rupees from American Bank at the bid rate and selling them to National Bank at the ask rate.
b. buying rupees from National Bank at the ask rate and selling them to American Bank at the bid rate.
c. buying rupees from American Bank at the ask rate and selling to National Bank at the bid rate.
d. buying rupees from National Bank at the bid rate and selling them to American Bank at the ask rate.
e. Locational arbitrage is not possible in this case.
b. buying rupees from National Bank at the ask rate and selling them to American Bank at the bid rate.
83
Which of the following is NOT true regarding covered interest arbitrage?
a. Covered interest arbitrage tends to force a relationship between the interest rates of two countries and their forward exchange rate premium or discount.
b. Covered interest arbitrage involves investing in a foreign country and covering against exchange rate risk.
c. Covered interest arbitrage opportunities only exist when the foreign interest rate is higher than the interest rate in the home country.
d. If covered interest arbitrage is possible, you can guarantee a return on your funds that exceeds the returns you could achieve domestically.
e. All of these are true regarding covered interest arbitrage.
c. Covered interest arbitrage opportunities only exist when the foreign interest rate is higher than the interest rate in the home country.
84
Which of the following is NOT true regarding covered interest arbitrage?
a. Covered interest arbitrage is a reason for observing interest rate parity (IRP).
b. If the forward rate is equal to the spot rate, conducting covered interest arbitrage will yield a return that is exactly equal to the interest rate in the foreign country.
c. When interest rate parity holds, covered interest arbitrage is not possible.
d. When interest rate disparity exists, covered interest arbitrage may not be profitable.
e. All of these are true.
a. Covered interest arbitrage is a reason for observing interest rate parity (IRP).
85
Which of the following is NOT true regarding interest rate parity (IRP)?
a. When interest rate parity holds, covered interest arbitrage is not possible.
b. When the interest rate in the foreign country is higher than that in the home country, the forward rate of that countrys currency should exhibit a discount.
c. When the interest rate in the foreign country is lower than that in the home country, the forward rate of that countrys currency should exhibit a premium.
d. When covered interest arbitrage is not feasible, interest rate parity must hold.
e. All of these are true.
e. All of these are true.
86
Translation exposure reflects:
a. the exposure of a firms international transactions to exchange rate fluctuations.
b. the exposure of a firms local currency value to transactions between foreign exchange traders.
c. the exposure of a firms financial statements to exchange rate fluctuations.
d. the exposure of a firms cash flows to exchange rate fluctuations.
c. the exposure of a firm's financial statements to exchange rate fluctuations.
87
Transaction exposure reflects:
a. the exposure of a firms internationall transactions to exchange rate fluctuations.
b. the exposure of a firms local currency value to transactions between foreign exchange traders.
c. the exposure of a firms financial statements to exchange rate fluctuations.
d. the exposure of a firms cash flows to exchange rate fluctuations.
a. the exposure of a firm's internationall transactions to exchange rate fluctuations.
88
Economic exposure refers to:
a. the exposure of a firms international transactions to exchange rate fluctuations.
b. the exposure of a firms local currency value to transactions between foreign exchange traders.
c. the exposure of a firms financial statements to exchange rate fluctuations.
d. the exposure of a firms cash flows to exchange rate fluctuations.
e. the exposure of a countrys economy (specifically GNP) to exchange rate fluctuations.
d. the exposure of a firm's cash flows to exchange rate fluctuations.
89
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?
a. Diz Co.
b. Yanta Co.
c. The firms have about the same level of exposure.
d. Neither firm has any exposure.
a. Diz Co.
90
According to the text, currency volatility levels ____ perfectly stable over time, and currency correlations ____ perfectly stable over time.
a. are; are not
b. are; are
c. are not; are not
d. are not; are
c. are not; are not
91
Which of the following operations benefits from appreciation of the firm's local currency?
a. borrowing in a foreign currency and converting the funds to the local currency prior to the appreciation.
b. receiving earnings dividends from foreign subsidiaries
c. purchasing supplies locally rather than overseas
d. exporting to foreign countries
a. borrowing in a foreign currency and converting the funds to the local currency prior to the appreciation.
92
Which of the following operations benefit(s) from depreciation of the firm's local currency?
a. borrowing in a foreign country and converting the funds to the local currency prior to the depreciation
b. purchasing foreign supplies
c. investing in foreign bank accounts denominated in foreign currencies prior to depreciation of the local currency
d. borrowing in a foreign country and converting the funds to the local currency prior to the depreciation AND purchasing foreign supplies
c. investing in foreign bank accounts denominated in foreign currencies prior to depreciation of the local currency
93
Economic exposure can affect:
a. MNCs only
b. purely domestic firms only
c. MNCs only AND purely domestic firms only
d. None of these are correct.
c. MNCs only AND purely domestic firms only
94
Under FASB 52:
a. translation gains and losses are included in the reported net income.
b. translation gains and losses are included in stockholders equity.
c. translation gains and losses are included in the reported net income AND translation gains and losses are included in stockholders equity.
d. None of these are correct.
b. translation gains and losses are included in stockholder's equity.
