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Exam 9: Transaction Exposure

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Question 1

True/False

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Hedging, or reducing risk, is the same as adding value or return to the firm.

A) True
B) False

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Question 2

Multiple Choice

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________ exposure is the potential for accounting-derived changes in owner's equity to occur because of the need to translate foreign currency financial statements into a single reporting currency.

A) Transaction
B) Operating
C) Economic
D) Accounting

E) A) and B)
F) A) and C)

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Question 3

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Use the information for the following problem(s) . Plains States Manufacturing has just signed a contract to sell agricultural equipment to Boschin, a German firm, for euro 1,250,000. The sale was made in June with payment due six months later in 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 $1.40/euro • The six month forward rate is $1.38/euro • 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-month lending 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 euro 625,000; strike price $1.42, premium price is 1.5% • Plains States' forecast for 6-month spot rates is $1.43/euro • The budget rate, or the lowest acceptable sales price for this project, is $1,075,000 or $1.35/euro -Refer to Instruction 9.1. Plains States could hedge the Euro receivables in the money market. Using the information provided, how much would the money market hedge return in six months assuming Plains States reinvests the proceeds at the U.S. investment rate?

Use the information for the following problem(s) . Plains States Manufacturing has just signed a contract to sell agricultural equipment to Boschin, a German firm, for euro 1,250,000. The sale was made in June with payment due six months later in 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 $1.40/euro • The six month forward rate is $1.38/euro • 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-month lending 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 euro 625,000; strike price $1.42, premium price is 1.5% • Plains States' forecast for 6-month spot rates is $1.43/euro • The budget rate, or the lowest acceptable sales price for this project, is $1,075,000 or $1.35/euro -Refer to Instruction 9.1. 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 been correct.

________ is NOT a popular contractual hedge against foreign exchange transaction exposure.

List and define the three types of foreign exchange exposure presented by your authors.

A U.S. firm sells merchandise today to a British company for £100,000. The current exchange rate is $2.03/£, the account is payable in three months, and the firm chooses to avoid any hedging techniques designed to reduce or eliminate the risk of changes in the exchange rate. If the exchange rate changes to $2.01/£ the U.S. firm will realize a ________ of ________.

There is considerable question among investors and managers about whether hedging is a good and necessary tool.

US firm submitted a fixed bid for a Euro multimillion project in Ukraine. The contract will be awarded in 12 months and the company knows there will be no advance payments. The company

Use the information for the following problem(s) . Plains States Manufacturing has just signed a contract to sell agricultural equipment to Boschin, a German firm, for euro 1,250,000. The sale was made in June with payment due six months later in 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 $1.40/euro • The six month forward rate is $1.38/euro • 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-month lending 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 euro 625,000; strike price $1.42, premium price is 1.5% • Plains States' forecast for 6-month spot rates is $1.43/euro • The budget rate, or the lowest acceptable sales price for this project, is $1,075,000 or $1.35/euro -Refer to Instruction 9.1. What is the cost of a put option hedge for Plains States' euro receivable contract? (Note: Calculate the cost in future value dollars and assume the firm's cost of capital as the appropriate interest rate for calculating future values.)

Use the information for the following problem(s). Plains States Manufacturing has just signed a contract to sell agricultural equipment to Boschin, a German firm, for euro 1,250,000. The sale was made in June with payment due six months later in 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 $1.40/euro • The six month forward rate is $1.38/euro • 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-month lending 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 euro 625,000; strike price $1.42, premium price is 1.5% • Plains States' forecast for 6-month spot rates is $1.43/euro • The budget rate, or the lowest acceptable sales price for this project, is $1,075,000 or $1.35/euro -Refer to Instruction 9.1. Money market hedges almost always return more than forward hedges because of the greater risk involved.

Each of the following is another name for operating exposure EXCEPT

When a firm enters into a 90 day forward exchange contract

German company is evaluating alternatives to hedge US1M payable in three months. A money market hedge for this transaction will be

________ is a technique used by MNEs to deal with currency exposure.

Which of the following is NOT cited as a good reason for hedging currency exposures?

Transaction exposure and operating exposure exist because of unexpected changes in future cash flows. The difference between the two is that ________ exposure deals with cash flows already contracted for, while ________ exposure deals with future cash flows that might change because of changes in exchange rates.

Which of the following is cited as a good reason for NOT hedging currency exposures?

Use the information for the following problem(s) . Plains States Manufacturing has just signed a contract to sell agricultural equipment to Boschin, a German firm, for euro 1,250,000. The sale was made in June with payment due six months later in 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 $1.40/euro • The six month forward rate is $1.38/euro • 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-month lending 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 euro 625,000; strike price $1.42, premium price is 1.5% • Plains States' forecast for 6-month spot rates is $1.43/euro • The budget rate, or the lowest acceptable sales price for this project, is $1,075,000 or $1.35/euro -Refer to Instruction 9.1. If Plains States chooses to hedge its transaction exposure in the forward market, it will ________ euro 1,250,000 forward at a rate of ________.

Company Y submits 7 day validity offer for spare parts to be exported in Germany starting from January 1st in the following year. By doing so the company has