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Shapiro’s Multinational Financial Management, 9th Edition Test Bank

CHAPTER 4Parity Conditions in International Finance and Currency Forecasting

EASY (definitional)

4.1 In its absolute version, purchasing power parity states that price levels worldwide should be _______when expressed in a common currency.a) equalb) roughly equalc) differentd) opportunities for arbitrage

Ans: aSection: Purchasing power parityLevel: Easy

4.2 The theory of relative purchasing power parity states that, between two nations, the a) inflation rates are unrelatedb) exchange rate differential reflects the inflation rate differentialc) inflation rate is smaller in weaker currenciesd) the interest rate is greater than the inflation rate during depreciations

Ans: bSection: Purchasing power parityLevel: Easy

4.3 The Fisher effect states that the _________ rate is made up of a real required rate of return and an inflation premium.a) nominal exchangeb) real exchange c) nominal interest d) adjusted dividend

Ans: cSection: The fisher effect Level: Easy

4.4 A rise in the inflation rate in one nation relative to others will be associated with a fall in the first nation’s exchange rate and with a rise of its interest rate relative to foreign interest rates. The two conditions combined result in the _________ Effect.a) Fisherb) Herstatt

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c) Unbiased forward rated) International Fisher

Ans: dSection: The fisher effectLevel: Easy

MEDIUM (applied)

4.5 Suppose annual inflation rates in the U.S. and Mexico are expected to be 6% and 80%, respectively, over the next several years. If the current spot rate for the Mexican peso is $.005, then the best estimate of the peso's spot value in 3 years isa) $.00276b) $.01190c) $.00321d) $.00102

Ans: dSection: Purchasing power parityLevel: Medium

4.6 If the expected inflation rate is 5% and the real required return is 6%, then the Fisher effect says that the nominal interest rate should be a) 1%b) 11.3%c) 11%d) 6%

Ans: bSection: The fisher effectLevel: Medium

4.7 The inflation rates in the U.S. and France in January 1991 were expected to be 4% per annum and 7% per annum, respectively. If the current spot rate that day was $.1050, then the expected spot rate in three years wasa) $.1150b) $.1112c) $.0964d) $.0992

Ans: cSection: Purchasing power parity

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Level: Medium

4.8 Suppose the expected inflation in the U.S. on January 1, 1988 was projected at 5% annually for the next 5 years and at 12% annually in Italy for the same time period, and the lira/$ spot rate that day was currently at L2400 = $1, then the PPP estimate of the spot rate five years from now wasa) 1738b) 3314c) 2560d) 2250

Ans: bSection: Purchasing power parityLevel: Medium

4.9 If expected inflation is 20% and the real required return is 10%, then the Fisher effect says that the nominal interest rate should be exactlya) 30%b) 32%c) 22%d) 12%

Ans: bSection: The fisher effectLevel: Medium

4.10 On January 1, 1990, the annual inflation rates in the U.S. and Greece were expected to be 3% and 8%, respectively. If the current spot rate that day for the drachma was $.007, then the expected spot rate in three years wasa) $.00607b) $.00823c) $.00751d) $.00694

Ans: aSection: Purchasing power parityLevel: Medium

4.11 If a country's freely floating currency is undervalued in terms of purchasing power parity, its capital account is likely to bea) in deficit or tending toward a deficitb) in surplus or tending toward a surplus

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c) Subsidized by the International Monetary Fundd) a candidate for loans from the World Bank


4.12 If the rate of inflation in all of the world’s currency markets rises from 5% to 7%, this will tend to make forward exchange rates move towarda) smaller premiums or larger discounts in relation to the dollarb) larger premiums or smaller discounts in relation to the dollarc) no change on averaged) parity

Ans: cSection: Purchasing power parityLevel: Medium

4.13 A 150% real return in Brazil is higher than a 15% dollar return in the U.S.a) because arbitrage opportunities existb) when the inflation controls are suspended in Brazilc) it depends on whether these are nominal or real returnsd) regardless of nominal or real returns


4.14 On January 1, 1994, the annual inflation rates in the U.S. and Italy were expected to be 4% and 7%, respectively. If the current spot rate on that day was $1 = L2,000, then the expected spot rate for the lira in three years wasa) $.0004591b) $.0011590c) $.0009892d) $.0005471


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4.15 On January 1, 1985, the annual inflation rates in the U.S. and France were expected to be 4% and 6%, respectively. If the current spot rate that day was $.1250, then the expected spot rate in two years wasa) $.1299b) $.1150c) $.1203d) $.1335

Ans: c Section: Purchasing power parityLevel: Medium

4.16 Suppose five-year deposit rates on Eurodollars and Euro marks are 12% and 8%, respectively. If the current spot rate for the mark is $0.50, then the spot rate for the mark five years from now implied by these interest rates isa) .5997b) .4169c) .5185d) .4821

Ans: aSection: The international fisher effectLevel: Medium

4.17 The direct spot quote for the Canadian dollar is $.76 and the 180-day forward rate is $.74. The difference between the two rates is likely to mean thata) inflation in the U.S. during the past year was lower than in Canadab) interest rates are rising faster in Canada than in the U.S.c) prices in Canada are expected to rise more rapidly than in the U.S.d) the Canadian dollar's spot rate is expected to rise in terms of the U.S. dollar

Ans: cSection: Interest rate parity theoryLevel: Medium

4.18 Suppose that on January 1, 1987, the spot rate on the Dutch guilder was $0.39 and the 180-day forward rate was $0.40. The difference between the spot and forward rates suggested thata) interest rates were higher in the U.S. than in the Netherlandsb) the guilder had risen in relation to the dollarc) the inflation rate in the Netherlands was decliningd) the guilder was expected to fall in value relative to the dollar

