Chapter 11
Managing Transaction Exposure
1. Assume zero transaction costs. If the 90-day forward rate of the euro is an accurate
estimate of the spot rate 90 days from now, then the real cost of hedging payables will
be:
A) positive.
B) negative.
C) positive if the forward rate exhibits a premium, and negative if the forward rate
exhibits a discount.
D) zero.
ANSWER: D
2. Assume zero transaction costs. If the 180-day forward rate is an accurate estimate of
the spot rate 180 days from now, then the real cost of hedging receivables will be:
A) positive.
B) negative.
C) positive if the forward rate exhibits a premium, and negative if the forward rate
exhibits a discount.
D) zero.
ANSWER: D
3. Assume the following information:
U.S. deposit rate for 1 year = 11%
U.S. borrowing rate for 1 year = 12%
Swiss deposit rate for 1 year = 8%
Swiss borrowing rate for 1 year = 10%
Swiss forward rate for 1 year = $.40
Swiss franc spot rate = $.39
Also assume that a U.S. exporter denominates its Swiss exports in Swiss francs and
expects to receive SF600,000 in 1 year.
Using the information above, what will be the approximate value of these exports in 1
year in U.S. dollars given that the firm executes a forward hedge?
A) $234,000.
B) $238,584.
C) $240,000.
D) $236,127.
, ANSWER: C
SOLUTION: SF600,000 × $.40 = $240,000
4. Assume the following information:
U.S. deposit rate for 1 year = 11%
U.S. borrowing rate for 1 year = 12%
New Zealand deposit rate for 1 year = 8%
New Zealand borrowing rate for 1 year = 10%
New Zealand dollar forward rate for 1 year = $.40
New Zealand dollar spot rate = $.39
Also assume that a U.S. exporter denominates its New Zealand exports in NZ$ and
expects to receive NZ$600,000 in 1 year. You are a consultant for this firm.
Using the information above, what will be the approximate value of these exports in 1
year in U.S. dollars given that the firm executes a money market hedge?
A) $238,584.
B) $240,000.
C) $234,000.
D) $236,127.
ANSWER: D
SOLUTION:
1. Borrow NZ$545,455 (NZ$600,000/1.1) = NZ$545,455.
2. Convert NZ$545,455 to $212,727 (at $.39 per NZ$).
3. Invest $212,727 to accumulate $236,127 ($212,727 × 1.11) = $236,127.
5. An example of cross-hedging is:
A) find two currencies that are highly positively correlated; match the payables of the
one currency to the receivables of the other currency.
B) use the forward market to sell forward whatever currencies you will receive.
C) use the forward market to buy forward whatever currencies you will receive.
D) use the forward market to sell forward or buy forward whatever currencies you will
receive.
ANSWER: A
6. Which of the following reflects a hedge of net receivables in British pounds by a U.S.
firm?
A) purchase a currency put option in British pounds.
B) sell pounds forward.
, C) borrow U.S. dollars, convert them to pounds, and invest them in a British pound
deposit.
D) purchase a current put option in British pounds OR sell pounds forward
ANSWER: D
7. Which of the following reflects a hedge of net payables on British pounds by a U.S.
firm?
A) purchase a currency put option in British pounds.
B) sell pounds forward.
C) sell a currency call option in British pounds.
D) borrow U.S. dollars, convert them to pounds, and invest them in a British pound
deposit.
E) purchase a currency put option in British pounds OR sell pounds forward
ANSWER: D
8. If Lazer Co. desired to lock in the maximum it would have to pay for its net payables
in euros but wanted to be able to capitalize if the euro depreciates substantially against
the dollar by the time payment is to be made, the most appropriate hedge would be:
A) a money market hedge.
B) purchasing euro put options.
C) a forward purchase of euros.
D) purchasing euro call options.
E) selling euro call options.
ANSWER: D
9. If a Salerno Inc. desired to lock in a minimum rate at which it could sell its net
receivables in Japanese yen but wanted to be able to capitalize if the yen appreciates
substantially against the dollar by the time payment arrives, the most appropriate
hedge would be:
A) a money market hedge.