95
Assume that the British pound and Swiss franc are highly correlated. A U.S. firm anticipates the equivalent of $1 million cash outflows in francs and the equivalent of $1 million cash outflows in pounds. During a ____ cycle, the firm is ____ affected by its exposure.
a. strong dollar; favorably
b. weak dollar; not
c. strong dollar; not
d. weak dollar; favorably
a. strong dollar; favorably
96
A U.S. MNC has the equivalent of $1 million cash outflows in each of two highly negatively correlated currencies. During ____ dollar cycles, cash outflows are ____.
a. weak; somewhat stable
b. weak; favorably affected
c. weak; adversely affected
d. None of these are correct.
a. weak; somewhat stable
97
Magent Co. is a U.S. company that has exposure to the Swiss franc (SF) and Danish kroner (DK). It has net inflows of SF200 million and net outflows of DK500 million. The present exchange rate of the SF is about $.40 while the present exchange rate of the DK is $.10. Magent Co. has not hedged these positions. The SF and DK are highly correlated in their movements against the dollar. If the dollar weakens, then Magent Co. will:
a. benefit, because the dollar value of its SF position exceeds the dollar value of its DK position.
b. benefit, because the dollar value of its DK position exceeds the dollar value of its SF position.
c. be adversely affected, because the dollar value of its SF position exceeds the dollar value of its DK position.
d. be adversely affected, because the dollar value of its DK position exceeds the dollar value of its SF position.
a. benefit, because the dollar value of its SF position exceeds the dollar value of its DK position.
98
Generally, MNCs with less foreign costs than foreign revenues will be ____ affected by a ____ foreign currency.
a. favorably; stronger
b. not; stronger
c. favorably; weaker
d. not; weaker
e. not; stronger AND not; weaker
a. favorably; stronger
99
When the dollar strengthens, the reported consolidated earnings of U.S.-based MNCs are ____ affected by translation exposure. When the dollar weakens, the reported consolidated earnings are ____.
a. favorably; favorably affected but by a smaller degree
b. favorably; favorably affected by a higher degree
c. unfavorably; favorably affected
d. favorably; unfavorably affected
c. unfavorably; favorably affected
100
A firm produces products for which substitute products are produced in all countries. Appreciation of the firm's local currency should:
a. increase local sales as it reduces foreign competition in local markets.
b. increase the firms exports denominated in the local currency.
c. increase the returns earned on the firms foreign bank deposits.
d. increase the firms cash outflow required to pay for imported supplies denominated in a foreign currency.
e. None of these are correct.
e. None of these are correct.
101
A firm produces products for which substitute products are produced in all countries. Depreciation of the firm's local currency should:
a. decrease local sales as foreign competition in local markets is reduced.
b. decrease the firm's exports denominated in the local currency.
c. decrease the returns earned on the firm's foreign bank deposits.
d. decrease the firm's cash outflow required to pay for imported supplies denominated in a foreign currency.
e. None of these are correct.
e. None of these are correct.
102
If a U.S. firm's cost of goods sold exposure is much greater than its sales exposure in Switzerland, there is a ____ overall impact of the Swiss franc's depreciation against the dollar on ____.
a. positive; interest expenses
b. positive; gross profit
c. negative; gross profit
d. negative; interest expenses
b. positive; gross profit
103
Assume that your firm is an importer of Mexican chairs denominated in pesos. Your competition is mainly U.S. producers of chairs. You wish to assess the relationship between the percentage change in the firm’s stock price (SPt) and the percentage change in the peso's value relative to the dollar (PESOt). SPt is the dependent variable. You apply the regression model to an earlier subperiod and a more recent subperiod. In the recent subperiod, you increased your importing volume. You should expect that the regression coefficient in the PESOt variable would be ____ in the first subperiod and ____ in the second subperiod.
a. negative; positive
b. positive; positive
c. positive; negative
d. negative; negative
d. negative; negative
104
A set of currency cash inflows is more volatile if the correlations are low.
a. True
b. False
b. False
105
Which of the following is NOT a form of exposure to exchange rate fluctuations?
a. transaction exposure
b. credit exposure
c. economic exposure
d. translation exposure
b. credit exposure
106
The maximum one-day loss computed for the value-at-risk (VaR) method does not depend on:
a. the expected percentage change in the currency for the next day.
b. the standard deviation of the daily percentage changes in the currency over a previous period.
c. the current level of interest rates.
d. the confidence level used.
c. the current level of interest rates.
