MEASURING AND MANAGING
FOREIGN EXCHANGE
EXPOSURE
1
THE REAL EXCHANGE RATE
Real rates are adjusted for price changes:
'
t
e
 et
(1  i f )
(1  ih )
t
t
The economic impact of currency changes
depends on differences in inflation rates -- the real
exchange rate. Hence, relative price changes
ultimately determine a firm’s long-run exposure to
currency change.
2
Suppose the English subsidiary of a U.S. firm had current assets of £3 million
and current liabilities of 1 million pounds both at the start and at the end of the
year. There are no long-term liabilities. If the pound depreciated during that
year from $1.50 to $1.30, the translation gain (loss. to be included in the parent
company's equity account according to FASB #52 is
– a.
– b.
– c.
– d.
0 since the current assets and current
liabilities cancel
+$200,000
-$250,000
-$400,000
ANSWER:
d
Statement of Financial Accounting Standards No. 52
3
Volkswagen almost went bankrupt in 1973 because
– a. it failed to offset the exchange risk associated
with its cost structure and revenue structure
with a suitable liability structure
– b. it gambled on the value of dollar
– c. it priced its cars in dollars
– d. all of the above
ANSWER:
a
financial management of exchange rate risk
4
A company producing an undifferentiated product and competing with
internationally diversified competitors will face a relatively _____ price
elasticity of demand for its products and possess a relatively ---- degree of
pricing flexibility.
–
–
–
–
a.
b.
c.
d.
high, low
low, low
low, high
high, high
ANSWER:
a
operating exposure
5
The appropriate response for a U.S. exporter to
appreciation of the dollar would be to
– a. raise the foreign currency price if the dollar
appreciation was expected to be temporary and
the cost of regaining market share was minimal
– b. move some production offshore if the
appreciation were expected to persist for an
extended period
– c. keep the foreign currency price constant if
demand is quite elastic
– d. all of the above
ANSWER:
d
characteristic economic effects of exchange rate changes
6
Suppose Apple is selling Macintosh computers in Germany for E 5,500 when
the exchange rate is E 1 = $0.68. If the E rises to $0.71, what price must Apple
charge to maintain its dollar unit revenue?
a.
b.
c.
d.
E 5,147
E 6,361
E 5,743
E 5,268
ANSWER:
d
calculating economic exposure
7
Following a devaluation of the euro, which of the following products sold in
Greece is most likely to bear a euro price increase?
a. Fiat automobile, sold to the low end of the market
b. Kentucky Fried Chicken dinner, facing competition from
local fast food restaurants
c. IBM mainframe computer, whose only competition
comes from other American computer companies
d. shirts from Hong Kong, facing competition from local
manufacturers
ANSWER:
c
operating exposure
8
In the face of an appreciating yen, Toyota should consider
– a. investing in U.S. production facilities
– b. raising its research and development
investment
– c. coming out with new cars targeted at the
low end of the market
– d. a and b only
ANSWER:
d
operating exposure
9
A U.S. exporter that anticipates an appreciation of the
dollar should
–
–
–
–
a. sell dollars forward
b. borrow foreign currencies
c. scout out possible foreign production sites
d. consider raising dollar prices on exports
ANSWER:
c
planning for exchange rate risk
10
Which of the following products is most likely to benefit
from depreciation of the dollar?
– a. high-end signal processor from HewlettPackard that faces minimal competition
– b. Chevrolet automobile with a highly price
elastic demand
– c. Mercedes-Benz auto facing price inelastic
demand
– d. low-end Japanese machine tool
ANSWER:
b
foreign exchange risk and economic exposure
11
Jet engine manufacturing entails enormous economies of scale. Pratt &
Whitney, a large U.S. jet engine producer, faces substantial competition from
Rolls-Royce, the British engine manufacturer. What would be the best way
for P & W to cope with a dollar that has recently appreciated by 50%?
– a. accelerate R&D spending and cost-cutting
efforts
– b. shift some of its production abroad
– c. raise the foreign currency prices of its
engines sold abroad
– d. buy dollars forward
ANSWER:
a
foreign exchange risk and economic exposure
12
Shorter product cycles can improve currency risk
management by allowing the firm to
– a. incorporate more up-to-date technology in
its products
– b. respond more quickly to changing market
conditions
– c. reduce the average price elasticity of
demand
– d. all of the above
ANSWER:
d
foreign exchange risk and economic exposure
13
Nissan, the Japanese car manufacturer, exports a substantial fraction
of its output to the United States. What financial measures would be
suitable for Nissan to take to reduce its currency risk?
– a. borrow only yen to finance its operations
– b. borrow dollars to finance part of its
operations
– c. sell yen forward in the amount of its annual
shipments to the U.S.
– d. buy yen forward in the amount of its annual
shipments to the U.S.
ANSWER:
b
foreign exchange risk and economic exposure
14
Sumitomo Bank wants to expand its lending in the United States, but to do so
it needs to raise more long-term debt capital to help finance these loans.
Currently, long-term interest rates are 9.5% in the U.S. and 6.3% in Japan.
What would you recommend Sumitomo do?
• a.
raise yen in Japan because of the lower
cost of money
• b.
raise yen in Japan because Japanese
investors are more patient than U.S. investors
• c.
raise dollars in the U.S. to hedge against
currency risk
• d.
raise dollars in the U.S. to avoid
depressing Tokyo stocks
ANSWER:
c
foreign exchange risk and economic exposure
15
If you fear the dollar will rise against the Euro, with a resulting adverse
change in the dollar value of the equity of your Spanish subsidiary, you can
hedge by
– a. selling euros forward in the amount of net
assets
– b. buying euros forward in the amount of net
assets
– c. reducing the liabilities of the subsidiary
– d. selling euros forward in the amount of total
assets
–ANSWER:
a
Designing a Hedging Strategy
16
A Japanese firm sells TV sets to an American importer for one billion yen
payable in 90 days. To protect against exchange risk, the importer could
– a. borrow yen, convert to dollars, and lend dollars for
the interim period
– b. sell yen on the forward market
– c. sell a call option on yen
– d.buy a futures contract for yen on the IMM
ANSWER:
d
Designing a Hedging Strategy
17
If you fear the dollar will rise against euro, with a resulting adverse change in
the dollar value of the equity of your French subsidiary, you can hedge by
– a. selling euros forward in the amount of net
assets
– b. buying euros forward in the amount of net
assets
– c. reducing the liabilities of the subsidiary
– d. selling euros forward in the amount of total
assets
ANSWER:
a
Designing a Hedging Strategy
18
On March 1, Bechtel submits a euro-denominated bid on a project in France.
Bechtel will not learn until June 1 whether it has won the contract. What is
the most appropriate way for Bechtel to manage the exchange risk on this
contract?
-- a. sell the euro amount of the bid forward for U.S.
dollars
– b. buy euros forward in the amount of the contract
– c. buy a put option on euros in the amount of the euro
exposure
– d. sell a call option on euros in the amount of euro
exposure
ANSWER:
c
Designing a Hedging Strategy
19