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Chapter 07 - Currency Exposure Management

Chapter 07
Currency Exposure Management

Multiple Choice Questions

1. The first step for a manager in dealing with the currency exposure of an MNC is to:
A. determine whether the estimated level of currency risk warrants mitigations efforts.
B. determine what strategies to use to reduce or eliminate currency risks.
C. decide whether currency risks arise from transaction or operating exposures.
D. analyze the options that are available to the firm and estimate the cost of pursuing each
option.

2. Using derivatives such as forwards, options and money markets to control currency
exposure is called:
A. swapping.
B. gambling.
C. debt contracting.
D. hedging.

3. In the context of corporate finance, activities undertaken to reduce the variance of cash
flow is called:
A. MNC management.
B. risk management.
C. hedging.
D. netting.

4. When a firm reduces its currency risk, it can better concentrate on its strategic plan and:
A. minimize its interest costs.
B. improve efficiency in operations.
C. maximize the use of tax shelters.
D. capture a larger share of its markets.

7-1
Chapter 07 - Currency Exposure Management

5. MNC's often use derivatives to control:

A. currency exposure.
B. management compensation.
C. operating exposure.
D. hedging.

6. Hedging to address mitigation of transaction exposure primarily focuses on:

A. risk management.
B. payables and receivables.
C. research and development costs.
D. taxable income.

7. In mitigating operating exposure, ____________ are more relevant than ______________.

A. standard deviation; market inefficiencies
B. debt contracting; customer and supplier concerns
C. hedging; operating strategies
D. operating strategies; hedging

8. Studies have shown that investment opportunities in many industries are negatively
correlated with industry cash flow. This means that:
A. firms that can maintain their cash flow when other firms in the industry are experiencing
declining cash flow can take advantage of opportunities that other firms cannot pursue.
B. firms within a particular industry are destined to experience the same cash flow declines
and increases as other firms in their industry experience.
C. investment opportunities within an industry increase when cash flow within the industry
increases.
D. hedging is not a benefit to a firm if the general trend of cash flow within that industry is
declining.

7-2
Chapter 07 - Currency Exposure Management

9. Firms can minimize income taxes by generating level taxable income from year to year
because:
A. large swings in taxable income attract the attention of taxing officials and can trigger tax
audits.
B. level taxable income from year to year makes computing income tax liability easier each
year.
C. tax rates and tax laws change often and consistent levels taxable income usually mean that
the effect of those changes on tax liability will be minimized.
D. income tax schemes are usually progressive and tax shields are only useful when a firm has
taxable income.

10. A progressive income tax scheme means:

A. marginal income tax rates increase as taxable income increases.
B. marginal income tax rates decrease as taxable income increases.
C. income tax revenues are used for more productive purposes as tax revenues increase.
D. firms can receive rebates of taxes paid after tax revenues reach prescribed levels.

11. If a firm cannot use available tax shields in the year those tax shields are available, what
happens to the benefits of those tax shields?
A. The benefits are not lost or reduced because they can be used to offset or reduce future
taxable income.
B. The benefits of the tax shields are always lost and cannot be taken advantage of in future
years.
C. The benefits are allocated to other firms in the industry.
D. The benefits provided by the tax shields are either lost because the tax shield benefits
expire or are reduced because the benefits are taken in later years.

12. Examples of tax shields available to firms include:

A. interest income and investment income.
B. hedging expenses and tax-free income.
C. depreciation and interest paid.
D. bond issuance expenses and dividends paid.

7-3
Chapter 07 - Currency Exposure Management

13. Managers who receive stock options in their firms as part of their compensation may be
most interested in:
A. level income in their firms because level income is an indication of stability and stability
leads to higher stock prices.
B. income volatility in their firms because income volatility can lead to stock price volatility
which can allow the exercise of stock options at times advantageous to the managers.
C. increasing income in their firms because increasing income leads to higher stock prices and
an increasing value of their investment in the firm.
D. decreasing income in their firms because decreasing income leads to lower stock prices
which gives the holders of stock options an opportunity to exercise those options at
advantageous stock price levels.

