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Chapter 10

Measuring Exposure to Exchange Rate Fluctuations
1. Translation exposure reflects: A) the exposure of a firm’s ongoing international transactions to exchange rate fluctuations. B) the exposure of a firm’s local currency value to transactions between foreign exchange traders. C) the exposure of a firm’s financial statements to exchange rate fluctuations. D) the exposure of a firm’s cash flows to exchange rate fluctuations. ANSWER: C 2. Transaction exposure reflects: A) the exposure of a firm’s ongoing international transactions to exchange rate fluctuations. B) the exposure of a firm’s local currency value to transactions between foreign exchange traders. C) the exposure of a firm’s financial statements to exchange rate fluctuations. D) the exposure of a firm’s cash flows to exchange rate fluctuations. ANSWER: A 3. Economic exposure refers to: A) the exposure of a firm’s ongoing international transactions to exchange rate fluctuations. B) the exposure of a firm’s local currency value to transactions between foreign exchange traders. C) the exposure of a firm’s financial statements to exchange rate fluctuations. D) the exposure of a firm’s cash flows to exchange rate fluctuations. E) the exposure of a country’s economy (specifically GNP) to exchange rate fluctuations. ANSWER: D 4. Diz Co. is a U.S.-based MNC with net cash inflows of euros and net cash inflows of Swiss francs. These two currencies are highly correlated in their movements against the dollar. Yanta Co. is a U.S.-based MNC that has the same level of net cash flows in these currencies as Diz Co. except that its euros represent net cash outflows. Which firm has a higher exposure to exchange rate risk? A) Diz Co. B) Yanta Co. C) the firms have about the same level of exposure. D) neither firm has any exposure. ANSWER: A

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Which of the following operations benefits from appreciation of the firm’s local currency? A) borrowing in a foreign currency and converting the funds to the local currency prior to the appreciation. D) exporting to foreign countries. are not B) are.S. ANSWER: A 8. currency variability levels _______ perfectly stable over time. are C) are not. are ANSWER: C 7. is a U. ANSWER: B 6. except that its Sunland francs represent cash outflows. D) borrowing in a foreign country and converting the funds to the local currency prior to the depreciation AND purchasing foreign supplies. Which firm has a high exposure to exchange rate risk? A) Jacko Co. C) the firms have about the same level of exposure. B) purely domestic firms only.245 International Financial Management 5.S. Jacko Co. Which of the following operations benefits from depreciation of the firm’s local currency? A) borrowing in a foreign country and converting the funds to the local currency prior to the depreciation. C) investing in foreign bank accounts denominated in foreign currencies prior to depreciation of the local currency. B) receiving earnings dividends from foreign subsidiaries. ANSWER: C . ANSWER: C 9. These two currencies are highly negatively correlated in their movements against the dollar. Economic exposure can affect: A) MNCs only. B) Kriner Co. D) none of these. B) purchasing foreign supplies. A) are. C) MNCs and purely domestic firms.-based MNC that has the same exposure as Jacko Co. According to the text.-based MNC with net cash inflows of Singapore dollars and net cash inflows of Sunland francs. and currency correlations _______ perfectly stable over time. are not D) are not. D) neither firm has any exposure. Kriner Co. in these currencies. is a U. C) purchasing supplies locally rather than overseas.

During _______ dollar cycles. firm anticipates the equivalent of $1 million cash outflows in francs and the equivalent of $1 million cash outflows in pounds.S. B) translation gains and losses are included in stockholder’s equity. If the dollar weakens. A U. then Magent Co. D) be adversely affected.S.10. ANSWER: B 11. somewhat stable B) weak. cash outflows are _______. because the dollar value of its DK position exceeds the dollar value of its SF position.40 while the present exchange rate of the DK is $. weaker ANSWER: A . because the dollar value of its DK position exceeds the dollar value of its SF position. The present exchange rate of the SF is about $. not D) weak dollar. favorably ANSWER: A 12. During a _______ cycle. C) translation gains and losses are included in both reported net income and stockholder’s equity. C) be adversely affected. favorably B) weak dollar. The SF and DK are highly correlated in their movements against the dollar. A U. because the dollar value of its SF position exceeds the dollar value of its DK position. adversely affected D) none of these ANSWER: A 13. Magent Co. A) strong dollar. because the dollar value of its SF position exceeds the dollar value of its DK position. MNC has the equivalent of $1 million cash outflows in each of two highly negatively correlated currencies. It has net inflows of SF200 million and net outflows of DK500 million. A) weak. not C) strong dollar. ANSWER: A 14. will: A) benefit. Generally. is a U. D) none of these. MNCs with less foreign costs than foreign revenue will be _______ affected by a _______ foreign currency. has not hedged these positions. A) favorably. Under FASB 52: A) translation gains and losses are included in the reported net income.Chapter 10: Measuring Exposure to Exchange Rate Fluctuations 246 10.S. Assume that the British pound and Swiss franc are highly correlated. the firm is _______ affected by its exposure. weaker D) not. company that has exposure to the Swiss francs (SF) and Danish kroner (DK). B) benefit. stronger B) not. stronger C) favorably. Magent Co. favorably affected C) weak.