RATIONALE: A$1,000,000 - A$1,500,000 = A$500,000 x $.55 = -$275,000
107
Appreciation in a firm's local currency causes a(n) ____ in cash inflows and a(n) ____ in cash outflows.
a. reduction; reduction
b. increase; increase
c. increase; reduction
d. reduction; increase
a. reduction; reduction
108
In general, a firm that concentrates on local sales, has very little foreign competition, and obtains foreign supplies (denominated in foreign currencies) will likely ____ a(n) ____ local currency.
a. be hurt by; appreciated
b. benefit from; depreciated
c. be hurt by; depreciated
d. None of these are correct.
c. be hurt by; depreciated
109
The ____ the percentage of an MNC's business conducted by its foreign subsidiaries, the ____ the percentage of a given financial statement item that is susceptible to translation exposure.
a. greater; smaller
b. smaller; greater
c. greater; greater
d. None of these are correct.
c. greater; greater
110
If the U.S. dollar appreciates, an MNC's:
a. U.S. sales will probably decrease.
b. exports denominated in U.S. dollars will probably increase.
c. interest owed on foreign funds borrowed will probably increase.
d. exports denominated in foreign currencies will probably increase.
e. All of these are correct.
a. U.S. sales will probably decrease.
111
An MNC can avoid translation exposure if its foreign subsidiaries do not remit their earnings to the parent.
a. True
b. False
b. False
112
Assume that the Japanese yen is expected to depreciate substantially over the next year. A U.S.-based MNC has a subsidiary in Japan, where its costs exceed revenues. The overall value of the MNC will ____ because of the yen's depreciation.
a. decrease
b. increase
c. remain unchanged
d. A and C are possible
b. increase
113
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.
a. True
b. False
b. False
114
A purely domestic firm is never exposed to exchange rate fluctuations.
a. True
b. False
b. False
115
An MNC’s stock valuation will not be affected by translation exposure if the MNC’s consolidated financial statements are prepared according to the accounting rules in FASB 52.
a. True
b. False
b. False
116
Currency correlations are generally negative.
a. True
b. False
b. False
117
Dollar cash flows associated with two foreign inflow currencies will normally be less volatile if the standard deviations of the individual currencies are lower.
a. True
b. False
a. True
118
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:
a. positive.
b. negative.
c. positive if the forward rate exhibits a premium, and negative if the forward rate exhibits a discount.
d. zero.
d. zero.
119
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:
a. positive.
b. negative.
c. positive if the forward rate exhibits a premium, and negative if the forward rate exhibits a discount.
d. zero.
a. positive.
120
An example of cross-hedging is:
a. find two currencies that are highly positively correlated; match the payables in one currency to the receivables in the other currency.
b. use the forward market to sell forward whatever currencies you will receive.
c. use the forward market to buy forward whatever currencies you will receive.
d. use the forward market to sell forward whatever currencies you will receive AND use the forward market to buy forward whatever currencies you will receive.
a. find two currencies that are highly positively correlated; match the payables in one currency to the receivables in the other currency.
121
Which of the following reflects a hedge of net payables in British pounds by a U.S. firm?
a. Purchase a currency put option in British pounds.
b. Sell pounds forward.
c. Sell a currency call option in British pounds.
d. Borrow U.S. dollars, convert them to pounds, and invest them in a British pound deposit.
e. Purchase a currency put option in British pounds AND sell pounds forward.
d. Borrow U.S. dollars, convert them to pounds, and invest them in a British pound deposit.
122
If Salerno Inc. desires to lock in a minimum rate at which it could sell its net receivables in Japanese yen but wants to be able to capitalize if the yen appreciates substantially against the dollar by the time payment arrives, the most appropriate hedge would be:
a. a money market hedge.
b. a forward sale of yen.
c. purchasing yen call options.
d. purchasing yen put options.
e. selling yen put options.
d. purchasing yen put options.
123
The real cost of hedging payables with a forward contract equals:
a. the dollar cost of hedging minus the dollar cost of not hedging.
b. the dollar cost of not hedging minus the dollar cost of hedging.
c. the dollar cost of hedging divided by the dollar cost of not hedging.
d. the dollar cost of not hedging divided by the dollar cost of hedging.
a. the dollar cost of hedging minus the dollar cost of not hedging.
124
From the perspective of Detroit Co., which has payables in Mexican pesos, hedging the payables is especially beneficial if the expected real cost of hedging the payables is:
a. negative.
b. zero.
c. positive and large.
d. positive and small.
a. negative.
125
Assume that Cooper Co. will not use its cash balances in a money market hedge. When deciding between a forward hedge and a money market hedge, it ____ determine which hedge is preferable before implementing the hedge. It ____ determine whether either hedge will outperform an unhedged strategy before implementing the hedge.
a. can; can
b. can; cannot
c. cannot; can
d. cannot; cannot
b. can; cannot
126
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:
a. sell euros forward.
b. purchase euro currency put options.
c. purchase euro currency call options.
d. purchase euros forward.
e. remain unhedged.
a. sell euros forward.