14. Agency theory in firms suggests that:

A. owners of firms want to pursue risk-adverse policies to stabilize the firm's cash flow and
increase the value of their ownership interests.
B. managers who hold stock in their firms will not pursue hedging opportunities because
hedging minimizes risk and managers want higher earnings so that their compensation will
increase.
C. managers who hold stock in their firms will pursue risk-adverse policies to reduce
volatility of the firm's cash flow.
D. owners will want to pursue hedging strategies to safeguard the values of their investments
in the firm.

15. Customers of a firm:

A. want income volatility for the firm because high income will allow the firm to spend more
on innovation and improve the products that customers obtain from the firm.
B. want income volatility for the firm so that the customers can negotiate better deals with the
firm.
C. are generally not concerned with the income stability or volatility of the firm.
D. want income stability for the firm so that they can be assured of a reliable supply of
products from the firm.

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Chapter 07 - Currency Exposure Management

16. A reason for a firm to engage in hedging that does not arise within the firm is:
A. market inefficiencies that provide profitable opportunities through hedging.
B. regulatory requirements that favor firms that hedge against various exposures.
C. the possibility that currency fluctuations may affect future obligations of the firm.
D. that hedging may make the firm less attractive to another firm that is considering a hostile
takeover of the firm.

17. The facts that individual currency standard deviation is usually 5% to 15 % and that the
standard deviation for other commodities used by a firm is usually much larger indicates that:
A. currency risks are the most important risk that any firm faces.
B. risks exist no matter what a firm does and efforts to reduce risks are generally ineffective.
C. currency risks are not as important to a firm as commodity price risks.
D. standard deviation is not a proper measure of risks faced by a firm.

18. Studies have shown that firms in industries producing primary products:
A. hedge more than firms in other industries.
B. hedge while firms in most other industries do not hedge very often.
C. hedge much less than firms in other industries.
D. hedge to the same extent as firms in other industries.

19. Most MNCs:

A. are large companies but do not engage in hedging.
B. are large companies and engage in hedging.
C. are not large companies but do engage in hedging.
D. are not large companies and do not engage in hedging.

20. "On Balance Sheet Commitments" are:

A. items such as receivables that constitute a significant part of a firm's transaction exposure.
B. items such as inventory that is not involved in a firm's transaction exposure.
C. items in connection with which the firm has some liability.
D. obligations owed by a firm to another firm that depends on currency values at a particular
time.

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Chapter 07 - Currency Exposure Management

21. In the context of international corporate finance, "repatriation" refers to:

A. repayment of funds owed to creditors in foreign countries.
B. payment of funds to foreign governments as compensation for the privilege of operating in
those countries.
C. the recovery of investments made in foreign firms.
D. cash flows between parent and subsidiary corporations in the form of dividends, interest
and fees.

22. Hedging involves taking positions in derivative instruments that are ___________ a firm's
currency position.
A. the same as
B. equal to
C. opposite to
D. not related to

23. When a firm's currency position produces losses, if its hedge position is effective:
A. its derivatives will produce offsetting gains.
B. its derivative position will not be affected.
C. it can use those losses to offset taxable income from operations.
D. its on-balance sheet commitments will be reduced.

24. A short position in a currency is:

A. a contract to buy that currency at some point in the future.
B. a contract to sell that currency at some point in the future.
C. an option to buy that currency at some point in the future.
D. an option to sell that currency at some point in the future.

25. Firms select their hedging instruments based on:

A. the instruments sensitivity to the underlying currency.
B. the cost of the instruments.
C. the amount of exposure being hedged.
D. the availability of alternative choices.

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Chapter 07 - Currency Exposure Management

26. With respect to selecting hedging instruments, "matching" refers to:

A. how closely the cost of the hedging instrument relates to the amount involved in the
exposure being hedged.
B. the relationship between the firm seeking to hedge an exposure and the firm offering the
hedging instrument.
C. the relationship of the two countries whose currency is involved in the hedge.
D. how closely the currency and maturity of the hedging instrument lines up with the
exposure being hedged.