D) decrease the firm’s cash outflow required to pay for imported supplies denominated in a foreign currency. firm’s cost of goods sold exposure is much greater than its sales exposure in Switzerland. favorably affected but by a smaller degree B) favorably. ANSWER: E 18. favorably affected D) favorably.S. A) positive. A firm produces goods for which substitute goods are produced in all countries. A firm produces goods for which substitute goods are produced in all countries. A) favorably. gross profit D) negative. C) decrease the returns earned on the firm’s foreign bank deposits.-based MNCs are _______ affected by translation exposure. interest expenses B) positive.S. favorably affected by a higher degree C) unfavorably. the reported consolidated earnings are _______. B) increase the firm’s exports denominated in the local currency. B) decrease the firm’s exports denominated in the local currency. Depreciation of the firm’s local currency should: A) decrease local sales as foreign competition in local markets is reduced. When the dollar weakens. E) none of these. D) increase the firm’s cash outflow required to pay for imported supplies denominated in a foreign currency. there is a _______ overall impact of the Swiss franc’s depreciation against the dollar on _______. E) none of these. Appreciation of the firm’s local currency should: A) increase local sales as it reduces foreign competition in local markets. the reported consolidated earnings of U. interest expenses ANSWER: B . ANSWER: E 17. unfavorably affected ANSWER: C 16.247 International Financial Management 15. gross profit C) negative. C) increase the returns earned on the firm’s foreign bank deposits. When the dollar strengthens. If a U.

000.500.000.55. C) $525. negative D) negative.000 × $.000 + €1. The expected exchange rate of the Australian dollar is $. You apply the regression model to an earlier subperiod and a more recent subperiod.000 = -€500. Your competition is mainly U.S. What is the net inflow or outflow as measured in U. D) $210. Subsidiary A of Mega Corporation has net inflows in Australian dollars of A$1.05. B) $500.S. SPt is the dependent variable. dollars? A) $500.05 = –$525.000 outflow. producers of chairs. translation exposure.675.000.000 = –A$500. while the Greek subsidiary generated a net inflow of €1.S.500. is a U.Chapter 10: Measuring Exposure to Exchange Rate Fluctuations 248 19.55 = –$275. What is the net inflow or outflow as measured in U. B) $525. dollars this year? The exchange rate for the euro is $1.-based MNC that has a subsidiary in Germany and another subsidiary in Greece. economic exposure. ANSWER: D SOLUTION: A$1.000 outflow. ANSWER: B SOLUTION: -€2. C) $275.000 this year.000. In the recent subperiod.000. Both subsidiaries frequently remit their earnings back to the parent company.000.000 inflow. ANSWER: B 21.000 22. Assume that your firm is an importer of Mexican chairs denominated in pesos. you increased your importing volume. A) negative. A) B) C) D) Which of the following is not a form of exposure to exchange rate fluctuations? transaction exposure.S. positive B) positive.500. Dubas Co. while Subsidiary B has net outflows in Australian dollars of A$1.000 inflow. negative ANSWER: D 20. credit exposure.000 outflow. You should expect that the regression coefficient in the PESOt variable would be _______ in the first subperiod and _______ in the second subperiod.000 .000 inflow. D) $275. The German subsidiary generated a net outflow of €2. positive C) positive.000 – A$1.000 outflow. You wish to assess the relationship between the percentage change in its stock price (SPt) and the percentage change in the peso’s value relative to the dollar (PESOt).000. A) $3.000 outflow.000 × $1.500.