127
A ____ involves an exchange of currencies between two parties, with a promise to re-exchange currencies at a specified exchange rate and future date.
a. long-term forward contract
b. currency option contract
c. parallel loan
d. money market hedge
c. parallel loan
128
If interest rate parity exists and transaction costs are zero, the hedging of payables in euros with a forward hedge will ____.
a. have the same result as a call option hedge on payables
b. have the same result as a put option hedge on payables
c. have the same result as a money market hedge on payables
d. require more dollars than a money market hedge
e. have the same result as a call option hedge on payables AND require more dollars than a money market hedge
c. have the same result as a money market hedge on payables
129
The ____ hedge is not a technique to eliminate transaction exposure discussed in your text.
a. index
b. futures
c. forward
d. money market
e. currency option
a. index
130
To hedge a ____ in a foreign currency, a firm may ____ a currency futures contract for that currency.
a. receivable; purchase
b. payable; sell
c. payable; purchase
d. None of these are correct.
c. payable; purchase
131
A forward contract hedge is very similar to a futures contract hedge, except that ____ contracts are commonly used for ____ transactions.
a. forward; small
b. futures; large
c. forward; large
d. None of these are correct.
c. forward; large
132
In a forward hedge, if the forward rate is an accurate predictor of the future spot rate, the real cost of hedging payables will be:
a. highly positive
b. highly negative
c. zero
d. None of these are correct.
c. zero
133
The real cost of hedging payables in Japanese yen is especially high when the yen appreciates over time.
a. True
b. False
b. False
134
Since the results of both a money market hedge and a forward hedge are known beforehand, an MNC can implement the one that is more feasible.
a. True
b. False
a. True
135
If interest rate parity exists, the forward hedge will always outperform the money market hedge.
a. True
b. False
b. False
136
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.
a. money market
b. futures
c. forward
d. options
d. options
137
A ____ is not normally used for hedging long-term transaction exposure.
a. long-term forward contact
b. futures contract
c. currency swap
d. parallel loan
b. futures contract
138
A ____ does not represent an obligation.
a. long-term forward contract
b. currency swap
c. parallel loan
d. currency option
d. currency option
139
Hedging the position of individual subsidiaries is generally necessary, even if the overall performance of the MNC is already insulated by the offsetting positions between subsidiaries.
a. True
b. False
b. False
140
If an MNC is extremely risk-averse, it may decide to hedge even though its hedging analysis indicates that remaining unhedged will probably be less costly than hedging.
a. True
b. False
a. True
141
A money market hedge involves taking a money market position to cover a future payables or receivables position.
a. True
b. False
a. True
142
To hedge a payables position with a currency option hedge, an MNC would write a call option.
a. True
b. False
b. False
143
Many MNCs use selective hedging, in which they consider each type of transaction separately.
a. True
b. False
a. True
144
Currency futures are very similar to forward contracts, except that they are standardized and are more appropriate for firms that prefer to hedge in smaller amounts.
a. True
b. False
a. True
145
To hedge payables with futures, an MNC would sell futures; to hedge receivables with futures, an MNC would buy futures.
a. True
b. False
b. False
146
When the real cost of hedging payables is positive, this implies that hedging was more favorable than not hedging.
a. True
b. False
b. False
147
A futures hedge involves taking a money market position to cover a future payables or receivables position.
a. True
b. False
b. False
148
If interest rate parity (IRP) exists, then the money market hedge will yield the same result as the options hedge.
a. True
b. False
b. False
149
The price at which a currency put option allows the holder to sell a currency is called the settlement price.
a. True
b. False
b. False
150
Johnson Co. has 1,000,000 euros as payables due in 30 days, and is certain that the euro is going to appreciate substantially over time. Assuming the firm is correct, the ideal strategy is to:
a. sell euros forward
b. purchase euro currency put options
c. purchase euro currency call options
d. purchase euros forward
e. remain unhedged
d. purchase euros forward
151
Linden Co. has 1,000,000 euros as payables due in 90 days, and is certain that the euro is going to depreciate substantially over time. Assuming the firm is correct, the ideal strategy is to:
a. sell euros forward
b. purchase euro currency put options
c. purchase euro currency call options
d. purchase euros forward
e. remain unhedged
a. sell euros forward
152
A cross-hedging strategy is most effective with currencies that are _____, whereas currency diversification is most effective with currencies that are ______.
a. highly positively correlated; not highly correlated
b. highly negatively correlated; not highly correlated
c. expected to appreciate; expected to depreciate
d. expected to depreciate; expected to appreciate
a. highly positively correlated; not highly correlated
153
A money market hedge on payables would involve, among others, borrowing ____ and investing in the ____.
a. the foreign currency; United States
b. the foreign currency; foreign country
c. dollars; foreign country
d. dollars; United States
c. dollars; foreign country
154
If a firm is hedging payables with futures contracts, it may end up paying more for the payables than it would have had it remained unhedged if the foreign currency depreciates.
a. True
b. False
a. True
155
A money market hedge involves taking a money market position to cover a future payables or receivables position.