27. A symmetric hedge is a:

A. fixed hedge that locks in currency values.
B. hedge that allows a firm to gain exactly as much as it loses on the exposure being hedged.
C. flexible hedge that allows currency values to be locked only when the firm pursuing the
hedge decides to use the hedge.
D. flexible hedge that allows the currency values to change until a specified date in the future.

28. Symmetric hedges use __________________,while asymmetric hedges usually use

_____________________.
A. options; forwards and futures
B. currency swaps; options
C. forwards and futures; options
D. options; derivatives

29. When hedging economic exposures, firms often use a hedge that has a shorter term than
the activity being hedged because:
A. maturity on economic exposures are often long-term and long-term hedges are expensive
and involve more risk.
B. the firm wants the benefit of the hedge to mature before the economic exposure matures.
C. the maturity of the economic exposure is not known and the firm wants to be sure that the
hedge is not longer than the economic exposure.
D. economic exposures are notoriously overstated and the firm wants to minimize the cost of
the hedge.

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Chapter 07 - Currency Exposure Management

30. Forward hedges can eliminate cash flow variability:

A. in most cases.
B. to some extent.
C. only occasionally.
D. completely.

31. In a forward hedge, the cash flow equals:

A. the amount of the foreign currency used in the hedge times the forward rate.
B. the amount of the currency the firm usually transacts business in times the forward rate.
C. the unhedged cash flow times the forward rate.
D. the unhedged cash flow.

32. If hedging eliminates risk but results in lower cash flow than not hedging, whether a firm
hedges or not depends on:
A. the anticipated changes in the exchange rate.
B. the firm's ability to increase cash flow from other sources.
C. the firm's risk-aversion and the firm's reason for considering hedging.
D. the anticipated changes in the forward rate.

33. Because under parity the forward and the money market hedges provide identical
outcomes, money market hedges are also known as:
A. symmetrical forward hedges.
B. synthetic forward hedges.
C. matching hedges.
D. asymmetrical forward hedges.

34. A purchase or sale of a foreign currency in anticipation of a future transaction is a(n):

A. money market hedge.
B. forward hedge.
C. unhedged transaction.
D. currency hedge.

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Chapter 07 - Currency Exposure Management

35. A potentially significant difference between using a forward hedge and a money market
hedge is that the:
A. forward hedge is less risky.
B. money market hedge produces less cash flow.
C. forward hedge produces less cash flow.
D. money market hedge involves greater transaction costs.

36. The purchase of an option is also known as a:

A. call.
B. put.
C. hedge.
D. match.

37. Unlike the forward hedge, there are upfront cash flows related to the option premium,
which means that:
A. the buyer or seller must pay a fee to buy or sell an option.
B. dealing with options always results in some loss of money.
C. money must be spent to buy the option or money is received on the sale of an option.
D. option results in the elimination of cash flow variables.

38. Firms typically buy put options to hedge against:

A. payables.
B. inventory.
C. recessions.
D. receivables.

39. A call option puts a limit on cash outflow and:

A. reduces risk.
B. increases risk.
C. eliminates risk.
D. increases cash inflow.

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Chapter 07 - Currency Exposure Management

40. In dealing with options, the strike price is:

A. the price that the parties negotiate the option price when the option is exercised.
B. the set price at which the option is exercised.
C. not relevant.
D. set by the seller of the currency subject to the option.

41. A financial alternative dominates a second financial alternative, when the first alternative:
A. provides a higher cash flow for the same or lower risk compared to the second alternative.
B. costs less than the second alternative.
C. reduces the risks at all costs.
D. provides more assurance of success.

42. If the maturity of a currency position and the maturity of the hedging instrument are the
same, then:
A. all risk is eliminated.
B. cash inflows and cash outflows are offsetting.
C. maturities match.
D. hedging is not necessary.

43. Maturities of hedging instruments and the maturity of currency exposures rarely are the
same because:
A. maturities of hedging instruments are standardized and set by the exchanges where they are
traded.
B. maturities of hedging instruments are not fixed and can change as circumstances change.
C. maturities of currency exposures are not fixed and can change as circumstances change.
D. the maturity of hedging instruments is not known when the hedging instruments are
acquired.

