section 2C Flashcards
One United States dollar is being quoted at 120 Japanese yen on the spot market and at 123 Japanese yen on the 90-day forward market, hence the annual effect in the forward market is the:
United States dollar is at a premium of 10%.
United States dollar is at a premium of 2.5%.
United States dollar is at a discount of 10%.
Japanese yen is at a discount of 2.5%.
United States dollar is at a premium of 10%.
The difference between the spot market and 90-day forward market price of a dollar in terms of yen, is 3 yen. Over a 360-day year, this 90-day difference of 3 yen translates into 12 yen, which is 10% of the spot market quote of 120 yen.
The forward market quote is higher than that in the spot market, hence it is expected that the dollar will appreciate, and the U.S. dollar is at a premium of 10%.
FORECASTING TECHNIQUES
___forecasting involves the use of historical exchange rate data to predict future values.
___forecasting is based on the presumed relationship between exchange rates and economic variables
_____forecasting starts from the premise that financial markets provide an unbiased estimate of future events, and uses either the spot rate or the forward rate.
………….The forward rate that is quoted for a specific date in the future is commonly used as a __for the forecasted future spot rate on that date.
Technical
Fundamental
Market-based
proxy
An importing partnership has experienced a dramatic surge in its exporting business and is looking for ways to minimize its risks from foreign currency fluctuations. The partnership’s imports and exports to European Union countries are at similar levels. Which of the following methods most effectively minimizes risk?
Purchase futures of the currency in which the payables will be paid.
Hold payables and receivables due in the same currency and amount.
Enter into an interest rate swap to mitigate the effects of exchange rate fluctuations.
Conduct all foreign transactions in U.S. dollars.
Hold payables and receivables due in the same currency and amount
One of the most effective methods to minimize the risk of foreign currency fluctuations is to hold payables and receivables in the same currency and amount; any fluctuations will offset each other.
TYPES OF RISK FOR FINANCIAL RISK MANAGEMENT
__risk: the risk to earnings or capital arising from changes in interest rates
__risk is an inability to convert assets to cash in a timely fashion
___risk: the uncertainty of the value of net income that would result from the variability of the market value of foreign-currency-denominated assets and liabilities due to fluctuating exchange rates
___risk: the risk that the counterparty will not meet an obligation when due and will never be able to meet the obligation at full value.
___risk: the risk that the counterparty will default on clearing obligations
___risk: the risk that payment system failures will lead to one market participant being unable to meet its obligation when due that will lead to additional participants being unable to meet commitments as well
___risk: the inability of a counterparty to meet its commitments
Interest rate
Liquidity
Foreign currency
Credit
Default
Systemic
Counterparty
Which of the following is not an exchange rate determinant?
Changes in consumer tastes
Relative interest rates
Relative income changes
Flexible exchange rates
Flexible exchange rates
Flexible exchange rates are not a determinant. It is an adjustment that eliminates balance of payment surpluses, or deficits. Exchange rates are determined by changes in consumer taste, relative interest rates, and relative income changes.
EXCHANGE RATE DETERMINANTS three determinants: Changes in \_\_\_ taste Relative \_\_\_ changes Relative \_\_\_ rates
Over time ___will adjust and eliminate balance-of-payments surpluses or deficits between two nations.. This is NOT a determinant.
Exchange rates are determined by the interaction of supply and demand for the various foreign currencies in foreign exchange markets. T/F
consumer
income
interest
flexible exchange rates
True
An example of a ____would be to use an interest rate swap to convert variable-rate interest exposure to a fixed interest rate.
……… The swap is an instrument that, in its usual form, transforms one kind of interest stream to another, such as floating to fixed or fixed to floating.T/F
Note: Swaps deal with INTEREST RATES
cash flow hedge
True
A company has several long-term floating-rate bonds outstanding. The company’s cash flows have stabilized, and the company is considering hedging interest rate risk. Which of the following derivative instruments is recommended for this purpose?