a. True
b. False
a. True
156
To hedge a payables position in a foreign currency with a money market hedge, the MNC would borrow the foreign currency, convert it to dollars, and invest that amount in the United States until the payables are due.
a. True
b. False
b. False
157
If interest rate parity exists, and transaction costs do not exist, the option hedge will yield the same results as no hedge.
a. True
b. False
b. False
158
MNCs should hedge receivables using bear spreads only for currencies that are expected to appreciate substantially prior to option expiration.
a. True
b. False
b. False
159
An advantage of using options to hedge is that the MNC can let the option expire. However, a disadvantage of using options is that a premium must be paid for it.
a. True
b. False
a. True
160
To hedge a receivables position with a currency option hedge, an MNC would buy a put option.
a. True
b. False
a. True
161
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.
a. True
b. False
a. True
162
If hedging projections cause a firm to believe that it will definitely be adversely affected by its transaction exposure, a currency option hedge is more appropriate than other methods.
a. True
b. False
b. False
163
Overhedging refers to the hedging of a larger amount in a currency than the actual transaction amount.
a. True
b. False
a. True
164
Most MNCs can completely hedge all of their transactions.
a. True
b. False
b. False
165
When a parent company tries to convince a subsidiary to hedge its transaction exposure, this is called leading.
a. True
b. False
b. False
166
Depreciation of the euro relative to the U.S. dollar will cause a U.S.-based MNC’s reported earnings (from the consolidated income statement) to ____. If a firm desired to protect against this possibility, it could stabilize its reported earnings by ____ euros forward in the foreign exchange market.
a. be reduced; purchasing
b. be reduced; selling
c. increase; selling
d. increase; purchasing
b. be reduced; selling
167
Springfield Co., based in the United States, has costs from orders of foreign material that exceed 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.
a. benefit from; be unaffected by
b. benefit from; be adversely affected by
c. be unaffected by; be adversely affected by
d. be unaffected by; benefit from
e. benefit from; benefit from
b. benefit from; be adversely affected by
168
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. Based on these exact figures, 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.
a. increase; increase
b. decrease; increase
c. decrease; decrease
d. increase; decrease
e. increase; be unaffected
a. increase; increase
169
Sycamore (a U.S. firm) has no subsidiaries and presently has sales to Mexican customers amounting to MXP98 million, while its peso-denominated expenses amount to MXP41 million. If it shifts its material orders from its Mexican suppliers to U.S. suppliers, it could reduce peso-denominated expenses by MXP12 million and increase dollar-denominated expenses by $800,000. This strategy would ____ Sycamore's exposure to changes in the peso's movements against the U.S. dollar. Regardless of whether the firm shifts expenses, it is likely to perform better when the peso is valued ____ relative to the dollar.
a. reduce; high
b. reduce; low
c. increase; low
d. increase; high
d. increase; high
170
Which of the following is an example of economic exposure but not an example of transaction exposure?
a. An increase in the dollars value hurts a U.S. firms domestic sales because foreign competitors are able to increase their sales to U.S. customers.
b. An increase in the pounds value increases a U.S. firms cost of British pound payables.
c. A decrease in the pesos value decreases a U.S. firms dollar value of peso receivables.
d. A decrease in the Swiss francs value decreases the dollar value of interest payments on a Swiss deposit sent to a U.S. firm by a Swiss bank.
a. An increase in the dollar's value hurts a U.S. firm's domestic sales because foreign competitors are able to increase their sales to U.S. customers.
171
Rockford Co. is a U.S. manufacturing firm that produces products in the United States and sells all the products to retail stores in the United Kingdom; the sales are denominated in pounds. It finances a small portion of its business with pound-denominated loans from British banks. Which of the following is true? (Assume that the amount of products to be sold is guaranteed by contracts.)
a. The dollar value of sales is higher if the pound depreciates against the dollar.
b. The dollar value of sales is unaffected by the pounds exchange rate.
c. The dollar value of sales is higher if the pound depreciates against the dollar AND the dollar value of sales is unaffected by the pounds exchange rate.
d. None of these are correct.
d. None of these are correct.
172
If a U.S. firm's expenses are more susceptible to exchange rate movements than its revenue is, the firm will ____ if the dollar ____.
a. benefit; weakens
b. be unaffected; weakens
c. be unaffected; strengthens
d. benefit; strengthens
d. benefit; strengthens
173
Laketown Co. has some expenses and revenue in euros. If its expenses are more sensitive to exchange rate movements than its revenue is, it could reduce economic exposure by ____. If its revenues are more sensitive than its expenses, it could reduce economic exposure by ____.
a. decreasing foreign revenues; decreasing foreign expenses
b. decreasing foreign revenues; increasing foreign expenses
c. increasing foreign revenues; decreasing foreign revenues
d. decreasing foreign expenses; increasing foreign revenues
d. decreasing foreign expenses; increasing foreign revenues
174
Any restructuring of operations that ____ the difference between a foreign currency's inflows and outflows may ____ economic exposure.
