Question 1

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?

Accepted Answer

The answer of American Airlines hedges a £2.5 million receivable...

Question 2

Firms that attempt to reduce risk and beat the market simultaneously may end up with

Accepted Answer

Attempting to beat the market usually involves taking on more risk, not less. Therefore, when firms attempt to reduce risk while also trying to beat the market, they may end up with more risk overall.

Question 3

If you fear the dollar will rise against the French franc, with a resulting adverse change in the dollar value of the equity of your French subsidiary, you can hedge by

Accepted Answer

Selling francs forward in the amount of net assets will lock in the current exchange rate, protecting against a rise in the dollar and a decrease in the dollar value of the subsidiary's equity.

Question 4

Suppose General Motors uses a money market hedge to protect an 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?

Accepted Answer

To use a money market hedge, GM would have borrowed Lit 200 million at the lira interest rate of 14% and invested the borrowed amount in the U.S. money market at the interest rate of 9%. GM would have received Lit 200 million * 14% = Lit 28 million in interest from the lira investment and would have paid Lit 200 million * 9% = Lit 18 million in interest on the U.S. investment, resulting in a net gain of Lit 10 million. 
Using the spot rates at the start and end of the year, we can calculate the cost of the hedge as follows: 
Lit 200 million / 1293 = $154,518
Lit 200 million / 1349 = $148,242
The cost of the hedge is the difference between the two amounts, or $148,242 - $154,518 = -$6,276. However, since the net gain from interest was Lit 10 million, which is approximately $7,796 at the exchange rate of Lit 1,293/USD, GM's overall gain was $7,796 - $6,276 = $1,520. Therefore, the correct answer is B.

Question 5

One argument that favors centralization of foreign risk management is the ability to take advantage of the portfolio effect through ________.

Accepted Answer

Exposure netting allows an organization to offset exposures in one currency with exposures in another, taking advantage of the portfolio effect to reduce overall risk. This is a key benefit of centralizing foreign risk management.

Question 6

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 could

Accepted Answer

The answer of A Japanese firm sells TV sets to...

Question 7

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 would

Accepted Answer

The answer of Suppose that the spot rate and the...

Question 8

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?

Accepted Answer

The answer of Suppose PepsiCo hedges a ¥1 billion dividend...

Question 9

In a forward market hedge, a company that is long a foreign currency will ____ the foreign currency forward.

Accepted Answer

In a forward market hedge, a company that is long a foreign currency (meaning it expects to receive or already holds that currency) will sell the foreign currency forward to lock in the exchange rate and hedge against the risk of the currency depreciating in value.

Question 10

Which of the following is NOT a basic hedging technique during a currency depreciation?

Accepted Answer

The answer of Which of the following is NOT a...

Question 11

Compaq Computer has a £1 million receivable that it expects to collect in one year. Suppose the interest rate on pounds is 15%. How could Compaq protect this receivable using a money market hedge?

Accepted Answer

To protect the receivable, Compaq needs to enter into a money market hedge. This involves borrowing or lending an amount in the present to offset the future receivable. To determine the amount to borrow or lend, we need to calculate the present value of the receivable using the interest rate.

Present value of receivable = £1 million / (1 + 0.15) = £869,565

Therefore, Compaq should borrow £869,565 today to offset the receivable. Option C is the correct choice.

Question 12

On March 1, 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?

Accepted Answer

Buying a put option on francs allows Bechtel to hedge against the risk of the franc depreciating, while still allowing them to benefit if the franc appreciates.

Question 13

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 Ptas. 1 = $0.087 in one year, what is the cost to Ford of this money market hedge?

Accepted Answer

The spot rate is expected to depreciate by 8.4% (from $0.095 to $0.087), which is less than the 10% return on the dollar investment. Therefore, Ford has a gain, not a cost.

Question 14

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.

Accepted Answer

A money-market hedge involves borrowing and investing in two different currencies to lock in the value of a future foreign currency cash flow. This can be done through the use of short-term securities, such as Treasury bills, in each currency. By doing so, the investor can offset the risk of currency fluctuations and ensure the value of the foreign currency cash flow at a specific point in time. None of the other options involve both borrowing and lending in two different currencies.

Question 15

Hedging cannot provide protection against ________ exchange rate changes.

Accepted Answer

Hedging is used to protect against unexpected changes in exchange rates, not expected changes, as expected changes are already factored into the hedging strategy.

Question 16

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 by

Accepted Answer

Selling pesetas forward in the amount of net assets is a hedge against the dollar rising against the peseta. By locking in a future exchange rate, you protect the dollar value of your equity from adverse currency movements.

Question 17

DEC is asked to quote a price in Belgian francs for computer sales to a Belgian company. The computers will be paid for in four equal, quarterly installments, beginning 90 days from now. DEC requires a minimum price of $2.5 million to accept this contract. Suppose the spot and forward rates for the Belgian franc are as follows:  What is the minimum Belgian franc price that DEC should quote for this order?

Accepted Answer

The answer of DEC is asked to quote a price...

Question 18

Suppose PPP holds, markets are efficient, there are no taxes, and relative prices remain constant. In such a world,

Accepted Answer

Exchange risk management remains of vital concern because even though PPP holds and markets are efficient, there is still the possibility of exchange rate fluctuations that can affect the value of investments.

Question 19

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.

Accepted Answer

A currency collar is a strategy for managing foreign exchange risk in which an investor holds a long position in a currency but wants to limit the potential loss due to exchange rate fluctuations. It involves buying both a put option and a call option on the currency with strike prices that bracket the current exchange rate. This limits the upside potential for gains but also limits the downside risk of losses. This option combination is used to protect against currency fluctuations while allowing for potential gains if the market moves in favor of the investor.

Question 20

The basic hedging strategy involves

Accepted Answer

The basic hedging strategy involves reducing soft currency assets and hard currency liabilities. This can be done in several ways, such as selling off soft currency assets and replacing them with hard currency assets, or taking out loans in hard currency to pay off soft currency liabilities. The goal is to minimize the risk of losses due to fluctuations in exchange rates. A and B are incorrect as they involve increasing either soft currency liabilities or soft currency assets, which would increase the level of risk. D is incorrect as it involves converting soft currencies to hard currencies and lending hard currencies, which does not necessarily reduce the risk of losses due to fluctuations in exchange rates.

Quiz 9: Measuring and Managing Translation and Transaction Exposure