Global Financial Chapter 14

Chapter 14: Global Financial Management
TRUE/FALSE
1. The two types of short-term effects on currency movements are transactions risk and
transformational risk.
ANS: F PTS: 1 DIF: Difficulty: Moderate

REF: p. 340 OBJ: LO: 14-01 NAT: BUSPROG: Diversity
STA: DISC: Environmental Influence KEY: Bloom's: Knowledge
2. Consolidated accounting statements consist of income statements and balance sheets of

multinational corporations including all subsidiaries abroad and are due to the IMF’s special
drawing right.

3. Marked-to-market involves the trading of futures contracts in major currencies and offering
price transparency and efficiency in addition to elimination of counterparty risk due to
guaranteed payments on contract.

4. Marked-to-market refers to futures contracts in which gains are earned in cash at the end of
each trading day.
ANS: T PTS: 1 DIF: Difficulty: Moderate

5. If losses occur causing a market participant’s balance to fall below the maintenance margin
at the end of the trading day, a margin premium occurs that requires the bank to replenish
the investor’s trading account.

6. Currency swaps allow firms to exchange currencies at a previously agreed exchange rate as
a way to hedge exchange rate movements.

7. An interest rate swap, often combined with a currency swap when the interest being
swapped is in different currencies, is called a syndicate swap.

8. Clearing House Interbank Payment System (CHIPS) is an organization that provides secure
communication for contracts, invoices, and other trade documents that normally accompany
cash payments.

9. Moody’s and Standard and Poor’s provide bond ratings which are important in assuring the
credit quality to foreign investors.

10. A group of banks that collectively make a loan to a firm is called a hedge.

11. Bonds that are sold in any country outside the home country, but in the home country’s
currency, are called government bonds.

12. On October 19, 1987 (Black Monday) stock prices in Hong Kong began collapsing and
spread throughout the day into the Europe and then North America. This is an example of
contagion.

STA: DISC: Environmental Influence KEY: Bloom's: Evaluation
13. Bank and government loans used by exporters to finance working capital are called trade
financing.

STA: DISC: Environmental Influence KEY: Bloom's: Comprehension
14. The cost of equity is required rate of return by stockholders in a firm and is estimated by
means of the Capital Asset Pricing Model (CAPM).

15. The sensitivity of a stock to market risk affected by currency movements is called the
weighted average cost of capital.

MULTIPLE CHOICE
1. The impact of random change in the value of one currency with respect to other currencies
is called the _____.
a. transactions risk
b. exchange rate risk
c. economic risk
d. consolidated risk
e. accounting risk
ANS: B PTS: 1 DIF: Difficulty: Moderate
2. Two kinds of short-term effects of currency movements are _____ risk and _____ risk.
a. transactions; translation
b. transactions; exchange rate
c. economic; translation
d. consolidated; economic
e. accounting; translation
ANS: A PTS: 1 DIF: Difficulty: Moderate
3. _____ risk arises from the import and export of goods and services.
a. Transactions
b. Translation
c. Economic
d. Consolidated
e. Accounting
ANS: A PTS: 1 DIF: Difficulty: Easy
4. _____ risk refers to the ways in which long-term exchange rate movements affect firms.
a. Transactions
b. Translation
c. Economic
d. Consolidated
e. Accounting
ANS: C PTS: 1 DIF: Difficulty: Moderate
5. A basket of currencies consisting of dollars, euros, pounds, and yen created by the
International Monetary Fund is known as the _____.
a. Trade Right
b. Value Factor Right
c. Currency Right
d. Export-Import Right
e. Special Drawing Right
ANS: E PTS: 1 DIF: Difficulty: Moderate
6. Using currency derivatives to reduce potential transaction, translation, and economic risks of
currency movements that could lead to losses for a firm or investor is called_____.
a. hedging
b. speculating
c. a short position
d. an organized exchange position
e. a marked-to-market position
7. Buying a currency in a currency futures contract and profiting on an increase in the value of
the currency over time is called _____.
a. hedging
b. syndicating
c. a short position
d. a long position
e. marked-to-market
ANS: D PTS: 1 DIF: Difficulty: Moderate
8. Selling a currency in a currency futures contract and profiting on a decrease in the value of
the currency over time is called _____.
a. hedging
b. syndicating
c. a short position
d. a long position
e. marked-to-market exchange position
9. A small commitment fee needed to purchase a futures contract is called a _____.

