Answer All Questions. Read all the answers carefully and select the best answer for each question.
1. _______ is a technique used by MNEs to deal with currency exposure?
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(a) Do nothing
(c ) Hedging
(d) All are techniques MNEs could use.
2. Assuming no transaction costs (i.e., hedging is “free”), hedging currency exposures
should _______ the variability of expected cash flow to a firm and at the same time, the
expected value of the cash flows should_________.
(a ) increase; not change
(b) decrease; not change
(c ) not change; increase
(d ) not change; not change
3. Which of the following is cited as a good reason for NOT hedging currency exposures?
(a) Shareholders are more capable of diversifying risk than management.
(b) Currency risk management through hedging does not increase expected cash flows.
(c) Hedging activities are often of greater benefit to management than to shareholders.
(d ) All of the above are cited as reason NOT to hedge.
4. A U.S. firm sells merchandise to a British company for £ 100,000 at a current exchange
rate of $1.43/£. If the exchange rate changes to $1.45/£ the U.S. firm will realize a ______ of _______.
(a) loss; $2000
(b) gain; $2000
(c) Loss; £2000
(d) gain; £2000
Use the following information for problem 5-13:
Plains States Manufacturing has just signed a contract to sell agriculture equipment to Boschin, a German firm, for € 1,250,000. The sale was made in June with payment due six months later than December. Because this is a sizable contract for the firm and because the contract is in Euros rather than dollars, Plains States is considering several hedging alternatives to reduce the exchange rate risk arising from the sale. To help the firm make a hedging decision you have gathered the following information.
• The spot exchange rate is $0.8924/€
• The six month forward rate is $0.8750/€
• Plains States’ cost of capital is 11%
• The Euro zone 6-month borrowing rate is 9%( or 4.5% for 6 months)
• The Euro zone 6-months borrowing rate is 7%( or 3.5% for 6 months)
• The U.S. 6-month borrowing rate is 8% (or 4% for 6 months)
• The U.S. 6-month lending rate is 6%( or 3% for 6 months)
• December put options for € 625,000; strike price $0.90,premium prices is 1.5%
• Plains States’ forecast for 6-month spot rates is $0.91/€
• The budget rate, or the lowest acceptable sales price for this project, is $1,075,000
5. If plains States chooses not to change hedge their euro receivable, the amount they
receive in six months will be_________.
(d) undeterminable today
6. If Plains States chooses to hedge its transaction exposure in the forward market, it will ________ € 1, 250,000 forward at a rate of ______.
(a) sell; $0.8750/€
(b) sell; $0.8924/€
(c) buy; $0.8750/€
(d) buy; $0.8924/€
7. Plains States chooses to hedge its transaction exposure in the forward market at the
available forward rate. The payoff in 6 months will be______.
(c) $1,093, 750
(d) $1,075, 000
8. If Plains States locks in the forward hedge at $0.8750/€, and the spot rate when the
transaction was recorded on the books was $0.8924/€, this will result in a “ foreign
exchange loss” accounting transaction of _______.
(c) This was not a loss, it was a gain of $21,750.
(d) There is not enough information to answer this question.
9. Plains States would be ________ by an amount equal to __________ with a forward
hedge than if they had not hedged and their predicted exchange rate for 6 months had
(a) better off; $43,750
(b) better off; $62500
(c) worse off; $43,750
(d) worse off; $62500
10. If Plains States chooses to implement a money market hedge for the Euro receivables, how much money will the firm borrow today?
(a) € 1,201,923
11. A ________ hedge allows Plains States to enjoy the benefits of a favorable change in exchange rates for their euro receivables contract while protecting the firm from unfavorable exchange rate changes.
(b) call option.
(c) put option.
(d) money market
12. The cost of a call option to Plains States would be________.
(a) $17, 653.
(b) $16, 733
(c) $18, 471
(d) there is not enough information to answer this question
13. If Plains States purchases the put option, and the option expires in six months on the
same day that Plains States receives €1,250,000, the firm will exercise the put at that time
if the spot rate is $0.91/€.
14. Whohauser is a U.S.-based forest products firm. In June Whohauser delivers a shipment of raw lumber to Japan. The ¥55,000,000 receivable is due in 180 days. The firm ‘s foreign exchange advisors believe the yen will be at about ¥115/$ then. The current spot rate is ¥110/$. Whohauser has received a 180 day forward quote of ¥ 108/$. If the company locks in the forward quote and the exchange rate goes to ¥115 as expected, how much will the firm receive in dollars in 180 days? Is this cash flow risky or known with certainty today?