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Ans: aSection: Interest rate parity theoryLevel: Medium

4.19 Suppose the price indexes in Mexico and the U.S., which both began the year at 100, are at 160 and 103, respectively, by the end of the year. If the exchange rate began the year at Mex$4.5 = $1 and ended the year at Mex$5.9 = $1, then the change in the real value of the peso during the year is (a "-" indicates a real devaluation)a) 0.0%b) -5.0%c) 18.5%d) -8.2%


4.20 Suppose the spot rates for the pound, mark, and Swiss franc prior to 1999 were $1.20, $.32, and $.40, respectively. At the same time, the associated 90-day interest rates (annualized) were 16%, 8%, and 4%, while the U.S. 90-day interest rate was 12%. What was the 90-day forward rate (to the nearest cent) on a TCU (TCU 1 = £1 + DM1 + SFr1) if interest parity were to hold?a) $1.92b) $1.98c) $1.94d) $1.87


4.21 The current five-year Euro yen rate is 6% per annum (compounded annually). The five-year Eurodollar rate is 8.5%. What is the implied forward premium or discount of the yen (over the current spot rate) for a five-year forward contract?a) 4.17% premiumb) 18.46% discountc) 11.00% discountd) 12.36% premium

Ans: dSection: Interest rate parity theoryLevel: Medium

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4.22 Suppose the spot rates on January 1, 1992 for the pound, mark, and Swiss franc were $1.50, $.42, and $.48, respectively. At the time, the associated 90-day interest rates (annualized) were 12%, 6%, and 4%, while the U.S. 90-day interest rate (annualized) was 8%. What was the 90-day forward rate on a DCU (DCU 1 = £1 + DM1 + SFr1) if interest parity were to hold?a) $2.4027b) $2.3923c) $2.4196d) $2.3738

Ans: bSection: Interest rate parity theoryLevel: Medium

4.23 Suppose it is January 1, 1998 and spot pounds are selling at $1.7342, while 90-day forward pounds are selling at $1.7156. At the same time, DM spot and 90-day forward rates are $0.6138 and $0.6014, respectively. According to these quotes thea) pound is selling at a 3.87% forward discount relative to the DMb) pound is selling at a 2.37% forward premium relative to the DMc) DM is selling at a 0.97% forward discount relative to the poundd) DM is selling at a 1.54% forward premium relative to the pound


4.24 If annualized interest rates in the U.S. and France on January 1, 1991 are 9% and 13%, respectively, and the spot value of the franc is $.1109, then at what 180-day forward rate will interest rate parity hold?a) $.1070b) $.1150c) $.1088d) $.1130


4.25 If annualized interest rates in the U.S. and Switzerland are 10% and 4%, respectively, and the 90-day forward rate for the Swiss franc is $.3864, at what current spot rate will interest rate parity hold?a) $.3902 b) $.3874

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c) $.3807d) $.3792


4.26 The spot rate on the euro is $1.33 and the 180-day forward rate is $1.34. The difference between the two rates means a) interest rates are higher in the U.S. than in Germanyb) the euro has risen in relation to the dollarc) the inflation rate in Germany is decliningd) the euro is expected to fall in value relative to the dollar


4.27 It is July 1, 1990. Suppose the spot rates for the pound, mark, and Swiss franc are $1.30, $.35, and $.40, respectively. The associated 90-day interest rates (annualized) are 16%, 8%, and 4%, while the U.S. 90-day interest rate (annualized) is 12%. What is the 90-day forward rate on an ACU (ACU 1 = £1 + DM1 + SFr1) if interest parity holds?a) $2.0512b) $2.1134c) $2.0397d) $2.0489


4.28 The current five-year Euro yen and Eurodollar rates are 8% and 12.5% per annum, respectively. What is the implied forward premium or discount of the yen (over the current spot rate for a five-year forward contract)?a) 4.17% premiumb) 18.46% discountc) 17.74% discountd) 22.64% premium


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4.29 The 90-day interest rates (annualized) in the U.S. and Japan are, respectively, 10% and 7%, while the direct spot quote for the yen in New York is $.004300. At what 90-day forward rate would interest rate parity hold?a) .004430b) .004271c) .004332d) .004176


4.30 If annualized interest rates on January 1, 1985 in the U.S. and France were 9% and 13%, respectively, and the spot value of the franc was $.1109, then at what 180-day forward rate would interest rate parity hold?a) $.1070b) $.1150c) $.1088d) $.1130


DIFFICULT (applied)

4.31 Suppose the pound devalues from $1.25 at the start of the year to $1.00 at the end of the year. Inflation during the year is 15% in England and 5% in the U.S. What is the real devaluation (-) or real revaluation (+) of the pound during the year?a) - 12.38%b) - 20.71%c) + 2.39%d) + 1.46%

Ans: aSection: Purchasing power parityLevel: Difficult

4.32 Suppose it is May 1, 1981 and the price indexes in Spain and the U.S., which both began the year at 100, are at 117 and 105, respectively, by the end of the year. If the beginning and

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ending exchange rates, respectively, for the peseta are $.1320 and $.1125, then the change in the real value of the peseta (a "-" indicates a real devaluation) during the year isa) 0%b) -5.0%c) 2.4%d) -8.2%

Ans: bSection: Purchasing power parityLevel: Difficult

4.33 Suppose the Swiss franc revalues from $0.40 at the beginning of the year to $0.44 at the end of the year. U.S. inflation is 5% and Swiss inflation is 3% during the year. What is the real devaluation (-) or real revaluation (+) of the Swiss franc during the year?a) + 7.9%b) - 5.3%c) + 8.1%d) - 1.6%