44. In hedging, "delta" refers to:

A. the cost involved in acquiring hedging instruments.
B. the degree of risk that a particular hedging instrument addresses.
C. the difference between hedged cash flow and unhedged cash flow.
D. the sensitivity between the hedging instrument and the underlying currency.

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Chapter 07 - Currency Exposure Management

45. For a US-based MNC to rely on invoice currency to reduce transaction exposure means
that the firm:
A. will invoice its customers in terms of US dollars.
B. will invoice its customers in the home currency of each customer.
C. will increase its cost related to collection of amounts owed to it.
D. will not be concerned about the currency in which its receivables are expressed.

Essay Questions

46. Why might an MNC have a currency exposure as the result of its business transactions?

47. How significant is currency risk compared to other risks that an MNC might face?

48. Why are firm managers generally considered to be risk-adverse?

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Chapter 07 - Currency Exposure Management

49. How does hedging assist a firm in reducing its currency exposure?

50. What steps can a firm take form an operational viewpoint to mitigate the exposure that it
faces as a result of its business transactions?

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Chapter 07 - Currency Exposure Management

Chapter 07 Currency Exposure Management Answer Key

Multiple Choice Questions

1. The first step for a manager in dealing with the currency exposure of an MNC is to:
A. determine whether the estimated level of currency risk warrants mitigations efforts.
B. determine what strategies to use to reduce or eliminate currency risks.
C. decide whether currency risks arise from transaction or operating exposures.
D. analyze the options that are available to the firm and estimate the cost of pursuing each
option.

Difficulty Level: Intermediate

Section: Introductory section

2. Using derivatives such as forwards, options and money markets to control currency
exposure is called:
A. swapping.
B. gambling.
C. debt contracting.
D. hedging.

Difficulty Level: Easy

Section: Introductory section

3. In the context of corporate finance, activities undertaken to reduce the variance of cash
flow is called:
A. MNC management.
B. risk management.
C. hedging.
D. netting.

Difficulty Level: Easy

Section: 7.1

7-13
Chapter 07 - Currency Exposure Management

4. When a firm reduces its currency risk, it can better concentrate on its strategic plan and:
A. minimize its interest costs.
B. improve efficiency in operations.
C. maximize the use of tax shelters.
D. capture a larger share of its markets.

Difficulty Level: Intermediate

Section: 7.1

5. MNC's often use derivatives to control:

A. currency exposure.
B. management compensation.
C. operating exposure.
D. hedging.

Difficulty Level: Easy

Section: 7.1

6. Hedging to address mitigation of transaction exposure primarily focuses on:

A. risk management.
B. payables and receivables.
C. research and development costs.
D. taxable income.

Difficulty Level: Intermediate

Section: 7.1.1

7. In mitigating operating exposure, ____________ are more relevant than ______________.

A. standard deviation; market inefficiencies
B. debt contracting; customer and supplier concerns
C. hedging; operating strategies
D. operating strategies; hedging

Difficulty Level: Intermediate

Section: 7.1.1

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Chapter 07 - Currency Exposure Management

8. Studies have shown that investment opportunities in many industries are negatively
correlated with industry cash flow. This means that:
A. firms that can maintain their cash flow when other firms in the industry are experiencing
declining cash flow can take advantage of opportunities that other firms cannot pursue.
B. firms within a particular industry are destined to experience the same cash flow declines
and increases as other firms in their industry experience.
C. investment opportunities within an industry increase when cash flow within the industry
increases.
D. hedging is not a benefit to a firm if the general trend of cash flow within that industry is
declining.

Difficulty Level: Difficult

Section: 7.1.1

9. Firms can minimize income taxes by generating level taxable income from year to year
because:
A. large swings in taxable income attract the attention of taxing officials and can trigger tax
audits.
B. level taxable income from year to year makes computing income tax liability easier each
year.
C. tax rates and tax laws change often and consistent levels taxable income usually mean that
the effect of those changes on tax liability will be minimized.
D. income tax schemes are usually progressive and tax shields are only useful when a firm has
taxable income.

