Exam 10: Transaction and Translation Exposure

Does foreign currency exchange hedging both reduce risk and increase expected value? Explain,and list several arguments in favor of currency risk management and several against.

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

Describe a balance sheet hedge and give at least two examples of when such a hedge could be justified.

According to your authors,the main purpose of translation is

Under the current rate method,specific assets and liabilities are translated at exchange rates consistent with the timing of the item's creation.

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 10.1.If Plains States chooses to implement a money market hedge for the Euro receivables,how much money will the firm borrow today?

If a European subsidiary of a U.S.firm has net exposed liabilities of euro 500,000,and the euro drops in value from $1.40/euro to $1.30/euro then the U.S.firm has a translation ________.

In efficient markets,interest rate parity should assure that the costs of a forward hedge and money market hedge should be approximately the same.

The two methods for the translation of foreign subsidiary financial statements are the current rate and temporal methods.Briefly,describe how each of these methods translates the foreign subsidiary financial statements into the parent company's consolidated statements.Identify when each technique should be used and the major advantage(s)of each.