4.34 Suppose the value of the Polish zloty moves from Z 1000 = $1 at the start of the year to Z 1,800 at the end of the year. At the same time, the Polish price level changes from an index of 100 on January 1 to 134 on December 31. U.S. inflation during the year was 4.5%. If the one-year interest rate on the zloty is 44%, what was the real dollar cost of borrowing the zloty during the year?a) 17.53%b) 27.81%c) -23.44%d) -8.76%

Ans: cSection: Purchasing power parityLevel: Difficult

4.35 Suppose it is October 1, 1990 and inflation rates in the U.S. and France are expected to be 4% and 9%, respectively, next year and 6% and 7%, respectively, in the following year. If the current spot rate is $.1050, then the expected spot value of the franc in two years isa) $.1111b) $.1024c) $.0992

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d) $.1074

Ans: cSection: Purchasing power parityLevel: Difficult

4.36 Suppose it is January 1, 1994 and the Deutsche mark revalues from $.30 at the beginning of the year to $.33 at the end of the year. Inflation during the year is 5% in the U.S. and 3% in Germany. What is the real devaluation (-) or real revaluation (+) of the Deutsche mark during the year?a) + 7.9%b) - 5.3%c) + 8.1%d) - 1.6%


4.37 If the U.S. trade balance with Japan is expected to go from a deficit this year to a surplus next year, the forward rate on yen woulda) be less than the spot rate b) be higher than the spot ratec) equal the spot rated) could be either above or below the spot rate

Ans: dSection: The relationship between the forward rate and the future spot rateLevel: Difficult

4.38 The following exchange and interest rate quotations in 1998 were observed:

Eurocurrency rates Exchange rate per $

90-days (% annum)(Discretely-compounded) Spot

90-dayforward

Bid:

Ask:

$

15 5/8

16

DM

7 7/8

8 1/4

£

12 1/4

13

DM

1.881

1.843

£

.4961

.4902

DM

1.801

1.773

£

.4937

.4889

An arbitrage profit can be obtained by

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a) borrowing pounds and lending dollarsb) borrowing dollars and lending DMc) borrowing DM and lending poundsd) there are no arbitrage opportunities

Ans: aSection: Interest rate and parity theoryLevel: Difficult

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CHAPTER 8Currency Futures and Options Markets

EASY (definitional)

8.1 Which one of the following currency futures contracts is currently NOT available?a) French francb) Hungarian forintc) Czech korunad) Norwegian krone

Ans: aSection: Futures contractsLevel: Easy

8.2 Which of the following has provided a major inducement for speculators to participate in the futures market?a) low margin requirementsb) low bid-ask spreadsc) high volume compared to the forward marketd) all of the above

Ans: aSection: Forward contracts versus futures contractsLevel: Easy

8.3 Options traded in the interbank market are known asa) listed optionsb) exchange-traded optionsc) over-the-counter optionsd) long-term options

Ans: cSection: Future contractsLevel: Easy

8.4 Major advantages of futures contracts include thea) large number of currencies tradedb) extensive delivery dates availablec) freedom to liquidate the contract at any time before its maturity d) unlimited contract sizes

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Ans: cSection: Advantages and disadvantages of future contractsLevel: Easy

8.5 The major disadvantage of forward and futures contracts relative to options is that the forwards and futures contractsa) cannot protect the holder against the risk of adverse movements in exchange ratesb) are more expensivec) are available only for relatively short maturitiesd) eliminate the possibility of gaining a windfall profit from favorable movements in exchange rates

Ans: dSection: Advantages and disadvantages of future contractsLevel: Easy

8.6 Suppose the current spot rate for the euro is $1.3427. A call option with an exercise price of $1.3550 is said to bea) in-the-moneyb) out-of-the-moneyc) at-the-moneyd) past breakeven

Ans: bSection: Using currency optionsLevel: Easy

8.7 Suppose the current spot rate for the pound is $01.7427. A put option with an exercise price of $01.7550 is said to bea) in-the-moneyb) out-of-the-moneyc) at-the-moneyd) past breakeven

Ans: aSection: Using currency optionsLevel: Easy

MEDIUM (applied)

8.8 The basic difference(s) between forward and futures contracts is that

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a) forward contracts are individually tailored while futures contracts are standardizedb) forward contracts are negotiated with banks whereas futures contracts are bought and sold on an organized exchangec) forward contracts have no daily limits on price fluctuations whereas futures contracts have a daily limit on price fluctuations d) all of the above

Ans: dSection: Forward contract versus futures contractLevel: Medium

8.9 Suppose the current spot rate for the Australian dollar is U.S.$0.8321. The intrinsic value of an A$50,000 call option with an exercise price of U.S.$0.8195 isa) $0b) $630c) $740d) $2,340

Ans: bSection: Option pricing and valuationLevel: Medium

8.10 The time value of a European option a) is always positive for an out-of-the-money optionb) is always positive for an in-the-money optionc) is always positive for an at-the-money optiond) decreases with the time that remains until the option expires

Ans: aSection: Option pricing and valuationLevel: Medium

8.11 You can speculate on pound depreciation bya) selling pound futures and buying a pound call optionb) buying pound futures and a pound put optionc) selling pound futures and a pound put optiond) none of the above

Ans: dSection: Using forward or futures contracts versus optionsLevel: Medium

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DIFFICULT (applied)