Difficulty Level: Intermediate

Section: 7.1.2

10. A progressive income tax scheme means:

A. marginal income tax rates increase as taxable income increases.
B. marginal income tax rates decrease as taxable income increases.
C. income tax revenues are used for more productive purposes as tax revenues increase.
D. firms can receive rebates of taxes paid after tax revenues reach prescribed levels.

Difficulty Level: Easy

Section: 7.1.2

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Chapter 07 - Currency Exposure Management

11. If a firm cannot use available tax shields in the year those tax shields are available, what
happens to the benefits of those tax shields?
A. The benefits are not lost or reduced because they can be used to offset or reduce future
taxable income.
B. The benefits of the tax shields are always lost and cannot be taken advantage of in future
years.
C. The benefits are allocated to other firms in the industry.
D. The benefits provided by the tax shields are either lost because the tax shield benefits
expire or are reduced because the benefits are taken in later years.

Difficulty Level: Difficult

Section: 7.1.2

12. Examples of tax shields available to firms include:

A. interest income and investment income.
B. hedging expenses and tax-free income.
C. depreciation and interest paid.
D. bond issuance expenses and dividends paid.

Difficulty Level: Intermediate

Section: 7.1.2

13. Managers who receive stock options in their firms as part of their compensation may be
most interested in:
A. level income in their firms because level income is an indication of stability and stability
leads to higher stock prices.
B. income volatility in their firms because income volatility can lead to stock price volatility
which can allow the exercise of stock options at times advantageous to the managers.
C. increasing income in their firms because increasing income leads to higher stock prices and
an increasing value of their investment in the firm.
D. decreasing income in their firms because decreasing income leads to lower stock prices
which gives the holders of stock options an opportunity to exercise those options at
advantageous stock price levels.

Difficulty Level: Difficult

Section: 7.1.3

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Chapter 07 - Currency Exposure Management

14. Agency theory in firms suggests that:

A. owners of firms want to pursue risk-adverse policies to stabilize the firm's cash flow and
increase the value of their ownership interests.
B. managers who hold stock in their firms will not pursue hedging opportunities because
hedging minimizes risk and managers want higher earnings so that their compensation will
increase.
C. managers who hold stock in their firms will pursue risk-adverse policies to reduce
volatility of the firm's cash flow.
D. owners will want to pursue hedging strategies to safeguard the values of their investments
in the firm.

Difficulty Level: Intermediate

Section: 7.1.3

15. Customers of a firm:

A. want income volatility for the firm because high income will allow the firm to spend more
on innovation and improve the products that customers obtain from the firm.
B. want income volatility for the firm so that the customers can negotiate better deals with the
firm.
C. are generally not concerned with the income stability or volatility of the firm.
D. want income stability for the firm so that they can be assured of a reliable supply of
products from the firm.

Difficulty Level: Intermediate

Section: 7.1.3

16. A reason for a firm to engage in hedging that does not arise within the firm is:
A. market inefficiencies that provide profitable opportunities through hedging.
B. regulatory requirements that favor firms that hedge against various exposures.
C. the possibility that currency fluctuations may affect future obligations of the firm.
D. that hedging may make the firm less attractive to another firm that is considering a hostile
takeover of the firm.

Difficulty Level: Intermediate

Section: 7.1.3

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Chapter 07 - Currency Exposure Management

17. The facts that individual currency standard deviation is usually 5% to 15 % and that the
standard deviation for other commodities used by a firm is usually much larger indicates that:
A. currency risks are the most important risk that any firm faces.
B. risks exist no matter what a firm does and efforts to reduce risks are generally ineffective.
C. currency risks are not as important to a firm as commodity price risks.
D. standard deviation is not a proper measure of risks faced by a firm.

Difficulty Level: Difficult

Section: 7.1.4

18. Studies have shown that firms in industries producing primary products:
A. hedge more than firms in other industries.
B. hedge while firms in most other industries do not hedge very often.
C. hedge much less than firms in other industries.
D. hedge to the same extent as firms in other industries.