(a) $509,259 certain
(b) $500,000 risky
(c ) $478,261 risky
(d) $500,000 certain
15. Expected changes in foreign exchange rates should already be factored into anticipated operating results by management and investors.
16. If an identical product can be sold in two different markets, and no restrictions exist on the sale or transportation costs, the product’s price should be the same in both markets. This is known as
(a) relative purchasing power parity.
(b) interest rate parity.
(c) the law of one price.
17. The Economist publishes annually the “hamburger standard” by which they compare the prices of the McDonalds Corporation Big Mac hamburger around the world. The index estimates the exchange rates for currencies based on the assumption that the burgers in question are the same across the world and therefore, the price should be the same. If a Big Mac costs $2.54 in the United States and 294 yen in Japan, what is the estimated exchange rate of yen per dollar as hypothesized by the Hamburger index?
18. If according to the law of one price the current exchange rate of dollars per British pound is $1.75/£, then at an exchange rate of $1.85/£, the dollar is __________.
(c) correctly valued
(d) unknown relative valuation
19. Other things equal, and assuming efficient markets, if a Honda Accord costs $18, 365 in the U.S. then at an exchange rate of $1.43/£, the Honda Accord should cost __________ in Great Britain.
20. __________ states that differential rates of inflation between two countries tend to be offset over time by an equal but opposite change in the spot exchange rate.
(a) The Fisher Effect
(b) The International Fisher Effect
(c) Absolute Purchasing Power Parity
(d) Relative Purchasing Power Parity
21. One year ago the spot rate of U.S. dollars for Canadian dollars was $1/C$1. Since that time the rate of inflation in the U.S. has been 4% greater than that in Canada. Based on the theory of Relative PPP, the current spot exchange rate of U.S. dollars for Canadian dollars should be approximately
(d) relative PPP provides no guide for this type of question.
22. __________ states that nominal interest rates in each country are equal to the required real rate of return plus compensation for expected inflation.
(a) Absolute PPP
(b) Relative PPP
(c) The Law of One Price
(d) The Fisher Effect
23. In its approximate form the Fisher effect may be written as __________. Where: i the nominal rate of interest, r the real rate of return and the expected rate of inflation.
(a) i (r)()
(b) i r (r)()
(c) i r
(d) i r 2
24. Assume a nominal interest rate on one-year U.S. Treasury Bills of 3.80% and a real rate of interest of 2.00%. Using the Fisher Effect Equation, what is the exact expected rate of inflation in the U.S. over the next year?
25. The relationship between the percentage change in the spot exchange rate over time and the differential between comparable interest rates in different national capital markets is known as
(a) absolute PPP
(b) the law of one price
(c) relative PPP
(d) the international Fisher Effect
26. According to the international Fisher Effect, if an investor purchases a five-year U.S. bond that has an annual interest rate of 5% rather than a comparable British bond that has an annual interest rate of 6%, then the investor must be expecting the __________ to __________ at a rate of at least 1% per year over the next 5 years.
(a) British pound; appreciate
(b) British pound; revalue
(c) U.S. dollar; appreciate
(d) U.S. dollar; depreciate
27. Assume the current U.S. dollar-British spot rate is 0.6993£/$. If the current nominal one-year interest rate in the U.S. is 5% and the comparable rate in Britain is 6%, what is the approximate forward exchange rate for 360 days?
28. The current U.S. dollar-yen spot rate is 125¥/$. If the 90-day forward exchange rate is 127 ¥/$ then the yen is selling at a per annum __________ of __________.
(a) premium; 1.57%
(b) premium; 6.30%
(c) discount; 1.57%
(d) discount; 6.30%
29. The theory of __________ states that the difference in the national interest rates for securities of similar risk and maturity should be equal to but opposite in sign to the forward rate discount or premium for the foreign currency, except for transaction costs.
(a) international Fisher Effect
(b) absolute PPP
(c) interest rate parity
(d) the law of one price
30. Use interest rate parity to answer this question. A U.S. investor has a choice between a risk-free one-year U.S. security with an annual return of 4%, and a comparable British security with a return of 5%. If the spot rate is $1.43/£, the forward rate is $1.44/£, and there are no transaction costs, the investor should invest in the U.S. security.