8.12 Suppose you are holding a long position in a euro futures contract that matures in 76 days. The agreed-upon price is $1.15 for 125,000 euro. At the close of trading today, the futures price has risen to $1.155. Under marking to market, you nowa) hold a futures contract that has risen in value by $1,250b) hold a futures contract that has fallen in value by $625c) will receive $625 and a new futures contract priced at $1.155d) must pay over $1,250 to the seller of the futures contract

Ans: cSection: Computing gains, losses and maintenance marginsLevel: Difficult

8.13 Suppose that the interbank forward bid for March 20 on Swiss francs is $0.7827 at the same time that the price of IMM Swiss franc futures for delivery on March 20 is $0.7795. How much of an arbitrage profit could a dealer earn per March Swiss franc futures contract of SFr 125,000?a) $400b) $68c) $215d) $58

Ans: aSection: Arbitrage between the futures and forward marketsLevel: Difficult

8.14 Suppose it is May 1998 and the current spot rate for the DM is $0.5925. The call premium on a call option with an exercise price of $0.5675 is $0.0373. What is the time value of one DM 62,500 call option?a) $2,331.25 b) $1,562.50c) $950.00d) $768.75

Ans: dSection: Option pricing and valuationLevel: Difficult

8.15 Suppose it is January 1990 and the current spot rate for the DM is $0.5925. The call premium on a call option with an exercise price of $0.5675 is $0.0373. What is the intrinsic value of one DM 62,500 call option?

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a) $2,331.25 b) $1,562.50c) $950.00d) $768.75

Ans: bSection: Option pricing and valuationLevel: Difficult

8.16 The value of a European option always a) exceeds its intrinsic valueb) rises with the time to maturityc) rises with the interest rated) rises with the volatility of the exchange rate

Ans: dSection: Option pricing and valuationLevel: Difficult

8.17 A rise in the domestic interest rate willa) raise the value of foreign-currency call options and reduce the value of foreign-currency put optionsb) raise the value of foreign-currency put options and reduce the value of foreign-currency call optionsc) raise the value of both foreign-currency put and call optionsd) reduce the value of both foreign-currency put and call options

Ans: aSection: Option pricing and valuationLevel: Difficult

18 A rise in the foreign interest rate willa) raise the value of foreign-currency call options and lower the value of foreign-currency put optionsb) raise the value of foreign-currency put options and lower the value of foreign-currency call optionsc) raise the value of both foreign-currency put and call optionsd) reduce the value of both foreign-currency put and call options

Ans: bSection: Option pricing and valuationLevel: Difficult

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8.19 You can speculate on an appreciation of the Japanese yen bya) selling a yen put option and buying a yen call option.b) selling a yen put option and selling a yen call option.c) buying a yen put option and selling a yen call option.d) buying a yen put option and buying a yen call option.

Ans: aSection: Option pricing and valuationLevel: Difficult

8.20 Fluor Corporation has just made a French euro bid on a major project located in France. It won't find out for 60 days whether it has won the contract. There will be a 10% signing bonus payable to the winner in euros. The best way to protect against currency risk on its bid is for Fluor toa) buy a euro futures contract.b) sell a euro call option.c) sell a euro futures contract.d) buy a euro put option.

Ans: dSection: Using forward or futures contracts versus options contractsLevel: Difficult

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CHAPTER 10Measuring and Managing Translation and Transaction Exposure

EASY (definitional)

10.1 ___________ a certain currency exposure means establishing an offsetting currency position so that the gain or loss from the exposure on the original currency is exactly offset buy the gain or loss from the currency hedge.a) Arbitragingb) Cross-hedgingc) Hedgingd) Risk shifting

Ans: cSection: Alternative measures of foreign exchange exposureLevel: Easy

10.2 Hedging cannot provide protection against ________ exchange rate changes.a) expectedb) nominalc) reald) pegged

Ans: aSection: Designing a hedging strategyLevel: Easy

10.3 The basic hedging strategy involvesa) reducing hard currency assets and soft currency liabilitiesb) increasing hard currency liabilities and soft currency assetsc) reducing soft currency assets and hard currency liabilitiesd) converting soft currencies to hard currencies and lending hard currencies

Ans: cSection: Designing a hedging strategyLevel: Easy

10.4 Translation exposure reflects the exposure of a company'sa) foreign operations to currency movementsb) foreign sales to currency movementsc) financial statements to currency movements

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d) cash flows to currency movements

Ans: cSection: Alternative currency translation methodsLevel: Easy

10.5 The current standard for measuring translation exposure isa) the current/noncurrent methodb) the monetary/nonmonetary methodc) FASB 8d) FASB 52

Ans: dSection: Statement of financial accounting standards No. 52Level: Easy

10.6 Under FASB 52, most financial statements must be translated using thea) monetary/nonmonetary methodb) current/noncurrent methodc) current rate methodd) temporal method

Ans: c Section: Statement of financial accounting standards No. 52Level: Easy

10.7 Firms that attempt to reduce risk and beat the market simultaneously may end up witha) more risk, not lessb) less riskc) a profit as well as reduced riskd) a loss as well as reduced risk

Ans: aSection: Designing a hedging strategyLevel: Easy

10.8 One argument that favors centralization of foreign risk management is the ability to take advantage of the portfolio effect through ________.a) risk shiftingb) risk sharingc) offshore bankingd) exposure netting

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Ans: dSection: Centralization versus decentralizationLevel: Easy

10.9 In a forward market hedge, a company that is long a foreign currency will _______ the foreign currency forward, whereas a company that is short a foreign currency will _______ the currency forward.a) buy; sellb) sell; buyc) borrow; selld) lend; buy