B) a forward sale of yen.
C) purchasing yen call options.
D) purchasing yen put options.
E) selling yen put options.
ANSWER: D
10. The real cost of hedging payables with a forward contract equals:
A) the nominal cost of hedging minus the nominal cost of not hedging.
B) the nominal cost of not hedging minus the nominal cost of hedging.
C) the nominal cost of hedging divided by the nominal cost of not hedging.
D) the nominal cost of not hedging divided by the nominal cost of hedging.
, ANSWER: A
11. From the perspective that Detroit Co. has payables in Mexican pesos and receivables
in Canadian dollars, hedging the payables would be most desirable if the expected
real cost of hedging payables is _______, and hedging the receivables would be most
desirable if the expected real cost of hedging receivables is _______.
A) negative; positive
B) zero; positive
C) zero; zero
D) positive; negative
E) negative; negative
ANSWER: E
12. Use the following information to calculate the dollar cost of using a money market
hedge to hedge 200,000 pounds of payables due in 180 days. Assume the firm has
no excess cash. Assume the spot rate of the pound is $2.02 and the 180-day forward
rate is $2.00. The British interest rate is 5%, and the U.S. interest rate is 4% over the
180-day period.
A) $391,210.
B) $396,190.
C) $388,210.
D) $384,761.
E) none of these.
ANSWER: E
SOLUTION:
1. Need to invest £190,476 (£200,000/1.05) = £190,476.
2. Need to exchange $384,762 to obtain the £190,476 (£190,476 × $2.02) =
$384,762.
3. At the end of 180 days, need $400,152 to repay loan ($384,762 × 1.04) =
$400,152.
13. Assume that Cooper Co. will not use its cash balances in a money market hedge.
When deciding between a forward hedge and a money market hedge, it _______
determine which hedge is preferable before implementing the hedge. It _______
determine whether either hedge will outperform an unhedged strategy before
implementing the hedge.
A) can; can
B) can; cannot
C) cannot; can
D) cannot; cannot
Managing Transaction Exposure
1. Assume zero transaction costs. If the 90-day forward rate of the euro is an accurate
estimate of the spot rate 90 days from now, then the real cost of hedging payables will
be:
A) positive.
B) negative.
C) positive if the forward rate exhibits a premium, and negative if the forward rate
exhibits a discount.
D) zero.
ANSWER: D
2. Assume zero transaction costs. If the 180-day forward rate is an accurate estimate of
the spot rate 180 days from now, then the real cost of hedging receivables will be:
A) positive.
B) negative.
C) positive if the forward rate exhibits a premium, and negative if the forward rate
exhibits a discount.
D) zero.
ANSWER: D
3. Assume the following information:
U.S. deposit rate for 1 year = 11%
U.S. borrowing rate for 1 year = 12%
Swiss deposit rate for 1 year = 8%
Swiss borrowing rate for 1 year = 10%
Swiss forward rate for 1 year = $.40
Swiss franc spot rate = $.39
Also assume that a U.S. exporter denominates its Swiss exports in Swiss francs and
expects to receive SF600,000 in 1 year.
Using the information above, what will be the approximate value of these exports in 1
year in U.S. dollars given that the firm executes a forward hedge?
A) $234,000.
B) $238,584.
C) $240,000.
D) $236,127.
, ANSWER: C
SOLUTION: SF600,000 × $.40 = $240,000
4. Assume the following information:
U.S. deposit rate for 1 year = 11%
U.S. borrowing rate for 1 year = 12%
New Zealand deposit rate for 1 year = 8%
New Zealand borrowing rate for 1 year = 10%
New Zealand dollar forward rate for 1 year = $.40
New Zealand dollar spot rate = $.39
Also assume that a U.S. exporter denominates its New Zealand exports in NZ$ and
expects to receive NZ$600,000 in 1 year. You are a consultant for this firm.
Using the information above, what will be the approximate value of these exports in 1
year in U.S. dollars given that the firm executes a money market hedge?
A) $238,584.
B) $240,000.