low D) none of these ANSWER: B 26. B) diversified stakeholders will not be affected by exchange rate movements because of offsetting effects. then the MNC’s transaction exposure is _______ is the two currencies are _______ correlated. _______ exposure is the degree to which the value of future cash transactions can be affected by exchange rate fluctuations.249 International Financial Management 23. A) high. ANSWER: B 24. A) negatively. and the two currencies are _______ correlated. One argument for exchange rate irrelevance is that: A) MNCs can hedge exchange rate exposure much more effectively than individual investors. If an MNC expects cash inflows of equal amounts in two currencies. negatively D) none of these ANSWER: C . negatively C) high. D) MNCs are typically not diversified across numerous countries. the MNC’s transaction exposure is relatively _______. C) purchasing power parity does not hold very well. low C) positively. positively B) low. If an MNC has a net inflow in one currency and a net outflow of about the same amount in another currency. high B) negatively. A) Transaction B) Economic C) Translation D) None of these ANSWER: A 25.

D) –1.012) × 5. Assume that these percentage changes are normally distributed. Cerra Co. C) –$111.5% − (1. ANSWER: D SOLUTION: 0.5%? The current spot rate of the euro (before considering the maximum one-day loss) is $1.5%. ANSWER: B SOLUTION: 0. the confidence level used. Cerra Co.5% − (1.Chapter 10: Measuring Exposure to Exchange Rate Fluctuations 250 27.000. the standard deviation of the daily percentage changes in the currency over a previous period.65 × 1%) = −1.750. Using the value-at-risk (VAR) method based on a 95% confidence level. what is the maximum one-day loss if the expected percentage change of the euro tomorrow is 0. Assume that these percentage changes are normally distributed. C) –1.600 29.2%. Cerra estimates the standard deviation of daily percentage changes of the euro to be 1 percent over the last 100 days. ANSWER: C . A) –$75. the current level of interest rates.600. A) B) C) D) The maximum one-day loss computed for the value-at-risk (VAR) method does not depend on: the expected percentage change in the currency for the next day.5%. B) –$60.2%. expects to receive 5 million euros tomorrow as a result of selling goods to the Netherlands.100.01. expects to receive 5 million euros tomorrow as a result of selling goods to the Netherlands. B) –2.2% 28.01 × (−.000 = −$60.65 × 1%) = −1. what is the maximum one-day loss in dollars if the expected percentage change of the euro tomorrow is 0.250. D) –$25.2% $1. Cerra estimates the standard deviation of daily percentage changes of the euro to be 1 percent over the last 100 days.5%? A) –0. Using the value-at-risk (VAR) method based on a 95% confidence level.

-based exporting firm that expects to receive payments denominated in both euros and Canadian dollars in one month. What is the portfolio standard deviation? A) 3.03) = 5.375) 2 (.00%.03) 2 + 2(.375)(. B) –30. Inc. the dollar value of the funds to be received is estimated at $500. A) reduction.00% 32.S.44%. Based on today’s spot rates.03) = 5.30)(.S. D) none of these. A) –9.08)(. the dollar value of the funds to be received is estimated at $500.625)(.44%) = −9. increase C) increase.625) 2 (.375)(.625)(.30.000 for the Canadian dollars.00%. B) 5. is a U.98%. Based on today’s spot rates. Inc. Volusia estimates the standard deviation of monthly percentage changes to be 8 percent for the euro and 3 percent for the Canadian dollar.000 for the euros and $300.08)(.30. Volusia. what is the maximum one-month loss of the currency portfolio? Use a 95 percent confidence level and assume the monthly percentage changes for each currency are normally distributed. Based on data for the last fifty months. is a U. Appreciation in a firm’s local currency causes a(n) _______ in cash inflows and a(n) _______ in cash outflows. Volusia estimates the standard deviation of monthly percentage changes to be 8 percent for the euro and 3 percent for the Canadian dollar.03) 2 + 2(.44% 31.65 × 5. Assuming an expected percentage change of 0 percent for each currency during the next month. The correlation coefficient between the euro and the Canadian dollar is 0. C) 17. ANSWER: B SOLUTION: σ p = (.375) 2 (.-based exporting firm that expects to receive payments denominated in both euros and Canadian dollars in one month. D) none of these.625) 2 (. The correlation coefficient between the euro and the Canadian dollar is 0.00%. ANSWER: A SOLUTION: σ p = (.08) 2 + (.00%.000 for the euros and $300. increase ANSWER: A . C) –5.30)(.08) 2 + (. reduction D) reduction. Volusia. reduction B) increase.000 for the Canadian dollars. Based on data for the last fifty months.251 International Financial Management 30.44% 0% − (1.