a. margin
b. speculator
c. short position
d. long position
e. marked-to-market
10. Losses that are incurred and that cause the participant’s balance to fall below the
maintenance margin at the end of the trading day is called a _____.
a. margin sell
b. margin call
c. short position
d. long position
e. marked-to-market
11. Futures contracts available in currencies of emerging-market countries by large banks in the
OTC market are called _____.
a. margin contracts
b. margin call contracts
c. currency forward contracts
d. organized exchanges
e. marked-to-market exchanges
12. A derivatives market run by large banks is called a(n) _____.

a. margin contract
b. over-the-counter market
c. currency forward contracts
d. organized exchanges
e. marked-to-market
13. The price paid by the buyer to the seller for an option contract is called a(n) _____.
a. call option
b. put option
c. premium
d. currency swap
e. marked-to-market
14. _____ allow firms to exchange currencies at a previously agreed exchange rate as a way to
hedge exchange rate movements.
a. Call options
b. Put options
c. Premiums
d. Currency swaps
e. Marked-to-market
15. Of the following, which is NOT true about international banking and payments?
a. Payment in advance is the safest method.
b. Payment in advance does not expose the importer to some risk concerning delivery
of the goods.
c. A commercial letter of credit offers payment protection to both parties.
d. A commercial letter of credit is usually irrevocable.
e. An open account is a simple agreement wherein the exporter sends an invoice with
the goods and the exporter pays upon the receipt.
ANS: B PTS: 1 DIF: Difficulty: Challenging
STA: DISC: Environmental Influence KEY: Bloom's: Analysis
16. The safest method available to an exporter, but that which exposes the importer to some risk
related to delivery of goods, is called _____.
a. payment in advance
b. a commercial letter of credit
c. a banker’s acceptance
d. a syndicate
e. a bond rating
17. _____ offers payment protection to both exporters and importers, as the importer’s bank
writes a guarantee of payment.
a. Payment in advance
b. A commercial letter of credit
c. A banker’s acceptance
d. A syndicate
e. A bond rating
18. When a bank sells a LC into the financial marketplace as a money market instrument, it is
called a(n) _____.
a. payment in advance
b. commercial letter of credit
c. banker’s acceptance
d. syndicate
e. bond rating
19. A simple agreement wherein the exporter sends an invoice with the goods and the exporter
pays upon the receipt is called a(n) _____.
a. open account
d. syndicate
e. bond rating
20. Debt contracts sold by firms domiciled in a country in the home currency are called _____.
a. open account
d. domestic bonds
e. bond rating
ANS: D PTS: 1 DIF: Difficulty: Easy
21. Bonds that are issued by foreign firms in another country in the home currency of that
country are called _____.
a. open account
c. foreign bonds
d. domestic bonds
e. bond ratings
ANS: C PTS: 1 DIF: Difficulty: Easy
22. Bonds that are sold in any country outside the home country, but in the home country’s
currency, are called _____.
a. closed
b. foreign
c. domestic
d. Eurobond
e. syndicate
23. Buying securities in a portfolio with price patterns over time that are different from one
another, which reduces the volatility of the portfolio, is called _____.
a. diversification
b. sensitivity
c. domestication
d. speculation
e. syndication
24. On October 19, 1987, stock prices in Hong Kong began collapsing and spread throughout
the day into Europe and then North America as their stock markets opened for trading.
Within one week, Hong Kong fell 46 percent, Australia 42 percent, the U.S. 23 percent, and
Canada 23 percent. This is an example of an event called _____.
a. diversification
b. sensitivity
c. domestication
d. speculation
e. contagion
ANS: E PTS: 1 DIF: Difficulty: Challenging
STA: DISC: Environmental Influence KEY: Bloom's: Application
25. Of the following, which is NOT true about the IMF and World Bank?
a. They were established in 1890.
b. Their purposes are to promote international monetary stability and international
trade.
c. The IMF provides short-term loans to countries in financial crises.
d. More than 180 countries participate as members of the IMF.
e. The World Bank focuses upon long-term loans to developing countries seeking
financing for economic reform purposes intended to raise the standard of living.
ANS: A PTS: 1 DIF: Difficulty: Challenging
26. The required rate of return demanded by stock and bond investors and used in net present
value capital budgeting analyses as the discount rate is called the _____.
a. net present value
b. cost of debt
c. cost of equity
d. cost of capital
e. exchange risk beta
27. The weighted average of different interest rates paid on long-term borrowings is called the
_____.
b. cost of debt
c. cost of equity
d. cost of capital
28. Whether a firm has growth or value and how this firm characteristic affects an estimate of
the cost of equity is called the _____.
b. value factor
c. cost of equity
d. cost of capital
e. beta risk
29. A stock value measured with the coefficient obtained by regressing the stock’s return on a
currency’s return over time is known as the _____.
b. value factor
c. exchange rate sensitivity
d. cost of capital
e. beta risk
30. The sensitivity of a stock to market risk affected by currency movements is known as the
_____.
b. value factor
c. exchange rate sensitivity
d. cost of capital
ANS: E PTS: 1 DIF: Difficulty: Moderate
COMPLETION
1. How short-term changes in exchange rates can affect operating costs and revenues of firms
engaged in international business activities is referred to as ________ risks.
ANS: transactions
PTS: 1 DIF: Difficulty: Moderate REF: p. 341

