Question 1

Although forward contracts may reduce translation exposure at the expense of increasing transaction exposure, they are sometimes used to hedge translation exposure.

Accepted Answer

Although forward contracts are primarily used to hedge transaction exposure, they can also be used to hedge translation exposure by locking in a specific exchange rate for a future date. This reduces the uncertainty of translation exposure but may increase transaction exposure if the company needs to adjust its cash flows to meet the terms of the forward contract.

Question 2

Transaction exposure results when an MNC translates each subsidiary's financial data to its home currency for consolidated financial statements.

Accepted Answer

Transaction exposure refers to the risk that an MNC faces due to fluctuations in exchange rates affecting the value of its financial transactions (e.g., receivables, payables) denominated in foreign currencies. Translation exposure, not transaction exposure, involves translating subsidiary financial data to the parent company's home currency for consolidated financial statements.

Question 3

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:

Accepted Answer

By purchasing Canadian supplies, Tennessee Co. can use up the excess Canadian dollars it receives from its Canadian operations, reducing its foreign exchange risk by not having to convert those Canadian dollars back to U.S. dollars. This will also provide a natural hedge against any currency fluctuations. Increasing borrowings in the United States or decreasing borrowed funds in Canada may not be feasible or practical options for Tennessee Co. at this time. Decreasing prices on Canadian goods may impact the company's profitability and may not necessarily reduce its foreign exchange risk.

Question 4

Economic exposure represents any impact of exchange rate fluctuations on a firm's future cash flows and thus includes transaction exposure.

Accepted Answer

Economic exposure refers to the impact of exchange rate changes on a company's future cash flows including both transaction and translation exposure.

Question 5

All MNCs are subject to transaction exposure.

Accepted Answer

The answer of All MNCs are subject to transaction exposure....

Question 6

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?

Accepted Answer

Since Thornton does not have any foreign subsidiaries, it does not have any foreign currency denominated assets or liabilities to convert to U.S. dollars for financial reporting purposes. Therefore, it does not have any translation exposure. Choices A, B, and C are all true because Thornton has either transaction or economic exposure to fluctuations in the Indian rupee exchange rate due to its import activities.

Question 7

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.

Accepted Answer

Appreciation of the euro relative to the U.S. dollar will cause the firm's reported earnings to decrease. To protect against this, the firm could stabilize its reported earnings by purchasing euros forward in the foreign exchange market.

Question 8

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.

Accepted Answer

Mercury's consolidated earnings were favorably affected by the euro's appreciation, increasing the value of its earnings when converted back to its home currency. However, the hedge position was adversely affected because Mercury had to sell euros at the predetermined lower forward rate, missing out on the benefits of the euro's appreciation.

Question 9

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.

Accepted Answer

When a foreign currency has a greater impact on cash inflows than on cash outflows, the MNC is said to have a net long position in that currency. To reduce this economic exposure, the MNC could reduce its level of foreign sales or increase its foreign supply orders, thereby decreasing its cash inflows in that currency. The MNC could also restructure debt to increase debt payments in the foreign currency, which would effectively convert some of its net long position to a net short position.

Question 10

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.

Accepted Answer

Atlanta Co. has economic exposure because it is exposed to fluctuations in exchange rates due to its international competition. Phoenix Co. has transaction exposure because it is exposed to exchange rate fluctuations in its business transactions with the Canadian supplier.

Question 11

The management of economic exposure is normally focused completely on transactions that will occur in the next three months.

Accepted Answer

The management of economic exposure is focused on predicting and managing the long-term impact of exchange rate fluctuations on a company's cash flow, profits, and overall financial health. It is not limited to just the next three months.

Question 12

Even if translation exposure does not affect cash flows, it is a concern of many MNCs.

Accepted Answer

Translation exposure refers to the potential impact of exchange rate fluctuations on the financial statements of an MNC's foreign operations. Although it may not directly affect cash flows, it can impact a company's profitability, competitiveness, and overall financial performance, making it an important consideration for many MNCs.

Question 13

If a U.S. firm has much more revenue than expenses denominated in euros, the firm will likely ____ if the euro ____.

Accepted Answer

If a U.S. firm has more revenue than expenses in euros, a strengthening euro increases the value of its euro-denominated revenue when converted back to dollars, thus benefiting the firm.

Question 14

Implementing a forward or money market hedge to hedge translation exposure may increase transaction exposure.

Accepted Answer

Implementing a forward or money market hedge involves entering into a foreign currency transaction, which creates a new transaction exposure that must be managed. This can lead to an increase in transaction exposure, as the company must monitor and manage both the original exposure and the new exposure created by the hedge.

Question 15

Translation exposure results when an MNC translates each subsidiary's financial data to its home currency for consolidated financial statements.

Accepted Answer

Translation exposure refers to the risk of fluctuations in exchange rates in the process of translating the financial statements of foreign subsidiaries into the home currency of the MNC for consolidation. This process results in gains or losses due to currency fluctuations, which can impact the overall financial performance of the MNC.

Question 16

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.

Accepted Answer

A U.S.-based MNC with a subsidiary in Barbados that generates substantial net cash inflows denominated in Barbados dollars would benefit from an appreciation of the Barbados dollar. This is because an appreciation of the Barbados dollar would increase the value of the subsidiary's cash inflows when they are translated into U.S. dollars for consolidation purposes.

Question 17

____ is (are) a limitation of hedging translation exposure.

Accepted Answer

The answer of ____ is (are) a limitation of hedging...

Question 18

A foreign subsidiary with more revenue than expenses denominated in a foreign currency will be favorably affected by appreciation of the foreign currency.

Accepted Answer

If the foreign subsidiary has more revenue than expenses denominated in a foreign currency, an appreciation of the foreign currency will result in higher revenue and lower expenses when translated back into the parent company's currency, leading to a favorable impact on the subsidiary's financial results.

Quiz 12: Managing Economic Exposure and Translation Exposure