Ans: bSection: Managing a Transaction ExposureLevel: Easy

10.10 A ________ involves simultaneously borrowing and lending activities in two different currencies to lock in the currency’s value of a future foreign currency cash flow.a) forward contractb) currency collarc) money-market hedged) currency option

Ans: cSection: Money-market hedgeLevel: Easy

10.11 A __________ involves offsetting exposures in one currency with exposures in the same or another currency, where exchange rates are expected to move in such a way that losses on the first exposed position should be offset by gains on the second currency exposure and vice versa.a) forward contractb) exposure nettingc) money-market hedged) currency option

Ans: bSection: Exposure nettingLevel: Easy

MEDIUM (applied)

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10.12 The major difference between the temporal method and the monetary/nonmonetary method is that a) under the monetary/nonmonetary method, long-term debt is translated at the historical rate, whereas under the temporal method, long-term debt is translated at the current rateb) under the monetary/nonmonetary method, inventory is always translated at the historical rate, whereas under the temporal method, inventory may be translated at the current rate if the inventory is shown on the balance sheet at market valuesc) under the monetary/nonmonetary method, fixed assets are translated at the historical rate, whereas under the temporal method, fixed assets may be translated at the current rated) under the monetary/nonmonetary method, accounts receivable are always translated at the historical rate, whereas under the temporal method, receivables may be translated at the current rate

Ans: bSection: Alternative currency translation methodsLevel: Medium

10.13 ____________ exposure results from the possibility of incurring a gain or loss related to a sale or purchase already entered into and denominated in another currency.a) translationb) transaction c) operatingd) accounting

Ans: bSection: Transaction exposureLevel: Medium

10.14 It is possible for transaction exposure to be positive and translation exposure in the same currency to bea) always positiveb) exactly offsettingc) negatived) synonymous

Ans: cSection: Transaction exposureLevel: Medium

10.15 Which one of the following would NOT be a suggested element for an effective exposure management strategy?a) determine the types of exposure to be monitored

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b) formulate corporate objectivesc) ensure that the corporate objectives a consistent with maximizing shareholder valued) avoid the use of forward contracts where possible

Ans: dSection: Designing a hedging strategyLevel: Medium

The following information is to be used in answering questions 16-17.

In 1995, Ajax Manufacturing's German subsidiary has the following balance sheet:

Cash, marketable securitiesAccounts receivableInventory (at market.Fixed Assets

Total assets

DM 250,0001,000,0002,700,0005,100,000-----------------DM 9,050,000

Current liabilitiesLong-term debtEquity

Total liabilitiesplus equity

DM 750,0003,400,0004,900,000

---------------DM 9,050,000

Suppose the DM appreciates from $0.70 to $0.76 during the period.

10.16 Under the current/noncurrent method, what is Ajax's translation gain (loss).?a) a gain of $294,000b) a gain of $192,000c) a loss of $174,000d) a loss of $12,000

Ans: bSection: Current/non current methodLevel: Medium

10.17 Under the temporal method, what is Ajax's translation gain (loss).?a) a gain of $294,000b) a gain of $192,000c) a loss of $174,000d) a loss of $12,000

Ans: dSection: Temporal methodLevel: Medium

10.18 Under the current rate method, what is Ajax's translation gain (loss).?

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a) a gain of $294,000b) a gain of $192,000c) a loss of $174,000d) a loss of $12,000

Ans: aSection: Current rate methodLevel: Medium

10.19 Under the monetary/non-monetary method, what is Ajax's translation gain (loss)?a) a gain of $294,000b) a gain of $192,000c) a loss of $174,000d) a loss of $12,000

Ans: cSection: Monetary/non-monetary methodLevel: Medium

10.20 Which of the following is a basic hedging technique during depreciation?a) buy local currency forwardb) sell a local currency put optionc) reduce levels of local currency cash and marketable securitiesd) loosen credit (increase local currency receivables)

Ans: cSection: Costs and benefits of standard hedging techniquesLevel: Medium

10.21 Dell Computer has a £1 million receivable that it expects to collect in one year. Suppose the interest rate on pounds is 15%. How could Dell protect this receivable using a money market hedge?a) borrow £1 million pounds todayb) lend £1 million pounds todayc) borrow £869,565 pounds todayd) lend £986,754 pounds today

Ans: cSection: Basic hedging techniquesLevel: Medium

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10.22 Suppose markets are efficient, there are no taxes, and relative prices remain constant. In such a world,a) hedging cannot still be of value.b) exchange risk management remains of vital concern.c) markets are always free of inflation.d) exchange risk is nonexistent.

Ans: bSection: Managing risk managementLevel: Medium

10.23 American Airlines hedges a £2.5 million receivable by selling pounds forward. If the spot rate is £1 = $1.73 and the 90-day forward rate is $1.7158, what is American's cost of hedging?a) $142,000b) $35,500c) $8,875d) it is unknown at the time American enters into its hedge

Ans: dSection: The true cost of hedgingLevel: Medium

10.24 Suppose it is 1987 and General Motors uses a money market hedge to protect a Lit 200 million payable due in one year. The U.S. interest rate at the time of the hedge was 9% and the lira interest rate was 14%. If the spot rate moved from Lit 1293 at the start of the year to Lit 1349 at the end of the year, what was GM's cost of the money market hedge?a) $3,647b) $414c) GM gained $1,069d) GM gained $5,631

Ans: bSection: Money-market hedgeLevel: Medium

10.25 Suppose PepsiCo hedges a ¥1 billion dividend it expects to receive from its Japanese subsidiary in 90 days with a forward contract. The current spot rate is ¥150/$1 and the 90-day forward rate is ¥149/$1. If the spot rate in 90 days is ¥154/$, how much has this forward market hedge cost PepsiCo?a) $173,160b) $44,743c) Pepsi gains $173,160 from the forward contractd) Pepsi gains $217,903 from the forward contract