a. reduces; increase
b. increases; reduce
c. reduces; reduce
d. reduces; increase AND increases; reduce
e. None of these are correct.
c. reduces; reduce
175
It is generally least difficult to effectively hedge various types of:
a. translation exposure
b. transaction exposure
c. economic exposure
d. translation exposure AND economic exposure
b. transaction exposure
176
With regard to hedging translation exposure, translation losses ____, and gains on forward contracts used to hedge translation exposure ____.
a. are not tax deductible; are taxed
b. are tax deductible; are taxed
c. are not tax deductible; are not taxed
d. are tax deductible; are not taxed
a. are not tax deductible; are taxed
177
If a firm does not have foreign subsidiaries, it is not subject to ____.
a. transaction exposure
b. economic exposure
c. transaction exposure AND economic exposure
d. translation exposure
d. translation exposure
178
If the Singapore dollar appreciates against the U.S. dollar over this year, the consolidated earnings of a U.S. company with a subsidiary in Singapore will be ____ as a result of the exchange rate movement.
a. negative
b. adversely affected
c. favorably affected
d. unaffected
c. favorably affected
179
Assume a U.S. firm uses a forward contract to hedge all of its translation exposure. Also assume that the firm underestimated what its foreign earnings would be. Assume that the foreign currency depreciated over the year. The firm would generate a translation ____, which would be ____ than the gain generated by the forward contract.
a. loss; smaller
b. loss; larger
c. gain; larger
d. gain; smaller
b. loss; larger
180
A perfect hedge (full coverage) on translation exposure can usually be achieved when:
a. using a money market hedge
b. using a forward hedge
c. using a futures hedge
d. None of these are correct, since a perfect hedge is nearly impossible.
d. None of these are correct, since a perfect hedge is nearly impossible.
181
Assume that a Japanese car manufacturer exports cars that are priced in yen to U.S. dealerships. The demand for those cars declines when the yen is strong. The manufacturer also produces some cars in the United States with U.S. materials, and those cars are priced in dollars. The manufacturer could reduce its economic exposure by:
a. closing down most of its plants in the United States.
b. producing more automobiles in the United States.
c. relying completely on Japanese suppliers for its parts.
d. pricing its exports in dollars.
b. producing more automobiles in the United States.
182
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?
a. increase Zambian supply orders
b. increase Zambian sales
c. restructure debt to increase debt payments in Zambia
d. reduce Zambian sales
b. increase Zambian sales
183
Which of the following firms is NOT exposed to translation exposure?
a. Firm X, with a fully owned subsidiary that periodically remits earnings generated in Great Britain to the U.S.-based parent.
b. Firm Y, with a fully owned subsidiary that periodically generates foreign losses in Sweden. The parent covers at least some of these losses.
c. Firm Z, with a fully owned subsidiary that generates substantial earnings in Germany. The subsidiary never remits earnings but reinvests them in Germany.
d. All of these firms are exposed to translation exposure.
d. All of these firms are exposed to translation exposure.
184
____ represents any impact of exchange rate fluctuations on a firm's future cash flows.
a. Translation exposure
b. Economic exposure
c. Transaction exposure
d. None of these are correct.
b. Economic exposure
185
An effective way for an MNC to assess its economic exposure is to review the firm's:
a. income statement
b. liquidity
c. retained earnings
d. level of stockholders equity
a. income statement
186
If revenues and costs are equally sensitive to exchange rate movements, MNCs may reduce their economic exposure by restructuring their operations to shift the sources of costs or revenues to other locations so that:
a. cash inflows exceed cash outflows in each foreign currency.
b. cash outflows exceed cash inflows in each foreign currency.
c. cash inflows match cash outflows in each foreign currency.
d. None of these are correct.
c. cash inflows match cash outflows in each foreign currency.
187
Managing economic exposure is generally perceived to be ____ managing transaction exposure.
a. more difficult than
b. less difficult than
c. just as difficult as
d. None of these are correct.
a. more difficult than
188
As opposed to transaction exposure, managing economic exposure involves developing a(n) ____ solution.
a. short-term
b. long-term
c. immediate
d. None of these are correct.
b. long-term
189
Cierra, Inc. is attempting to assess its degree of economic exposure in euros. In order to do so, it has applied regression analysis to determine whether the percentage change in its total cash flows is related to the percentage change in the euro. A ____ and statistically significant slope coefficient resulting from this analysis implies that the cash flows are ____ related to the percentage changes in the euro.
a. positive; positively
b. positive; negatively
c. negative; positively
d. positive; negatively AND negative; positively
e. None of these are correct.
a. positive; positively
190
Assume that an MNC's cash flows are positively related to the movements in a foreign currency. If the MNC expects the foreign currency to weaken, it could purchase the currency forward to reduce its degree of economic exposure.