Difficulty Level: Easy

Section: 7.2.1

19. Most MNCs:

A. are large companies but do not engage in hedging.
B. are large companies and engage in hedging.
C. are not large companies but do engage in hedging.
D. are not large companies and do not engage in hedging.

Difficulty Level: Easy

Section: 7.2.1

20. "On Balance Sheet Commitments" are:

A. items such as receivables that constitute a significant part of a firm's transaction exposure.
B. items such as inventory that is not involved in a firm's transaction exposure.
C. items in connection with which the firm has some liability.
D. obligations owed by a firm to another firm that depends on currency values at a particular
time.

Difficulty Level: Intermediate

Section: 7.2.2

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Chapter 07 - Currency Exposure Management

21. In the context of international corporate finance, "repatriation" refers to:

A. repayment of funds owed to creditors in foreign countries.
B. payment of funds to foreign governments as compensation for the privilege of operating in
those countries.
C. the recovery of investments made in foreign firms.
D. cash flows between parent and subsidiary corporations in the form of dividends, interest
and fees.

Difficulty Level: Easy

Section: 7.2.2

22. Hedging involves taking positions in derivative instruments that are ___________ a firm's
currency position.
A. the same as
B. equal to
C. opposite to
D. not related to

Difficulty Level: Easy

Section: 7.3

23. When a firm's currency position produces losses, if its hedge position is effective:
A. its derivatives will produce offsetting gains.
B. its derivative position will not be affected.
C. it can use those losses to offset taxable income from operations.
D. its on-balance sheet commitments will be reduced.

Difficulty Level: Easy

Section: 7.3

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Chapter 07 - Currency Exposure Management

24. A short position in a currency is:

A. a contract to buy that currency at some point in the future.
B. a contract to sell that currency at some point in the future.
C. an option to buy that currency at some point in the future.
D. an option to sell that currency at some point in the future.

Difficulty Level: Easy

Section: 7.3

25. Firms select their hedging instruments based on:

A. the instruments sensitivity to the underlying currency.
B. the cost of the instruments.
C. the amount of exposure being hedged.
D. the availability of alternative choices.

Difficulty Level: Intermediate

Section: 7.3.1

26. With respect to selecting hedging instruments, "matching" refers to:

A. how closely the cost of the hedging instrument relates to the amount involved in the
exposure being hedged.
B. the relationship between the firm seeking to hedge an exposure and the firm offering the
hedging instrument.
C. the relationship of the two countries whose currency is involved in the hedge.
D. how closely the currency and maturity of the hedging instrument lines up with the
exposure being hedged.

Difficulty Level: Easy

Section: 7.3.1

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Chapter 07 - Currency Exposure Management

27. A symmetric hedge is a:

A. fixed hedge that locks in currency values.
B. hedge that allows a firm to gain exactly as much as it loses on the exposure being hedged.
C. flexible hedge that allows currency values to be locked only when the firm pursuing the
hedge decides to use the hedge.
D. flexible hedge that allows the currency values to change until a specified date in the future.

Difficulty Level: Easy

Section: 7.3.1

28. Symmetric hedges use __________________,while asymmetric hedges usually use

_____________________.
A. options; forwards and futures
B. currency swaps; options
C. forwards and futures; options
D. options; derivatives

Difficulty Level: Intermediate

Section: 7.3.1

29. When hedging economic exposures, firms often use a hedge that has a shorter term than
the activity being hedged because:
A. maturity on economic exposures are often long-term and long-term hedges are expensive
and involve more risk.
B. the firm wants the benefit of the hedge to mature before the economic exposure matures.
C. the maturity of the economic exposure is not known and the firm wants to be sure that the
hedge is not longer than the economic exposure.
D. economic exposures are notoriously overstated and the firm wants to minimize the cost of
the hedge.

