Exam 10: Transaction Exposure

Hedging can be advantageous to shareholders because management is in a better position than shareholders to recognize disequilibrium conditions and to take advantage of single opportunities to enhance firm value through selective hedging.

Transaction exposure and operating exposure exist because of unexpected changes in future cash flows. The difference between the two is that ________ exposure deals with cash flows already contracted for, while ________ exposure deals with future cash flows that might change because of changes in exchange rates.

Which of the following is NOT cited as a good reason for hedging currency exposures?

The key arguments in opposition to currency hedging such as market efficiency, agency theory, and diversification do not have financial theory at their core.

________ exposure deals with cash flows that result from existing contractual obligations.

Assuming no transaction costs (i.e., hedging is "free"), hedging currency exposures should ________ the variability of expected cash flows to a firm and at the same time, the expected value of the cash flows should ________.

Currency risk management techniques include forward hedges, money market hedges, and option hedges. Draw a diagram showing the possible outcomes of these hedging alternatives for a foreign currency receivable contract. In your diagram, be sure to label the X and Y-axis, the put option strike price, and show the possible results for a money market hedge, a forward hedge, a put option hedge, and an uncovered position. (Note: Assume the forward currency receivable is British pounds and the put option strike price is $1.50/£, the price of the option is $0.04 the forward rate is $1.52/£ and the current spot rate is $1.48/£.)

Hedging, or reducing risk, is the same as adding value or return to the firm.

Like a forward market hedge, a money market hedge also involves a contract and a source of funds to fulfill that contract. In this instance, the contract is a loan agreement.

The hedge ratio, ?, is an individual exposure's nominal amount covered by a financial instrument such as a forward contract or currency option.

A hedge constructed using a put foreign currency option would protect you against value losses, but allow, at the same time, the possibly reap value increases in the event the exchange rate moved in your favor.

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.

Losses from ________ exposure generally reduce taxable income in the year they are realized. ________ exposure losses may reduce taxes over a series of years.

Losses from ________ exposure generally reduce taxable income in the year they are realized. ________ exposure losses are not cash losses and therefore, are not tax deductible.

Shareholders are LESS capable of diversifying currency risk than is the management of the firm.

MNE cash flows may be sensitive to changes in which of the following?

Transaction exposure could arise when borrowing or lending funds when repayment is to be made in the firm's domestic currency.

Which of the following is cited as a good reason for NOT hedging currency exposures?

A U.S. firm sells merchandise today to a British company for £150,000. The current exchange rate is $1.55/£ , 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 $1.58/£ the U.S. firm will realize a ________ of ________.

With the use of forwards, a perfect hedge is possible.