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Ans: dSection: Money-market hedgeLevel: Medium

DIFFICULT (applied)

10.26 Suppose the English subsidiary of a U.S. firm had current assets of £1 million, fixed assets of £2 million and current liabilities of 1 million pounds both at the start and at the end of the year. There are no long-term liabilities. If the pound depreciated during that year from $1.50 to $1.30, the translation gain (loss) to be included in the parent company's equity account according to FASB #52 isa) 0 since the current assets and current liabilities cancelb) +$200,000c) -$250,000d) -$400,000

Ans: dSection: Application of FASB No. 52Level: Difficult

10.27 Suppose the German subsidiary of a U.S. firm had current assets of €3 million, fixed assets of €6 million and current liabilities of €3 million both at the start and at the end of the year. There are no long-term liabilities. If the euro depreciated during that year from $.48 to $.38, the FASB-52 translation gain (loss. to be included in the parent company's equity account isa) 0, since the current assets and current liabilities cancelb) +$300,000c) -$350,000d) -$600,000

Ans: dSection: Application of FASB No. 52Level: Difficult

10.28 Transaction gains and losses that result from adjusting assets and liabilities denominated in a currency other than the functional currency must appear on the foreign unit's income statement unless the gains or losses are attributable toa) foreign currency transactions that are designated as an economic hedge of a net investment in a foreign entityb) intercompany foreign-currency transactions that are of a short- term naturec) foreign-currency transactions that involve currency speculation

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d) the prospect of government intervention using currency controls

Ans: aSection: Application of FASB No. 52

Level: Difficult

10.29 If you fear the dollar will rise against the Spanish peseta, with a resulting adverse change in the dollar value of the equity of your Spanish subsidiary, you can hedge bya) selling pesetas forward in the amount of net assetsb) buying pesetas forward in the amount of net assetsc) reducing the liabilities of the subsidiaryd) selling pesetas forward in the amount of total assets

Ans: aSection: Forward market hedge Level: Difficult

10.30 On March 1, 1998, Bechtel submits a franc-denominated bid on a project in France. Bechtel will not learn until June 1 whether it has won the contract. What is the most appropriate way for Bechtel to manage the exchange risk on this contract?a) sell the franc amount of the bid forward for U.S. dollarsb) buy French francs forward in the amount of the contractc) buy a put option on francs in the amount of the franc exposured) sell a call option on francs in the amount of franc exposure

Ans: cSection: Foreign currency optionsLevel: Difficult

10.31 A Japanese firm sells TV sets to an American importer for one billion yen payable in 90 days. To protect against exchange risk, the importer coulda) borrow yen, convert to dollars, and lend dollars for the interim periodb) sell yen on the forward marketc) sell a call option on yend) buy a futures contract for yen on the IMM

Ans: dSection: Cross-hedgingLevel: Difficult

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10.32 If you fear the dollar will rise against the French euro, with a resulting adverse change in the dollar value of the equity of your French subsidiary, you can hedge bya) selling euros forward in the amount of net assetsb) buying euros forward in the amount of net assetsc) reducing the liabilities of the subsidiaryd) selling euros forward in the amount of total assets

Ans: aSection: Forward market hedgeLevel: Difficult

10.33 Suppose that the spot rate and the 90-day forward rate on the pound sterling are $1.35 and $1.30, respectively. Your company, wishing to avoid foreign exchange risk, sells £500,000 forward 90 days. Assuming that the spot rate remains the same 90 days hence, your company woulda) receive £500,000 90 days henceb) receive more than £500,000 in 90 daysc) have been better off not to have sold pounds forwardd) receive nothing

Ans: cSection: Forward market hedgeLevel: Difficult

10.34 In 1993, Ford simultaneously borrows Spanish pesetas at 13% and invests dollars at 10%, both for one year. At the time Ford enters into these transactions, the spot rate for the peseta is $0.095. If the spot rate is peseta 1 = $0.087 in one year, what is the cost to Ford of this money market hedge?a) 2.0%b) 3.8% c) 1.3%d) Ford has a 6.5% gain, not a cost

Ans: dSection: Money market hedgeLevel: Difficult

10.35 Du Pont has entered into a currency risk sharing arrangement with British Gas. Under the contract, Du Pont agrees to pay British Gas a base price of $10 million for gas purchases, but the parties would share the currency risk equally beyond a neutral zone, specified as a band of exchange rates: $1.67-1.73:£1. Within the neutral zone, Du Pont must pay BG the pound equivalent of $10 million at the base rate of $1.70. Suppose the spot rate at the time of payment is £1 = $1.63. How much will Du Pont owe British Gas?

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a) $10 millionb) $9,702,381c) $9,588,235d) $9,819,277

Ans: bSection: Currency risk sharingLevel: Difficult

The following information is to be used in answering questions 36-38.

