general business data bank
10.3 Trident's Transaction Exposure
1) 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. The U.S. firm is at risk today of a loss if
A) the exchange rate changes to $2.00/£.
B) the exchange rate changes to $2.05/£.
C) the exchange rate doesn't change.
D) all of the above.
2) 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 $2.05/£ the U.S. firm will realize a ________ of ________.
A) loss; $2000
B) gain; $2000
C) loss; £2000
D) gain; £2000
3) 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 ________.
A) loss; $2,000
B) gain; $2,000
C) loss; £2000
D) gain; £2000
4) ________ is NOT a popular contractual hedge against foreign exchange transaction exposure.
A) Forward market hedge
B) Money market hedge
C) Options market hedge
D) All of the above are contractual hedges.
Instruction 10.1:
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
5) Refer to Instruction 10.1. If Plains States chooses not to hedge their euro receivable, the amount they receive in six months will be ________.
A) $1,750,000
B) $1,250,000
C) $892,857
D) undeterminable today
6) Refer to Instruction 10.1. If Plains States chooses to hedge its transaction exposure in the forward market, it will ________ euro 1,250,000 forward at a rate of ________.
A) sell; $1.38/euro
B) sell; $1.40/euro
C) buy; $1.38/euro
D) buy; $1.40/euro
7) Refer to Instruction 10.1. Plains States chooses to hedge its transaction exposure in the forward market at the available forward rate. The payoff in 6 months will be ________.
A) $1,750,000
B) $1,250,000
C) $1,725,000
D) $1,787,500
8) Refer to Instruction 10.1. If Plains States locks in the forward hedge at $1.38/euro, and the spot rate when the transaction was recorded on the books was $1.40/euro, this will result in a "foreign exchange loss" accounting transaction of ________.
A) $0
B) $25,000
C) This was not a loss; it was a gain of $25,000.
D) There is not enough information to answer this question.
9) Refer to Instruction 10.1. 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.
A) better off; $43,750
B) better off; $62,500
C) worse off; $43,750
D) worse off; $62,500
10) Refer to Instruction 10.1. 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?
A) $1,250,000
B) $1,724,880
C) $1,674,641
D) $1,207,371
11) Refer to Instruction 10.1. Money market hedges almost always return more than forward hedges because of the greater risk involved.
12) Refer to Instruction 10.1. If Plains States chooses to implement a money market hedge for the Euro receivables, how much money will the firm borrow today?
A) euro 1,201,923
B) $1,201,923
C) euro 1,196,172
D) $1,196,172
13) Refer to Instruction 10.1. A ________ hedge allows Plains States to enjoy the benefits of a favorable change in exchange rates for their euro receivables contract while protecting the firm from unfavorable exchange rate changes.
A) forward
B) call option
C) put option
D) money market
14) Refer to Instruction 10.1. 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.)
A) $27,694
B) $26,250
C) euro 27,694
D) euro 26,250
15) Refer to Instruction 10.1. The cost of a call option to Plains States would be ________.
A) $17,653
B) $16,733
C) $18,471
D) There is not enough information to answer this question.
16) Refer to Instruction 10.1. If Plains States purchases the put option, and the option expires in six months on the same day that Plains States receives the euro 1,250,000, the firm will exercise the put at that time if the spot rate is $1.43/euro.
17) The structure of a money market hedge is similar to a forward hedge. The difference is the cost of the money market hedge is determined by the differential interest rates, while the forward hedge is a function of the forward rates quotation.
18) In efficient markets, interest rate parity should assure that the costs of a forward hedge and money market hedge should be approximately the same.
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