FINAL EXAM

Question 1

a measure of the potential for a firm’s profitability, net cash flow, and market value to change because of a change in exchange rates

Answer 1

Foreign exchange exposure

Question 2

What is the goal of management for foreign exchange exposure?

Answer 2

To measure foreign exchange exposure and to manage it so as to maximize the profitability, net cash flow, and market value of the firm

Question 3

What are the two categories of foreign exchange exposure?

Answer 3

• Accounting exposure
• Economic exposure

Question 4

Arise from contracts and accounts being denominated in foreign currency

Answer 4

Accounting exposures

Question 5

the potential change in the value of the firm from its changing global competitiveness

Answer 5

Economic exposure

Question 6

What are the 3 types of foreign exchange exposure

Answer 6

• Transaction exposure
• Translation exposure
• Operating exposure

Question 7

Transaction exposure changes in expected cash flows resulting from _______ __________ _________

Answer 7

existing contractual obligations

Question 8

the potential for accounting-derived changes in owner’s equity to occur because of the need to “translate” foreign currency financial statements of foreign subsidiaries into a single reporting currency to prepare worldwide consolidated financial statements.

Answer 8

Translation exposure

Question 9

measures the change in the present value of the firm resulting from any change in future operating cash flows of the firm caused by an unexpected change in exchange rates.

Answer 9

Operating exposure

Question 10

What is the similarities between transaction and operating exposure?

Answer 10

Both deal with unexpected changes in future cash flows

Question 11

What is the difference between transaction exposure and operating exposure?

Answer 11

-transaction exposure is concerned with future cash flows already contracted for

-operating exposure focuses on expected (not yet contracted for) future cash flows

Question 12

the taking of a position — an asset, a contract, or a derivative — that will rise (fall) in value and offset a fall (rise) in the value of an existing position

Answer 12

Hedging

Question 13

Hedging can protect the owner of an asset from a ____;
however, it also eliminates any ____ from an increase in the value of the asset hedged.

Answer 13

loss; gain

Question 14

Opponents of hedging:

Answer 14

Shareholders are much more capable of diversifying currency risk than the management of the firm

Currency risk management does not increase the expected cash flows of the firm

Management incentives

Question 14

Proponents of Hedging

Answer 14

• Reduction in risk in future cash flows improves the planning capability of the firm
• Reduction of risk in future cash flows reduces the likelihood that the firm’s cash flows will fall below a necessary minimum (the point of financial distress)
• Management has a comparative advantage over the individual shareholder in knowing the actual currency risk of the firm
• Management is in better position to take advantage of disequilibrium conditions in the market with selective hedging.

Question 15

measures gains or losses that arise from the settlement of existing financial obligations whose terms are stated in a foreign currency

Answer 15

Transaction exposure

Question 16

Transaction exposure arise from a variety of business activities:

Answer 16

• Purchasing or selling goods or services with settlement in foreign currencies
• Borrowing and lending funds with repayment in a foreign currency
• Other causes: Being a party to an unperformed forward contract

Question 17

Operating exposure is also called…

Answer 17

• Economic exposure
• Competitive exposure
• Strategic exposure

Question 18

arise from intercompany (between unrelated companies) and intracompany (between units of the same company) receivables and payables, such as rent and lease payments, royalty and license fees and assorted management fees.

Answer 18

Operating cash flows

Question 19

payments for the use of intercompany and intracompany loans (principal and interest) and stockholder equity (new equity and dividends).

Answer 19

Financing cash flows

Question 20

Operating exposure is far more important for the ____ ___ health of a business than changes caused by transaction or translation exposure.

Answer 20

Long run

Question 21

What are the challenges of operating exposure?

Answer 21

• Operating exposure is subjective - it depends on estimates of future cash flow changes over an arbitrary time horizon.
• Planning for operating exposure depends on the interaction of strategies in finance, marketing, purchasing, and production.

Question 22

Only _________ changes in exchange rates, or an inefficient foreign exchange market, should cause market value to change.

Answer 22

unexpected

Question 23

The objective of both operating and transaction exposure management is

Answer 23

to anticipate and influence the effect of unexpected changes in exchange rates on a firm’s future cash flows

Question 24

adopt operating or financing policies that offset anticipated foreign exchange exposures.

Answer 24

Proactive management of operating exposure

Question 25

The most commonly employed proactive policies include:

Answer 25

1. Matching currency cash flows 2. Risk-sharing agreements 3. Back-to-back or parallel loans 4. Cross-currency swaps 5. Contractual approaches

Question 26

The particular strategy of trying to offset stable inflows of cash from one country with outflows of cash in the same currency is known​ as:

Answer 26

Matching

Question 27

seek out potential suppliers in Canada as a substitute for sourcing from U.S. or other foreign firms. Hedge an operational cash inflow with an operational cash outflow

Answer 27

Natural hedge

Question 28

pay foreign suppliers with Canadian dollars.

Answer 28

Currency switching

Question 29

This is a contractual arrangement in which the buyer and seller agree to “share” or split currency movement impacts on payments between them.

Answer 29

Risk-Sharing Agreements

Question 30

two business firms in separate countries arrange to borrow each other’s currency for a specific period.

Answer 30

Back-to-Back or Parallel Loans

Question 31

A firm and a swap dealer (or swap bank) agree to exchange an equivalent amount of two different currencies for a specified amount of time

Answer 31

Currency swap

Question 32

A currency swap resembles a back-to-back loan excepts that it does not appear on a firm's ________ _____

Answer 32

Balance sheet

Question 33

When financial statements are consolidated into one currency, accounts...

Answer 33

do not balance

Question 34

What are the two methods of translation?

Answer 34

- Current rate method - Temporal method

Question 35

all financial statement items are translated at the “current” exchange rate (the rate of exchange in effect on the balance sheet date)

Answer 35

Current Rate Method

Question 36

Under this method, specific assets and liabilities are translated at exchange rates consistent with the timing of the item’s creation

Answer 36

Temporal Method

Question 37

Under the temporal method, any gains or losses from remeasurement are carried directly to...

Answer 37

current consolidated income and not to equity reserves

Question 38

Under the current rate method, any gain or loss from re-measurement is closed to...

Answer 38

an equity reserve account entitled the cumulative translation adjustment, rather than through the company’s consolidated income statement

Question 39

The US differentiates foreign subsidiaries on the basis of functional currency, not subsidiary characterization For the financial statements maintained in local currency: If the functional currency is the Local currency The US primarily uses the __________ If the functional currency is the US dollar The US primarily uses the _____________

Answer 39

Current rate method; Temporal method

Question 40

this requires an equal amount of exposed foreign currency assets and liabilities on a firm’s consolidated balance sheet

Answer 40

Balance sheet hedge

Question 41

As a general matter, firms seeking to reduce both types of exposures typically go with ____________ ___________ first

Answer 41

Transaction exposure