C) $234,000.
D) $236,127.
ANSWER: D
SOLUTION:
1. Borrow NZ$545,455 (NZ$600,000/1.1) = NZ$545,455.
2. Convert NZ$545,455 to $212,727 (at $.39 per NZ$).
3. Invest $212,727 to accumulate $236,127 ($212,727 × 1.11) = $236,127.
5. An example of cross-hedging is:
A) find two currencies that are highly positively correlated; match the payables of the
one currency to the receivables of the other currency.
B) use the forward market to sell forward whatever currencies you will receive.
C) use the forward market to buy forward whatever currencies you will receive.
D) use the forward market to sell forward or buy forward whatever currencies you will
receive.
ANSWER: A
6. Which of the following reflects a hedge of net receivables in British pounds by a U.S.
firm?
A) purchase a currency put option in British pounds.
B) sell pounds forward.
, C) borrow U.S. dollars, convert them to pounds, and invest them in a British pound
deposit.
D) purchase a current put option in British pounds OR sell pounds forward
ANSWER: D
7. Which of the following reflects a hedge of net payables on British pounds by a U.S.
firm?
A) purchase a currency put option in British pounds.
B) sell pounds forward.
C) sell a currency call option in British pounds.
D) borrow U.S. dollars, convert them to pounds, and invest them in a British pound
deposit.
E) purchase a currency put option in British pounds OR sell pounds forward
ANSWER: D
8. If Lazer Co. desired to lock in the maximum it would have to pay for its net payables
in euros but wanted to be able to capitalize if the euro depreciates substantially against
the dollar by the time payment is to be made, the most appropriate hedge would be:
A) a money market hedge.
B) purchasing euro put options.
C) a forward purchase of euros.
D) purchasing euro call options.
E) selling euro call options.
ANSWER: D
9. If a Salerno Inc. desired to lock in a minimum rate at which it could sell its net
receivables in Japanese yen but wanted to be able to capitalize if the yen appreciates
substantially against the dollar by the time payment arrives, the most appropriate
hedge would be:
A) a money market hedge.
B) a forward sale of yen.
C) purchasing yen call options.
D) purchasing yen put options.
E) selling yen put options.
ANSWER: D
10. The real cost of hedging payables with a forward contract equals:
A) the nominal cost of hedging minus the nominal cost of not hedging.
B) the nominal cost of not hedging minus the nominal cost of hedging.
C) the nominal cost of hedging divided by the nominal cost of not hedging.
D) the nominal cost of not hedging divided by the nominal cost of hedging.
, ANSWER: A
11. From the perspective that Detroit Co. has payables in Mexican pesos and receivables
in Canadian dollars, hedging the payables would be most desirable if the expected
real cost of hedging payables is _______, and hedging the receivables would be most
desirable if the expected real cost of hedging receivables is _______.
A) negative; positive
B) zero; positive
C) zero; zero
D) positive; negative
E) negative; negative
ANSWER: E
12. Use the following information to calculate the dollar cost of using a money market
hedge to hedge 200,000 pounds of payables due in 180 days. Assume the firm has
no excess cash. Assume the spot rate of the pound is $2.02 and the 180-day forward
rate is $2.00. The British interest rate is 5%, and the U.S. interest rate is 4% over the
180-day period.
A) $391,210.
B) $396,190.
C) $388,210.
D) $384,761.
E) none of these.
ANSWER: E
SOLUTION:
1. Need to invest £190,476 (£200,000/1.05) = £190,476.
2. Need to exchange $384,762 to obtain the £190,476 (£190,476 × $2.02) =
$384,762.
3. At the end of 180 days, need $400,152 to repay loan ($384,762 × 1.04) =
$400,152.
13. Assume that Cooper Co. will not use its cash balances in a money market hedge.
When deciding between a forward hedge and a money market hedge, it _______
determine which hedge is preferable before implementing the hedge. It _______
determine whether either hedge will outperform an unhedged strategy before
implementing the hedge.
A) can; can
B) can; cannot
C) cannot; can
D) cannot; cannot
