1 MEASURING AND MANAGING FOREIGN EXCHANGE EXPOSURE

2 THE REAL EXCHANGE RATE Real rates are adjusted for price changes: 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.

3 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.0 since the current assets and current liabilities cancel –b.+$200,000 –c.-$250,000 –d.-$400,000 ANSWER:d Statement of Financial Accounting Standards No. 52

4 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

5 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.high, low – b.low, low – c.low, high –d.high, high ANSWER:aoperating exposure

6 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

7 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.E 5,147 b.E 6,361 c.E 5,743 d.E 5,268 ANSWER:dcalculating economic exposure

8 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:coperating exposure

9 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:doperating exposure

10 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:cplanning for exchange rate risk

11 Which of the following products is most likely to benefit from depreciation of the dollar? –a. high-end signal processor from Hewlett- Packard 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

12 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

13 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

14 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

15 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

16 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:aDesigning a Hedging Strategy

17 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:dDesigning a Hedging Strategy

18 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:aDesigning a Hedging Strategy

19 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