OBJ: LO: 14-01 NAT: BUSPROG: Diversity
2. The _____ risk refers to the impact of random change in the value of one currency with
respect to other currencies.
ANS: exchange rate

3. The short- term effects of currency movements on the consolidated accounting statements of
a firm represents a ______ risk.
ANS: translation

4. _______ accounting statements are the income statements and balance sheets of
multinational corporations and of all subsidiaries abroad due to home tax requirements.
ANS: Consolidated

5. _______ risks are the ways in which long-term exchange rate movements impact firms.
ANS: Economic

6. __________ refers to a basket of currencies consisting of dollars, euros, pounds, and yen
created by the International Monetary Fund (IMF).
ANS:
Special drawing right (SDR)
Special drawing right
SDR

7. ________ is the practice of using currency derivatives to reduce potential transaction,

translation, and economic risks of currency movements that could lead to losses for a firm or
investor.
ANS: Hedging

8. Attempts in currencies and currency derivatives to earn profits from trading them and help
to make prices efficient are referred to as _______.
ANS: speculators

9. Standardized agreements to buy or sell a specified amount of currency at a date in the future
at a pre-determined price are called _________.
ANS: currency future contracts

10. The buying of a currency in a currency futures contract and profiting on an increase in the
value of the currency over time is called taking a _______.
ANS: long position

11. _______ refers to selling a currency in a currency futures contract and profiting on a
decrease in the value of the currency over time
ANS: Short position

12. The trading of futures contracts in major currencies and offering price transparency and
efficiency in addition to elimination of counterparty risk due to guaranteed payments on
contacts is called _______.
ANS: organized exchanges

13. ______ refers to futures contracts in which gains or losses are earned in cash at the end of
each trading day.
ANS: Marked-to-market

14. The small commitment fee needed to purchase a futures contract is a ______.
ANS: margin

15. ______ refers to losses that are incurred and that cause the participant’s balance to fall
below the maintenance margin at the end of the trading day.
ANS: Margin call

16. Futures contracts available in currencies of emerging-market countries by large banks in the
OTC market refers to _____.
ANS: currency forward contracts

17. Derivatives market run by large banks refers to _____.
ANS:
over-the-counter (OTC) market
over-the-counter market
OTC market

18. ______ refers to an investor’s right to buy an asset at a pre-determined price.
ANS: Call option

19. ______ refers to an investor’s right to sell an asset at a pre-determined price.
ANS: Put option

20. The price paid by the buyer to the seller for an option contract refers to the _____.
ANS: premium

21. ______ allow firms to exchange currencies at a previously agreed exchange rate as a way to
hedge exchange rate movements.
ANS: Currency swaps

22. ______ refers to an interest rate swap, often combined with a currency swap, if the interest
being swapped is in different currencies.
ANS: Plain vanilla currency swap

