Exam 9: Transaction Exposure

Instruction 9.2: Use the information for following problem(s). Oregon Transportation Inc. (OTI) has just signed a contract to purchase light rail cars from a manufacturer in Germany for euro 2,500,000. The purchase 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, OTI 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 ∙ OTI's 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 call options for euro 625,000; strike price $1.42, premium price is 1.5% ∙ OTI's forecast for 6-month spot rates is $1.43/euro ∙ The budget rate, or the highest acceptable purchase price for this project, is $3,625,000 or $1.45/euro -Refer to Instruction 9.2. What is the cost of a call option hedge for OTI's 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 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 heding 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 ________.

Instruction 9.1: Use the information for 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 9.1. If Plains States chooses to hedge its transaction exposure in the forward market, it will ________ euro 1,250,000 forward at a rate of ________.

Hedging accounts payable foreign currency exchange risk would likely consider the purchase of a ________ option whereas hedging accounts receivable currency exchange risk would be likely be to purchase a ________ option.

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

Instruction 9.1: Use the information for 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 9.1. Money market hedges almost always return more than forward hedges because of the greater risk involved.

Instruction 9.2: Use the information for following problem(s). Oregon Transportation Inc. (OTI) has just signed a contract to purchase light rail cars from a manufacturer in Germany for euro 2,500,000. The purchase 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, OTI 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 ∙ OTI's 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 call options for euro 625,000; strike price $1.42, premium price is 1.5% ∙ OTI's forecast for 6-month spot rates is $1.43/euro ∙ The budget rate, or the highest acceptable purchase price for this project, is $3,625,000 or $1.45/euro -Refer to Instruction 9.2. OTI 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.

Whohauser is a U.S.-based forest products firm. In June Whohauser delivers a shipment of raw lumber to Japan. The ¥55,000,000 receivable is due in 180 days. The firm's foreign exchange advisors believe the yen will be at about ¥115/$ then. The current spot rate is ¥110/$. Whohauser has received a 180 day forward quote of ¥108/$. If the company does nothing and the exchange rate goes to ¥115 as expected, how much will the firm receive in dollars in 180 days? Is this cash flow risky or known with certainty today?

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.

According to a survey by Bank of America, when firms do hedge, the most common type of hedging instruments are ________.

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

Instruction 9.1: Use the information for 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 9.1. Plains States chooses to hedge its transaction exposure in the forward market at the available forward rate. The payoff in 6 months will be ________.

Instruction 9.2: Use the information for following problem(s). Oregon Transportation Inc. (OTI) has just signed a contract to purchase light rail cars from a manufacturer in Germany for euro 2,500,000. The purchase 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, OTI 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 ∙ OTI's 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 call options for euro 625,000; strike price $1.42, premium price is 1.5% ∙ OTI's forecast for 6-month spot rates is $1.43/euro ∙ The budget rate, or the highest acceptable purchase price for this project, is $3,625,000 or $1.45/euro -Refer to Instruction 9.2. The cost of a put option to OTI would be ________.

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.

A ________ hedge and a ________ hedge guarantee fixed payoffs but a ________ hedge or ________ hedge offer uncertain outcomes.

Instruction 9.1: Use the information for 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 9.1. If Plains States chooses to implement a money market hedge for the Euro receivables, how much money will the firm borrow today?

Choosing which transaction exposure hedging strategy is best for a particular transaction depends on which of the following?

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

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.

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