Difficulty Level: Difficult

Section: 7.3.1

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Chapter 07 - Currency Exposure Management

30. Forward hedges can eliminate cash flow variability:

A. in most cases.
B. to some extent.
C. only occasionally.
D. completely.

Difficulty Level: Easy

Section: 7.3.2

31. In a forward hedge, the cash flow equals:

A. the amount of the foreign currency used in the hedge times the forward rate.
B. the amount of the currency the firm usually transacts business in times the forward rate.
C. the unhedged cash flow times the forward rate.
D. the unhedged cash flow.

Difficulty Level: Easy

Section: 7.3.2

32. If hedging eliminates risk but results in lower cash flow than not hedging, whether a firm
hedges or not depends on:
A. the anticipated changes in the exchange rate.
B. the firm's ability to increase cash flow from other sources.
C. the firm's risk-aversion and the firm's reason for considering hedging.
D. the anticipated changes in the forward rate.

Difficulty Level: Intermediate

Section: 7.3.2

33. Because under parity the forward and the money market hedges provide identical
outcomes, money market hedges are also known as:
A. symmetrical forward hedges.
B. synthetic forward hedges.
C. matching hedges.
D. asymmetrical forward hedges.

Difficulty Level: Intermediate

Section: 7.3.3

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Chapter 07 - Currency Exposure Management

34. A purchase or sale of a foreign currency in anticipation of a future transaction is a(n):

A. money market hedge.
B. forward hedge.
C. unhedged transaction.
D. currency hedge.

Difficulty Level: Easy

Section: 7.3.2

35. A potentially significant difference between using a forward hedge and a money market
hedge is that the:
A. forward hedge is less risky.
B. money market hedge produces less cash flow.
C. forward hedge produces less cash flow.
D. money market hedge involves greater transaction costs.

Difficulty Level: Intermediate

Section: 7.3.3

36. The purchase of an option is also known as a:

A. call.
B. put.
C. hedge.
D. match.

Difficulty Level: Easy

Section: 7.3.4

37. Unlike the forward hedge, there are upfront cash flows related to the option premium,
which means that:
A. the buyer or seller must pay a fee to buy or sell an option.
B. dealing with options always results in some loss of money.
C. money must be spent to buy the option or money is received on the sale of an option.
D. option results in the elimination of cash flow variables.

Difficulty Level: Intermediate

Section: 7.3.4

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Chapter 07 - Currency Exposure Management

38. Firms typically buy put options to hedge against:

A. payables.
B. inventory.
C. recessions.
D. receivables.

Difficulty Level: Easy

Section: 7.3.4

39. A call option puts a limit on cash outflow and:

A. reduces risk.
B. increases risk.
C. eliminates risk.
D. increases cash inflow.

Difficulty Level: Intermediate

Section: 7.3.4

40. In dealing with options, the strike price is:

A. the price that the parties negotiate the option price when the option is exercised.
B. the set price at which the option is exercised.
C. not relevant.
D. set by the seller of the currency subject to the option.

Difficulty Level: Intermediate

Section: 7.3.4

41. A financial alternative dominates a second financial alternative, when the first alternative:
A. provides a higher cash flow for the same or lower risk compared to the second alternative.
B. costs less than the second alternative.
C. reduces the risks at all costs.
D. provides more assurance of success.

Difficulty Level: Intermediate

Section: 7.3.5

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42. If the maturity of a currency position and the maturity of the hedging instrument are the
same, then:
A. all risk is eliminated.
B. cash inflows and cash outflows are offsetting.
C. maturities match.
D. hedging is not necessary.

Difficulty Level: Easy

Section: 7.4

43. Maturities of hedging instruments and the maturity of currency exposures rarely are the
same because:
A. maturities of hedging instruments are standardized and set by the exchanges where they are
traded.
B. maturities of hedging instruments are not fixed and can change as circumstances change.
C. maturities of currency exposures are not fixed and can change as circumstances change.
D. the maturity of hedging instruments is not known when the hedging instruments are
acquired.

Difficulty Level: Intermediate

Section: 7.4

44. In hedging, "delta" refers to:

A. the cost involved in acquiring hedging instruments.
B. the degree of risk that a particular hedging instrument addresses.
C. the difference between hedged cash flow and unhedged cash flow.
D. the sensitivity between the hedging instrument and the underlying currency.