D) an MNC’s exports denominated in foreign currencies will probably increase. appreciated B) benefit from. A) greater. and et is the percentage change in the exchange rate of the currency over period t. has very little foreign competition. depreciated D) none of these ANSWER: C 34. dollar appreciates: A) an MNC’s U. E) all of these. ANSWER: B . The regression model estimates a coefficient of a1 of 2. A) be hurt by.S. dollars will probably increase. the _______ the percentage of a given financial statement item that is susceptible to translation exposure. smaller B) smaller. The _______ the percentage of an MNC’s business conducted by its foreign subsidiaries. C) an MNC’s interest owed on foreign funds borrowed will probably increase. This indicates that: A) if the foreign currency appreciates by 1%. sales will probably decrease. has applied the following regression model to estimate the sensitivity of its cash flows to exchange rate movements: PCFt = a0 + a1et + µt where the term on the left-hand side is the percentage change in inflation-adjusted cash flows measured in the firm’s home currency over period t. depreciated C) be hurt by. and obtains foreign supplies (denominated in foreign currencies) will likely _______ a(n) _______ local currency. Mill’s cash flows will increase by 2%. greater D) none of these ANSWER: C 35. E) none of these. 252 In general. greater C) greater. Mill’s cash flows will decline by .Chapter 10: Measuring Exposure to Exchange Rate Fluctuations 33. B) if the foreign currency appreciates by 1%.2%. Mill’s cash flows will decline by 2%. Assume that Mill Corporation. a U. D) if the foreign currency depreciates by 1%. a firm that concentrates on local sales. Mill’s cash flows will decline by 2%.S. B) an MNC’s exports denominated in U. If the U. C) if the foreign currency depreciates by 1%.S.S.-based MNC. ANSWER: A 36.

A) B) C) D) International Financial Management _______ is(are) not a determinant of translation exposure.-based MNC to determine its degree of economic exposure as it relates to the Australian dollar and Sudanese dinar (SDD): PCFt = a0 + a1et + µt where the term on the left-hand side is the percentage change in inflation-adjusted cash flows measured in the firm’s home currency over period t. C) The MNC probably had more outflows than inflows in Australian dollars in the earlier subperiod. The MNC’s degree of foreign involvement The locations of foreign subsidiaries The local (domestic) earnings of the MNC The accounting methods used ANSWER: C 38. D) The MNC probably had more inflows than outflows denominated in dinar in the more recent subperiod.20 Regression Coefficient ( a1 ) Recent Subperiod . E) All of these are true. ANSWER: C . which of the following statements is probably not true? A) The MNC was more sensitive to movements in the Australian dollar than in the dinar in the earlier subperiod.S. with the following results: Regression Coefficient ( a1 ) Earlier Subperiod –. B) The MNC was more sensitive to movements in the dinar than in the Australian dollar in the more recent subperiod.10 .25 Currency Australian dollar (A$) Sudanese dinar (SDD) Based on these results. and et is the percentage change in the exchange rate of the currency over period t.80 . The following regression model was run by a U. The regression was run over two subperiods for each of the two currencies.253 37.