Structured short-term note
Forward contract on a commodity
Futures contract on a stock
Swap agreement
Swap Agreement
In the risk management process, a firm has the choice to do all of the following except:
accept risk.
default risk.
shift/transfer risk.
manage risk.
Default risk
A default risk assumes the counterparty will default on the obligation. It is not part of the risk management process.
The firm has a choice to accept, transfer, or manage risk.
The future value of an investment using compound interest will be ________ the same investment using simple interest.
More than
The future value using compound interest will always be more than under simple interest because it includes interest calculated on interest earned as well as on the principal amount. This is true for any interest rate used.
If a CPA’s client expected a high inflation rate in the future, the CPA would suggest to the client which of the following types of investments?
Precious metals
Treasury bonds
Corporate bonds
Common stock
Precious metals
An inflation hedge is an investment with intrinsic value, not tied to financial assets
___ (purchasing power risk) is the risk that inflation will result in less purchasing power for a given sum of money. Assets that are expected to rise in value during a period of inflation have a lower risk.
Purchasing risk
___is an attempt to use what is believed to be relevant information to “outguess the market.”
Financial transactions in foreign exchange markets are very ___to market expectations regarding exchange rates.
Speculation
sensitive
For currency exchange rates, all of the following describe speculation except:
outguessing the market.
financial transactions in foreign exchange markets are sensitive to market expectations.
fixed-value currencies.
value determined by current expectations of the value of the currency.
speculation
Fixed currencies do not fluctuate; therefore, their value cannot be speculated.
Miller Manufacturing and Mining is facing potential translation exposure and believes that it would be desirable to use a money market hedge to reduce their risk to currency fluctuation. They have a 1.2 billion yen receivable that will come due one year from today. Current interest rates in the United States and Japan are 8% and 5% respectively. The current spot exchange rate is 120 yen = $1. If the money market hedge is structured correctly the firm would:
borrow 1.143 billion yen in Japan and invest it in a Japanese bank at 5% so that they would have 1.2 billion yen available when the receivable comes due.
borrow 1.111 billion yen and convert the proceeds into $9,259,259 and invest the money in the United States and use the proceeds of the receivable to repay the Japanese loan, collecting the proceeds $10,000,000 from the U.S. investment which would represent the guaranteed proceeds from the Japanese sale.
borrow 1.143 billion yen and convert the proceeds into $9,524,810 and invest the money in the United States and use the proceeds of the receivable to repay the Japanese loan, collecting the proceeds of $10,285,714 from the U.S. investment which would represent the guaranteed proceeds from the Japanese sale.
borrow $10,000,000 and convert the proceeds into 1.2 billion yen and invest the proceeds to have 1.26 billion yen available when the receivable comes due.
borrow 1.143 billion yen and convert the proceeds into $9,524,810 and invest the money in the United States and use the proceeds of the receivable to repay the Japanese loan, collecting the proceeds of $10,285,714 from the U.S. investment which would represent the guaranteed proceeds from the Japanese sale.
A money market hedge involves borrowing an amount equal to the discounted value of the receivable (1.2B yen ÷ 1.05 = 1.143 billion yen). The proceeds of the loan would be converted to dollars at the current spot rate (1.143B yen ÷ 120 = $9,524,810), and the proceeds would then be invested in the United States. When the receivable is paid, the firm will use the proceeds to pay off the loan balance in Japan and collect the proceeds of the U.S. investment ($9,524,810 × 1.08 = $10,285,714). This would be the guaranteed proceeds from the Japanese sale that were created by using a money market hedge.
Division A currently makes a widget. The following is information related to the production of the widgets:
Production capacity 100,000 units per year
Current sales level 80,000 units per year
Sell price 2 outside customer $20 per unit
Variable costs per unit $12 per unit
Total fixed costs $600,000
Division B wishes to purchase 15,000 widgets from Division A for $16 per unit. Division A has the capacity to handle all of Division B’s needs without changing either fixed or variable costs nor losing any sales to outside customers. Division B currently purchases widgets from the outside for $18 per unit. If Division A accepted the $16 internal price and Division B purchases the widgets from Division A, the company as a whole will be:
$30,000 better off each period.