U.S. borrowing rate for 1 year = 9.5%U.S. deposit rate for 1 year = 8.7%French borrowing rate for 1 year = 11.3%French deposit rate for 1 year = 10.2%French franc spot quote = $0.1763-78French franc 1-year forward quote = $0.1729-47

10.36 What value can Alcoa lock in for a receivable of FF 3 million due in one year if it executes a money market hedge today?a) $525,540b) $516,545c) $530,012d) $520,940

Ans: b Section: Money-market hedgeLevel: Difficult

10.37 What value can Alcoa lock in for its FF 3 million receivable if it executes a forward contract today?a) $518,700b) $524,100c) $528,900d) $532,410

Ans: aSection: Forward market hedge Level: Difficult

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10.38 Suppose Alcoa in 1995 had a payable of FF 1 million due in one year. Alcoa's cost of the payable using a money market hedge is _______ and its cost using a forward market hedge is _______.a) $173,900; $177,470 b) $174,925; $176,300c) $176,671; $172,900d) $178,937; $174,700

Ans: dSection: Money-market hedgeLevel: Difficult

10.39 In 1990, Goodyear had operations in both Germany and the Netherlands. In the past the Dutch guilder and Deutsche mark were highly correlated in their movements against the U.S. dollar. If the Dutch unit has net inflows of guilders and the German unit has net inflows of DM, then Goodyear's combined transaction exposurea) approximately equals the sum of its guilder and DM exposuresb) is less than the sum of its guilder and DM exposures because the currencies are highly correlatedc) is less than the sum of its guilder and DM exposures because of diversification between the company’s subsidiariesd) is not significant due to the highly correlated nature of the two currencies

Ans: aSection: Cross-hedgingLevel: Difficult

10.40 In 1996, DEC hedges a FF 3.2 million receivable due in 180 days. The current spot rate is FF 1 = $0.18834 and the 180-day forward rate is FF 1 = $0.18625. If the spot rate at the end of 180 days is $0.18728, how much has the forward market hedge cost DEC?a) $6,688b) $3,392c) $3,296d) DEC gains $6,688 on the hedge

Ans: cSection: Forward market hedgeLevel: Difficult

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CHAPTER 11Measuring and Managing Economic Exposure

EASY (definitional)

11.1 During a home currency appreciation, exporters may pull out of markets that foreign competition makes ________.a) unprofitableb) more competitivec) profitabled) more liquid

Ans: aSection: Foreign exchange risk and economic exposureLevel: Easy

11.2 Economic exposure is based on the extent to which the ______ of the firm will change when exchange rates change.a) value b) current assetsc) long-term liabilitiesd) competitive advantages

Ans: aSection: Foreign exchange risk and economic exposureLevel: Easy

11.3 _______ exposure arises because currency fluctuations can alter a company’s future revenues and expenses.a) transactionb) operatingc) politicald) translation

Ans: bSection: Foreign exchange risk and economic exposureLevel: Easy

11.4 With respect to home currency (HC) appreciation, the key issue for a domestic firm is its degree of ______.a) market share

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b) product differentiationc) marketing pland) pricing flexibility

Ans: dSource: Operating exposureLevel: Easy

11.5 In the face of exchange rate volatility, developing a pricing strategy must address two key issues:a) market selection and segmentationb) market share and the work forcec) market share and profit margind) market share and segmentation

Ans: cSection: Pricing strategyLevel: Easy

11.6 The _______ the price elasticity of demand, the _____ the incentive to hold down price and thereby expand sales.a) lower, greaterb) lower, lowerc) greater, lowerd) greater, greater

Ans: dSection: Operating exposureLevel: Easy

11.7 During periods of exchange rate volatility, firms dealing in _______ products face more exchange rate risk that the firms selling _________ products.a) low demand, high demandb) low supply, high supplyc) undifferentiated, differentiatedd) differentiated, undifferentiated

Ans: cSection: Operating exposureLevel: Easy

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11.8 With respect to production management of exchange risk, ________ and plant location are the principal variables that companies may change to manage the risk.a) product innovationb) product retirementc) market selectiond) product sourcing

Ans: aSection: Product strategyLevel: Easy

11.9 One way an MNC may improve productivity in the face of exchange rate volatility is by revising ________.a) product offeringsb) the input mixc) and shifting production between plantsd) the promotional strategy

Ans: aSection: Product strategyLevel: Easy

11.10 The greatest boost to a firm’s competitiveness comes from compressing the time it takes to bring new and improved products to market also known as _________.a) product innovationb) the product cyclec) input mixd) market segmentation

Ans: bSection: Planning for exchange rate changesLevel: Easy

11.11 While the strategic marketing and production adjustments occur over the long run, financial management may finance the firm’s operations such that shortfalls in cash flows during the adjustments are offset by a reduction in __________ expenses.a) marketing b) productionc) debt-servicingd) hedging

Ans: cSection: Financial management of exchange rate risk

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Level: Easy

MEDIUM (applied)

11.12 A weak dollar willa) force American exporters to raise their foreign currency pricesb) enable American importers to reduce their dollar costsc) enable American exporters to improve their profit marginsd) cost American exporters market share abroad

Ans: cSection: Real exchange rate changes and exchange rate riskLevel: Medium

11.13 A company producing an undifferentiated product and competing with internationally diversified competitors will face a relatively _____ price elasticity of demand for its products and possess a relatively _____ degree of pricing flexibility.a) high, lowb) low, lowc) low, highd) high, high

Ans: aSection: Operating exposureLevel: Medium

11.14 Which one of the following would NOT be an appropriate response for a U.S. exporter to appreciation of the dollar?a) raise the foreign currency price if the dollar appreciation was expected to be temporary and the cost of regaining

market share was minimal

b) move some production offshore if the appreciation were expected to persist for an extended periodc) keep the foreign currency price constant if demand is quite elasticd) lower the foreign currency price if demand is inelastic for the product

Ans: dSection: Operating exposureLevel: Medium

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11.15 Which one of the following areas is NOT a way companies often respond to exchange rate risk when they alter their product strategy?a) shifting the firm’s manufacturing base to another countryb) the timing of new-product introductionc) changing the size of its product line d) product innovation with advanced technology