Difficulty Level: Intermediate

Section: 7.4

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45. For a US-based MNC to rely on invoice currency to reduce transaction exposure means
that the firm:
A. will invoice its customers in terms of US dollars.
B. will invoice its customers in the home currency of each customer.
C. will increase its cost related to collection of amounts owed to it.
D. will not be concerned about the currency in which its receivables are expressed.

Difficulty Level: Difficult

Section: 7.5.1

Essay Questions

46. Why might an MNC have a currency exposure as the result of its business transactions?

By definition, MNCs do business in countries outside of their home countries. That means
that unless the MNC specifies that it will be paid in the currency of its home country, the
MNC will receive payment for its goods or services in the currencies of the countries where it
does business. Every currency has a value when compared to every other currency, and that
value changes from time-to-time, sometimes often. When an MNC receives payment in some
currency other than the currency of its home country, it will, at some point, have to convert
that currency into it's home currency, and that conversion will take place at the exchange rate
between the two countries at the time of the exchange. Since exchange rates change, the MNC
has a currency exposure that can work in favor of the MNC or against it. If that exchange rate
has changed in such a way that the MNC receives less of its home currency than it would
have received if the conversion had taken place at a different time, then the currency exposure
has turned out to be negative.

Difficulty Level: Intermediate

Section: 7.1.3

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47. How significant is currency risk compared to other risks that an MNC might face?

MNCs face not only currency risks but also interest rate risk (the risk that interest rates may
change to the determent of the firm), commodity price risk ( the risk that the price of
commodities used by or sold by the firm may change so as to have a negative effect on the
firm), and other risks. Individual currency standard deviation is usually substantially less than
standard deviation for many commodities, indicating that there is more risk to a firm from
adverse changes in commodity prices than from adverse currency value changes. However,
currency risk may have a more significant effect on individual firms, whereas commodity
price changes will generally affect all firms in an industry in a similar manner.

Difficulty Level: Intermediate

Section: 7.1.4

48. Why are firm managers generally considered to be risk-adverse?

Many managers have significant investments in their firms, and their compensation is often
tied to the success of the firm. To the extent that managers of a firm have a significant portion
of their wealth dependent on the firm, their self-interest, as predicted by agency theory, will
lead them to adopt strategies and policies that will minimize the risk to the firm's profitability
and stability. Those strategies and policies will include efforts to reduce the volatility of the
firm's cash flow, which may involve hedging activities.

Difficulty Level: Intermediate

Section: 7.1.3

49. How does hedging assist a firm in reducing its currency exposure?

A firm's currency exposure results from transactions that are either anticipated or that will be
concluded in the future and that will require that the firm convert the cash it receives or that it
is required to pay as a result of the transaction into its home currency. Because exchange rates
of currencies change, the anticipated amount of currency involved in the transaction will have
a certain value at the current exchange rate, but that value can change, positively or
negatively, at the time that the actual conversion of the funds involved in the transaction is
made. Hedging allows the firm to take action now to minimize the fluctuation in the value of
that transaction caused by changes in the exchange rate.

Difficulty Level: Intermediate

Section: 7.3

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Chapter 07 - Currency Exposure Management

50. What steps can a firm take form an operational viewpoint to mitigate the exposure that it
faces as a result of its business transactions?

There are several things that a firm can do to address the issues of transaction exposure other
than traditional hedging. A firm that sells its products in other countries can expect to be paid
in the currency of the country where its products or sold or in the operating currency of the
purchaser of its products. The receipt of that foreign currency will require that the firm
convert the currency to its home currency at some point. To avoid the risk involved in that
conversion, the firm can specify at the time that its products are sold that payment is to be
made in the currency specified by the firm. That shifts the risk involved to the purchaser.
Firms can also attempt to coordinate their cash expenditures with their cash receipts so that
any conversion of funds that is necessary takes place in such a way that losses on conversion
of a currency to the firm's home currency are offset by gains on conversion of the firm's home
currency to another currency.

Difficulty Level: Intermediate

Section: 7.5

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