Exam 9: Transaction Exposure

________ is NOT a popular contractual hedge against foreign exchange transaction exposure.

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 ________.

________ exposure is the potential for accounting-derived changes in owner's equity to occur because of the need to translate foreign currency financial statements into a single reporting currency.

________ are transactions for which there are, at present, no contracts or agreements between parties.

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. 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.

According to the authors, firms that employ proportional hedges increase the percentage of forward-cover as the maturity of the exposure lengthens.

A ________ hedge refers to an offsetting operating cash flow such as a payable arising from the conduct of business.

________ is a technique used by MNEs to deal with currency exposure.

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 locks in the forward quote 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?

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. If OTI chooses not to hedge their euro payable, the amount they pay in six months will be ________.

________ exposure measures the change in the present value of the firm resulting from unexpected changes in exchange rates.

________ exposure may result from a firm having a payable in a foreign currency.

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.

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 $2.01/£ the U.S. firm will realize a ________ of ________.

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. If OTI chooses to hedge its transaction exposure in the forward market, it will ________ euro 2,500,000 forward at a rate of ________.

The stages in the life of a transaction exposure can be broken into three distinct time periods. The first time period is the time between quoting a price and reaching an actual sale agreement or contract. The next time period is the time lag between taking an order and actually filling or delivering it. Finally, the time it takes to get paid after delivering the product. In order, these stages of transaction exposure may be identified as,