B) 2.70)(.30) 2 (.05) 2 + 2(.50%.85.7) = 5. The standard deviation of exchange movements is 7% for Taiwan dollars and 5% for pounds. Under FASB 52. 25% of the MNC’s funds are Taiwan dollars and 75% are pounds.30)(. B) false.75) 2 (. ANSWER: A SOLUTION: σ p = (. consolidated earnings are sensitive to the functional currency’s weighted average exchange rate.15)(.33%. C) 4.55%. The correlation coefficient between movements in the value of the lev and the leu is .13% 40. D) 5. the standard deviation of this two-currency portfolio is approximately: A) 17.10)(. Based on this information.15) 2 + 2(. A) true.7. ANSWER: B SOLUTION: σ p = (.25)(. B) false. ANSWER: A 43.13%.04%. B) false.10) 2 + (. Based on this information. A) true.07) 2 + (.63%.Chapter 10: Measuring Exposure to Exchange Rate Fluctuations 254 39. B) 13. A) true. The standard deviation of exchange movements is 10% for lev and 15% for leu. the standard deviation of this two-currency portfolio is approximately: A) 5. One argument why exchange rate risk is irrelevant to corporations is that shareholders can deal with this risk individually. D) 12. 30% of the MNC’s funds are lev and 70% are leu.85) = 1315% . The correlation coefficient between movements in the value of the Taiwan dollar and the pound is .25) 2 (. Consider an MNC that is exposed to the Taiwan dollar (TWD) and the Egyptian pound (EGP). C) 14. Consider an MNC that is exposed to the Bulgarian lev (BGL) and the Romanian leu (ROL).05)(.75)(. ANSWER: B 42. ANSWER: A .70) 2 (.28%.07)(.15%. A set of currency cash inflows is more volatile if the correlations are low. 41.

U. B) false. ANSWER: A 45. B) false. A) true. If the functional currencies for reporting purposes are highly correlated. B) false. ANSWER: B 47. ANSWER: B 46. B) false. B) false. ANSWER: A . A) true. exchange rate movements may cause earnings to be more volatile. A) true. ANSWER: B 48. A) true. B) false. ANSWER: A 49. A firm’s transaction exposure in any foreign currency is based solely on the size of its open position in that currency. That is it exhibits low correlations with the other currencies. exchange rate risk is probably relevant. A) true. exporters may not necessarily benefit from weak-dollar periods if foreign competitors are willing to reduce their profit margin. The Canadian dollar consistently appears to move almost independently of other currencies. and because investors may prefer corporations to perform hedging for them.255 International Financial Management 44. B) false.S. ANSWER: A 50. A) true. A) true. translation exposure is magnified. Two highly negatively correlated currencies act almost as if they are the same currency. Because creditors may prefer that firms maintain low exposure to exchange rate risk. The transaction exposure of two inflow currencies is offset when the correlation between the currencies is high.

B) false. ANSWER: B . ANSWER: B 53. ANSWER: B 57. B) false. Regression analysis cannot be used to assess the sensitivity of a company’s performance to economic conditions because economic conditions are unpredictable. A company may become more exposed or sensitive to an individual currency’s movements over time for several reasons. 256 Translation exposure is less of a concern when earnings are not remitted by the subsidiary to the parent. ANSWER: A 55. or an increased use of the foreign currency. including a reduction in hedging. A) true. Assume a regression is run of the firm’s stock price percentage change on the percentage change in the foreign currency. B) false. A) true.Chapter 10: Measuring Exposure to Exchange Rate Fluctuations 51. The coefficient is negative. A high correlation between two currencies would be desirable for achieving low exchange rate risk if one is an inflow currency and the other is an outflow currency. A) true. ANSWER: A 52. B) false. ANSWER: A 56. B) false. A) true. The exposure of an MNC’s consolidated financial statements to exchange rate fluctuations is known as transaction exposure. This implies that the company’s stock price increases if the foreign currency appreciates. B) false. A) true. ANSWER: A 54. A) true. Firms with more in foreign costs than in foreign revenues will be favorably affected by a stronger foreign currency. B) false. a greater involvement in the foreign country. A) true.

the decision by one subsidiary to hedge its position in that currency would increase the MNC’s overall exposure. B) false. ANSWER: A 59. A) true. In general. B) false. A) true. A) true. A) true. B) false. If exchange rate movements are less volatile in the past than in the future. B) false. ANSWER: B 60. ANSWER: A 61. ANSWER: A . If positions in a specific currency among an MNC’s subsidiaries offset each other. ANSWER: A 64.257 International Financial Management 58. B) false. A) true. A) true. ANSWER: A 63. the estimated maximum expected loss derived from the VAR method will be underestimated. Some MNCs are subject to economic exposure without being subject to transaction exposure. A reduction in hedging will probably reduce transaction exposure. B) false. A) true. translation exposure is more closely monitored when the foreign earnings of the subsidiaries are more likely to be remitted to the parent. The VAR method assumes that the volatility (standard deviation) of exchange rate movements changes over time. ANSWER: B 62. The VAR method is presumes that the distribution of exchange rate movements is normal. B) false.