a. True
b. False
b. False
191
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.
a. more; fewer
b. more; more
c. less; fewer
d. less; more
c. less; fewer
192
An MNC has fixed assets in Europe that it expects to sell in the distant future. In order to hedge the sale of these assets in the distant future, the MNC could create a(n) ____ that ____ the expected value of the assets in the future.
a. asset; matches
b. asset; exceeds
c. liability; matches
d. liability; is less than
c. liability; matches
193
Long-term forward contracts are a possible way to hedge the distant sale of fixed assets in foreign countries, but they may not be available for many emerging market currencies.
a. True
b. False
a. True
194
____ exposure occurs when an MNC translates each subsidiary's financial data to its home currency for consolidated financial statements.
a. Translation
b. Transaction
c. Economic
d. None of these are correct.
a. Translation
195
____ is (are) not a limitation of hedging translation exposure.
a. Inaccurate stock price forecasts
b. Inadequate forward contracts for some currencies
c. Taxation on gains from forward contracts
d. Increased transaction exposure
a. Inaccurate stock price forecasts
196
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.
a. purchase the currency forward
b. sell the currency forward
c. purchase futures contracts of the currency
d. purchase the currency forward AND purchase futures contracts of the currency
e. None of these are correct.
b. sell the currency forward
197
Which of the following is a possible strategy for reducing economic exposure?
a. hedging with forward contracts
b. purchasing foreign supplies
c. financing with foreign funds
d. All of these are correct.
d. All of these are correct.
198
In general, it is more difficult to effectively hedge economic or translation exposure than to hedge transaction exposure.
a. True
b. False
a. True
199
A foreign subsidiary with expenses that are more susceptible to exchange rate movements than its revenue will be favorably affected by an appreciation of the foreign currency.
a. True
b. False
b. False
200
U.S. firms can attempt to hedge the translation exposure of their European subsidiaries with a forward purchase of euros.
a. True
b. False
b. False
201
Hedging translation exposure with forward contracts can backfire if the currency being hedged depreciates.
a. True
b. False
b. False
202
A limitation of hedging translation exposure is that translation losses are not tax deductible, whereas gains on forward contracts used to hedge translation exposure are taxed.
a. True
b. False
a. True
203
The translation gain (or loss) is simply a paper gain (or loss). Conversely, the gain (or loss) resulting from a hedge strategy is a real gain (or loss).
a. True
b. False
a. True
204
All MNCs are subject to translation exposure.
a. True
b. False
b. False
205
U.S.-based MNCs invoicing in Asian currencies and incurring expenses in Asian currencies will probably be less affected by weakness in Asian currencies than U.S.-based MNCs that invoice in Asian currencies but do not incur expenses in those currencies.
a. True
b. False
a. True
206
Transaction exposure results when an MNC translates each subsidiary's financial data to its home currency for consolidated financial statements.
a. True
b. False
b. False
207
Although forward contracts may reduce translation exposure at the expense of increasing transaction exposure, they are sometimes used to hedge translation exposure.
a. True
b. False
a. True
208
Vermont Co. has foreign expenses denominated in euros that exceed foreign revenues. Appreciation of the euro relative to the U.S. dollar will cause this firm's reported earnings (from the consolidated income statement) to ____. If the firm desires to protect against this possibility, it could stabilize its reported earnings by ____ euros forward in the foreign exchange market.
a. decrease; purchasing
b. decrease; selling
c. increase; selling
d. increase; purchasing
a. decrease; purchasing
209
If a U.S. firm has much more revenue than expenses denominated in euros, the firm will likely ____ if the euro ____.
a. benefit; weakens
b. be unaffected; weakens
c. be unaffected; strengthens
d. benefit; strengthens
d. benefit; strengthens
210
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 United States. 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.
a. transaction; translation
b. translation; transaction
c. economic; transaction
d. economic; translation
c. economic; transaction
211
Tennessee Co. conducts business in the United States and Canada. The net cash flows from Canadian operations are expected to be C$500,000 next year. The Canadian dollar is valued at about $.90. The net cash flows from U.S. operations are expected to be $200,000. To reduce the sensitivity of its net cash flows without reducing its volume of business in Canada, Tennessee Co. could:
a. purchase Canadian supplies
b. increase its borrowings in United States.
c. decrease prices on Canadian goods.
d. decrease its borrowed funds in Canada.
a. purchase Canadian supplies
212
Mercury Co. has a subsidiary based in Italy and is exposed to translation exposure. Mercury forecasts that its earnings next year will be €10 million. Mercury decides to hedge the expected earnings by selling €10 million forward. During the next year, the euro appreciated. Mercury's consolidated earnings were ____ affected by the euro's movement, and Mercury's hedge position was ____ affected by the euro's movement.
a. favorably; favorably
b. favorably; adversely
c. adversely; favorably
d. adversely; adversely
b. favorably; adversely
213
All MNCs are subject to transaction exposure.