$90,000 better off each period.
$30,000 worse off each period.
$60,000 worse off each period.
$90,000 better off each period.
Division A will have an additional
Contribution Margin of $4 per widget
sold internally ($4 x 15,000) $60,000
Division B will have an additional saving in variable cost of $2 per widget Purchased internally ($2 x 15,000) 30,000
Savings to Company if purchased Division B
purchases the widget from Division A $90,000
=======
INTERNAL PRODUCTIONS
When idle capacity exists, the selling division’s opportunity cost may be ___
Under the idle capacity condition, as long as the selling division can receive a price greater than its variable costs, it will be ___
As long as the purchasing division can purchase the product for less from the sister division than the current purchase price from the outside, it will be better off and, thus, the corporation as a whole will benefit. T/F
zero.
better off
True
Assume that a firm is able to issue 20-year fixed-rate bonds at an attractive rate. When looking at their balance sheet and cash flow position, management finds that the key interest rate risk the firm is facing is related to movements in short-term interest rates. Management decides that the rate on the 20-year bond is too attractive to pass up. They issue the bond and then choose to develop ________ to offset their interest rate risk.
an interest rate swap transaction
a collateralized debt transaction secured by subprime mortgages
a forward hedge
a technical forecast model
Interest Rate Swap
An interest rate swap in its usual form would transform one interest stream into another
A forward hedge is designed to deal with foreign exchange transactions and is a customized transaction that is usually written by a bank for a specific client.
The risk management process includes both internal and external controls and involves the following:
Identifying and ___risks and understanding their relevance
Understanding the stakeholder’s objectives and their ___for risk
Developing and implementing appropriate ___in the context of a risk management policy
prioritizing
tolerance
strategies
In the modern world economy, balance-of-payments deficits and surpluses can be eliminated:
through the market mechanism of flexible exchange rates.
if all nations adopt tight monetary policies.
when the opportunity costs of production are made the same in all countries.
if nations trade inputs instead of outputs.
through the market mechanism of flexible exchange rates.
Flexible exchange rates automatically adjust so as to eliminate balance of payments surpluses and deficits
The dominant reason why countries devalue their currencies is to:
improve the balance of trade.
discourage exports without having to impose controls.
curb inflation by increasing imports.
slow what is regarded as too rapid an accumulation of international reserves.
improve the balance of trade.
Countries devalue their currencies so as to lower the prices of their domestic goods relative to those of foreign imports.
Devaluation of one’s currency makes foreign goods more expensive, and demand for the goods denominated in the devalued currency become more attractiv
FIXED EXCHANGE RATE SYSTEM
The advantage of a fixed rate system is that ___) would be able to engage in international trade without worrying about exchange risk.
A key disadvantage of the fixed exchange rate system is that a government, faced by economic pressures, will choose to ____the value of its currency. While the exchange rate does not fluctuate on a regular basis, it may be revalued or devalued by a significant amount unexpectedly
multinational companies (MNCs
alter
If an institution is developing a capital position that is designed to cover risk beyond what is considered necessary for its best estimate reserves, the institution would be creating what would be called:
____is generally defined as the level of reserves established in addition to the best estimate level of reserves.
Risk MArgin
____ reserves tend to create a cushion to cover any fluctuations or misestimation of errors in best estimate liabilities (reserves) and to cover risk of fluctuations under “normal situations” with required capital serving as a buffer against more extreme black swan events
The risk margin covers risks linked to the ____cash flows over their whole time horizon.
The goal is to have the concept of risk margin be made applicable to determining ___in the more broadly defined financial risk areas as well as to insurance.
Risk margin
Future liability
potential losses