23. Large global banks are called _______ banks.
ANS: money center
PTS: 1 DIF: Difficulty: Easy REF: p. 347

24. ______ is an organization in New York City that provides large, wholesale dollar payments
services for businesses, banks, and governments.
ANS:
CHIPS (Clearing House Interbank Payments System)
CHIPS
Clearing House Interbank Payments System

25. ______ is an organization that provides secure communications for contracts, invoices, and
other trade documents that normally accompany cash payments.
ANS:
SWIFT (Society of Worldwide Interbank Financial Telecommunications)
SWIFT
Society of Worldwide Interbank Financial Telecommunications

26. _______ is the safest method available to an exporter, but that which exposes the importer to
some risk related to delivery of goods.
ANS: Payment in advance

27. Payment protection to both exporters and importers, as the importer’s bank writes a
guarantee of payment refers to ______.
ANS:
commercial letter of credit (LC)
commercial letter of credit
LC

28. When a bank sells a LC into the financial marketplace as a money market instrument, this is
called ______.
ANS: banker’s acceptance

29. ______ is a simple agreement wherein the exporter sends an invoice with the goods and the
exporter pays upon their receipt.
ANS: Open account

30. _____ refers to a group of banks that collectively make a loan to a firm.
ANS: Syndicate

31. Moody’s and Standard and Poor’s rating services, which are important in assuring foreign
investors of the credit quality of bond issues, refers to _____.
ANS: bond ratings

32. ______ are debt contracts sold by firms domiciled in a country in the home currency.
ANS: Domestic bonds

33. ______ are bonds that are issued by foreign firms in another country in the home currency
of that country.
ANS: Foreign bonds

34. ______ are bonds that are sold in any country outside the home country, but in the home
country’s currency.
ANS: Eurobonds

35. Buying securities in a portfolio with price patterns over time that are different from one
another, which reduces the volatility of the portfolio, refers to _____.
ANS: diversification

36. ______ refers to investing most of retirement and other savings in one’s home country,
which reduces diversification.
ANS: Home bias

37. ______ refers to when stock markets in many countries move down in concert with one
another and thereby reduce international diversification benefits.
ANS: Contagion

38. ______ is a U.S. government export finance agency that supports U.S. firms competing
against exports of other countries that are government supported.
ANS:
Export-Import (Ex-Im) Bank
Export-Import Bank
Ex-Im Bank

39. Bank and government loans used by exporters to finance working capital refers to ______.
ANS: trade finance

40. Bank and government loans to importers to cover the cost of major purchases refers to
_____.
ANS: term financing

41. ______ is a Japanese bank that supports exporters around the world that have at least 30
percent Japanese content.
ANS:
Bank of International Cooperation (JBIC)
Bank of International Cooperation
JBIC

42. The _____ is the difference between present value of futures profits on an investment
project minus the initial investment cost.
ANS: net present value

43. The uncertainty in predicting how a variety of different factors will affect an investment in a
country, including political risk, economic risk, inflation risk, tax risk, etc., refers to ______.
ANS: country risk

44. ______ is an examination of optimistic, expected, and pessimistic scenarios to give a more
complete picture of the risks and returns of investments abroad.
ANS: Sensitivity analysis

45. The ______ is the required rate of return demanded by stock and bond investors and is used
in net present value capital budgeting analyses as the discount rate.
ANS: cost of capital

46. The sum of the costs of equity and debt weighted by the amount of financing from these two
capital sources is the ______.
ANS: weighted average cost of capital

47. The ______ is the weighted average of different interest rates paid on long-term borrowings.
ANS: cost of debt

48. _____ is the required rate of return by stockholders in a firm and is estimated by means of
the Capital Asset Pricing Model (CAPM).
ANS: Cost of equity

49. _____ is a measurement of the general market risk of a stock in the Capital Asset Pricing
Model (CAPM).
ANS: Beta risk

50. ______ is an asset pricing model that includes both domestic and global market factors to
estimate the cost of equity or required rate of return on stocks.
ANS:
International CAPM (ICAPM)
International CAPM
ICAPM

51. Whether a firm is small or large and how this size provides an estimate of the cost of equity
refers to the ______.
ANS: size factor

52. Whether a firm has growth or value and how this firm characteristic provides an estimate of
the cost of equity refers to the ______.
ANS: value factor

53. ______ is a coefficient obtained by regressing a stock’s return on a currency’s return over
time.
ANS: Exchange rate sensitivity