Ans: aSection: Product strategyLevel: Medium

11.16 Which of the following strategies assumes that the MNC has already collected a portfolio of different facilities world wide? a) production shifting b) product innovationc) product sourcingd) raising productivity

Ans: aSection: Shifting production among plantsLevel: Medium

11.17 When we examine operating exposure, the key issue for a domestic firm is itsa) prior import competitionb) pricing flexibilityc) asset valuation adjustmentd) low import content

Ans: bSection: Operating exposureLevel: Medium

DIFFICULT (applied)

11.18 Volkswagen almost went bankrupt in 1973 becausea) it failed to offset the exchange risk associated with its cost structure and revenue structure with a suitable liability structureb) it gambled on the value of dollarc) it priced its cars in dollarsd) it priced its cars in deutschemarks

Ans: a

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Section: Financial management of exchange rate riskLevel: Difficult

11.19 A company producing a differentiated product and competing with internationally diversified competitors will face a relatively _______ price elasticity of demand for its products and possess a relatively _______ degree of pricing flexibility.a) high, lowb) low, lowc) low, highd) high, high

Ans: cSection: Operating exposureLevel: Difficult

11.20 The appropriate response for a U.S. exporter to depreciation of the dollar would be toa) raise the foreign currency price if the dollar depreciation was expected to be temporary and the cost of losing market share was minimalb) move some production offshore if the depreciation were expected to persist for an extended periodc) lower the foreign currency price constant if demand is quite inelasticd) set up a netting center in the home country

Ans: aSection: Characteristic economic effects of exchange rate changesLevel: Difficult

11.21 Suppose McDonald's charges Ptas. 25 for a burger in Madrid. Its costs are Ptas. 18 per burger and these costs are not expected to change with the exchange rate. If the peseta devalues from $0.107 to $0.096, what price will McDonald's have to charge for its burgers to maintain its dollar profit margin?a) Ptas. 25.80b) Ptas. 27.86c) Ptas. 22.43d) Ptas. 24

Ans: aSection: Calculating economic exposureLevel: Difficult

11.22 Suppose Apple is selling Macintosh computers in 1996 in Germany for DM 5,500 when the exchange rate is DM 1 = $0.68. If the DM rises to $0.71, what price must Apple charge to maintain its dollar unit revenue?

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a) DM 5,147b) DM 6,361c) DM 5,743d) DM 5,268

Ans: dSection: Calculating economic exposureLevel: Difficult

11.23 Following a devaluation of the Greek drachma, which of the following products sold in Greece is most likely to bear a drachma price increase?a) Fiat automobile, sold to the low end of the marketb) Kentucky Fried Chicken dinner, facing competition from local fast food restaurantsc) IBM mainframe computer, whose only competition comes from other American computer companiesd) shirts from Hong Kong, facing competition from local manufacturers

Ans: cSection: Operating exposureLevel: Difficult

11.24 In the face of an appreciating yen, Toyota should considera) investing in U.S. production facilitiesb) raising its research and development investmentc) coming out with new cars targeted at the low end of the marketd) a and b only

Ans: dSection: Operating exposureLevel: Difficult

11.25 A U.S. exporter that anticipates an appreciation of the dollar shoulda) sell foreign currencies forwardb) borrow foreign currencies c) scout out possible foreign production sitesd) consider raising dollar prices on exports

Ans: cSection: Planning for exchange rate riskLevel: Difficult

11.26 Which of the following products is most likely to benefit from depreciation of the U.S. dollar?

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a) high-end signal processor from Hewlett-Packard that faces minimal competition

b) Chevrolet automobile with a highly price elastic demandc) Mercedes-Benz auto facing price inelastic demandd) low-end Japanese machine tools

Ans: bSection: Foreign exchange risk and economic exposureLevel: Difficult

11.27 Jet engine manufacturing entails enormous economies of scale. Pratt & Whitney, a large U.S. jet engine producer, faces substantial competition from Rolls-Royce, the British engine manufacturer. What would be the BEST way for P & W to cope with a dollar that has recently appreciated by 50%?a) accelerate R&D spending and cost-cutting effortsb) shift some of its production abroadc) raise the foreign currency prices of its engines sold abroadd) buy dollars forward

Ans: aSection: Foreign exchange risk and economic exposureLevel: Difficult

11.28 Which one of the following would not be an improvement from shorter product cycles to improve currency risk management? It would allow the firm toa) incorporate more up-to-date technology in its productsb) respond more quickly to changing market conditionsc) reduce the average price elasticity of demandd) increase the average price elasticity of demand

Ans: dSection: The economic consequences of exchange rate changesLevel: Difficult

11.29 Nissan, the Japanese car manufacturer, exports a substantial fraction of its output to the United States. What financial measures would be suitable for Nissan to take to reduce its currency risk?a) borrow only yen to finance its operationsb) borrow dollars to finance part of its operationsc) sell yen forward in the amount of its annual shipments to the U.S.d) buy yen forward in the amount of its annual shipments to the U.S.

Ans: b

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Section: The economic consequences of exchange rate changesLevel: Difficult

11.30 Sumitomo Bank wants to expand its lending in the United States, but to do so it needs to raise more long-term debt capital to help finance these loans. Currently, long-term interest rates are 9.5% in the U.S. and 6.3% in Japan. What would you recommend Sumitomo do?a) raise yen in Japan because of the lower cost of money b) raise yen in Japan because Japanese investors are more patient than U.S. investors

c) raise dollars in the U.S. to hedge against currency riskd) raise dollars in the U.S. to avoid depressing Tokyo stocks

Ans: cSection: The economic consequences of exchange rate changesLevel: Difficult

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