Exam 11: Transaction Exposure

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

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

Each of the following is another name for operating exposure EXCEPT ________.

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

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 11.2:Use the information for the 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 11.2. The cost of a put option to OTI would be ________.

Instruction 11.2:Use the information for the 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 11.2. If OTI chooses NOT to hedge their euro payable, the amount they pay in six months will be ________.

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

According to a survey by Bank of America, the type of foreign exchange risk most often hedged by firms is ________.

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 ________.

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

Instruction 11.2:Use the information for the 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 11.2. 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.

The treasury function of most firms, the group typically responsible for transaction exposure management, is NOT usually considered a profit center.

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

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

As a generalized rule, only realized foreign exchange losses are deductible for tax purposes.

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/£.)

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

Instruction 11.2:Use the information for the 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 11.2. If OTI chooses to hedge its transaction exposure in the forward market, it will ________ euro 2,500,000 forward at a rate of ________.