54. ______ is the sensitivity of a stock to market risk affected by currency movements.
ANS: Exchange risk beta

ESSAY
1. Differentiate between transaction and translation risks. Explain how these risks affect firms
and investors.
ANS:
Student answers will vary.
PTS: 1 DIF: Difficulty: Moderate REF: p. 340-341

2. Differentiate between futures contract and forward contract. Provide an example of each.
ANS:

3. Describe the options and swaps contract in hedging the forex risks. Provide an example of
each.
ANS:

4. Differentiate between the three types of bonds.
ANS:

5. Briefly discuss the sources of funds to finance international trade and investment.
ANS:

6. Explain the domestic versus global cost of capital.
ANS:
PTS: 1 DIF: Difficulty: Challenging REF: p. 358-359

7. Does exchange rate risk affect firms’ cash flows and its stock value? Explain.
ANS:
PTS: 1 DIF: Difficulty: Challenging REF: p. 360-362

CASE
Scenario – Aero, Inc.
Aero, Inc. started from the idea of Brad Aerostle of Madison, South Dakota in 1992. Brad
earned a financial degree from Harvard and had watched the financial markets for years.
Armed with college credentials and knowledge, he believed he could offer needed services
to individuals and companies desiring to conduct business around the globe. From the
minute Brad put his idea into motion, his brainchild – Aero, Inc. – proved quite profitable.
Aero, Inc. currently has over five thousand clients ranging from slightly wealthy individuals
to very rich and thriving corporations around the world. Brad’s skill at what he does has
made his company a sought out firm by those who want to prosper in the foreign
marketplace.
1. Aero, Inc. likes to make its customers aware of what is taking place within the global
financial world. One of the lessons it imparts to its clients is about the International
Monetary Fund’s special drawing right. Which of the following best identifies what Aero,
Inc. would be discussing with its clients?
a. The short-term effects of currency movements on the consolidated accounting
statements of a firm
b. The ways in which long-term exchange rate movements affect firms
c. Buying a currency in a currency futures contract and profiting on an increase in
the value of the currency over time
d. The Global Center for Financial Restructuring
e. A basket of currencies consisting of dollars, euros, pounds, and yen
ANS:
e

OBJ: LO: 14-01 NAT: BUSPROG: Reflective Thinking
2. When Aero, Inc. recommends purchasing futures contracts to its clients, it always informs
the clients of the rather small commitment fee that is needed to purchase a futures contract.
Which one of the following best identifies what this fee is called?
a. Weighted average cost of capital
b. Margin
c. Put option
d. Beta risk
e. Margin call
ANS:
b

3. One of the prominent concerns the clients of Aero, Inc. express is that of currency
fluctuations. The clients know fluctuations in currency can wind up costing them money.
Aero, Inc. alleviates its clients concern by suggesting the client enter into a situation where
currencies can be exchanged at a previously agreed exchange rate as a way to hedge
exchange rate movements. Which one of the following best identifies what Aero, Inc. is
likely suggesting?
a. Currency swap
b. Call option
c. Sensitivity analysis
d. Speculation
e. Diversification
ANS:
a

Scenario – The Gayla Corporation
The Gayla Corporation is a multinational business that conducts operations in twelve

foreign markets. This multi-million dollar organization is very familiar with currency
exchanges and has considerable understanding when it comes to the risks associated with
operating in the global market arena. The Gayla Corporation claims it would not be as
successful without the expertise of the financial wizards that work for it. The company has
not lost money so far and plans to stay that way.
4. The financial experts of the Gayla Corporation are very much aware of the organization’s
cost of debt. Which of the following best identifies what cost of debt means to the
corporation?
a. Futures contracts in which gains are earned at the end of each trading day
b. Ways in which long-term exchange rate movements affect firms
c. Sum of the cost of capital and the cost of equity
d. The required rate of return by stockholders in a firm that is estimated by means
of CAPM
e. Weighted average of different interest rates paid on long-term borrowings
ANS:
e

5. The Gayla Corporation must fully understand and effectively handle the short-term changes
in exchange rates and how this can affect operating costs and revenues derived from its
international business operations. Which of the following best identifies what this
organization is facing in this situation?
a. Exchange risk beta
b. Beta risk
c. Transactions risk
d. Hedging
e. Translation risk
ANS:
c