a. True
b. False
b. False
214
A foreign subsidiary with more revenue than expenses denominated in a foreign currency will be favorably affected by appreciation of the foreign currency.
a. True
b. False
a. True
215
Economic exposure represents any impact of exchange rate fluctuations on a firm's future cash flows and thus includes transaction exposure.
a. True
b. False
a. True
216
To reduce economic exposure when a foreign currency has a greater impact on cash inflows than on cash outflows, an MNC could reduce its level of foreign sales, increase its foreign supply orders, or restructure debt to increase debt payments in the foreign currency.
a. True
b. False
a. True
217
Even if translation exposure does not affect cash flows, it is a concern of many MNCs.
a. True
b. False
a. True
218
Thornton Corp. is based in the U.S. and has no foreign subsidiaries. It has extensive liabilities denominated in Indian rupees resulting from imports from India. However, Thornton's revenues are denominated solely in U.S. dollars. Which of the following is probably not true?
a. Thornton would benefit from a depreciation of the Indian rupee.
b. Thornton has at least some transaction exposure.
c. Thornton has at least some economic exposure.
d. Thornton has at least some translation exposure.
e. All of these are true.
d. Thornton has at least some translation exposure.
219
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.
a. benefit; appreciation
b. benefit; depreciation
c. not benefit; appreciation
d. None of these are correct.
a. benefit; appreciation
220
____ is (are) a limitation of hedging translation exposure.
a. Inaccurate earnings forecasts
b. Inadequate forward contracts for some currencies
c. Accounting distortions
d. Increased transaction exposure
e. All of these are correct.
e. All of these are correct.
221
Assume the bid rate of a New Zealand dollar is $.33 while the ask rate is $.335 at Bank X. Assume the
bid rate of the New Zealand dollar is $.32 while the ask rate is $.325 at Bank Y. Given this information,
what would be your gain if you use $1,000,000 and execute locational arbitrage? That is, how much will
you end up with over and above the $1,000,000 you started with?
a. $15,385
b. $15,625
c. $22,136
d. $31,250
a. $15,385
RATIONALE: $1,000,000/$.325 = NZ$3,076,923 x $.33 = $1,015,385. Thus, the profit is $15,385.
222
Assume the bid rate of a Singapore dollar is $.40 while the ask rate is $.41 at Bank X. Assume the bid
rate of a Singapore dollar is $.42 while the ask rate is $.425 at Bank Z. Given this information, what would
be your gain if you use $1,000,000 and execute locational arbitrage? That is, how much will you end up
with over and above the $1,000,000 you started with?
a. $11,764
b. -$11,964
c. $36,585
d. $24,390
e. $18,219
d. $24,390
RATIONALE: $1,000,000/$.41 =S2,439,024 x $.42 =$1,024,390
223
Bank A quotes a bid rate of $.300 and an ask rate of $.305 for the Malaysian
ringgit (MYR). Bank B quotes a bid rate of $.306 and an ask rate of $.310 for the
ringgit. What will be the profit for an investor who has $500,000 available to conduct locational arbitrage?
a. $2,041,667
b. $9,804
c. $500
d. $1,639
d. $1,639
RATIONALE: $500,000/$.305 = MYR1,639,344 x $.306 = $501,639. Thus, the
profit is $1,639.
224
You just received a gift from a friend consisting of 1,000 Thai baht, which you
would like to exchange for Australian dollars (A$). You observe that exchange rate
quotes for the baht are currently $.023, while quotes for the Australian dollar are
$.576. How many Australian dollars should you expect to receive for your baht?
a. A$39.93
b. A$25,043.48
c. A$553.00
d. None of these are correct.
a. A$39.93
RATIONALE: $.023/$.576 x THB1,000 = A$39.93.
225
Assume the bid rate of a Swiss franc is $.57 while the ask rate is $.579 at Bank X. Assume the bid rate of the Swiss franc is $.560 while the ask rate is $.566 at Bank Y. Given this information, what would be your gain if you use $1,000,000 and execute locational arbitrage? That is, how much will you end up with over and above the $1,000,000 you started with?
a. $7,067
b. $8,556
c. $10,114
d. $12,238
a. $7,067
RATIONALE: $1,000,000/$.566 = SF1,766,784 x $.57 = $1,007,067. Thus, the profit is $7,067.
226
Assume the bid rate of an Australian dollar is $.60 while the ask rate is $.61 at Bank Q. Assume the bid rate of an Australian dollar is $.62 while the ask rate is $.625 at Bank V. Given this information, what would be your gain if you use $1,000,000 and execute locational arbitrage? That is, how much will you end up with over and above the $1,000,000 you started with?
a. $10,003
b. $12,063
c. $14,441
d. $16,393
e. $18,219
d. $16,393
RATIONALE: $1,000,000/$.61 = A$1,639,344 $.62 = $1,016,393. Thus, the profit is $16,393.
227