6. When the Gayla Corporation conducts its operations in foreign markets, its customers often
pay in different forms of currency. Many times there is a difference in the value of that
currency received in comparison to the company’s U. S. currency. Which of the following
best identifies what the Gayla Corporation is experiencing?
a. Translation risk
b. Economic risk
c. Short position
d. Exchange rate risk
e. Transactions risks
ANS:
d


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Chapter 14: Global Financial Management

ANS: F PTS: 1 DIF: Difficulty: Moderate

2. Consolidated accounting statements consist of income statements and balance sheets of

ANS: F PTS: 1 DIF: Difficulty: Moderate

ANS: F PTS: 1 DIF: Difficulty: Moderate

ANS: T PTS: 1 DIF: Difficulty: Moderate

ANS: F PTS: 1 DIF: Difficulty: Moderate

ANS: T PTS: 1 DIF: Difficulty: Moderate

ANS: F PTS: 1 DIF: Difficulty: Moderate

ANS: F PTS: 1 DIF: Difficulty: Moderate

ANS: T PTS: 1 DIF: Difficulty: Moderate

ANS: F PTS: 1 DIF: Difficulty: Moderate

ANS: F PTS: 1 DIF: Difficulty: Moderate

ANS: T PTS: 1 DIF: Difficulty: Moderate

ANS: T PTS: 1 DIF: Difficulty: Moderate

ANS: T PTS: 1 DIF: Difficulty: Moderate

ANS: F PTS: 1 DIF: Difficulty: Moderate

9. A small commitment fee needed to purchase a futures contract is called a _____.

12. A derivatives market run by large banks is called a(n) _____.

PTS: 1 DIF: Difficulty: Moderate REF: p. 341

ANS: exchange rate

PTS: 1 DIF: Difficulty: Moderate REF: p. 340

PTS: 1 DIF: Difficulty: Moderate REF: p. 341

PTS: 1 DIF: Difficulty: Moderate REF: p. 341

PTS: 1 DIF: Difficulty: Moderate REF: p. 341

PTS: 1 DIF: Difficulty: Moderate REF: p. 341

7. ________ is the practice of using currency derivatives to reduce potential transaction,

PTS: 1 DIF: Difficulty: Moderate REF: p. 342

PTS: 1 DIF: Difficulty: Moderate REF: p. 342

ANS: currency future contracts

PTS: 1 DIF: Difficulty: Moderate REF: p. 342

ANS: long position

PTS: 1 DIF: Difficulty: Moderate REF: p. 342

ANS: Short position

PTS: 1 DIF: Difficulty: Moderate REF: p. 342

ANS: organized exchanges

PTS: 1 DIF: Difficulty: Moderate REF: p. 342

PTS: 1 DIF: Difficulty: Moderate REF: p. 342

PTS: 1 DIF: Difficulty: Moderate REF: p. 343

ANS: Margin call

PTS: 1 DIF: Difficulty: Moderate REF: p. 343

ANS: currency forward contracts

PTS: 1 DIF: Difficulty: Moderate REF: p. 344

17. Derivatives market run by large banks refers to _____.

PTS: 1 DIF: Difficulty: Moderate REF: p. 344

18. ______ refers to an investor’s right to buy an asset at a pre-determined price.

ANS: Call option

PTS: 1 DIF: Difficulty: Moderate REF: p. 345

19. ______ refers to an investor’s right to sell an asset at a pre-determined price.

ANS: Put option

PTS: 1 DIF: Difficulty: Moderate REF: p. 345

PTS: 1 DIF: Difficulty: Moderate REF: p. 345

ANS: Currency swaps

PTS: 1 DIF: Difficulty: Moderate REF: p. 345

ANS: Plain vanilla currency swap

23. Large global banks are called _______ banks.

ANS: money center

PTS: 1 DIF: Difficulty: Easy REF: p. 347

PTS: 1 DIF: Difficulty: Moderate REF: p. 347

PTS: 1 DIF: Difficulty: Moderate REF: p. 347

ANS: Payment in advance

PTS: 1 DIF: Difficulty: Moderate REF: p. 348

PTS: 1 DIF: Difficulty: Moderate REF: p. 348